Northern Trust Management Discusses Q4 2013 Results - Earnings Call Transcript

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Northern Trust (NASDAQ:NTRS)

Q4 2013 Earnings Call

January 22, 2014 12:00 pm ET

Executives

Beverly J. Fleming - Senior Vice President and Director of Investor Relations

Michael G. O'Grady - Chief Financial Officer and Executive Vice President

Analysts

Luke Montgomery - Sanford C. Bernstein & Co., LLC., Research Division

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Ashley N. Serrao - Crédit Suisse AG, Research Division

Betsy Graseck - Morgan Stanley, Research Division

Michael Mayo - CLSA Limited, Research Division

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Kenneth M. Usdin - Jefferies LLC, Research Division

Cynthia Mayer - BofA Merrill Lynch, Research Division

Nancy A. Bush - NAB Research, LLC, Research Division

James F. Mitchell - The Buckingham Research Group Incorporated

Jeffrey Harte - Sandler O'Neill + Partners, L.P., Research Division

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Andrew Marquardt - Evercore Partners Inc., Research Division

Operator

Good day, everyone, and welcome to the Northern Trust Corporation's Fourth Quarter 2013 Earnings Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the call over to Director of Investor Relations Bev Fleming for opening remarks and introductions. Please go ahead, ma'am.

Beverly J. Fleming

Thank you, Aaron. Good morning, everyone, and welcome to Northern Trust Corporation's Fourth Quarter 2013 Earnings Conference Call. Joining me on our call this morning are Mike O'Grady, Northern Trust's Chief Financial Officer; Jane Karpinski, our Controller; and Allison Quaintance from our investor relations team.

For those of you who did not receive our fourth quarter earnings press release or financial trends report via email this morning, they are both available on our website at northerntrust.com. In addition and also on our website, you will find our quarterly earnings review presentation which we will use to guide today's conference call.

This January 22 call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available through February 20. Northern Trust disclaims any continuing accuracy of the information provided in this call after today.

Now for our Safe Harbor statement. What we say during today's conference call may include forward-looking statements which are Northern Trust's current estimates and expectations of future events or future results. Actual results, of course, could differ materially from those indicated by these statements because the realization of those results is subject to many risks and uncertainties. I urge you to read our 2012 annual report and our periodic reports to the Securities and Exchange Commission for detailed information about factors that could affect actual results.

[Operator Instructions]

Thank you again for joining us today. Let me turn the call over to Mike O'Grady.

Michael G. O'Grady

Thank you, Bev. Good morning, everyone, and welcome to Northern Trust's Fourth Quarter 2013 Earnings Conference Call. On today's call, I'll review both our fourth quarter and full year results. Bev and I will then be pleased to answer your questions.

Starting on Page 2. This morning, we reported fourth quarter net income of $170 million and earnings per share of $0.70. Our reported results included a charge of $19 million in connection with an agreement to resolve certain long-standing class action litigation related to our securities lending program. The settlement is not final as it requires further documentation, signed agreements and court approval. The settlement will not resolve all security funding litigation involving Northern Trust but will resolve the majority of the pending claims, those involving Northern Trust index funds. We intend to continue to vigorously defend the remaining securities lending cases.

Excluding this charge, net income would have been $182 million and earnings per share would have been $0.75. For the full year, net income was $731 million and earnings per share were $2.99.

The operating environment in the fourth quarter continued to be mixed, with both positive and negative implications for our business. Equity markets in the U.S. and Europe were higher, which supplemented our strong new business results, while fixed income markets were a modest headwind. The S&P 500 was up 30% year-over-year and 10% sequentially, while the EAFE Index was up 19% year-over-year and 5% sequentially. The Barclays U.S. Aggregate Bond Index was down 5% year-over-year and down 1% sequentially.

Client assets under custody ended the quarter at $5.6 trillion, up 16% over last year. And assets under management ended at $885 billion, up 17%. On a sequential basis, client custody and managed asset levels were up 6% and 5%, respectively.

Currency volatility and client trading volumes, both of which influence foreign exchange trading income, were lower in the fourth quarter but higher year-over-year. Short-term interest rates remained at very low levels. 3-month LIBOR and fed funds were 8 and 7 basis points lower, respectively, than the year-earlier quarter, and 3-month LIBOR was 2 basis points lower sequentially, placing continued pressure on our net interest margin. Average overnight repo was 16 basis points lower compared to the prior year, resulting in higher waivers year-over-year in connection with our money market mutual funds and similar to last quarter.

We continued to successfully execute on the Driving Performance initiatives announced in early 2012, enhancing our capacity for investment in growth and improving our financial performance despite the macro environment. The net effect of all these factors was a reported return on equity of 8.7% in the fourth quarter, or 9.3% excluding the charge, and 9.5% for the full year, which while higher than last year's return, was still below our target range of 10% to 15%.

Let's move to Page 3 and discuss the financial highlights of the fourth quarter.

Starting with the year-over-year comparison, revenues were up 8% and expenses, when adjusted for charges in both quarters, were up 6%. Revenue growth was a result of trust, investment and other servicing fees increasing 8%, net interest income increasing 7% and foreign exchange trading income increasing 25%. Expenses were up due to higher compensation, outside services and equipment and software expenses. As a result, net income, excluding the special items, was 5% higher than last year's fourth quarter.

Compared to last quarter, revenues, excluding the third quarter gain, were up 3%. And expenses, excluding the fourth quarter settlement charge, were up 5%. Higher trust investment and other servicing fees and net interest income were partially offset by lower foreign exchange trading income. Expense growth on a sequential basis, similar to the year-over-year comparison, reflects higher compensation, outside services and equipment and software expenses, as well as higher other operating expense. As a result, net income, excluding the special items, would have been 2% lower sequentially.

Earnings per share was $0.70 on a reported basis and $0.75 excluding the charge. Our return on equity of 8.7% for the fourth quarter would have been 9.3% excluding the charge. With that background and summary, let's get into more details behind our fourth quarter results.

Turning to Page 4. Fourth quarter revenues on a fully taxable equivalent basis were approximately $1.05 billion, up 8% year-over-year and 3% sequentially when adjusted for the third quarter gain. Trust, investment and other servicing fees, the largest component of revenues, were $674 million in the quarter, up 8% year-over-year and 4% sequentially. Higher equity markets and new business were both drivers of growth, with higher money market fund fee waivers offsetting in the year-over-year comparison. Money market mutual fund fee waivers were approximately $31 million in the fourth quarter, an increase of $16 million over last year and $1 million lower sequentially. The year-over-year increase was primarily due to the gross yield of the funds declining by approximately 9 basis points on average from the prior year. I'll go into further detail on trustees shortly.

Foreign exchange trading income was $51 million in the fourth quarter, up 25% year-over-year and down 19% sequentially. Higher currency market volatility and higher trading volumes both drove the improved results year-over-year. On a sequential quarter basis, both volatility and volumes were lower.

Other noninterest income was $70 million in the fourth quarter, down 3% year-over-year, primarily reflecting lower securities commissions and trading income. Excluding the third quarter gain, other noninterest income was up 5% sequentially, primarily reflecting higher income on employee benefit assets held in trust.

Net interest income, which I will also discuss in more detail later, was $259 million in the fourth quarter, up 6% year-over-year and sequentially.

With that backdrop, let's look at the components of our fee revenues on Page 5. For our Corporate & Institutional Services business, fees totaled $371 million in the fourth quarter, up 8% year-over-year and 3% sequentially. Custody and fund administration fees, the largest component of C&IS fees, were $251 million in the fourth quarter, up 12% year-over-year and 5% sequentially, while assets under custody for C&IS clients were $5.1 trillion at year end, up 17% year-over-year and 7% sequentially. Growth in fees and assets primarily reflects higher equity markets and new business. Fee growth, like asset growth, however, as a higher proportion of our fees, are based on transactions rather than asset values given the growth in our Global Fund Services business, as well as the impact of the timing of new business installations and lagged pricing.

Investment management fees in C&IS of $75 million in the fourth quarter were up 1% year-over-year, and assets under management for C&IS clients increased 18%, both reflecting new business in mutual funds and index management and higher equity markets. Fee growth was dampened on a year-over-year basis by higher waivers on institutional money market mutual funds. Waivers impacting C&IS fees equaled $15 million in the fourth quarter, $9 million higher year-over-year, primarily reflecting the lower gross yields achieved in the underlying funds that I've previously mentioned. Investment management fee growth in C&IS, excluding waivers, would have been 12% year-over-year. Additionally, the mix of AUM in passive equity strategies, which carry lower fees relative to active strategies, increased during the year.

On a sequential basis, C&IS investment management fees were up 5% and assets under management were up 4%.

Securities lending fees were $22 million in the fourth quarter, up 7% year-over-year and down 4% sequentially. The year-over-year increase primarily reflects higher volumes, as securities lending collateral increased 16% to $102 billion, offset partially by lower spreads. The sequential quarter decline primarily reflects lower collateral levels.

Other fees in C&IS were $23 million in the fourth quarter, down $2 million year-over-year and the $3 million sequentially.

Moving to our Wealth Management business. Trust, investment and other servicing fees were $303 million in the fourth quarter, up 9% year-over-year and 5% sequentially. Assets under management for Wealth Management clients were 202 -- $222 billion at year end, up 12% year-over-year and 5% sequentially. And assets under custody were $496 billion at year end, up 11% year-over-year and 5% sequentially. This growth reflects higher equity markets and strong new business. The year-over-year fee comparison was dampened by higher money market fund fee waivers, which were $16 million in the fourth quarter, $7 million higher year-over-year. Excluding the waivers, Wealth Management fees would have been up 11% year-over-year.

Moving to Page 6. Net interest income was $259 million in the fourth quarter, up 6% year-over-year and sequentially. Growth in net interest income was driven by a larger balance sheet as client interest-bearing deposits averaged $64 billion in the quarter, up 18% year-over-year and 8% sequentially. In the year-over-year comparison, short-term borrowings were also higher. This higher level of funding was primarily invested on the asset side in Federal Reserve deposits at 25 basis points.

Partially offsetting the impact of a larger balance sheet was a lower net interest margin which, at 1.12% in the fourth quarter, was down 5 basis points year-over-year and 2 basis points sequentially. The lower margin reflects the mix shift in earning assets resulting from the higher level of Federal Reserve deposits, as well as lower yields on the loan portfolio, which declined 17 basis points year-over-year and 3 basis points sequentially. Over half of the loan portfolio is floating rate, and new fixed-rate loans and leases are coming onto our balance sheet at lower yields than those rolling off.

The yield on the securities portfolio increased 12 basis points both year-over-year and sequentially, primarily reflecting adjustments to premium amortization in our mortgage-backed securities portfolio due to changes in prepayment speed assumptions. Adjustments to premium amortizations were approximately $10 million in the fourth quarter and $3 million in the third quarter. The adjustments in the fourth quarter increased the net interest margin by approximately 4 basis points.

Turning to Page 7. Expenses were $794 million in the fourth quarter, up 7% both year-over-year and sequentially. Excluding charges recorded in the fourth quarter of each year, expenses would have increased 6% year-over-year and 5% sequentially. Across all the categories, expense growth is being driven primarily by the costs in investments to support the growth of the business and meet higher risk management compliance and regulatory requirements.

Compensation and benefits expense increased 6% year-over-year and 3% sequentially, primarily reflecting staff growth. The year-over-year increase also reflects annual merit increases. Staff increased 4% in 2013 and was primarily focused in 2 areas. First, approximately half of our net new hires in 2013 support the growth of Global Fund Services in C&IS, a business in which we are investing for our clients and for future growth across traditional hedge and other fund structures. Second, about 15% of our new hires during 2013 joined our corporate functions, the majority in our risk management group.

Outside services increased 8% year-over-year and 4% sequentially. The year-over-year increase primarily reflects higher consulting and technical services expense related to heightened regulatory efforts, as previously mentioned. The sequential increase reflects higher legal and sub-custodian expense.

Equipment and software expense was higher by 9% year-on-year and 3% sequentially. This growth reflects the higher level of investment we are making in our technology platform both for our clients and risk-related initiatives. Occupancy expense was down 5% versus the prior year and up 1% sequentially.

Other operating expense, excluding the litigation settlement charge, decreased 5% year-over-year and increased 17% sequentially. The sequential increase primarily reflects higher charges associated with account servicing activities and seasonally higher business promotion and marketing costs.

Turning to the full year. Our results in 2013 are summarized on Page 8. Net income was $731 million and earnings per share were $2.99, both up 6% compared with 2012. We achieved a return on equity for the year of 9.5%, better than 9.3% in 2012 and 8.6% in 2011 but still short of our target range of 10% to 15%.

Full year revenue and expense trends are outlined on Page 9. Trust, investment and other servicing fees grew 8% in 2013 and have grown at a compound annual growth rate of 10% since 2011. New business across segments and geographies, and higher equity markets both contributed to these results.

Foreign exchange trading income was up 19% on higher volatility and volume, particularly in the first half of the year. This revenue growth was offset by a 6% decline in net interest income as low short-term interest rates continued to pressure net interest margin. The net result was 5% growth in overall revenue in 2013. Excluding the third quarter gain on a sale an office building, revenue growth would have been 4%.

Expenses were 4% higher in 2013 than 2012, reflecting investments in people, outside services and technology to support the growth of the business and risk management and compliance requirements. Although we saw a meaningful increase in costs related to these activities in 2013 and many requirements were met, some of the expenses are permanent and there will continue to be additional work on these fronts required in 2014.

Let's move to Page 10 for an update on our Driving Performance effort. In January of 2012, we indicated our goal to improve pretax operating income by $250 million in 2013. In the fourth quarter, we produced over $80 million in pretax operating income improvement from Driving Performance initiatives. This brings the 2013 benefit to approximately $270 million. Driving Performance has added about 1 percentage point to the revenue growth rate and reduced our expense growth rate by approximately 3 percentage points, with approximately 60% of expense savings achieved through compensation and benefits and about 15% through procurement initiatives.

Driving Performance efforts have contributed to the continued improvement in the level of noninterest expenses as a percentage of core trust and investment fees. However, the decline in net interest income and foreign exchange trading income over the last 2 years has muted the impact on our pretax margin, which has only improved from about 24% to about 27%.

While we believe the Driving Performance has created sustainable improvements to our operating model and is embedded in the ongoing management of our business, we continue to pursue meaningful additional efforts to improve productivity and deliver financial benefits beyond our original targets. In 2014, for example, we have established internal productivity targets on both the revenue and expense side. We have developed these targets using the same approach we used for Driving Performance and have included these targets in our 2014 financial plans and expectations. We expect that this next round of productivity efforts will continue to improve our financial performance in a sustainable way, holding other factors constant. The ultimate measure of the success of our efforts will be our ability to consistently achieve our financial target of a return on equity between 10% and 15%.

Capital, outlined on Page 11, remained very strong, with tier 1 common and tier 1 capital ratios of 12.9% and 13.4%, respectively. Based on our interpretation of the final Basel III rules released by the Federal Reserve, our tier 1 common capital ratio, based on the standardized approach on a fully phased-in basis, will be approximately 11%. Under the advanced approach, our tier 1 common capital ratio will be approximately 12%. Both of these ratios are well above the fully phased-in requirement of 7%, which includes the capital conservation buffer. The sequential decline in the tier 1 common capital ratio calculated under the advanced approach was mainly related to an increase in operational risk-weighted assets given some refinements to our modeling approach and the fourth quarter litigation settlement.

The supplementary leverage ratio is estimated to be approximately 5% at the holding company, which is above the requirement applicable to Northern Trust. As Northern Trust progresses towards fully phased-in Basel III implementation, there could be additional enhancements to our models and further guidance from the regulators on the implementation of the final rule, which could change the calculation of our regulatory ratios under the final Basel III rules.

In the fourth quarter, we repurchased 2.1 million shares at a cost of $123 million. Combined with dividends, Northern Trust returned $609 million in capital to our shareholders in 2013, an increase of 35% over 2012. Our 2013 capital plan provided for the repurchase of up to $400 million in common stock, of which $164 million remains for repurchase through March 2014.

In closing, 2013 was another successful year for enhancing our ability to serve our clients. We are offering our Wealth Management clients several new asset management products, like FlexShares ETFs, a new way to think about their wealth through goals-driven investing; and new technology to utilize, like mobile capabilities. For our institutional clients, we expanded our geographic presence by opening offices in Riyadh, Saudi Arabia and Frankfurt, Germany; and added depository capabilities in Europe to help clients meet new AIFMD requirements. We also made meaningful investments in our technology in order to be a secure, stable, efficient partner for all our clients.

From a financial perspective, 2013 was an improvement over 2012 but fell short of our plans and goals. We were not able to meet the challenges presented to effectively grow our revenues and manage our expenses efficiently to achieve the returns on capital expected by our shareholders. We were able to make significant returns of capital during the year, providing our shareholders with over $600 million through dividends and share repurchases. We're already hard at work this year, determined to make 2014 even more successful for our clients, shareholders and partners.

Thank you again for participating in Northern Trust's Fourth Quarter Earnings Conference Call today.

Aaron, please open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go first to Luke Montgomery with Sanford Bernstein.

Luke Montgomery - Sanford C. Bernstein & Co., LLC., Research Division

Just in terms of the regulatory compliance spending. You indicated that should have peaked in the second half of 2013. Just wondering if you have any more clarity around how much and how quickly some of that could fall off in 2014.

Michael G. O'Grady

Yes. I think that I -- in looking at the increased cost for the regulatory initiatives and compliance initiatives, that we did see the ramp. And that came in the form both of additional personnel, so you saw that through the comp and ben line, particularly in this quarter. I -- and then also through outside services, which increased 9% this quarter year-over-year. And I think, going forward, I -- as I mentioned in the prepared remarks there, we continue to have a number of these initiatives that we're working on, albeit that the portfolio mix changes as we go forward. So for example, things like CCAR, we definitely had a big step-up this year and, as a result, had to bolster our teams but also to use outside consultants in order to help us get to what we thought was the appropriate level for the 2014 capital plan. As we move forward into 2014 and prepare for our 2015 capital plan, we're going to continue to make improvements on that front, but the incremental increase won't be as much. And I would expect that the use of outside consultants to help us get there will also be lower. So you have things like that where the trajectory, I would expect, would go down. At the same time, we have initiatives like AIFMD over in Europe where we did incur expenses in 2013 and again particularly in the second half, but I would say, in 2014, the costs related to that will go up relative to 2013. Now in certain situations, like in AIFMD, that's a new service that we're also providing to our clients, so there are revenues that come along with the incremental costs. So I take all of that together from an expense perspective, what we're looking at is that the expense levels we experienced in 2013, relative to these risks and regulatory initiatives, will be approximately the same, albeit that the mix between what I'll call the permanent costs will go up a little bit from where we are now, where I would expect from the outside costs to begin to come down.

Luke Montgomery - Sanford C. Bernstein & Co., LLC., Research Division

That's helpful. And then just more broadly, would you agree that some of the difficulty with operating leverage over the last few years is that you've been adding clients and mandates and, with that, I think, more support costs, while relationship revenues have obviously been falling? I guess I'm aiming at whether you've attempted to isolate the impact of organic growth on your expense and margin trends.

Michael G. O'Grady

Yes, we absolutely look at the impact of organic growth on operating leverage. And I would say, we further break it down or the way, I would say, we think about it is looking at that ratio of expenses to trust fees, and we brought that down over the last couple of years, as we've talked about. Now we have benefited in that from the fact that equity markets have been strong. So that's raised that growth rate. And as again we talked about in the call, it's 8% this year and it's been a compound annual growth rate of 10% relative to expense growth of 4%. So between those 2, clearly a lot of operating leverage, but we're recognizing the fact that we're getting the benefit of the markets in that. I will say, at the same time, even within that line, we've had the detraction as a result of money market fee waivers being up, which detracts from our ability to improve on that. And then outside of that ratio to true operating leverage, meaning revenues versus the expenses, we've seen headwinds, as we've talked about many times on some of the other revenue line items, that has caused us essentially to be basically flat when it comes to operating leverage over the last couple of years.

Operator

We'll go next to Alex Blostein with Goldman Sachs.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

So just picking up on the last question, Mike. Clearly, 2013, pretty nice tow-in from the market perspective, and it feels like the NII headwinds that you have experienced for the last 1.5 years-plus are at least starting to subside a little bit. So maybe help us understand a little bit more on the type of operating leverage you guys could get from just the market performance and better NII, because it feels like those are obviously 2 pretty high-margin revenue streams for you guys. And any -- and if you could provide any specifics around the type of expenses that would move up along with those 2 kind of line items would be helpful.

Michael G. O'Grady

Okay. I think I have it there, Alex. So I would say that the way we look at the positive operating leverage is to first look at the areas that we can drive and control the most. So it's looking at that organic fee growth rates and the expectations that we have there and then the related expense growth to that, and we want to ensure that we are achieving positive operating leverage based on that. To the extent that the, I'm going to say, operating environment is more favorable, so whether it's positive equity markets, interest rates, FX, et cetera, that should only accelerate or expand the positive operating leverage for us. To your point, not all of that incremental revenue growth necessarily drops down without incurring some expenses to it. So to your point specifically, when the equity markets go up, we have higher sub-custodian expenses, we have higher market data costs, we have higher third-party adviser fees. So there are a number of line items that also increase with the increase in equity markets, albeit the total amount that derives from those is less than certainly what we pick up on the revenue side. So it is a detractor. And we saw some of that in the fourth quarter where sub-custodian expenses, as you saw, were up a couple million dollars both year-over-year and sequentially. Likewise, I -- when we say that tech services or technical services are higher, that includes our market data costs in there. And so again, I -- generally speaking, those also have gone up with the markets and something that we essentially have to make up for in other areas that are not linked to market growth.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

And then the second question is just on the balance sheet. Clearly, a big move up on -- in deposits. How much of that do you guys think is seasonal or are sort of temporary in nature versus maybe a little bit more sticky? And if it is a portion and if there's a portion that is stickier, how do you think about starting to move some of the balances away from the fed into the securities portfolio or something like that? Because it does seem like fed has -- fed balances is closer to 14% or something close to that as a percentage of earning asset, and that feels like on the higher side of things.

Michael G. O'Grady

Yes, I think your observation is correct, Alex, just in the sense that it was higher. And looking at that increase in deposits and a little bit in borrowings as well there, I would say that I -- our view is that about half of that is -- looks to be just increased client deposit levels. Now the nature of the deposits that we have for our clients on the custody side tends to go up and down over time, but as you know, as we grow the business, it generally increases. So just as you pointed out, when we get new deposit levels in or they begin to go up for some level, we don't immediately move them to longer-term investments on the asset side and we want to make sure that we have essentially established new levels of ongoing operational deposits, if you will. And so that's where we saw it. And as I said, about half of that looks to be, at this point, longer term, which would give us the opportunity to increase the size of the securities portfolio a little bit, as well as some of the other money market investments that really fall in between just being overnight at the fed or being in our securities portfolio which has just a little bit longer duration.

Operator

And we'll go next to Ashley Serrao with Crédit Suisse.

Ashley N. Serrao - Crédit Suisse AG, Research Division

So Mike, as you look out over the next 2 to 3 years, like how would you rank order all the organic revenue opportunities in front of you across your business? And then how should we think about the payoff there versus the incremental investment spend?

Michael G. O'Grady

Sure. So let me try to do it by our primary businesses. And I would say, as we have discussed and invested in the last couple of years in our Global Fund Services business within C&IS, that continues to be an area that we see out over the next, as you said, 2 to 3 years, if not longer, as that continues to be an opportunity for accelerated growth. I -- and that comes in a number of different forms. So in other words, that can be traditional fund managers, but as we've talked about within that, we've also been very successful in growing our Hedge Fund Services business within that. So that would be an area, along with just the whole investment outsourcing business that we have there, where we continue to see good growth. Now even having said that, in 2013, that portion of the C&IS business grew well. The traditional part of our business also grew very well. So it's not to say that we only see growth opportunity in Global Fund Services, it's just at a higher rate on that side. Within Wealth Management, we continue to believe that, just within our current footprint, we have a significant opportunity to continue to grow. When you think about the areas where we probably have the greatest area for opportunity, it's going to be areas like the East Coast and the West Coast where we don't have the same penetration that we do in the Central region. And frankly, that's an area where it does require some investment in people, expertise, in marketing in order to continue to develop what are some very large markets. And what we have been trying to do through Driving Performance and otherwise is really to be able to create the capacity to spend more in those areas. We've been reticent to spend aggressively to grow the Wealth Management business in some of those markets until we felt like we have the overall returns for the company at the places where we talk about as far as our targets. And then within asset management, we talked about ETFs, I would say that ETFs right now are close to $7 billion, so that's been very successful for us. And yet at $7 billion, we still think we have significant headroom to continue to grow the ETF business. So those will give you 3 areas, I would say, that not only are they near term but they fit into your 2- or 3-year time frame as well.

Ashley N. Serrao - Crédit Suisse AG, Research Division

And I guess, maybe shifting gears to just expenses. Towards the -- I guess you've, more or less, concluded the Driving Performance program, but you've always talked about the cultural shift with respect to expenses. So like maybe, can you give us some examples of what you're working on today? And how should we think about any potential savings above and beyond this program?

Michael G. O'Grady

Yes. So with Driving Performance, if you went back 2 years ago and just if we talked about the 4 primary categories that we had for opportunity, they were revenue, process optimization, technology and then corporate. I -- and I would say, within each of those areas, we've -- again, we're successful in executing on the initiatives that we've discussed. Those are the same 4 primary areas that we see going forward and, as I mentioned, continue to have new initiatives which we put in place and then measure our performance against those initiatives. So for example, on the revenue front, for Driving Performance, it was focused, with the Wealth Management business, around essentially our pricing structure, which we changed 2 years ago. We don't anticipate changing that pricing structure going forward. However, we still, within that pricing structure, discount our fees for various clients across the business. We have opportunities to continue to align the discounting mechanics, if you will, and process around that, which we think will achieve revenue for us going forward. And there's other very high-value-added services within Wealth Management that we either don't charge for or that we think that are not appropriately aligned with the value that's being delivered. So there continue to be opportunities on the revenue side. On the process optimization front, if you recall, that was all about trying to look at different activities that run across the bank and make those more efficient. So for example, client administration. And going forward, there are still more opportunities essentially to centralize additional functions into more shared service type opportunities. We also talk about our global operating model and the fact that we look to put the right activity in the right place. As much as we've been very successful in that, there certainly are more opportunities to expand how we do that, and we'll be doing some of that in 2014 globally as we expand our operational footprint. Within technology, on the technology front, we were able to essentially shift our development mix. And what I mean by that is trying to optimize the balance between onshore and offshore, as well as when we develop something whereas we otherwise could outsource the development. And achieved gains there, there are some opportunity there, but then going forward, we see further opportunity on the efficiency front in further essentially simplifying our portfolio of applications. So these are areas that do require some investments, but we see the returns both in the sense of a more simplified operating platform for our clients and our partners but also of efficiency and savings. And then just finally, on the corporate front, we essentially looked at realigning the organization a couple of years ago, realigning the benefit structure that we had in place, and that definitely produced some significant savings for us. There's probably additional opportunities on the organizational front to continue to ensure that we have the most efficient organizational structure kind of across-the-board. And then also, we've been very successful in procurement. And I -- as much as that, likewise, has delivered significant savings for the company in the last 2 years, we still see more opportunities in procurement, broadly speaking, in just the way in which we manage our vendors. So Driving Performance, very successful so far, we see more opportunity for us. The incremental improvements are more difficult to get but all the same critical for us to be able to deliver on our ultimate financial performance.

Operator

And we'll go next to Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley, Research Division

A couple of questions, one just again on the operating leverage. I heard you indicate that some of the external fees that you're paying for, CCAR-related work, will come internal in the coming year. And at that, swap external/internal should be positive to the operating leverage. In addition, beyond that, you got a little bit more work to do on the regulatory front and the CCAR front, but all in on just that line item, should I expect that you're going to be having a reduction in expenses year-on-year and that, that's one of its drivers of positive operating leverage into '14?

Michael G. O'Grady

Just to be clear, when you say on that line, do you mean on, for example, outside services?

Betsy Graseck - Morgan Stanley, Research Division

No, just all-in expenses associated with the regulatory performance.

Michael G. O'Grady

Yes. No, I would say, for 2014, it's likely to be pretty consistent. And the reason why I say that, Betsy, is we really ramped up in those expenses more into the second half. And I would say we're kind of essentially at that level, the mix is changing. We'd like to think that it stabilizes out and starts to go down in 2014, but it's hard to say. And so certainly from a year-over-year basis, we would think that we'll be basically in the same neighborhood.

Betsy Graseck - Morgan Stanley, Research Division

Okay. I have a question [indiscernible]. There was a little bit of a step-up in comp and benefits in 4Q. And I was wondering if that was at all a function of moving in-house people that were out of house, but maybe you can give some color on why that line item went up.

Michael G. O'Grady

Sure. So comp and ben went up about 6% year-over-year, as you mentioned there. About half of that relates to more hires that we had during the year in the areas that we've talked about. So that's just the -- approximately, we said 4% increase in staff growth, and here, the hires and salary was an increase of about 3 -- a little over 3% there. The other half of it, part of it, we actually had a restructuring charge in the prior year that went the opposite direction. And then we also have some base pay adjustment, about 1%, that's in there as well. And then currency, given that a number of our partners are outside the U.S., particularly in the U.K. and other parts of Europe, were from a currency impact standpoint, that was about another percentage point increase year-over-year in those quarters. And just to be clear, we get the benefit of currency impacts like that on the revenue side as well, but it does hit different line items differently.

Betsy Graseck - Morgan Stanley, Research Division

Okay. And then on the revenue side, 2 questions. One is on, the Wealth Management fees have a component that is backward looking. Since we ended the year in 4Q at an S&P high, I would expect that, that's pretty much a high for the [ph] Wealth Management fee base for 1Q '14. Is that fair?

Michael G. O'Grady

Right. As we talked about, there are certain lags that are in the business, one of them is with our Wealth Management regions where we have the 1-month lag.

Betsy Graseck - Morgan Stanley, Research Division

Okay. And then on the securities portfolio, you've had some nice step-ups in yields over the past couple of quarters [indiscernible] durational [indiscernible] like you mentioned 2 quarters back. Are you pretty much done with the securities duration extension that you had talked about or is there anymore of that you're likely to be doing?

Michael G. O'Grady

I would say that we're pretty much in a balanced position, if you will, as far as the duration. So the duration of the portfolio was about 1 year and 2 months, 14 months as of the end of the year. We've been a little bit below that before. But at this point, we're not necessarily expecting to extend that duration further. And at this point, we're largely increasing -- we're largely matching the yield on the portfolio as it rolls over and we reinvest. So it's a relative [indiscernible]. And I should say as far as the actual yield on the securities portfolio, if you went back and just backed out the premium amortization over the last 4 quarters, for example, the yield on the portfolio, absent that, is very stable.

Operator

We'll take our next question from Mike Mayo with CLSA.

Michael Mayo - CLSA Limited, Research Division

Do you think you will achieve your key financial target ROE of 10% or more in 2014? And the reason I asked that on the downside, you missed it in 2013, you're done with the main part of Driving Performance, the regulatory cost stay elevated. And as the company has said, you're still investing in technology, risk location and capabilities. I guess on the other hand though and this is really my question, you highlight the pretax margin on Slide 10, which you hadn't done before, and you had as you mentioned 24% to 26% to 27% the last 3 years. So where do you think the pretax margin will go or should go? And can you give us some color on the new expense plans for 2014 that you say are in the internal plans? And just more generally, where are you in the investing curve? You're investing a lot, when do we get to that crossover point where the payoff net investing offsets the expenses?

Michael G. O'Grady

Okay. Let me try to recall all those, Mike, and address them. So to the first one, yes, we expect to achieve a return on equity in our range, in other words, above 10% in 2014. I think that was the first question. The second question with regard to the margin, the first -- the answer to the first question essentially answers the second one in the sense that we need to increase our pretax margin, essentially, in order to achieve the return on equity target that we want. So we're at about 27%. In order to get into the range, we're going to need to be closer to 28%, 29%. So that's certainly our objective to do that. Underlying that is the other part of that page that we showed there which is we need to continue to bring down the expenses relative to the fees because we don't necessarily know what's going to happen with some of the other revenue lines, but we don't want to necessarily plan around those in order to get our margin improvement. And that largely leads, I think, to your third question about how we think and plan around expenses. And if you take the last couple of years, our fees have grown, as we've talked about, let's say, 8% to 10% and our expenses have grown about 4%. Now going forward, that is what we look at. And our expectation is to have a similar-type relationship. So when we develop our plans, we're very focused on how can we drive the fee line there, and that's not with the expectation that markets go up, but rather from an organic perspective, how can we grow that fee line. And as much as we grew at 8% in 2013, we didn't grow it quite as much as we expected to and that we planned to. And then what's the relationship because there is a relationship there as you grow those fees and add clients with regard to the expenses required to do that and just other things that are happening, like the regulatory cost that you have to take into account as you do that. And we're looking for a similar-type relationship, and again I would say in 2013, while 4% gave us that difference between our fees and our expenses, it wasn't as much as likewise that we targeted. And so 2014, the expectation is pretty similar in the sense of looking to grow those fees at about that rate and from an expense perspective, we're essentially in the same neighborhood as well, given the considerations that we've discussed. As far as your last question about the investment curve, the way I would think about it is that there are many investment curves within the overall investment curve. So there's not one just Northern Trust is a company on a particular singular investment curve, and we very much do look at our initiatives and what curves they're on. So more specifically, when I talk about Global Fund Services and within that, just to give a better example, Hedge Fund Services, we made a true investment in that business a couple of years ago. And when we think about the returns that it's generating to the extent that it's not generating the corporate return, then it's in the investment stage. So it's been in the investment stage. But the payoff for that is in front of us right now in the sense of being not only profitable, but also earning the return that adds to the company's overall return. So that's an example of where we are in that investment stage. I would say, when we talked about Wealth Management and I've talked a little bit earlier on the call here about investing in some of these larger markets, for example, on the East or West Coast, those are markets where right now we really haven't truly invested much in those. Instead, they've been more in a growth mode, but we'd like to invest in those. So those would be earlier into the investment cycle. But then pulling up and just to give one more example, on the ETFs, that's something again that would be similar to what I just said with Hedge Fund Services, which is a couple of years ago when we started, clearly, we were not only -- do we have operating losses there, but also there's capital invested that you're not getting the return. We're now at the point where in 2014, that won't necessarily be contributing to the overall value add, if you will, even though it will be positive, but then in the next year, it is. So it's much closer to the payoff part of that curve. So now if you do pull back and say, that's interesting that you have individual initiatives and curves, but what is it for the company overall? Frankly, our view is we need to get to within our range before we can invest significantly in any of these areas. And so it's critical for us to get above that 10%, so that we -- it gives us a little more capacity to invest in some of these things that have curves that are in the investment stage earlier on, but then produce the higher returns for us longer-term.

Michael Mayo - CLSA Limited, Research Division

By the way, what's the name of the Driving Performance Part 2? Do we have a name for that?

Michael G. O'Grady

We don't have a name per se, so I'll leave it at that. It's really -- as we've talked about, Mike, Driving Performance, one of the key objectives really was to just ingrain it in what we're doing. And so it's not viewed as an initiative that ended per se. But it's also not saying that the only time you have to think about either improving revenues or bringing down expenses is if you use the term Driving Performance. These are things we should be thinking about all the time and I think that people do that. At the same time, it did allow us to develop a discipline around certain initiatives and that discipline really paid off for us to be able to stay on track and make sure that we delivered on some of these plans, so we want to keep that type of Driving Performance structure in place.

Operator

We'll go next to Gerard Cassidy with RBC.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Do you guys think that you'll finish the rest of your share repurchase this remaining in the calendar first quarter of 2014? I think you said it was about 168 million shares maybe -- might be remaining. And second as part of that, is there ever a point where the stock price gets too high to repurchase or the valuation is too high and if you think -- and that's a nice problem to have, of course, but if that is ever reached, would you use a special dividend as an alternative to return capital?

Michael G. O'Grady

So on your first question, Gerard, there's $164 million remaining on the 2013 capital plan and our intention still is to fully execute on that. On your second question, we've talked before about the framework in which we think about capital returns and how share repurchases play into that. And to your point, a special dividend is something that it is certainly a consideration for us. Having said that, that needs to be a part of our capital plan and our capital management policies and things like that. And so in order to have that type of flexibility, it needs to be a part of the broader capital management that ultimately is reviewed by the Federal Reserve that's part of your capital plan.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Okay. And then as a follow-up, coming back to your comments about your deposit growth on your average balance sheet year-over-year are very strong as you pointed out, and on the corresponding side of the balance sheet deposits that the Fed, of course, were up quite dramatically. If you're confident that about half of them are sticky deposits, what was the thinking not to grow the securities book year-over-year? I think it was actually down a little bit and then the loan portfolio, of course, was about flat with those deposits that you grew in 2013?

Michael G. O'Grady

Yes. Part of it, as I mentioned are those custody deposits definitely tend to move around and vary over time. And so just -- so it's different I would say than if you think about a retail deposit or deposits we may get in Wealth Management where we have some early indication that, that deposit makes it with us for a long time. Some of these deposits are very large and their needs can change relatively quickly over time. So that's why from our perspective on how that gets invested, we'd like to see what the behavior of the higher level of deposit is because before we necessarily think about extending on the asset side. As I did mention, it does appear that a reasonable portion, about half of that looks like it is just higher levels by clients. And what we do with that is, in addition to just getting invested at the Fed, we also looked invested in money markets which can have a longer-term maturity, if you will, than just overnight. It's still counted in days, so it's, as a portfolio, it's less than 1 month. But depending on market rates and depending on the currency, we're going to get a different spread on that. So for example, we talked about 25 basis points at the Fed, if that deposit is in euro and the marketplace we're getting less than that 25 basis points pretty significantly, it's going to be single digits. Whereas if it's in sterling, we're going to get about 50 basis points right now. So it depends on factors like that. And then just to your last part on the securities portfolio, we really use that then. Once we do see the overall balance sheet growing to a size and expect that there's a certain level of stability to think about increasing the amount that we would invest in the securities portfolio. And we've done some of that over time then we certainly will look at the current size of the balance sheet and to the extent that we do think that it is going to remain stable at this level, look to potentially increase the securities portfolio.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

And just quickly on the LCR, I assume your -- with the liquidity that you have at the Fed, the LCR ratio is not an issue for you guys?

Michael G. O'Grady

That's right. We're obviously, closely watching all the developments with the LCR and making sure that in fact, we think it does meet with what the appropriate way is to measure and when not, to try to be a part of that dialogue. But as it's currently stated, we would be very comfortable at our current ratio.

Operator

We'll go next to Ken Usdin with Jefferies.

Kenneth M. Usdin - Jefferies LLC, Research Division

Mike, I was wondering if you can talk a little bit about business wins and pipelines? Specifically did ADT on board this quarter and for how much of the quarter was it on board to start?

Michael G. O'Grady

So first, just a general comment which is with regards to new business, it continues to be what I would consider relatively broad based. So that's true both geographically, where North America, we had a very strong year, and then in EMEA where it had dropped off more, we've seen a nice pick up in momentum over there and ATP would be a good example of that. So ATP, a very large client and large win for us, we did on board that during the quarter and was successfully on boarded, but you won't really see the financial impact of that until the first quarter. And I would say, on that front as well, with ATP, a very large client. At this point, we are providing custody and other safekeeping services. So it's a relatively straightforward service offering. And so the fees related to that are not going to be as high as some of the other clients that we have. The pipeline, likewise I would say in general, continues to be very good within C&IS, I gave it geographically there, but also from a product perspective, fund administration and our investment operations outsourcing also continuing to see nice opportunities, both that we've won recently, but I would also say, opportunities to pitch on, if you will, are also high. And on the Wealth Management front, 2012, so going back a little bit over 1 year ago, if you recall, was very, very strong because of some of the changes in tax laws and that rolled over into the first quarter of 2013. It did slow down as we went through the year and I think that's just as far as levels of market activity just slowed down. So we've seen that stabilize here, but all the same, I would say not as strong as it was as we are speaking 1 year ago.

Kenneth M. Usdin - Jefferies LLC, Research Division

Right. Okay. And then -- so we'll get the follow-through from ATP. And then is Bridgewater still on track for somewhere in midyear?

Michael G. O'Grady

Yes. I would say with Bridgewater, again another very large, complex situation and the implementation there is ongoing and it's going well. But I would say, given that we are in that case a shadow administrator, that does mean that not only do we have to coordinate with the client, but we have to coordinate with the other administrators. So it's just a more complex proposition to do that. And that is going well. And the expectation now would be that we would have that on board in the third quarter.

Kenneth M. Usdin - Jefferies LLC, Research Division

Okay. And then 2 just balance sheet-related questions. First of all, just on the premium am side, I know it's a $7 million incremental helper this quarter. Can you just remind us on what you have left in unamortized premium? And then your mechanism, I believe, is some blend of lag versus current. Can you just walk us through that?

Michael G. O'Grady

So we have approximately $100 million in premium that needs to be amortized over what is about, I believe, approximately a $5.5 billion MBS portfolio. And right now, that's amortizing at basically $8 million a quarter. But as prepayments speeds change just due to interest rates, that needs to get adjusted and we're on a 3-month lag in looking at prepayment speeds in order to adjust that. So the adjustment in the quarter essentially gets it to the same effective yield over the new estimated life of the portfolio. I will say though, we do this security by security, so it's literally hundreds of mortgage-backed securities and it's each individual one that you do that calculation and then just overall you have the impact, so that we don't do it at a portfolio level.

Kenneth M. Usdin - Jefferies LLC, Research Division

Right. Okay. And then my last one is I noticed that period-end loans were decently above the average, which is the first time in a while you've seen that period end loan growth shoot up. I was just wondering if you could talk through, have you seen any change in either the C&IS side or the Wealth Management side? And do you expect that any incremental growth opportunities there at this point?

Michael G. O'Grady

I would say that we continued to see loan growth very difficult. And so as much as they were a little bit higher, it's still is an area that on both fronts, as you mentioned, both the commercial front and the personal front, that we think it's going to be low or slow growth for some time period because one of the things as to whether it can be higher or lower in any particular point in time is that a portfolio is turning. So it's really just the net effect of what you're replacing or as a certain amount rolls off every quarter, are you more than replacing that or not? And we've been largely running in place on the portfolio side as I think the industry has for some time period. And I would say, we continue to essentially be at about that level.

Operator

We'll take our next question from Cynthia Mayer with Bank of America Merrill Lynch.

Cynthia Mayer - BofA Merrill Lynch, Research Division

I guess a question on asset management fee rates. I think you mentioned that the few rates were affected by a mix shift to passive, which I guess I can see on the fund and ETF flows for the industry and for you guys. But then you're also mentioning an initiative to maybe restore some of the fees and Wealth Management, which is discount or charge for services which are free right now, so where are those shakeout? Would you expect the fee rate, assuming no change to the mix of equity to stabilize here, go a little bit higher? Or is passive going to push that down?

Michael G. O'Grady

As you point out, Cynthia, there's a number of factors that impact that yield, if you will. And if you look over the last several quarters, but frankly over the last several years, our overall fee levels have been relatively stable. Even when we changed the fee structure, they largely remain stable. And yet underneath that, you have factors, which I'll get to, but one of them that you didn't mention is you also have money market fee waivers, which is a detractor certainly from that fee level. I think that as we go forward, it's difficult to predict overall where it's going to be, certainly to the extent money market fee waivers come off. You heard some of the numbers that I gave on the asset growth relative to fee growth, you come much more in line when you adjust for those money market fee waivers. I do think that the product mix will continue to experience some dilution as a result of active to passive. I think that, that trend, if you will, as you mentioned, it's not just for us but is broader to the industry. And that happens at what I would call the product level for us, whereas the account management fee, because we broke apart our fee, that part of it and when I talk about Driving Performance opportunities there, that's where I would think that, that remains stable, if not improves a little bit to the extent that we decrease some of the discounting that we've done on that portion of the fees. Because again we've separated what I would call an account management fee from a product fee.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay. Yes, I was speaking apart from money market. And then just a really specific one, it looks like commissions and trading income dropped pretty severely. So they got 27%. So that's more than what we saw elsewhere. Was that just market volumes? Or was there something else driving that?

Beverly J. Fleming

Well, part of that, Cynthia, would be the fact that last year, we would have seen a higher level of activity because of the same reasons that Mike talked about in terms of the new business opportunities there. And there were just a lot going on in the marketplace in the fourth quarter of last year that led to higher trading volumes, especially in the equities arena.

Michael G. O'Grady

And I would just add to that, that on the institutional side, that also includes our transition management business. And those transitions can definitely move up and down quarter-to-quarter. They're relatively large transaction volumes, but they're also inconsistent.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay. So that doesn't necessarily mean we should think of it as coming in at a new, low level for this quarter, it's just going to be lumpy every quarter?

Michael G. O'Grady

Yes.

Operator

We'll take our next question from Nancy Bush with NAB Research LLC.

Nancy A. Bush - NAB Research, LLC, Research Division

I hate to beat the dead horse of the ROE range, the 10% to 15% range, but it's easy for me to see what gets you to 10%. It's harder for me to see what gets you sort of to the upper end of that range. And if you could just talk about that and when getting to the upper end of that range might be a realistic expectation?

Michael G. O'Grady

Sure. So as you point out, to get to the 10% side of that range, we're on a path, granted that it's taking us longer than we wanted to get to that path, but we're going to continue to drive towards that. And frankly, absent things that happen in the market, if they don't dramatically impact us, we expect to get into that range. And we expect that, again absent the macro environment changing dramatically, that we also have the ability to move within that range and move towards the middle part of that range. So the 11%, 12% into that neighborhood, doing the same types of things. To your point, to get to the higher end, if you really just said, put all the macro factors aside, we could get there, but it would take a certain amount of time to get there. And so really to get to the high end, that's where if we do have some positive impact from interest rates, FX volatility, those are the type of things that we can get there very quickly because with interest rates, just to give the magnitude of the impact with those money market fee waivers, they're over $100 million this year. And as you would imagine, there's no to very little expenses that are related to that. So those types of revenue streams have relatively high margins. And so it's those types of impact that can quickly get you towards the high end.

Nancy A. Bush - NAB Research, LLC, Research Division

Okay. On another note, could you just speak to sort of the risk appetite of your Wealth Management clients right now, whether you've seen any changes there in light of the fact that the market was up quite dramatically last year? And whether you're doing any kind of significant mix shift in their assets?

Michael G. O'Grady

I would say, as far as our perspective and what we're doing with them, I think the first part, which is critical, is just that our approach to Wealth Management is much more around goals-driven investing, if you will. So less about pure return and less about asset allocation per se. Having said that, as far as risk appetite and the allocations that underlie meeting those objectives, we have been advising our clients to essentially move towards riskier assets for some time period here. And that's a much broader and in-depth view that's developed by our CIO, and the office of the CIO. And we've seen them progress towards that, frankly, more slowly last year that we necessarily were advising. And that's just I think investor or human behavior, it just takes longer to follow up on the advice and to actually execute on that. What we're seeing is that it is continuing now. And so you have seen the equity allocation, for example, in our Wealth Management business continue to go up and is now at a level that's close to some of the highest levels that we've seen. Now part of that, of course, is because the market has performed, but this is on top of the market where we have seen them shift assets from fixed income into equities. And I would say, as to why they're doing that we think overall, it's the direction of the advice, if you will. But we think underlying that, as well, it doesn't hurt that equities are performing well, that's certainly a positive. And I think there's also still the expectation that there's clearly risk in fixed income to the extent that we have expectations that tapering will continue and that interest rates are going to be going up over the next several years.

Operator

Our next question is from Jim Mitchell with Buckingham Research.

James F. Mitchell - The Buckingham Research Group Incorporated

Most of my question have been asked and answered. I just want to make sure I have this crystal clear, on the premium amortization question, which was very helpful but I just want to make sure when you think about that $10 million benefit this quarter versus the $3 million last quarter, all else being equal if rates stay flat and that's a big statement, all else being equal. But that would mean that, that the $10 million would come back out or wouldn't recur, I guess would be the point, all else being equal.

Michael G. O'Grady

That's correct. If you truly say, all else equal, no adjustments, et cetera, you would be $10 million lower.

James F. Mitchell - The Buckingham Research Group Incorporated

Right, but as rate, but we should kind of keep an eye on rates and if they start to move higher that, that you could still see more adjustments going forward.

Michael G. O'Grady

Correct, in the opposite direction, correct.

James F. Mitchell - The Buckingham Research Group Incorporated

Fair enough. And I guess just on the compensation side, I want to make sure I hear what you're saying on the expense front. Outside services was elevated, could come down. But in compensation, the current run rate reflects new hires and that we should probably think about that as the base into next year and then some growth with revenues on top of that. Is that a fair statement on the compensation cost side?

Michael G. O'Grady

Yes. I think that's -- overall, that's a fair statement.

Operator

We'll go next to Jeffrey Harte with Sandler O'Neill.

Jeffrey Harte - Sandler O'Neill + Partners, L.P., Research Division

Question on capital levels and your thinking there. I mean, the buyback has really accelerated the last couple of quarters. And if you actually execute on the whole authorization from or approval from the Fed, it's going to step up again in the first quarter. Have you guys changed your thinking as far as the willingness to return capital to shareholders or that is an attractive alternative because it still seems like there's a lot of capital in there?

Michael G. O'Grady

Yes. So as I mentioned, we feel very good about our capital levels. We feel good about being able to return over $600 million in 2013. We'd like to return more capital to our shareholders going forward. So of course, that whole process, not only has to do with us, but also the process with the Federal Reserve and our regulators. And so we go through that trying to make sure that not only are we comfortable with our capital levels, but all the processes around determining their capital adequacy and being in a position to handle stress situations, et cetera, and making sure that they're comfortable with that as well.

Jeffrey Harte - Sandler O'Neill + Partners, L.P., Research Division

Okay. But this is a recent acceleration, I mean, it seems like the approval spend there, it almost suggests that kind of management's willingness to return capital has improved as opposed to getting approval to necessarily do more.

Michael G. O'Grady

Yes, I would say from quarter-to-quarter, it can change for any number of reasons. But within the capital plans, we've used our capital plans or what we've been allowed to use over the last several years.

Jeffrey Harte - Sandler O'Neill + Partners, L.P., Research Division

Okay. And on expenses, kind of going forward, I mean that's been asked a lot and who knows with the activity levels. But I want to make sure I'm clear, when you were talking about hitting the ROE target next year, you mentioned kind of getting the pretax margin to 28% or 29%. As you think of the pretax margin expanding by 100 basis points maybe 200 basis points, is that revenue driven? Or should we be thinking of kind of a flat revenue environment and you think expenses are actually going to be potentially declining quite a bit?

Michael G. O'Grady

Yes. We are expecting to grow our revenues and as I mentioned before, particularly driven through our trust fees. And expenses will go up, as I said, over the last couple of years, the way that we've both planned and then executed has resulted in about 4% growth in that. That's allowed us to improve that ratio between our expenses and our trust fees. We're looking to continue to stay on that line. And absent what happens in the macro environment, that's going to result in improving our in pretax margin.

Operator

And we'll go next to Robert Lee with KBW.

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Most of my questions have been asked. I just have a very simple one. I mean, the last several quarters, tax rates kind of drifted down a bit. How much, if at all, is your tax rate being affected by a changing mix, maybe greater non-U.S. business? And any color on what we -- how should we expect that to migrate in the coming year?

Michael G. O'Grady

Yes. So it does change with the global mix of our business and we continue to expand globally. And so, you have seen some improvement as a result of that. So with lower tax rates outside of the U.S., we've seen our effective tax rate come down a little bit as a result. There's also always from quarter-to-quarter just various aspects within taxes that can move it up or down a little bit. So we're largely speaking in the same range that we've been. But I think that over time, we try to be as efficient on that line item as well.

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Was there anything worth calling out in this quarter that may have driven the tax rate down a little bit or just kind of a unreasonable time going forward?

Michael G. O'Grady

I would say that, Robert, that this quarter was a little bit lower on the tax rate. It was not any one individual item that affected that. As you can imagine, you're constantly looking at the adequacy of your reserves, your tax reserves to determine if they are appropriate. And as a result of that, you have to look at potential situations that can happen and make sure that the levels are appropriate. And those always get adjusted over time. But there was nothing significant that happened, it's just that the reserve levels and the adjustment made the rate a little bit lower. For the full year, we're at about 32%. That's definitely within the appropriate neighborhood for us.

Operator

We'll take our next question from Andrew Marquardt with Evercore.

Andrew Marquardt - Evercore Partners Inc., Research Division

Also, mostly have asked and answered, but a couple of ticky-tack questions, if you don't mind. Just to be clear on the expenses, I hear you on the 4% kind of ongoing growth rate we should generally expect. But should we think about it on a full year versus '13 base or kind of a 4Q run rate just because to factor in maybe the higher run rate on regulatory compliance cost that maybe were not fully baked in?

Michael G. O'Grady

Yes, Andrew, I would think about my comments there about growth more on an ongoing basis, meaning kind of multiple quarters year-over-year, if you will, as opposed to necessarily saying, every particular quarter that we're going to achieve a particular growth rate, whether that's revenues or expenses. And I hope that helps it.

Andrew Marquardt - Evercore Partners Inc., Research Division

And just a reminder that, that typically seasonally higher expenses still to be expected in the first quarter, is that fair because of the Open?

Michael G. O'Grady

Correct. So that dynamic will still play out this quarter.

Andrew Marquardt - Evercore Partners Inc., Research Division

Okay, got it. And then in terms of -- can you just remind us where you stand in terms of capital targets that you have internally for Tier 1 common Basel III, I guess, or is it PCE, good old-fashioned PCE? Or how do you think about what's appropriate for you guys?

Michael G. O'Grady

We think that in the current regulatory environment, it's important to look at a number of the ratios. So certainly Tier 1 common capital is an important ratio for us. Tier 1 ratio, we have internal levels that we look at for that as well. And then total capital, it's important to the regulators, it's also important to us. You saw us issue $750 million of subordinated debt in the fourth quarter. That was to bolster our total capital levels. And then the leverage ratio, also the supplementary leverage ratio, is an important focus, more recently, of the regulators. And so it's important that we feel comfortable with all our levels there, too. So overall, it requires us to look at a number of ratios. I will say that, that's going to get easier going forward with Basel I essentially going away and really being able to focus primarily just on Basel III ratios. That will actually seem easier than where we've been.

Andrew Marquardt - Evercore Partners Inc., Research Division

And that's because that is really the constraining factor? Is that fair?

Michael G. O'Grady

It's not as much the constraining factor per se, although we have very high Basel I ratios. But I would say, it's because that's what the regulators -- that's where they're focused, those are the effective regulations, so that's where we need to be primarily focused.

Andrew Marquardt - Evercore Partners Inc., Research Division

You guys are already at a fairly healthy combined payout ratio, is it fair to assume that you could do more than that in the upcoming CCAR? Or maybe you don't want to trigger them all again and -- how should we think about it?

Michael G. O'Grady

Yes. Don't know how they would think about it. And so all I can really say at this point, Andrew, given that we've submitted our capital plan, is we feel very good about our capital levels. We've put a tremendous amount of work into the CCAR process this year and that's been submitted. And we're working through the -- I'll call it diligence process with the regulators right now and we look forward to hearing back where they are when it comes down in March.

Beverly J. Fleming

And with that, we will end our fourth quarter call today. We look forward to talking to everybody in the middle of April when we will hold our Annual Meeting and also release first quarter earnings. Thank you very much.

Operator

This does conclude today's conference. We thank you for your participation.

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