Northern Trust Corporation (NASDAQ:NTRS) Q1 2023 Earnings Call Transcript

Northern Trust Corporation (NASDAQ:NTRS) Q1 2023 Earnings Call Transcript April 25, 2023

Northern Trust Corporation misses on earnings expectations. Reported EPS is $1.51 EPS, expectations were $1.52.

Operator: Good day, and welcome to the Northern Trust Corporation First Quarter 2023 Earnings Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Jennifer Childe, Director of Investor Relations. Please go ahead.

Jennifer Childe: Thank you, Cynthia. Good morning, everyone, and welcome to Northern Trust Corporation’s first quarter 2023 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 Allnut, our Controller, and Grace Higgins from our Investor Relations team. Our first quarter earnings press release and financial trends report are both available on our website at northerntrust.com. Also on our website, you will find our quarterly earnings review presentation, which we will use to guide today’s conference call. This April 25 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 May 25.

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 12 of the accompanying presentation, which will apply to our commentary on this call. 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.

Michael O’Grady: Thank you, Jennifer. Let me join in welcoming you to our first quarter 2023 earnings call. The recent disruption in the banking sector reminds us of the importance of resiliency to be able to meet the needs of clients in all operating environments. During the past six weeks, much like over the past 130 years, our strong balance sheet and conservative approach to risk management have enabled us to provide the support, liquidity and exceptional service our clients have come to expect from us. Northern Trust continues to be viewed as a source of strength and stability as symbolized by our anchor. During the quarter, we continued to assist our clients manage their liquidity, including deposits, money market funds and short-term treasuries through the transition from a period of quantitative easing and low interest rates to one of rapid tightening and higher rates.

Overall, we saw client liquidity increased during the quarter as a decline in deposits was more than offset by increases in higher yielding money market funds. Our results for the first quarter reflect sequential improvement in revenue and expense growth. The sequential growth and trust fees outpaced the slight decrease in net interest income, which still experience healthy year-over-year growth. Expense growth moderated from recent quarters, which was attributable to both our renewed spending discipline and certain timing differences. Within our wealth management business, assets under management grew mid-single digits sequentially, while our trust fees increased modestly. The turmoil in the banking space contributed to a flurry of new business activity later in the quarter.

We saw solid new account openings, particularly at the upper end of the wealth market. We took in almost $1 billion in inflows from the $50 million and over segment alone, and discussions are continuing with a solid pipeline of prospective clients. In asset management, we had a strong start to the year with a sequential increase in new business, including large inflows into our institutional money market platform. New product launches focused on alternatives and extending securities lending capabilities in our collective funds space with three new funds launched. Within asset servicing, we saw continued momentum with particularly good traction in Europe. For example, during the quarter, we transitioned in Artemis investment management, a large UK-based investment manager for whom we are providing a full suite of services, including custody, fund administration, investment operations outsourcing and risk and handling services for both their UK and Luxembourg funds.

In closing, we are well-positioned to continue to serve our clients and navigate the ongoing economic uncertainty from a position of strength. I’ll now turn the call over to Jason.

Jason Tyler: Thank you, Mike, and let me join Jennifer and Mike in welcoming you to our first quarter 2023 earnings call. Let’s dive into the financial results of the quarter starting on Page 4. This morning, we reported first quarter net income of $334.6 million, earnings per share of $1.51 and our return on average common equity was 12.4%. On a year-over-year basis, currency movements unfavorably impacted our revenue growth by approximately 100 basis points, and favorably impacted our expense growth by approximately 130 basis points. On a sequential basis, currency movements favorably impacted our revenue growth by approximately 70 basis points and unfavorably impacted our expense growth by approximately 90 basis points. Our first quarter results were also impacted by two notable items.

One, we recognized a $6.9 million pre-tax gain on the securities repositioning we announced last quarter and executed in January; two, we reported $9.8 million of pre-tax charges associated with various early lease terminations actions taken to further optimize our global real estate footprint. Notable items from previous periods are listed on the slide. Excluding the notable items in all periods, revenue was flat on a sequential quarter basis and up 1% over the prior year. Expenses were flat on a sequential quarter basis and up 6% over the prior year, reflecting an expense to trustee ratio of 120%. Pre-tax income was down 2% sequentially and down 13% over the prior year. Trust, investment and other servicing fees representing the largest component of our revenue totaled $1 billion and we’re down 9% from last year, but up 2% sequentially.

Excluding notable items, we had year-over-year and sequential declines in all other non-interest income, which is primarily driven by lower foreign exchange trading income. We saw significantly reduced volumes in the first two months of the quarter with a modest pickup in March. Net interest income on an FTE basis, which I’ll also discuss in more detail in a few moments, was $544 million, up 40% from a year ago, down 1% sequentially. Our provision for credit losses was $15 million for the first quarter, reflecting growth in the size and duration of the commercial real estate loan portfolio. Given the increased attention being placed on commercial real estate loans, we want to provide some detail we felt would be of interest. Commercial real estate loans comprise 12% of our total portfolio and commercial office loans comprise 2% of total loans.

Approximately 95% of commercial real estate loans are personally guaranteed and approximately 70% have a loan-to-value ratio of less than or equal to 70%. Turning to our asset servicing results on Page 5. Assets under custody and administration for asset servicing clients were $13 trillion at quarter-end, down 9% year-over-year, but up 4% sequentially. Asset servicing fees totaled $603 million, which were also down 9% year-over-year, but up 3% sequentially. Custody and fund administration fees, the largest component of fees in the business, were $414 million, down 9% year-over-year, but up 2% sequentially. Custody and fund administration fees decreased from prior year quarter, primarily due to unfavorable markets and unfavorable currency translation.

The increase sequentially due to favorable markets, favorable currency translation and solid new business activity, particularly later in the quarter. Transactional activity, which comprises approximately 15% of our custody and fund administration fees, was generally weaker due to lower volumes and lower one time fees. Assets under management for asset servicing clients were $962 billion, down 12% year-over-year, but up 7% sequentially. Investment management fees within asset servicing were $126 million, down 14% year-over-year, but up 2% sequentially. Investment management fees decreased from the prior year quarter primarily due to asset outflows and unfavorable markets, partially offset by lower money market fund fee waivers. Investment management fees increased sequentially due to favorable markets and favorable currency translation.

Moving to our wealth management business on Page 6. Assets under management for our wealth management clients were $368 billion at quarter-end, down 7% year-over-year, but up 5% on a sequential basis. Trust investment and other servicing fees were $461 million, down 9% compared to the prior year, but up 1% sequentially. Within both the regions and GFO the year-over-year declines were primarily driven by unfavorable market impacts and product level acid outflows partially offset by the elimination of money market fund fee waivers. Sequentially, the increase within the regions and GFO was primarily driven by favorable markets, partially offset by product level asset outflows. The upturn we saw in our AUM occurred later in the quarter was not fully reflected in our trust fees.

Importantly, we continue to see modest organic growth in our core advisory fees. Moving to Page 7 in our balance sheet and NII trends. Given the attention being placed on balance sheet trends, we also thought you might be interested in some additional data points this quarter. We think about client liquidity in three categories; deposits, money market funds, and short term treasuries. With that background, we can provide some color and data on what we saw throughout the quarter and through the first few weeks of April. Most importantly, client liquidity was up meaningfully for the quarter in both asset servicing and wealth management. And it’s continued to rise during the first three weeks of April. While we saw the kind of deposits for the quarter there was more than offset by increases in money market funds as clients continue to migrate into higher yielding products.

Relative to the fourth quarter our money market funds are up $15 billion, or 7%. As mentioned, average deposits were $112 billion down 4% sequentially with wealth management deposits down 7% and institutional down 3%. Approximately three quarters of our average deposits are institutional. Within this segment, approximately 68% are considered operational, the stickiest as clients use these funds to run their ongoing operations. Across the organization, we experienced a $2 billion decline in non-interest bearing deposits as clients shifted to higher yielding alternatives. This reduced the mix of non-interest bearing deposits to 18%. We actively manage our assets and liabilities considering a wide range of possible stress scenarios, including interest rate risks, and how they may affect liquidity and capital.

So let’s shift to the asset side of the balance sheet to see how investments are allocated. Average cash held at the Fed and other central banks was up 12% to $37 billion. And we had $67 billion of immediately available liquidity reflecting approximately 50% of average earning assets. Loan balances averaged $42 billion and were down 1% sequentially. Our own portfolio is well diversified across geographies, operating segments and loan types. Approximately 75% of the portfolio is floating and the overall duration is less than one year. Securities were down 3% sequentially reflecting the impact of both our repositioning early in the quarter, and the natural run off which we’ve chosen to reinvest at the short end of the curve. Our $49 billion investment portfolio consists largely of highly liquid U.S. Treasury, agency and sovereign wealth fund bonds.

And it’s split 50/50 between available for sale and held to maturity. In the aggregate, the securities portfolio has a duration of 2.3 years. The total balance sheet duration is 1.1 year. Net interest income was $544 million for the quarter, up 40% from the prior year and down 1% sequentially. NII reflected the impact of several dynamics many occurring late in the quarter. As mentioned, we saw continued improvement deposits from our balance sheet to money market funds and treasuries. Deposit costs increased with our interest bearing deposit beta during the quarter at 85%. And our cumulative data for the cycle as of March 31 of 65%. And finally, we have the impact from two fewer days in the quarter. Net interest margin was 1.62% in the quarter, up 57 basis points from a year ago and roughly flat with the prior quarter.

The sequential results reflect the impact of higher short term market rates offset by higher funding costs. The prior year increases primarily due to higher average interest rates. For the second quarter, our NII will continue to be driven by client demand which is less predictable than it was 90 days ago. Our average client deposits thus far in the quarter are approximately $110 billion and subsequent to tax season, we’ve observed an incremental typical decline of a few billion dollars. Turning to Page 8. As reported non-interest expenses were $1.3 billion in the first quarter, 7% higher than the prior year but 3% lower sequentially. Excluding charges in both periods is noted on the slide. Expenses in the first quarter were up 6% year-over-year, but flat sequentially.

Overall, we’re focused on reducing the rate of expense growth and controlling those costs that are most under our control. I’ll hit on just a few highlights. Compensation technology expense continued to be the areas of highest spend. Compensation expense excluding charges was up 6% compared to the prior year, and up 7% sequentially. The year-over-year growth largely reflects the annualization of last year’s headcount expansion and inflationary wage pressure, partially offset by lower incentives. The sequential increases due to our annual payment of retirement eligible equity incentives in the first quarter. Equipment software, largely reflecting our technology spend was up 20% year-over-year, but up 1% sequentially. More than 50% of our spend is comprised of business driven investment, followed by spending on core infrastructure and modernization and to a lesser extent spending on information security, risk and regulatory areas.

Turning to Page 9. Our capital ratios improved in the quarter and continue to be well above our required regulatory minimum. Our common equity tier one ratio under the standardized approach was up 50 basis points from the prior quarter to 11.3% despite resuming common stock repurchases. This reflects 430 basis point buffer above our regulatory requirements. As a reminder, as a category two institution under the Federal Reserve’s framework, we already include unrealized losses on our available for sale securities in this calculation. Thus, mark-to-market losses occur immediately in our capital and capital ratios. Our tier one leverage ratio was 7.3% up 20 basis points from the prior quarter. Higher net income, improved accumulated other comprehensive income, the securities repositioning and lower loan balances were the primary factors in this quarters increase in capital ratios.

We returned $259 million to common shareholders in the quarter through cash dividends of $159 million and after pausing meaningful share buybacks for the prior five quarters, we’ve repurchased over $100 million of common stock. And with that, Cynthia, please open the line for questions.

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Q&A Session

Operator: Thank you. And we will take our first question from Betsy Graseck with Morgan Stanley. Please go ahead.

Betsy Graseck: Hi, good morning. Really great quarter. Thanks for all the detail and the incremental information here. I did just want to understand how you’re thinking about managing the balance sheet in an environment where deposits are under pressure, even though it might be modest. I think you indicated that average deposits Q-to-date is around 110, and that’s down around 3% from last quarter, I believe. So just wanted to understand how you’re thinking about that. Thanks.

Michael O’Grady: Sure. The most important thing and you referenced it is that it’s just – it’s an uncertain environment. And although we’ve got well over $50 billion in what we refer to as economic liquidity, which is the cash we have on hand at the Fed here and central banks around the world and also the short-term securities we have, so that provides a ton of liquidity, but the environment is just uncertain. And so in some ways, we want to just maintain as much liquidity as possible and not be greedy. And on the other side, the balance sheet is always available for clients particularly from a liquidity perspective. And that means we want to leave plenty of room for clients that either want to deposit with us, or also might need lending from us. And so these uncertain times, just call for maximum patience for us and maximum flexibility, so that we can be available for whatever our clients want.

Betsy Graseck: And just as a follow-up to that, could you help us understand how you’re thinking about the loan book going forward because to the extent there is demand, it seems like you’ve got a decent amount of capacity there. Thanks.

Michael O’Grady: Sure. Yes, you’re right. There’s a – if you think about this effectively, the securities book at $50 billion acts as the ultimate fulfillment of incompletion mechanism in the balance sheet. We couldn’t do all of that with loans, but we certainly have capacity to do a lot more. But it’s always going to start from our perspective with maintaining prudent credit quality and approach. And then working, the best thing we can do is work with existing clients on existing types of loans. And so that’s why a couple of years ago, you heard us talk about an initiative to do more lending, we did that. That was very largely with existing clients. From here forward, we’re not looking to have an any initiatives to dramatically increase the loan book.

From our perspective, it’s responding to clients as they need in different categories. And – but the turmoil that we’re looking at, it does provide opportunities. If you look at the – if you look internally at the opportunities that we have, there’s a lot of opportunity. And so we have to be thoughtful about how to grow and with what clients or prospects we want to grow. But this is a period where there are opportunities out there.

Betsy Graseck: Thank you.

Michael O’Grady: Sure. Thanks, Betsy.

Operator: We will take our next question from Alex Blostein with Goldman Sachs. Please go ahead.

Michael O’Grady: Good morning, Alex.

Alex Blostein: Good morning. Thank you for the question. So I was hoping we could start with opportunities you guys are seeing in the wealth channel on the back of the dislocation in the banking space. Mike, you mentioned obviously a flurry of activity towards the end of the quarter. So maybe help us frame what that means in terms of maybe revenues. And I guess zooming out a little bit does what has been happening, and I guess continues to happen in the banking world? Does that increase your kind of organic growth prospects and to what extent in the wealth channel?

Jason Tyler: Sure, Alex. So as I did mention, there has been a lot of activity. And as we’ve talked about before, when there’s more money in motion, we do have the opportunity to grow a little bit faster. And so we did see that pickup in the first quarter after the back half of last year. We’ve talked about the fact that there was less activity as a result of the interest rate environment. That said, this is something where the nature of the clients that we serve and that we work with and that we look to bring on Board are pretty meaningful. And so it’s a longer-term process. And I would say business building process than what I would call a sales process to do that. I mentioned, some of the momentum that we saw in the upper part of the market above $50 million and the fact that we have a lot of prospects in that area as well.

So we see this more as I would say a longer running opportunity rather than a one quarter, two quarter opportunity. And that’s how we’re approaching it.

Alex Blostein: Got it. Great. And then my follow-up just around deposits and talk about this in common. Thanks again, for the extra detail. So, 110, average so far in April, and it sounds like maybe down a little bit more on the back of the tax season where things is tending now. What’s the mix, I guess, between interest bearing and non-interest bearing balances as the way you guys see right now in April? And when it comes to the wealth deposits, in particular, sounds like they were down a little bit more than institutional in the quarter. So I guess as you think about a rolling forward, what’s their approach to the rate you guys are paying on wealth deposits from here, since it seems like a lot of it is ultimately still sorting into money market funds?