Q2 2022 Northern Trust Corp Earnings Call
Speaker 2: Good day and welcome to the Northern Trust's second quarter 2022 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Jennifer Child. Please go ahead.
Speaker 3: Thank you, Kevin. Good morning, everyone, and welcome to Northern Trust Corporation's second quarter 2022 earnings conference call. Joining me on our call this morning are Mike O'Grady, our chairman and CEO , Jason Tyler, our chief financial officer, Lauren Elnut, our controller, and Mark Betty and Briar Rose from our investor relations team. Our second quarter earnings press release and financial trends report are both available on our website at northerntrust.com.
Speaker 3: Also on our website, you will find our quarterly earnings review presentation, which we will use to guide today's conference call. This July 20th call is being webcast live on NorthernTrust.com. The only authorized rebroadcast of this call is the replay that will be made available on our website through August 17th.
Speaker 3: Northern Trust disclaims any continuing accuracy of the information provided in this call after today. Please refer to our Safe Harbor statement regarding forward-looking statements on page 11 of the accompanying presentation, which will apply to our commentary on this call.
Speaker 3: During today's question and answer session, please limit your initial query to one question and one related follow-up. This will allow us to move through the queue and enable as many people as possible the opportunity to ask questions as time permits. Thank you again for joining us today. Let me turn the call over to Mike O'Grady.
Speaker 4: Thank you, Jennifer. Let me join in welcoming you to our second quarter 2022 earnings call. We generated solid results in what turned out to be a more volatile and uncertain market and macroeconomic backdrop than we've experienced in some time. New business momentum continued to be strong and our capital position remains robust. Revenue increased 12%, EPS grew 8%, and we delivered a return on average common equity of 15.7%. For more information, visit www.fema.gov
Speaker 4: Second quarter results benefited significantly from higher interest rates and the elimination of money market fee waivers related to low rates.
Speaker 4: The weaker equity and six income markets began to impact our fees and client levels. And due to the lag in our billing cycle, this impact will continue in the third quarter. We saw 7% sequential decline in average deposits. However, these were largely non-operational in nature. Our clients continue to see us as a valuable partner for the liquidity needs.
Speaker 4: Our expenses increase 9% compared to the prior year, reflecting inflationary impacts across our cross space, particularly within our compensation, and equipment and software lines.
Speaker 4: Despite this inflationary pressure, we achieved three points of positive operating leverage in the second quarter.
Speaker 4: In wealth management, we continue to see healthy levels of engagement with new and existing clients. We look within our global family office was particularly strong.
Speaker 4: In asset management, consistent positive flows into our flex shares ETF complex help to partially offset equity market headwinds and broad base liquidity outflows in our institutional channel.
Speaker 4: At 21 billion, our flexures assets under management were a 13% year over year. We also saw strong growth in our alternative offerings in the quarter. We also saw strong growth in our alternative offerings in the quarter. We also saw strong growth in our alternative offerings in the quarter.
Speaker 4: Notably, we were recognized by Asia Asset Management's 2022 Best of the Best Awards as the winner of the Best ESG Manager in Asia. Best Factor Investing Manager in APEC as well as the Best Application of ESG.
Speaker 4: Our asset servicing business continue to see positive new business momentum and the pipeline remains robust. Notable wins announced in the quarter, including Wilmington Trust and UK-based International Biotech Trust. United Department of Education and International Biotech Trust.
Speaker 4: Our integrated trading solutions capability continues to be an area of strength. We also continue to see strong interest in our Investment Data Science product suite.
Speaker 4: In closing, as we navigate these volatile and uncertain times, we remain laser-focused on serving our clients, generating profitable long-term growth, and delivering value to our stakeholders.
Speaker 4: Before turning it over to Jason to review our financial results in greater detail, I would like to note that we plan to publish our 2021 Sustainability Report in the next few days. I'm very proud of the progress we've made in our sustainability journey and serving as a force for change.
Speaker 4: Highlights for the report include our commitment to be net zero by 2050, a summary of our community support initiatives, and a launch of a more holistic business diversity program.
Speaker 4: I'll now turn the call over to Jason.
Speaker 4: Thank you, Mike. Let me join Jennifer and Mike in welcoming you to our second quarter 2022 earnings call. Let's dive into the financial results of the quarter starting on page 2. This morning we reported second quarter net income of $396.2 million. Our earnings per share were $1.86 and our return on average common equity was 15.7%.
Speaker 5: Results for the quarter included a $20.3 million our pension settlement charge within the employee benefits expense category.
Speaker 5: Also recall from last year, we implemented accounting reclassifications to certain fees at the beginning of the year, which will continue to impact the year over year comparisons as noted on this page.
Speaker 5: Our effective tax rate was 26.7%, which compared to 24.3% in the prior year and 23.8% in the prior quarter.
Speaker 5: The increase is largely related to our international earnings mix, including reserves for uncertain tax positions.
Speaker 5: We now expect our effective tax rate to be approximately 24 to 25% on a go forward basis.
Speaker 5: Let's move to page 3 and review the financial highlights of the quarter.
Speaker 5: Year over year, revenue was up 12% and expenses increased 9%. Net income was up 8%. In a sequential comparison, revenue was up 3% and expenses were up 1% while net income increased 2%.
Speaker 5: The strengthening of the U.S. dollar resulted in a reduction in our year-over-year revenue and expense growth rates of approximately 2 percent, and a reduction in the sequential growth rates of approximately 1 percent.
Speaker 5: The provision for credit losses was $4.5 million in the quarter.
Speaker 5: We're trying to average common equity with 15.7% for the quarter, up from 13.7% a year ago, and up from 14.2% in the prior quarter. We're trying to average common equity with 15.7% a year ago, up from 14.2% in the prior quarter.
Speaker 5: Let's look at the results in greater detail starting with Revenue on page 4.
Speaker 5: Trust, investment in other servicing fees, representing the largest component of our revenue, totaled $1.1 billion, and we're up 6% from last year down 2% sequentially. $1.2 billion from last year down 2% sequentially. $1.2 billion from last year down 2% sequentially. $1.2 billion from last year down 2% sequentially. $1.2 billion from last year down 2% sequentially.
Speaker 5: All other remaining non-interest income declined 2% from both the prior year and the prior quarter.
Speaker 5: And interesting come, which I'll discuss in more detail later, was $470 million and was up 37% from one year ago and up 21% sequentially.
Speaker 5: Let's look at the components of our trust and investment fees on page five.
Speaker 5: For asset servicing business, fees totaled $643 million and we're up 5% year over year and down 3% sequentially.
Speaker 5: Custody and fund administration fees were $434 million, down 5% year-over-year, and down 4% sequentially.
Speaker 5: The year over year decline is primarily driven by unfavorable currency translation, partially offset by new business.
Speaker 5: The sequential decline was driven by unfavorable currency translation as well as unfavorable markets.
Speaker 5: assets under custody and administration for asset service and clients were $12.8 trillion a quarter end down 13% year over year and down 12% sequentially.
Speaker 5: Both the year-over-year and sequential declines were primarily driven by unfavorable markets and unfavorable currency translation.
Speaker 5: Investment management fees and assets are everything of $148 million or up 47% year over year and up 1% sequentially. The year over year performance was driven primarily by lower money market mutual fund fee waivers and previously mentioned accounting reclassification partially upset by client outflows.
Speaker 5: Sequentially, the increase is primarily due to lower fee waivers, partially offset by client outflows and unfavorable markets.
Speaker 5: There were no fee waivers relating to low interest rates in the second quarter results compared to $28 million in the prior quarter and $50 million in the prior year quarter. $25 million in the prior year quarter.
Speaker 5: Assets under management for asset service and clients were $950 billion. Down 19% year over year and down 13% sequentially. Both declines are driven by unfavorable markets, buying out flows and unfavorable currency translation.
Speaker 5: Security lending fees are $22 million, up 11% year over year and up 14% sequentially as wider spreads offset the impact of lower volume.
Speaker 5: Average securities lending collateral levels were down 7% year over year and down 5% sequentially.
Speaker 5: Other cross fees.
Speaker 5: These were $39 million, up 7% compared to the prior year, and down 11% sequentially.
Speaker 5: The sequential decline is primarily driven by higher seasonal benefit payment services fees in the prior quarter.
Speaker 5: Moving to our wealth management business.
Speaker 5: Trust, investment and other servicing fees were $501 million and we're up 8% compared to the prior year and down 1% from the prior quarter.
Speaker 5: There are no fee waivers in relation to low interest rates in the current quarter compared to $23 million in the prior quarter and $29 million in the prior year quarter.
Speaker 5: within the region, the Euroyear growth was driven by lower money market mutual fund fee waivers and new business.
Speaker 5: For the sequential performance, the decline within the regions was primarily driven by unfavorable markets, partially offset by lower fee waivers.
Speaker 5: Within Global Family Office, the year-over-year growth was driven by lower fee waivers, new business, and favorable markets. The year-over-year growth was driven by lower fee waivers, and the year-over-year growth was driven by lower fee waivers, and the year-over-year growth was driven by lower fee waivers, and the year-over-year growth was driven by lower fee waivers,
Speaker 5: The sequential increases mainly related to lower fee waivers, and partially offset by unfavorable markets.
Speaker 5: Access under management for our welcome management clients were $353 billion at quarter end down 5% year over year and down 11% on a sequential basis. Access under management for our welcome management clients were $153 billion at quarter end
Speaker 5: The year-over-year decline was driven by unfavorable markets partially upset by client flows.
Speaker 5: The sequential decline was driven by unfavorable markets and client outflows.
Speaker 5: Moving to page six, and that interest income was $470 million in the quarter, and was up 37% from the prior year.
Speaker 5: earning assets averaged $140 billion in the quarter, down 1% versus the prior year.
Speaker 5: Average deposits were $129 billion and were up 1% of the prior year while loan balances averaged $41 billion.
Speaker 5: and we're up 12% compared to the prior year.
Speaker 5: On a sequential quarter basis, net interest income grew 21%.
Speaker 5: Average earning assets and average deposits both decline 7%, while average loan balances are up 3%.
Speaker 5: The net interest margin was 1.35% in the quarter, up 38 basis points from a year ago, and up 30 basis points from the prior quarter.
Speaker 5: The increases from the prior year and prior quarter were both driven primarily by higher average interest rates, the favorable balance sheet mix, and $7 million in non-recurring interest received from certain non-acrollo.
Speaker 5: Turning to page 7, expenses were $1.2 billion in the second quarter and were 9% higher than the prior year and 1% higher than the prior quarter.
Speaker 5: The current quarters expenses included a $20.3 million pension settlement charge within the employee benefits category, while the prior year quarter included a pension settlement charge of $17.6 million.
Speaker 5: Also included in the quarter is the impact of the previously mentioned accounting reclassification, which increased other operating expense by $10.4 million compared to the prior year.
Speaker 5: Excluding these impacts, expenses were up 8% versus the prior year and flat sequentially.
Speaker 5: Compensation expense was up 12% compared to the prior year and was down 3% sequentially. The year-over-year growth was primarily driven by higher salaries as well as higher cash-based incentives.
Speaker 5: The sequential decreases primarily due to the prior quarters equity incentives, including $49 million in expense associated with retirement eligible staff, partially upset by higher salaries.
Speaker 5: Both a year over year and sequential comparisons benefited by favorable currency translation.
Speaker 5: Excluding the previously mentioned settlement charges, employee benefits expense was down 1% compared to the prior year and down 5% from the prior quarter.
Speaker 5: Outside services expense was $213 million and was down 2% from a year ago and flat sequentially. The year-over-year decline was primarily driven by lower third-party advisor and technical services costs partially offset by higher consulting expenses.
Speaker 5: Equipment software expense of $204 million was up 14% from one year ago and 5% sequentially.
Speaker 5: The year-over-year and sequential growth were both primarily driven by higher software costs.
Speaker 5: Due to continued investments in technology, as well as higher amortization.
Speaker 5: Occupancy expense of $51 million is down 2% from a year ago and flat sequentially.
Speaker 5: Other operating expenses of $90 million was up 33% from a year ago and up 13% sequentially.
Speaker 5: The year-over-year increase was driven by the previously mentioned accounting reclassification and higher business promotion and other miscellaneous expense partially offset by lower supplemental compensation plan expense.
Speaker 5: Just a sequential performance was primarily due to higher business promotion and staff related expats.
Speaker 5: Turning to page eight, our capillary shows remain strong, with our Common Equity Tier 1 ratio of 10.5% under the standardized approach.
Speaker 5: down from the prior quarter's 11.4%.
Speaker 5: Our Tier 1 leverage ratio is 6.7% up from 6.5% in the prior quarter.
Speaker 5: An increase in net unrealized losses on the available for sales securities portfolio was a primary factor in this quarter's decline in capital ratios.
Speaker 5: Accumulated other comprehensive income at the end of the current quarter with the loss of 1.5 billion dollars with the loss in the second quarter totaling approximately 600 million.
Speaker 5: During the quarter, we declared cast dividends of 70 cents per share, totaling $148 million to common stockholders.
Speaker 5: As announced yesterday, our Board of Directors approved an increase in our third quarter dividend to 75 cents per share.
Speaker 5: The current environment continues to demonstrate the importance of a strong capital base and liquid balance sheet to both whether the uncertain economic conditions and to support our clients' needs.
Speaker 5: We remain laser focused on providing exceptional client service while executing on our strategic priorities to grow the franchise and create long-term value to our shareholders. Thank you. I'm glad you're a share of the olders. Thank you. I'm glad you're a share of the olders. Thank you. I'm glad you're a share of the olders. Thank you.
Speaker 5: Before we open it up to questions, I'd like to take a moment to thank Mark Betty, who's transitioning from heading investor relations to his new role as DFO for our shared services group.
Speaker 5: Mark, thank you for your leadership, your partnership, and your unwavering commitment to serving our analyst and investor community over the past six years. I know I speak for all of us when I say we've learned so much from your insights and perspectives. I think we've learned so much from your insights and perspectives.
Speaker 6: So thank you. With that.
Speaker 5: Please open the line for questions.
Speaker 2: Ladies and gentlemen, if you would like to ask a question, please signal by pressing star 1 on your telephone keypad. As a reminder, please limit yourselves to one question and one follow-up to allow all participants the opportunity to signal for questions.
Speaker 2: Again, please press the power button to ask a question.
Speaker 2: And the first question today comes from Alex Blowstein of Goldman Sachs.
Speaker 7: Morning, Alex.
Speaker 4: And Jason, good morning everybody. I'd like to echo your prior comments from Mark as well. I was great working with you. Good luck, good luck in your next role. So maybe to start with the NII related questions, and I'm sure you guys didn't expect it given the theme of the quarter, you've spoken in the past about the positive outflows about a month ago. They seemed like they have continued a little bit in June , so maybe help us unpack.
Speaker 4: Sort of the sources of where you guys seeing some of the deposit outflows, the mix between interest bearing and non-interest bearing, any comments on kind of how the things are standing so far in the third quarter and any sort of broader commentary you might have around where deposit levels could ultimately drop.
Speaker 5: Sure. So I'll give you some thoughts that don't hesitate if you want us to touch on a different component of it. And first of all, just taking a longer term perspective deposits have been strong since the beginning of the pandemic, including relative to peers in the industry. So the institutional channel has declined in the last few months, but it appears that we just, we may have peaked later. Since if you go back to the beginning of the pandemic, our deposits are still up meaningfully, we started the pandemic.
Speaker 5: Let's, I want to unpack where those sub-channels came from. The first of all, more than half of that decline was in non-operational, financial deposits.
Speaker 5: And generally, that is the most rate-sensitive channel by far. It's also the fastest declining category for us. It was down over 11 percent.
Speaker 5: The second fastest category of decline was actually other non-operational deposits, which declined about 5%. And so if you focus on the wealth channel and the institutional deposits that are operational, the decline was just 3%. And another dynamic to think about is that. And another dynamic to think about is that.
Speaker 5: Within that period, we had tax payments. And so you'd expect some decline alone just coming from that. So I think that just highlights the focus on the fact that the vast majority of the decline has come in non-operational. And then I think you wanted to get a sense of where we are in the quarter, even at this point, deposits have been down from the average of second quarter, but they seem to be leveling off.
Speaker 5: The decline that we saw in second quarter was actually largely just in the month of May, and since then deposits have stabilized about $120 billion. The decline that we saw in second quarter was actually just in the month of May, and since then deposits have stabilized the decline that we saw in second quarter
Speaker 5: That's a lot, but I'll stop there, but that should hopefully give you a good sense of how deposits have been trending.
Speaker 4: Great and is it fair to assume that the outflows that you guys have seen OBS smaller athletes so far in the third quarter are also non operational and is there a way to frame Where you guys think the total size of non operational deposits kind of bucket is and how much of that could ultimately still leave?
Speaker 8: im out.
Speaker 5: I'll answer the first, which is just what we've seen so far this quarter, 85% of that has been nonoperational. So there's strong continuing of that theme that those deposits are nonoperational. We haven't talked externally about the mix of operational and nonoperational deposits. And so we can think about that and whether in future quarters we'd want to do it unless
Speaker 5: But I think that's a lot for you guys to be able to work from at this point. And this is Mark and as a reminder.
Speaker 5: the non-operational deposits wouldn't all be at risk. I mean, we had plenty of them before the pandemic. And so, but that is where we've seen the flows, the movement so far.
Speaker 9: Gotcha, thanks, I'll help back in the queue.
Thanks, Alex.
You can go to Stephen Chuback of Wolf Research.
Bit high. Good morning!
I wanted to start off with a question on the NIM outlook. Just looking at last rate cycle, your NIM peaked somewhere in the low 160s. I saw a nice uplift this quarter, and with loans composing a similar percentage of the balance sheet today versus last cycle, you have the benefit of higher terminal-fed funds, higher non-U.S. rates contributing as well. Is it reasonable to expect higher NIMs this cycle? Any way you could help us frame how you think about peak NIM potential.
given some of those tailwinds? Sure. So one, you're absolutely right. You go back to mid 2019, even if you look inside 2019, we were over 160 in the middle of that year. And you're highlighting the right things to look on mix. There's no reason we shouldn't achieve or frankly, surpass that level. The only caveat would be if you shot saw a very significant change in the yield curve, but we're not anticipating that. So no reason why we
give you just so you can work the models better. For second quarter, betas are right at 25 percent. And as we're looking into third quarter, the betas could be twice that. But...
not a hundred percent and so we're still seeing attractive increase and so I'm glad you asked about that because we've hit on deposit levels and then NIM and so we're trying to give you both volumes and betas so
that at least gives you the building blocks to work from as you're thinking about modeling and II going forward.
Thanks for that, Collier Jason. And just for my follow-up on capital, you've noted in the past that you've wanted to run with capital levels that are consistent with your G-SIB peers, despite the lower reg requirements. And given some of the AOCI volatility that we've seen, as well as the strong loan growth, which has certainly consumed some capital of late, was hoping you could provide some updated thoughts on how you're thinking about target CET1, whether that 10 to 11 percent range is something you're comfortable running at.
and just how it informs your appetite to potentially accelerate bybacks, especially if other categories like lending potentially begin to slow in a rising rate backdrop.
You're right in that we, just competitively, we like to have a strong position relative to the G-SIP peers. And it's when we're, I always say, when clients are depositing $100,000, they, those deposits are insured usually by the FDIC. When they're depositing $100 million or a billion, they're effectively lending money to us. And we want to reflect that our balance sheet is strong. And so we look at that closely.
We look at the CT-1 is important when you highlight it, but also the leverage ratio. And so looking at those in conjunction, we look good on a relative basis, and obviously plenty of room relative to any regulatory limits, but we'll continue to look at where things are competitively. And we'll also continue to look at what opportunities we have in the returns on buyback versus what opportunities we're seeing, the long growth we had.
We were very deliberate in looking at what the returns on that growth are. And we also talked about the spikiness of loan volume and other activity. The even right now, currency markets moving aggressively has an impact on FX positions, which has an impact on what our RWA looks like. So all these things come into play. But in general, we feel good about the capital levels, but you've got to...
but we know what's coming with the lag deposit pricing on lower fees. So I wonder if you could give us any thoughts on expenses on a go forward basis. I know on any given quarter, you'll have ups and downs, but just your thoughts on the jumping off point for expenses and then the possibility of operating leverage on the full year. I know it's moving boat right now, thanks.
Sure. Go tight, Josh.
You're right that it's hard to look in a quarter and it's in this year it's even hard to think to aggressively about operating leverage for the full year. If you think about what's happening and the influence of rates, it has a big impact on that interest income. That's coming over time. It comes over quarters. The impact on expenses is happening more quickly.
We can't get too excited about the net interest income coming, but we've got to stay focused on expenses. But let me walk through a little bit on the expense side and just give you a couple of highlights, and if you want us to drill in farther, we can. So first, and it relates to inflation, let's talk about compensation. partisanship Lem Su lot That's great.
For the quarter, just a couple of comments, and I'll give you a bullet point or two on third quarter, the base pay adjustment came into play in third quarter and fall. And that's in and of itself $20 million left quarter over quarter. It usually half that amount.
And then head count was higher and we also had some off-cycle adjustments which brought in another call at $10 million. And then a big component is...
the cash is cash-based incentive accrual. And so I think sometimes people forget as we do better, even in a category like NII, we're gonna have higher CBI accrual coming along with it. And so that's something that's really important to think about.
The second category on expenses that I'll call out is equipment and software, because that was a big, that was a $10 million left just quarter over quarter. And we mentioned it in the last conference that we were gonna have about a $5 million left in amortization alone. That's coming through. We'll have another sequential left going to third quarter.
And then the other component that we experienced in second quarter, in addition to the increase in amortization, is just software rental and support costs are higher. And some of that is inflationary. Some of it is just our consumption is higher. But we are at this point anticipating another similar rise. And so just looking into third quarter, you see a similar step up potentially from second to third quarter than what we experienced in first to second quarter.
rates over time. Can you grow NIM from here in the near term if betas are doubling? Sure, it's how to think about that in the short term.
Yeah, definitely. And the power of rates going up on where we are and if you look at just the way the balance sheet is naturally positioned and loans are high, probably 75ish percent floating and then even a big chunk of the securities portfolio re-prices within a year and then obviously the cash position is short and so...
The the asset side is significantly floating and so even if we give up
just half the increase on the deposit side, then we still have plenty of room to grow NIM and NII significantly in a rising rate environment even from here.
Awesome. Thank you for that. Appreciate it.
Awesome. Thank you for that. Appreciate it.
The next question comes from Mike Mayo of Wells Fargo Securities.
Hey, part of your NII guide, I guess higher, but you're not telling us how much higher because you tell us your sensitivity to lower stock markets, the impact and fees, but you're not giving us the NII guide.
I guess you're giving us some building blocks, but one component is mongrow, and it's up 12% year every year, and one reason some investors hold Northern Stock is because it's perceived as a safe haven during a recession. Your loan loss has tend to be a fraction of the industry. So my question to you is, what are you seeing in the mongrow, especially among your retail customers? How much appetite do you have to expand that?
Are you noticing some more competition because some of your peers are mentioning this more vocally about being a growth area and does northern experience recession if we were to have one because the clients would let's high end. Thanks.
Turn.
So a few things there on on loan growth the the rate should definitely slow Relative to what we experienced over the last two years the last two years that growth was highly initiative driven we were we had a plan to communicate more with our clients tell them that We wanted to be there more in their journey of investing more in their businesses and
And we wanted to be being a liquidity provider isn't just taking deposits, it's also loan, it's also creating loan opportunities for clients when they need it. The growth has been very largely in that type of channel. And the quality in our appetite has not changed at all. And we were extremely deliberate in saying our appetite from a credit quality perspective was not changing. And if you look at some of that,
that even the numbers are on credit quality at this point, and nothing's changed. All of the increases we had this quarter were in the inherent reserves, not specific reserves. We actually had net recoveries again, a small amount. And so all early signs are very good. And that gets into your last question, which is, do we have a recession, and do we have loan issues in a recession? We don't want to proclaim victory before something like that happens. But.
at this point all the indicators are look good and we haven't changed our appetite and what we brought on
And I'm going to ask one more really big picture question. Maybe this is for you Mike, but one concern about going into a recession is the negative wealth effect. And since you deal with the highest end customers, especially the family offices and like, what's the behavior of your customers after such?
decline in in their personal net worth. Thanks.
You're exactly right, Mike, that that portion of our client base does have different dynamics to it. And so we're coming off of a time period where as we know, not only did we see asset values increase significantly, but also, as we've talked about in previous calls, the opportunity to monetize assets if you will meaning.
sell businesses or real estate or whatever it may be, also was at a very high level. And so, you know, that dynamic clearly has changed as we've seen. So, you know, you see it in the sense of, you know, market activity as far as IPOs and things like that going down. And as much as there's still plenty of private equity, you know, capital that's out there and looking to do transactions, you know, valuations are lower and that changes their attitude about whether now's the right time to sell that business.
That said, the position that a lot of these clients are in is that they've had a high level of liquidity, and so when they see the markets go down, they are in a position to be very long-term investors, and so we see a lot of those clients actually deploying capital into the markets at this point, so investing that liquidity that they've raised in the previous phase. Thank you for watching, and have a good one now.
As you move forward from that, beyond having no idea where markets go, etc., but just to your point on the wealth effect, there's no doubt that our business benefits when the overall wealth is increasing and accumulating and markets are robust. So that is a better environment for us. We think that it's more resistant on the downside of it as well, but all the same, it's at a lower level than...
than when things are so good. So hopefully that addresses your macro question. All right, thank you.
Hopefully that addresses your macro questions. All right. Thank you. Thank you.
The next question comes from Michael Brown of KBW.
Saw it
Hello?
Good, thanks for taking my questions. So the AUCA decline was a bit greater than we were expecting this quarter and above some of your peers.
on a sequential basis. Can you just expand on some of those key drivers? I mean, you called out that you had some wins.
the interquarter, but was there any material, you know, lost business or is it truly just FX and markets that hit the AUC levels this quarter?
Mike, just a confirmed, did you say AUCA?
Correct. It's under a couple of minutes. OK. Yep.
And I can take it and add anything you'd like Mark, but nothing significant from a flow perspective to call out. So if I look at it mathematically, FX was, so currency translation was a 2.5% hit and market levels another.
eight and so the vast majority of the movement you see was in those two factors, but the core business, nothing to note from a flow perspective.
Okay, that's helpful. Thank you, Jason.
and just as a follow up.
One of your peers talked about a plan to reprise certain aspects of their servicing business and they talked about areas that are experiencing greater wage pressure and capacity constraints.
I was curious, is this a dynamic that you guys are seeing and is there any opportunities to reprise your business higher as you think about the coming quarters or year would be inflationary pressures that you and industry are experiencing? I think that you and industry are experiencing.
Why don't I take that Michael? So I would say that we tend to approach the client relationships a little bit different, I think, than differently than some of our competitors. What I mean by that is on an ongoing basis, we look to make sure that we have a balanced relationship or one that is generating value for both the client and ourselves. And there are a lot of dynamics.
to the relationships that we have with our clients, meaning that we're providing a lot of services that we're paid a fee for. There's a lot of other activity, whether it's balances or FX and things like that that we're doing that the nature of the compensation, the revenues are different. And so it's always kind of shifting. And sometimes it can go more or less to one side with particular clients. And we like to be in dialogue with them. That doesn't always.
involve a change in the fee, up or down. It can be a change in the level of activity that we're doing with them, that they do leave more balances with us or do other things. And so it's a different approach and I would say less programmatic about going out at a particular time and looking to necessarily increase fees. And as we know, just over time,
because the asset levels have gone up. That's why there is a bit more pressure on the fee side of the equation to come down over time. When you have periods like this with inflation, I think you do see less of that activity because all the players are in the same position. So a client or prospect going out to put their business out to bid, so to speak, is less likely to get aggressive bids by multiple parties.
in this type of environment than they would in others. So, I would say there's no doubt that, as you can see, we're feeling that the impact of inflation on the expense side, we get a benefit in the sense of interest rates are higher. So that's a little bit of a hedge, if you will, that's built into our financials. And then just something that we look at over longer periods of time. Okay, thanks for interesting perspectives.
So curious you guys gave a lot of color on the non-operating deposits And you know the runoff and kind of comparing that to how the operating deposits look but but I And it was clear that the deposits were under pressure, but you know the NIM looks really good this quarter so what I'm Hoping to understand and maybe you could give us a bit of a comparison
Can you help us frame what the spreads look like for non-operating deposits versus operating deposits? I think that might help when we try and frame not just what mechanically the deposits might and the balances might look like, but really how that might actually triangulate the NII.
Yep, yeah, absolutely. So one, there's a couple things at a high level and I'll dig in a little bit. So I mentioned, I think, for 75% of the loans replaced, reprise within 90 days. And even the security portfolio about a third of those are floating. And then the cash portfolio, obviously, is very short. Those are the three big categories. And you can pay $1,000.
It's interesting because in non-operational deposits, and it's why it specifically separated the financial versus the non-financial, the most extreme case of something where you have to stay liquid with the deposit is a non-operational.????
Financial Services Channel Deposit. You really can't go, you really can't invest that long. And so that just stays effectively overnight. And it largely, and there are exceptions, but largely. And that's part of the reason why, that you see our, the deposits come down. I've talked about the fact that they were largely non-operational. And that's why you saw the decline on the earning assets come largely from our cash position.
And so you can see what the yields are in the cash positions. And if you think about the cost on the non-operational deposits, again, highly rate sensitive. And in many instances, those clients are saying it's fed funds minus something. And so it's tight. Those spreads are tight. And then if you work toward...
operational deposits, those are ones that by nature, you know you're able to invest longer. And so those are, there's a component of it that you have to keep liquid, you have to maintain liquidity for, but generally that's what's gonna be represented in the longer duration of the securities portfolio. And in today's environment, those are repricing, and we're waiting anxiously for those to mature, but it just gives you a sense that those spreads...
are actually likely going to increase over time. So first of all, those clients tend to be, those are transaction accounts. They tend to be less spread sensitive, and we've got opportunity to invest them longer. And so that's why we keep emphasizing this distinction between the operational and non-operational or transactional and non-transactional because the economics underneath them are very, very different. Right, okay, that's him.
It's really important and thanks for laying that out Jason. It sounds like there's a big difference in between the economics.
I guess my follow-up would be on beta. So you talked about the beta increasing in the third quarter. Number one, that's a third quarter beta commentary, the roughly 50%, not a cumulative, right? So we would be not necessarily looking to get the whole cumulative up to 50. And then does that increase in beta also contemplate the reduction in these?
far more rate sensitive, non-operating deposits running off, and maybe how much are those non-operating, more rate sensitive deposits pressing that beta higher? Are they the largest contributor and as they continue to run off will that help to contain continued increases in beta?
Sorry, it's a multi-partner. But I, that is multi-part. But so let me, let me, a couple thoughts, but don't hesitate if I, we wanna be helpful as you guys are thinking this through. So don't hesitate to clarify anything. So let me try to work backwards. I may not get all the way to back to the beginning. Yes, to the extent that the non-operational deposits are the ones that continue to run off faster.
that insulates betas a little bit. And then secondly, as we provided some commentary on what betas look like in the third quarter, yes, that is incremental within the quarter, but that's us leaning in, in the spirit of trying to be helpful to uncertainty. We just don't, a lot of what we're doing is just trying to hold on to those deposits, those operational deposits, because we feel they're so volatile. And so we're not starting from we want our betas to be.
beta of 50 that's just a third quarter not a cumulative right
Yes, yeah. But again, that's a lot of uncertainty and what that's gonna look like. That's less factual, it's less target, and it's more just our forecasting of what we think is gonna happen based on what we think is gonna happen with the yield curve and what we think is gonna happen in the market.
And it's so the last component of the I know and apologize it was so many parts but the last component is does the 50% like is that based on the current mix of Operational non-operational, you know financial non-financial is it is it based on the current mix or as that non-operating piece winds down Does that ease the upward pressure on the beta? You know what I mean? So could allow for some better beta outcomes than you're thinking
Yeah, that 50% is overall based on what we currently see and project the mix to be.
Thanks for the tour. It will flock to appreciate the color. Yeah, sure. The next question is from Brian Badell of Deutsche Bank.
Great, Brian .
Good morning. Good morning. Thanks very much. And I also echo all my comments for Mark as well. It's been great working with you So also best of luck The I think Brendan got got my multi parts on the deposit pages as well. So move over to expenses and the only other two Categories again, Jason. Thanks so much for for the granular color there. The only other two categories I just wanted to get a comment on with
The typical seasonal lift that we see and outside services in the second half of the year, whether you think that's likely to repeat as it has in the past. And then on the other expense line, in lieu of having the golf open, I know you've wanted to reallocate those expenses to marketing initiatives. Is that also a second half event like the Northern Open was where have you done those?
over the course of the year so we shouldn't see as much of a spike up. All right, so on outside, let me start on outside services. So.
Yes, there tends to be a second half lift there. We don't expect it to be that dramatic at this point. In this quarter, it was, we actually, remember, a lot of the expenses there are actually volume related and so it's related to, you got market data and other transaction related services. There's other items that are very volume related and frankly, some of it's market level related and so,
That's something to just keep in mind that can dominate the seasonality component of that line item. And so in the second quarter volumes were down slightly and that was fully offset by a little bit higher consumption level and consulting and legal. And so as we go into third quarter, we'd actually, those two dynamics are probably still at play and we'll see which ones as we get further into the quarter, which one wins out.
And then on marketing related, Mike, you want to talk about that for sure, just on the marketing Brian there. Yes, we're spending that if you will throughout the year. So there's no seasonality, major seasonality like you had with the golf tournament. And as we talked about before, it's less about one particular area and more just doing marketing within the three businesses. That's great color thanks. And then maybe Mike, if I could just,
Clearly it's a great way to retain clients given their interest in that. But the midi just also share, if you think that, and also have a revenue impact or an order in trust, even if you're not managing them, but rather having them on your shelf, so to speak.
You described it well as far as our approach there, which is we want to be able to provide the full set of alternatives for our clients and yet provide the added value if you will of certain particular funds that we can offer for them and then funds that we manage on our own or through vehicles on our own. And so within wealth management for the platform, you kind of hit on some of the areas that are of greatest interest right now, like private credit.
And then again, we've seen strong interest on the part of our clients to have that type of more diversified exposure to alternatives. And you're right, it has the benefit, you know, certainly from a return perspective for our clients, but from our perspective, it is something that has a more attractive financial profile for us and one that further cements the relationship that we have. So we expect, although there's always, you know,
Just given rising rates and the OCI, can you talk us through about where your securities portfolio duration is and what you're seeing on incremental pickups of new pickups relative to the roll-off on the back end and just how you're thinking about mixing the portfolio and protecting OCI from here? Thank you. Thank you.
Sure. So a couple thoughts. Number one.
duration overall duration is down to about 2.6 from 2.7 and then secondly just as from a reinvested perspective. Wording.
Just that fact alone indicates we've been going short. And as we, we investing, as we're re-investing maternity, that are maturing, we're leaving that powder dry effectively for the time being given a couple of dynamics. One, just the significant volatility in the markets and then secondly, anticipating higher rates. And so it very much been, been, not re-investing longer on the curve at this point.
Then what was the second part? The second part was then just related to capital and the earlier question. Just about OCI and have you been moving things from AFS to HCM? Are you rethinking at all into your prior point about changing duration, how you protect incremental AFS from here, and I guess just how would you expect the existing OCI to kind of return back into capital over time? All things related to OCI management.
Sure, couple thoughts there. One is we did move about $7 billion from AFS to HTM. And we did that post quarter close actually. And the future impact is that should be, that should protect about half of the exposure we have had on from an OCI perspective. And then in terms of return, it should be about three and a half years total for us to recall.
Hi, okay, just want to make sure you can hear me. A couple of questions, one a little nitpicky, but on the average balance sheets, I think you show what the yields are obviously by asset class. And I'm just wondering repo yields went up. It looks like a repurchase agreements went up about two percentage points Q and Q, and I wanted to make sure I understood that. Okay.
Yeah, Betsy, part of that, this is Mark. Part of that was a, there's a footnote, I think, on our reports that kind of talk about a netting change that we made. And those yields, I think it's both on the asset side and the liability side. And the yields would have been, for instance, on the asset side trying to find that line, which is reported as 231. I think it would have been, um...
around 70, I believe. But there is, so it was really driven by this kind of gross and that change both on the asset and liability side. That change both on the asset and liability side.
Okay, so any details that we can do offline. The second question is just, as we look at the 10Q analysis regarding rate sensitivity and impact of 100-bit parallel shift, versus what we got this quarter, obviously this quarter was a much bigger benefit than what the Q would suggest. And I just wanna make sure I understand the differences of what the assumptions are in the Q that we see versus, you know, what happened in the real world. We see versus, you know, what happened in the real world.
Yeah, I mean, I guess one thing I would say is in the queue...
It's a model process and it does look at the forward curve. And it's really a shock, you know, a movement away from the forward curve. So I know that I think from beginning of the quarter, the end of the quarter, there was a move from the forward curve, but probably not in the same magnitude of how it would have been, you know, modeled within the queue. And so it's a directional guide. I mean, the base case.
is not there, which is what the forecast is with the forward curve. So I don't know if that helps, Betsy. And timing matters a lot, too. I mean, we came into the quarter with some lift from where rates were prior, and then we also had mixed was another benefit of probably eight basis points alone, just by higher mix in the balance sheet. And so there are other dynamics that came into play. And frankly, back to when you're doing those.
those shock scenarios. You're making assumptions around data, you're making assumptions of a bunch of different things, but it's not in reality that she doesn't always play out that way. And the data is at 25% for us were low. And we also had movements and other currencies. And so a lot of things at play that led to the increase in them.
Okay, and then just lastly, I know at the beginning of the call you mentioned that non-operational deposit outflows look like they've stabilized.
And I guess my question is, how do you feel your non-operational deposit, depositors are behaving? In other words, we're about to get another 75 bits. We're about to get another 75 bits.
next week and do you feel that they are optimizing for you know they're over over this next six months already or do you feel like they optimize each time you know the feds moving in other words I'm wondering if we should be expecting another outflow as you know the Fed continues to jack up rates here
I think that channel of depositors disproportionately relative to others have relationships at multiple institutions and cash doesn't have a long-term commitment on it and they're able to seek yield when it's important to them. And I'm glad you asked the question because I don't want the interpretation to be that we don't want non-operational deposits. Oftentimes...
Those deposits are tied to broader relationships. Sometimes we do want those deposits for various reasons. The reason that we're highlighting the distinction is just the economics and the behavior of those deposits is very different. And as you think about where NII is going... And as you think about where NII is going...
it's important to understand and appreciate those differences. Thanks so much for the color.
and appreciate those differences. Yep. Okay. Thanks so much for the color. Thanks for that.
Our next question is from Vivek Janajja of JP Morgan.
Hi, thanks for taking my question. One is, how much benefit did you have to expenses from FX translation, Jason?
So I'm going to hear over, this is Mark, you're over your basis.
It was about 2% and out of sequential basis it was about 1%.
2 percent, and on a sequential basis it was about 1 percent. And that's for total expense.
Right, right. And most of that would show up in which lines?
Most in carbon benefits, it would be...
You know, as I look at it, probably a little in equipment and software. Yeah, equipment and software. And you're probably looking at, you know, just like our expense base, I guess, maybe two thirds of that probably being within a comprehensive benefit.
Okay, a completely different question.
Welles Management access and sorry.
Wrong one. Assets servicing assets under management fell 19% link quarter, much more than, you know, overall wealth management, AU numbers are much less. Nineteen percent seems like a lot. Any color on that seems more than what markets dropped. Sure. Yeah, that was – we had outflows in the Money Market Mutual Fund business, and so that business has grown significantly since pre-pandemic, but declined in the quarter.
from a flow perspective.
Thank you.
All right, thank you.
The next question is from Jeff Hart of Piper Sandler.
Good morning, Jeff. Hey, good morning, guys. Excuse me, one question left from me. How do you expect funding costs on non-US interest rates to move with the ECB hiking? I'm just gonna think, could we see some near-term pressure on NIM or NII's ECB goes from negative through the zero bound to something higher than 25 base at points?
Higher beta and the client, again I'm glad you brought that up.
For clients where they have potentially been in negative rates.
We're expecting data to be higher. This is clients to say we understand that we were negative, but when do we get out? And that's the one channel where we expect that to be aggressive. Mark, what would you do anything to add there? Yeah, anything I would, I was just gonna mention that the size of that, so the Euro deposits for us, it's about, it's a little bit over 5%, 6% of our total deposits. So that's just something to keep in mind from a...
order of magnitude perspective. Okay, I mean any guess to how much higher baits might be there? I guess it would be purely a guess I suppose.
Yeah, it's just super hard to tell and sometimes rates are, you know, are part of larger –
pricing and relationship considerations, but we would just expect at this point in the curve for those those betas to be quite high.
And again, it's 6% of the total, it's not.
tremendous and impact, but I don't think it's crazy to assume it again. I'm just speculating, say 75 to 100%. I don't think it changes the dynamics of the outcome significantly on NII, but it's the one I, when we say significantly higher, it's not 55 versus 50. It's more like 75, 100.
is a safer way to model it.
to model it. Okay. Okay.
Sure.
Next question is from Alex Bloestein of Goldman Sachs.
Hey guys, thanks for taking the time. Hello again. Thanks for taking the follow up. I wanted just to get your perspective, maybe top of the house view on operating leverage. And over the years, we've kind of gotten accustomed to thinking about operating expenses as a percentage of fees and obviously quarter to quarter, you know, that will move around and you guys gave some explicit guidance, I guess, for a couple of line items. So really just kind of want to zoom out and think about in an environment we're in today where the markets are a little choppier, I guess to say the least and inflation is rising.
What is the new normal for that expense to fee ratio over the next year or two? Clearly, you guys are highlighting that some of the higher NII will show up in comp with respect to a decent of base compensation. That will also pressure that expense to fee ratio. Helping just think through that is if we lived in a 1-5, we're now thinking like 110 plus and other inexpensive initiatives that you guys are starting to contemplate.
beyond 2022, it feels like the budgeting for this year has sort of left the station, but any incremental thoughts there would be helpful. Sure. Alex, it's Mike. So the way that we're thinking about it is that, as you pointed out, a number of factors on both the revenue side and on the expense side, that we wanna be in the range for a pre-tax margin of kind of that, you know,
low to mid 30s. That's the type of range that gets us at the higher end of our ROE target as well. So that's what we're shooting for. And then you're exactly right, we're also looking at that expense to trust fee ratio, which has a different set of dynamics to it and has more pressure on it when you have markets going down and inflation. But that's not a reason to say that we're not focused on trying to keep that in the range that we've been in.
So that is kind of the, you know, whether it's 105, you know, plus or minus around that. And that's where we're trying to keep it, because our view is that over time, that's a, you know, a better, more stable level, or measure of our profitability, you know, for the business. So that's where we're looking to do it. As far as, you know, looking at expenses, you know, again, I always tried to be, trying to be focused on that.
And I would say, even though you said, the train is left to station for this year, we are very much focused on getting productivity in all the businesses, but particularly in the asset servicing business. And so those initiatives were very much in place at the beginning of the year, and we're executing on those. And as we do next year, there'll be a new set of initiatives around how we get greater scale and efficiency in the company, but particularly in that business.
Great, very helpful. Thanks Mike. Cheers. The next question is from Jared Cassidy of RBC.
And your Art trudg.
I'm Mike Andreessen.
You guys may have touched on this and I apologize if you didn't, and I missed it on your call. But obviously you're talking a lot about betas with deposits with rates going higher. Have you guys been able to map out or build models to see what impact, you know, the full blown quantitative tightening will have on deposit flows at your organization? You figure they're going to reach what? 95 billion, or 95 billion a month coming up soon here. And we really haven't gone through this before. We're an uncharted territory.
$130 billion deposit base, we have clients that have $10,50,100,200, some super large institutional or even wealth or even global family office clients to be over $1 billion. So it's just very spiky and it's hard to throw a correlation out publicly at what those models spit out. I think with the one thing I'd...
I think it's instructive to think through is that a lot of our clients think about cash as an asset allocation output. And so one of the things to think about as you're predicting where even core operational transactional deposits will look like is what are overall asset levels and what are market levels because our clients...
consistently think about liquidity as an asset allocation tool and probably less affected in a predictive way by what's happening at the macro level by the Fed.
Very good, thank you. And then as a follow up, granted the market conditions are very unsettling today and a lot of disruption going on out there. But there's also probably opportunities to pick up maybe some businesses at discounted prices relative to where it was maybe a year or two years ago. And over the years has done acquisitions. So Mike, can you give us some color of, you know, allocating capital or should something come up for sale that really makes sense? Is that something you guys could consider in the next 12 to 18 months?
focus, which is growing the business organically, and then over time, if there are opportunities to accelerate that through acquisitions, then we consider it.
Great, thank you. And Mark, good luck in the next run. Good work on it. Thank you. Thanks, Charlie. Appreciate it.
the next run. Good work on it. Thank you. Thanks, charge. Appreciate it.
We can go back to the direction of JP Morgan.
Hi, thanks for taking a follow-up question.
Going back to capital, Jason, I hear your comment on, you know, you're competitively, you want to be ahead of your peers. But, you know, is there a level below which you would not, want to see your CET one go, especially given the still uncertain in the markets and involved with the end.
what do you intend to do to not let it go below that?
We've got...
A lot of different guardrails around how we think about what to do. We obviously, we have not been, you know, sharey purchases the first thing to do. Conversely, you saw us increase our dividend at this point. And so I think that tells you that we're not. And so I think that tells you that we're not.
desperately trying to increase levels from here. We feel fine. And again, we've got plenty of room from a regulatory perspective and we feel good how we look on a competitive basis. And so thank you for saying that.
And we've always said it's a combination of different factors. We have very good conversations with our board about how we want to position capital levels.
But we feel good where we are and always want at the same time take advantage of any opportunities in the market to grow the business. And sometimes that means just what we did with loans a couple of years ago. And we made a big investment there from a capital perspective in the form of higher RWA exposure. And so it's just a good example of how we're balancing different factors.
at any given point in an economic cycle. The absolute levels is an important, but it's just one of those factors. Thank you, and Mark, I was remiss. Thank you for, it was great working with you, and good luck in your mural.
Thanks for back. Appreciate it.
Thank you. Great. Welcome to Mike Mayo of Wells Fargo Securities.
I'm to Mike Mayo of Wells Fargo Securities. Hi, I'm Mike Ham.
Yeah, as we tweak our or update our earnings models, I'm just looking at page 38 of your proxy and I'm looking at your peer group and you do have a lot of banks in this peer group but the two most comparable banks seem to have tax rates that are 500 basis points below what you have. So I think you're in the range of 25% and there's other two trust banks or close to 20% or below give or take. And so the question is we always talk about pre-tax margins. What about after-tax margins? What can you do?
give you a sense of how where we are relative to others. First, you know, a high percentage of our income is from wealth management. And that's predominantly a domestic business which comes with a higher tax rate. To even within the domestic exposures, we're in Illinois, California, New York, we're in high tax states.
then a lot of our, we've got less benefits from tax credit investments. And another dynamic is we've got less income from tax exempt income and then more of a nuanced.
but important factor is there are limitations on US foreign tax credits, and that's actually increasing in our difference relative to our peers. And so those are at least a half dozen things that get to the vast majority of the reason why there's a difference. Going forward, there are things that we can look at and implement to try and get that tax rate down. And so...
We're not just resting on that as a pay to complete. We did something that we want to work on over time. We did something that we want to work on over time.
And Mike, I would say we're a global company that is headquartered in Chicago. I'm proud to be headquartered in Chicago. And like other important decisions, we look at it from a stakeholder perspective. You highlight one, which is, I'll say the tax rate, but more broadly, the financial implications of being headquartered anywhere. And that is absolutely a relevant consideration of one that we're...
you know, looking at all the time. But then you have other stakeholders that are critical to that, you know, certainly where our clients are and where we need to be to serve them. But then also, you know, equally important is all of our partners, meaning our employees. It needs to be, you know, a great place to live. And so we are very focused on, you know, not just monitoring that over time and determining if it's a great place to live, but I would say.
actively being a part of the community to address the challenges and make Chicago an even better city to live in and to have our headquarters.
Thank you. Sure. Ladies and gentlemen, I conclude today's question and answer session. I would like to turn the call back to Mark that for any additional closing remarks. Thank you.
I think we're all good, so thanks everyone for joining us to appreciate it and we'll talk to you next quarter. Congratulations Mark on a great run. Thank you. I think we're done. Thank you.
So thanks everyone for joining us, appreciate it, and we'll talk in next quarter. Congratulations Mark on a great run. Thank you Mark. Congratulations. Thanks everybody.
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