Northern Trust Q3 2007 Earnings Call Transcript

Northern Trust Corp.(NTRS)

Q3 2007 Earnings Call

October 17, 2007 12:00 PM ET

Executives

Bev Fleming - Director of IR

Steve Fradkin - CFO

Aileen Blake - Controller

Preeti Sullivan - VP of Investor Relations

Bill Osborn - Chairman and CEO

Analysts

Mike Mayo - Deutsche Bank

Mark Fitzgibbon - Sandler O'Neill

Jason Goldberg - Lehman Brothers

Glenn Schorr - UBS

Gerard Cassidy - RBC Capital Markets

Tom McCrohan - Janney Montgomery Scott

Robert Lee - KBW

Brian Bedell - Merrill Lynch

Ken Usdin - Banc of America Securities

Presentation

Operator

Good day everyone, and welcome to the Northern Trust Corporation's Third Quarter 2007 Earnings Conference Call. Today's call is being recorded.

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

Bev Fleming

Thank you, Cynthia. Welcome to Northern Trust Corporation's third quarter 2007 earnings conference call. Whether you are participating in today's conference call live or via replay, we sincerely appreciate you taking the time to listen to Northern Trust's third quarter 2007 financial results.

Joining me this morning are Steve Fradkin, our Chief Financial Officer, Aileen Blake, Controller, and Preeti Sullivan from our Investor Relations team. In addition, we are joined this morning by Bill Osborn, Chairman and Chief Executive Officer, who will provide some opening remarks.

For those of you who have not received our third quarter earnings press release or our financial trend report by e-mail this morning, they are both available on our website at northerntrust.com. In addition, this October 17 call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available through October 24. 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 or 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 2006 Financial Annual Report, and our periodic reports to the SEC for detailed information about factors that could affect actual results.

Again, thank you for your time today. Let me now turn the call over to Chairman and Chief Executive Officer, Bill Osborn. Bill?

Bill Osborn

Thank you, Bev. First of all, I want to thank all of you for listening to me and working with me over the last 12 plus years. I am in an outside board meeting this morning and therefore I am going to make some comments, and then I will be available this afternoon back at the bank, if anyone wants to call me and ask me specific questions. But, let me first of all comment on the fact that yesterday at our board meeting, the Board of Directors approved a succession plan where I will step down at the end of the year as Chief Executive Officer, and Rick Waddell will assume the CEO role effective January 1 of 2008.

And I will remain Chairman of the Board, and I have not put down and nor has the Board decided on any specific retirement date for me as Chairman. My intention is to continue to work with the company and to be focused very much on client relationships, strategic issues that we are going to continue to deal with, and doing whatever I can to help Rick and the rest of the management group.

I've worked on this transition plan for well over 2 years, actually I started probably twelve and half years ago, but it's really been accelerating over the last couple years. And it's really driven at this time by the fact that I think the company is in absolutely terrific shape. We have great momentum as you saw in our third quarter earnings and all of our business year-to-date. Our global franchise continues to expand. Our personal business, our high-net-worth business has been doing terrifically well, and I see it has a lot of momentum.

And we’ve got a great management group. This is really the issue, Rick is ready to go, he's chopping at the bit to take over, and after twelve and a half years, it’s time for me to get out of the way and let a group take over, that I know that will just drive us to greater heights. I will continue to be around to help out wherever I can, and I’m very, very confident in the future of our organization.

I know that Rick, and Steve, and the whole group will continue to have the very open dialogue that I've maintained with all of you, and I appreciate all, that you all have done to support me in the Northern. This is a very special organization, and I know that you'll continue to have the same relationship with Rick as you have had with me, going forward.

Now, I’m going to just turn this over to Steve, but I just want to tell you again, if anyone has any specific questions, they can call me. I also want to mention, I know there is a lot of, there will be speculation. I am in perfectly good health, the company is in great shape, and this is literally a personal decision based on the fact that we have a great group that’s ready to go forward. And again, thanks very much, and I’m going to sign off now. Bye-bye.

Steve Fradkin

Thank you, Bill, and good morning, everyone. Let me extend my welcome to all of you listening Northern Trust Corporation's third quarter 2007 earnings conference call. Now, before I provide you with an overview of our third quarter performance, let me offer just a few comments on the management changes announced yesterday, and just discussed with you by Bill.

I hope that all of you will join me in congratulating Rick Waddell, our new Chief Executive Officer, effective January 1, 2008. As many of you know, Rick is a 32 year veteran of Northern Trust with a very diversified experienced set, expanding our banking, private client, strategic planning, wealth management, institutional, and more recently, investment businesses.

Rick has worked for Northern Trust, both in a headquarters context and from outside Chicago. And we are delighted to have someone with his breadth of experience and knowledge of Northern Trust, serving as our next CEO.

I would also like to take a moment to offer a few comments on behalf of the management team, with respect to Bill Osborn's decision to step down as CEO, while remaining Chairman of the Board, again all effective January 1.

Bill has been a true leader and steward of Northern Trust Corporation, not only during his twelve years as Chief Executive Officer, but also across his entire 37 year career. At a time when the conventional wisdom said, that size and consolidation were the watchwords for banks, and that only the big would survive, Bill executed large scale M&A transaction and filed ahead with industry leading growth rates on an organic basis.

When people said that he led a small mid-western institution, Bill defied them by building a premium national wealth management franchise in the United States, that now serves approximately 20% of the Forbes 400 Wealthiest America. When critics said that he ran a great company, but that the organization would never be able to compete globally, he led the company in a transformation that took it from earning approximately 7% of its net income from international activities in 1992 to approximately 35% in 2006. The vast majority of which again, was done organically.

When some said that he was too conservative with the balance sheet, and should take more risk, he ignored their admonitions and avoided the pitfalls of one-time items and restatements that others experienced.

And when people told him that it was either corporate performance or philanthropy, but that the two could not coexist, he ignored them yet again and consistently led the Company in making still in profit contributions equal to approximately 1.5% of pretax profits per year, in addition to the countless hours of his own time and energy, that he spends on civic issues, all while the Company still performed at the highest levels relative to others in it's peer group.

On behalf of all of his colleagues and friends here in Chicago, across the country and around the world, I want to thank Bill for his incredible and indelible contributions to Northern Trust. We look forward to his continuing work as CEO for the remainder of 2007 and his counsel as Chairman of the Board of Directors thereafter.

With that, let's move into a discussion of our third quarter performance. Earlier this morning Northern Trust reported very strong third quarter 2007 earnings of $0.93 per share, an increase of 26% compared to the $0.74 that we reported in the third quarter of 2006.

Net income equaled the quarterly record of $208 million representing an increase of 27% year-over-year. This was our eleventh consecutive quarter of double-digit, year-over-year growth in earnings per share, and our tenth consecutive quarter of double-digit year-over-year growth in net income.

Accumulation of client assets under custody and assets under management was robust. Assets under custody equaled a record $4.1 trillion on September 30, representing an increase of 24% compared with one year ago.

Assets that we manage on behalf of our clients experienced strong growth as well, equaling $761 billion at September 30th, up 14% compared with the year ago.

Now we have organized our earnings call today into three sections: first for the benefit of those of you who maintain detailed models on Northern Trust, I will outline two items that you should consider as you analyze our third quarter results.

Second, I'll review our financial performance focusing on those areas that most impacted the third quarter's results.

And third, I'll comment on an exciting announcement that we made on Monday, and also offer a few perspectives on the strategic positioning of Northern Trust in-light of the volatile market conditions that existed in the third quarter. As always, Bev and I will then be pleased to answer your questions.

As you analyzed our third quarter financial performance, I want to draw your attention to two items that impacted our reported results. First, in the third quarter Northern Trust recorded a gain of $6.3 million on the sale of shares of CME Group which is the parent company of the Chicago Mercantile Exchange. The gain on the sale of these shares is shown in our income statement in the Investment Security Transactions line.

Second, during the third quarter we recorded an income tax benefit of $5 million. This item relates to new state tax legislation enacted in the third quarter. We currently estimate based on our current interpretation of the tax law, that our deferred income tax reserves will be overstated by $5 million as of January 1, 2008, when the new law becomes effective. Therefore, we recorded a $5 million benefit in the third quarter as required by FAS 109.

With that background, let me review the quarter's key performance drivers. I will start with revenues focusing on the major items impacted our results.

Total revenues equaled $892.5 million in the third quarter, up a strong 19% or $143 million compared to last year's third quarter. Revenues grew 1% or $10 million on a sequential quarter basis. Recall that the second quarter is typically a seasonally strong quarter as a result of the international dividends season in securities lending.

Trust investment and other servicing fees represent the largest component of our revenue mix, accounting for 57% of total revenues in the third quarter. We are very pleased with the continued strong growth in this important revenue category across both, our private client and institutional businesses.

Trust investment and other servicing fees increased 16% or $71 million to $509 million compared to the third quarter of last year. Within this line item, PFS trust investment and other servicing fees equaled a record, $227 million in the third quarter, and grew 17% or $33 million versus last year's third quarter. This is our fourth consecutive quarter of double-digit year-over-year growth in PFS trust fees and the best year-over-year growth rate that we have achieved in PFS quarterly fees since the third quarter of 2000.

On a sequential quarter basis, PFS trust fees increased 1% or $3 million. Our excellent PFS fee growth reflects strong net new business. PFS net new business on a year-to-date basis represents the best nine months period achieved since the first nine months of 2001. In addition to excellent net new business results, the equity market environment relative to our quarterly PFS fees also provided support for the quarter's 17% year-over-year growth in fees.

Recall that our private client business across all PFS states is on a consistent monthly fee methodology with a one month flag. Using this monthly methodology, the S&P 500 was up 15% compared to one year ago.

Equity market support was not evident on a sequential quarter basis as the S&P 500 was flat compared to the second quarter, using the PFS month flag methodology. Keep in mind too, that PFS manages broadly diversified portfolios for client. The asset allocation of PFS Managed Assets as of September 30th, was 49% equities, 24% fixed income, and 27% cash and other asset class.

Our fee growth in PFS is derived largely from growth in client assets, whether winning new clients or doing more to support the needs of existing client. We were very pleased with our ability to aggregate private client assets at attractive rates of growth in the third quarter.

PFS assets under management equaled a record, $147 billion at September 30th, up 15% or $19 billion from a year ago, and up 2% or $2.5 billion sequentially.

Assets under Custody in PFS also equaled a record, reaching $329 billion at the quarter-end. PFS Assets under Custody increased 36% or $86 billion from a year ago, and were up 3% or $10 billion sequentially.

The ultra wealthy client segment within PFS, which we called the Wealth Management Group, continues to be an outstanding contributor to our growth. Wealth Management serves the complex needs of some of the world's wealthiest families.

We currently work with 20% of the Forbes 400 richest Americans. Forbes published its 25th anniversary edition of the Forbes 400 in September. The minimum net worth required to earn a spot on the Forbes 400 list in 2007 rose to $1.3 billion in wealth, signifying the very high-end of the wealth market. The average size of our custody relationships would be approximately 380 families served in Northern Trust Wealth Management Group, across $0.5 billion mark at September 30.

Fees in our Wealth Management Group for the third quarter equaled $33 million, an increase of 16% or $5 million compared with last year. This fee growth was fueled by excellent year-over-year growth in Wealth Management client assets. Custody assets in Wealth Management equaled $192 billion at September 30, up 55% or $68 billion from one year ago.

We also manage a portion of the assets that our Wealth Management clients have placed in custody at Northern Trust. Managed assets in Wealth Management totaled $29 billion at September 30, up 18%, or $4 billion year-over-year. On a sequential quarter basis, Wealth Management fees declined 4% or $1 million. This sequential quarter decline in Wealth Management fees is not reflective of the core positive trends that we are seeing in the business.

Rather the sequential decline in Wealth Management fees resulted from a prior period adjustment. The sequential quarter trend in custody assets was strong in Wealth Management with assets under custody increasing $7 billion or 4% compared with June 30.

Wealth Management assets under management equaled to $29 billion at September 30, which were all lower than the $30 billion high reported at June 30, again, primarily reflected in the adjustment from the prior period.

Switching to our Institutional business, C&IS trust investment and other servicing fees equaled to $282 million in the third quarter, an increase of 16% or $38 million year-over-year. C&IS fees declined 9% or $27 million, when compared with the seasonally strong second quarter. C&IS fees includes three primary revenue areas, custody and fund administration, institutional asset management and securities lending.

Let me discuss the performance of each in the third quarter. C&IS custody and fund administration fees equaled $159 million in the third quarter, up 27% or $34 million year-over-year. This strong double-digit custody fee growth was driven by market growth, new business, particularly in global custody and higher transaction volumes during the quarter,

Sequential growth in C&IS custody fees was also strong, up 8% or $11 million compared with the second quarter. Sequential growth was also driven by market growth in new business, including strong new business in fund administration.

Recall that C&IS custody fees are built on primarily on a one quarter lag basis. For the year-over-year comparison, the S&P 500 was up 18% versus prior year on a one quarter lag basis. And EAFE Index was up 20%. Market growth on a quarter lag sequential basis, was also supported with fee growth with the S&P 500 up 5.8% in the second quarter and the EAFE Index up 4.9%.

An important contributor to C&IS custody fees is our ability to successfully aggregate client asset. Institutional assets under custody equaled a record, $3.8 trillion at September 30, up 24% or $722 billion from a year ago, and up 3% or $118 billion versus last quarter.

International activities continued to fuel the institutional assets and fee growth in the third quarter. Global custody assets equaled $2 trillion at September 30, an increase of 31% or $476 billion from a year ago.

The third quarter represents the eighteenth consecutive quarter that we have reported double-digit year-over-year growth in global custody assets. On a sequential quarter basis, global custody assets were up 5% or $91 billion.

Investment management fees in C&IS equaled $73 million in the third quarter, an increase of 15% or $9 million year-over-year. Growth was driven by both, new business and positive markets. New business results were strong in short duration assignments, including institutional mutual funds and cash sweep products, and in quantitative management.

Note too, that in our institutional asset management business, we manage a wide array of asset classes for clients. The asset allocation of C&IS managed assets, as of September 30 was 33% equities, 9% fixed income and 58% short duration and other. Institutional investment management fees increased 2% or $1 million on a sequential quarter basis. Managed assets for institutional clients equaled $615 billion at September 30, up 14% or $75 billion from last year and down 1% or $8 billion sequentially.

The sequential decline primarily reflects a lower level of securities lending collateral, reflective of the deleveraging phenomenon that occurred during the third quarter as a result of the challenging fixed income environment. C&IS securities lending fees equaled $33 million in the third quarter, representing a decrease of 19% or $8 million, compared with last year's third quarter, and a decrease of 55% or $40 million, compared with the record $73 million that we posted in the seasonally strong second quarter of 2007.

Securities lending collateral equaled $284 billion at September 30, up 14.5% or $36 billion versus one year ago, and down 5% or $16 billion compared with June 30. So, let me pause for a moment and provide some perspective around our securities lending results in the third quarter.

Securities lending is a low risk, value added product that has been a consistent source of incremental return for our clients over a long period of time. The credit market environment in this year's third quarter had a negative impact on securities lending results that we are reporting today.

Let me start by describing the mechanics of securities lending to you, after which, I will describe the factors that impacted our third quarter securities lending results. Securities lending is a service that is offered to our clients. Northern Trust acts as agent for our clients in the administration of the securities lending program.

For those participating clients, we lend their securities to high quality, credit committee approved financial institutions. Now I should add as well, that we do not lend securities directly to hedge funds. In return for the lend securities, borrowers provide collateral, typically in the form of cash equal to 102% to 105% of the borrowed amount. The lender of the securities, haze the borrower a rate of return on their cash collateral, called the rebate rate, which generally floats with the Federal Funds Rate. On behalf of our clients, who have lent their securities to approved borrowers, we invest their cash collateral in a variety of investment pool. Our clients select which investment pools they would like to have their cash collateral invested in, depending on their return objectives and risk tolerance.

Investment options available to our clients to their securities lending collateral stand a risk reward continuum of short duration investment management products. Our clients then earn a return on their participation in securities lending, based on the spread between what is earned on the collateral and what is paid to the borrower as a rebate rate. These earnings are apportioned between the client, the owner of the lend securities and Northern Trust, the agent of the program at a negotiated percentage amount.

Our securities lending results in the third quarter were adversely impacted by this summer's disruption in the credit environment, which began with concerns in the sub-prime mortgage market and spread to the fixed-income arena more broadly.

It is also important to note that there were positive offsets in our securities lending business to the sub-prime mortgage contingent in the third quarter, including strong demand for treasury securities and the Federal Reserves 50 basis point reduction in the Federal Funds Rate later in the quarter. This noted the extreme credit market disruption did negatively impact returns achieved in one cash collateral investment fund used for securities lending.

Approximately 6% of our $284 billion in securities lending cash collateral is invested at our client's selection and discretion in a total return mark-to-market, short duration, fixed-income fund. This is our only meaningful fund that is structured as a mark-to-market fund and understanding this designation is essential to understanding the impact during the quarter.

Our other tax collateral investment options do not recognize mark-to-market fluctuations in the yield. The consequences of being a mark-to-market fund during the third quarter of 2007 worst of the year, as fixed income securities were repriced across even the highest quality instruments. Assets value changes, in this case asset value markdowns flowed directly through to the total return of the fund, thus impacting the earnings of a small numbers of our securities lending clients during this period and Northern Trust's securities lending fees as well.

While the environment was a challenging one for this fund, in particular. And therefore for our overall securities' lending revenues, I do want to make a few key points.

First, this mark-to-market fund has followed its investment guidelines consistently and appropriately. No way typical portfolio management decisions were made in the fund prior to, during or after quarter end. Its performance results reflect the full impact of the extraordinary market environment.

Second, the fund does not use leverage. Third, the fund did not post a negative total return for the third quarter. Put in another way, the fund earned a positive annualized return for the third quarter of 2.72% to be precise.

Keep in mind however, that securities lending revenue is earned based on the spread, between what is earned on the collateral pool and what is paid in terms of the rebate rate. With this fund having earned 2.72% annualized in the third quarter, and Fed funds averaging a little over 5%, you can see how the negative net spread on this specific fund would yield negative securities lending earnings across the quarter.

Fourth, the fund has a very high quality profile. 64% of the securities held in it are rated either AAA or AA.

Fifth, the fund is conservatively managed with an interest rate sensitivity of 65 days and a credit based weighted average maturity of 1.65 years as of September 30.

Sixth, the third quarter total return of the fund reflected negative marks-to-market on a broad mix of holdings. We do not believe at this time that there exists any permanent impairment of any holdings. All of the asset markdowns recorded in the fund during the third quarter are unrealized, and we expect given what we know, that all of the funds holdings will mature at par as expected. Any such future positive marks-to-market would similarly be reflected in the yield of the fund and the resultant securities lending revenues.

And lastly, the fund is used as a securities lending cash collateral option by only a small number, approximately 10 of our more sophisticated clients. None of these clients uses this mark-to-market fund exclusively for their collateral investments. All have other less aggressive funds to round out their total collateral investments.

Moving on through our revenue line items let me shift our discussion to net interest income, which accounted for 26% of revenues in the third quarter. Net interest income equaled a record $228 million, an increase of 15% or $30 million compared with last year. On a sequential quarter basis, net interest income increased a strong at 9% or $20 million.

The driver of the year-over-year increase in net interest income was balance sheet growth. Average earning assets equaled $54 billion in the third quarter, an increase of 18% or $8 billion year-over-year. Growth in average earning assets was broad-based with money market assets up 22%, securities up 25%, and loans up 12%.

Client oriented growth on the liability side of the balance sheet continued to fuel the increase in earning assets. Once again and consistent with trends in prior quarters, liability growth was driven by non-U.S office time deposits, which averaged $28 billion in the third quarter, up 26% or $6 billion versus last year. This strong growth in non-U.S office time deposits is directly related to our international success in the institutional custody business, which I discussed earlier.

The strong sequential growth of 9% in net interest income was driven by several factors.

First, recall that in the second quarter, net interest income was reduced by $7 million representing the entire first half amount related to our adoption of FSP 13-2, the FASB standards pertaining to Leveraged Lease accounting. The comparable third quarter amount recorded for FSP 13-2 was $2.5 million resulting in a $4.5 million favorable sequential swing.

In addition, net interest income in the third quarter benefited from wider spreads between overnight rates and one to three months rate. This widened spread at the short-end of the yield curve was driven by the disruption in the credit markets during the quarter, and late in the quarter by the Federal Reserve Banks 50 basis point cut in the Federal funds rate.

Our net interest margin in the third quarter equaled 1.69%, down four basis points from the prior year and up 11 basis points sequentially. The 4 basis point year-over-year decrease in our net interest margin reflects the mix shift on the asset side of our balance sheet that I have described in past call.

As I mentioned earlier, our international business has been a strong growth driver at Northern Trust for over a decade. As this business grows, our clients place their short-term cash on our balance sheet in the form of non-US time deposits. These deposits in turn have been predominantly invested on the asset side of our balance sheet, in a lower margin short-term money market assets and securities, which profile differently when compared with the relatively higher margins associated with traditional loans.

This mix shift in earning assets which is directly linked to the success of one of our core growth strategies is the primary reason for the decline we reported in our net interest margin. The sequential increase in our net interest of 11 basis points was driven by the same two factors that influenced the sequential increase in net interest income. First, the lessened impact of FSP 13-2, and second, wider spread between overnight rate and one to three month rate.

Foreign exchange trading income of $92 million equaled a record up 74% or $39 million compared with the third quarter of 2006. On a sequential quarter basis, foreign exchange trading income increased 13% or $11 million.

The key drivers of our quarterly results in foreign exchange were volume and volatility; both were very high in the third quarter, with client volumes up significantly both year-over-year and sequentially. Currency volatility was also quite high, due in large part to the disruptions in the credit market. This was a clearly an unusual third quarter for our foreign exchange activity, and that the summer months are typically the quietest and therefore more often they're not the seasonally slowest of the year for foreign exchange trading. The normal July-August slowdown certainly did not occur in the summer of 2007.

Other operating income equaled $23 million, a decrease of 19% or $5.5 million compared with the prior year and a decrease of 21% or $6 million sequentially. The majority of the year-over-year and sequential declines resulted from currency revaluations intended to hedging activities, and a small additional loss accrued in the third quarter for the disposition of Isle of Man fund administration business.

Recall that other operating income in the second quarter of 2007 was elevated, as it included a $4.9 million gain on the sales of leased equipment, partially offset by a $3 million initial loss on the Isle of Man business.

As I mentioned at the outset of this call, during the third quarter we sold shares of the Chicago Mercantile Exchange and recorded a gain of $6.3 million. Northern Trust has held seats on the Chicago Mercantile Exchange and the Chicago Board of Trade for many years. The initial public offering of the CME and its subsequent merger with the Chicago Board of Trade resulted in a publicly traded share ownership position by Northern Trust in CME Group, which was the source of the shares that we sold.

During the third quarter, we recorded a loan loss provision of $6 million compared with the provision of $6 million in the third quarter of last year, and $4 million in the second quarter of this year. The majority of our loan loss provision this quarter reflects loan growth as average loans increased 12% year-over-year and 3% sequentially.

Non-performing assets totaled $29 million at quarter-end, down $3 million from $32 million at June 30, and equaled only 12 basis points of total loans on September 30. We recorded $2 million in net charge-offs during the third quarter.

Now let me shift my comments to a review of the key expense categories that impacted our third quarter performance.

Expenses during the third quarter of 2007 equaled $567 million, up 19% or $90 million from the year ago quarter. On a sequential-quarter basis, expenses were up 2% or $11 million. Compensation expense equaled $260 million and increased 20% or $44 million from the year ago period. The year-over-year increase in compensation expense reflects higher incentive compensation, additional staff to accommodate growth and expansion, our April 2007 annual salary merit increases, and market and promotional increases.

Staffing levels equaled approximately 10,600 full-time equivalent positions at quarter-end, including approximately 630 staff at our operation center in Bangalore, India. Total staff count was up 11% from last year. Staff in India was up, 430 full-time equivalent positions year-over-year from the 200 reported last year and increased 26% from last quarter.

On a sequential-quarter basis, compensation expense increased 3% or $8 million, primarily reflecting increased staff level. Employee benefit expenses equaled $57 million in the third quarter up 8% or $4 million versus last year, and down 3% or $2 million sequentially. The year-over-year increase was primarily driven by higher staff levels, partially offset by lower pension costs. The sequential decline primarily reflects normal seasonal declines in freighter insurance.

Outside services equaled $99 million, an increase of 31% or $24 million compared with last year and 6% or $6 million sequentially. The year-over-year increase primarily reflects higher expenses driven by increase in client volumes, such as global sub-custodian fees and investment management sub-advisory fees. In addition, technical and consultant services increased year-over-year. The sequential increase was driven primarily by higher consulting services.

Equipment and software related expense equaled $54 million in the third quarter, up 4% or $2 million year-over-year and down 4% or $2 million sequentially. The year-over-year increase is primarily attributable to higher software amortization resulting from continued investment in technology. The sequential decline primarily reflects a $3 million software write down taken in this year’s second quarter.

Occupancy expense in the third quarter equaled $39 million, up 16% or $5 million, year-over-year and down 7% or $3 million sequentially. The year-over-year increase is primarily attributable to higher rent and building operation cost. The sequential decline primarily reflects a $3 million rent expense adjustment in the second quarter of 2007, which represented a catch up related to certain rent escalation causes in existing leases.

Other operating expense equaled $58 million in the third quarter, an increase of 21% or $10 million compared with last year.

On a sequential basis, other operating expense increased 8% or $4 million. The primary drivers of both the year-over-year and sequential increases were charges related to securities processing activities and employee hiring and relocation expense.

Our provision for income taxes in the third quarter equaled $93 million resulting in a tax rate equal to 30.8%. This compares to a tax rate of 34.6% in the third quarter of last year and 33.2% in the second quarter of this year.

The lower tax-rate on a year-over-year basis primarily reflects two items: first, we recorded a state tax benefit of $5 million related to the new tax legislations, as I mentioned in my opening remarks.

And second, we continue to benefit from our adoption of APB 23. Recall that in the fourth quarter of 2006 and in the first two quarters of 2007, we recorded tax benefits associated with our decision to indefinitely reinvest earnings of certain non-U.S subsidiaries. The sequential decline in our tax-rate primarily reflects the $5 million state tax benefit.

Northern Trust repurchased 1.2 million shares of common stock in the third quarter at a cost of $77 million. Diluted shares averaged $224 million. We can purchase an additional 9.8 million shares under a buyback authorization approved by our Board of Directors in October of 2006.

In keeping with our practice, we increased average common equity by 11% versus one year ago to a record $4.2 billion at September 30.

Let me close with one exciting update that I hope you all heard about and then a few thoughts on the positioning of Northern Trust, particularly in light of the volatile and disruptive market environment that we all had to contend with in the third quarter.

This past Monday, we jointly announced with the PGA Tour, that Northern Trust has become the title sponsor for the PGA's historic golf tournament at Riviera Country Club in Los Angeles, beginning in February 2008.

With this five year agreement the tournament will be named the Northern Trust Open, marking the beginning of a transformation process through this high profile tournament. The Northern Trust Open will provide us with another platform to showcase our premier brand and raise our brand awareness. The men and women who play, who watch, play and enjoy golf mirror our target demography. We have been continuously building and extending our global brand awareness through increased advertising in print, online, and on televisions, and through prominent sponsorships.

The Northern Trust Open will help continue to drive our brand awareness both in the United States and the around the world. This major event enjoys great media exposure, reaching more than 450 million households in more than a 150 countries.

Viewed from any angle, global reach, demographic fit, client interaction, philanthropic support, and brand synergy, the Northern Trust Open represents a terrific platform to strengthen the Northern Trust brand.

And now let me shift from marketing to the market environment. As you know the third quarter posed extremely challenging market conditions, particularly in the month of August. We saw the result of this in the variety of company crisis, earnings preannouncements and earnings releases with weaker results.

Financial services firms had to contend with the sub-prime mortgage crisis, which then morphed into a broader contingent. Equity fixed income and currency markets were all volatile and the Federal Reserve also jumped into the fray with the 50 basis point rate cut late in the quarter.

The environment tested many great firms and a wider array of financial services business model. This was a period in which the strength of Northern Trust strategy, business position and execution was clearly in evidence. Though not immune from the dynamics of the broader environment in which we and our clients operate, we were very pleased with the strength of our results and the inherent quality embedded in our management prophecy.

Our client focus and conservatism across cycles continues to serve Northern Trust and its shareholders well. We have in our view, an attractive and enduring business model. Our attractive and enduring business model is evident in the intensity of our focus. We concentrate our efforts on only two, very targeted clients' segments; institutional clients, served by our Corporate and Institutional Services business unit and private clients, served by our Personal Financial Service business unit.

These two clients facing business units are supported by our investment management arm, Northern Trust Global Investments, which delivers a wide range of investment management solutions to our target clients. And by our Worldwide Operations and Technology unit, which delivers products and services to our clients on one integrated operations and technology platform globally.

We have not strayed from this focus. We have not sort entry into 10 gentle businesses, such as retail consumer lending, sub-prime mortgage origination, sub-prime mortgage packaging or wholesaling, credit cards or investment banking.

Our attractive and enduring business model is evident in our commitment to our organic growth. We have not chosen to take or undertake rather large scale, culture changing mergers and acquisitions to drive our revenue growth.

Our use of M&A has been very selective and strategic. We have undertaken acquisitions only to facilitate entry into new geographic markets or to assist us from a product perspective in meeting the needs of our target clients. And where we have undertaken acquisitions, they have been managed within the broader enterprise and the management of our overall risk profile.

Our attractive and enduring business model is evident in the strength of our balance sheet. We maintain a conservative securities portfolio that takes limited credit, currency and interest rate risk. That conservative stand positioned us well to manage through the difficult fixed income environment in the third quarter.

We also have excellent loan quality, a hallmark of Northern Trust relationship lending strategy for many years. Our relationship lending strategy consistently applied across the years means that we do not provide rich financing on private equity or leveraged buyout yield.

Non-performing assets actually declined in the third quarter and represented a minimal 12 basis points of loans. A figure that historically ranks among the best of the largest banks in the United States. In addition, we do not have any off-balance sheet commercial paper conduit facility.

Our attractive and enduring business model is evident in our capital strength. Northern Trust maintains very strong regulatory capital ratio. All of our subsidiary banks maintain capital ratios above the level required for classification, as well capitalized. And we have increased our stockholder's equity at Northern Trust for 78th consecutive quarters or over 19 years, a record that we believe is unmatched among large banks in the United States.

And our attractive and enduring business model is also evident in our asset management business, where we have dramatically expanded the array of capabilities available to our clients in recent years. We make little use of various strategies that have been in the headlines of late.

Our investment strategies do not employ leverage with the very small exceptions of modest leverage employed in our 130-30 strategies. We also have only very small holdings of sub-prime asset backed securities in some of our investment portfolios, and those holdings are limited to short-term AAA tranches representing the most senior tranches in the structure.

In short, we continue to focus on the targeted market and client segments that we have served well for many years, and that we continued to have excellent long-term growth demographics. This is a strategy that has served us well, in both good times and tumultuous times such as those experienced in the most recent quarter.

In closing, our performance in the third quarter again validated our focused business strategy and our consistent attractive and enduring business model. We are very pleased with the financial results that we are reporting to you today including strong top-line revenue growth and attractive double-digit earnings per share and net income growth.

And now, Bev and I would be happy to answer your questions. Cynthia, please open the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). We will take our first question from Mike Mayo with Deutsche Bank. Please go ahead.

Mike Mayo - Deutsche Bank

Good afternoon.

Steve Fradkin

Hi Mike.

Mike Mayo - Deutsche Bank

Just some questions on the one-timers, you mentioned right off at that, the tax benefit and the sale of the CME shares, it seems like the couple of other items. Outside services, it was up $6 million, should we consider that core or was that temporary?

Steve Fradkin

You're with me, Mike.

Mike Mayo - Deutsche Bank

I am really just trying to see if there's any unusually high expenses that might go away?

Steve Fradkin

No, I think, Mike, obviously, the CME is one-time, the tax rate was one-time, but there was nothing dramatic that comes to my mind that would be additive to that.

Bev Fleming

And Mike, when we do have items that we know that you all would consider as one-time, we do try to disclose that in that upfront section of our call. So, had we had any other items that we felt, you should be aware of, we would have mentioned them during the call.

Mike Mayo - Deutsche Bank

Okay. And other income being down $6 million from the second quarter?

Bev Fleming

Well, we gave some of the detail, Mike there, during the prepared remarks. We did so Mike.

Steve Fradkin

I don't think there is anything to add.

Mike Mayo - Deutsche Bank

And you spent a lot of time on securities lending, if we were thinking about normalizing that, how might we go about that?

Steve Fradkin

Well, I think Mike, as I said on securities lending, you really have to understand this constructive and mark-to-market fund versus a constant dollar NAV and there are a variety of guidelines that drive the appropriateness of when one would have one structure versus another, but I want to emphasize understanding that vehicle structure really is critical because the mark-to-market fund is fully transparent. And if you had the same holdings in a custom account, a non-mark-to-market fund, we would have reported dramatically, different results.

So, for example, our holding in the mark-to-market fund, if you had the exact same holding, exact same profile, and put those in a custom account, our securities lending results would have increased by approximately 70%, compared to what we reported, which was a 19% year-over-year decline. So, I mean it’s a very dramatic point that needs to be understood.

Bev Fleming

The other point that I would make, Mike, is, it’s difficult, I think for any of us to “normalize” the securities lending. Keep in mind that, typically the third quarter would have seen a decrease from the second quarter, which is typically the seasonal peak, and of course, as you saw it, some of peers, that didn’t happen, because it affected the market environment was so tumultuous in the third quarter. So, it’s difficult to normalize when you are coming off of such a tumultuous period.

Steve Fradkin

The other thing I will add, Mike, to that, because I’m sure, you or someone else would have the question is, when you think about the timing of the recruitment of that yield, that is going to be very difficult to predict. And it’s impossible for me to predict exactly how quickly that’s going to happen because you need the credit markets to stabilize, but I guess what I would say, without giving forward-looking guidance which we don’t give, is that with all those caveats noted, and assuming that there is no change in impairments or anything like that, we would estimate that the yield on the mark-to-market fund would reflect positive marks as we progress from now through 2008. So, sometime over the next 18 months, the headwind that we got on mark-to-markets this quarter will be recouped as we move into 2008.

Mike Mayo - Deutsche Bank

So, we do not long to wait to see that?

Steve Fradkin

No. Again, I cannot predict with pinpoint accuracy, but that’s our best guess at this point in time.

Mike Mayo - Deutsche Bank

And then, just one separate question on the processing business, good revenue growth, but the revenue growth is almost twice as fast as the growth in assets under custody linked quarter. Just wondered, if you had any color on that, and you are operating in a consolidating world. Are you seeing any benefits from that and also the international growth within processing?

Steve Fradkin

That’s about half hour question. But, what I would say Mike is, look, we feel terrific about our asset servicing business and the growth rates there, and have no apology for the success that we have had in keeping and aggregating new clients on that front. Pipelines remain strong, international growth as in past quarter has been strong.

As to the asset management business, we feel very good about the growth this quarter on the assets under management front. You are correct in noting that the rate of growth, if you want to compare that to our assets under custody differs, but remember, you have a vastly different asset allocation paradigm for our managed assets. So, I think it' being a relatively small equity asset manager, I think it’s a mistake to impute market growth to our assets under management growth. But we feel good about the growth this quarter.

Mike Mayo - Deutsche Bank

And international?

Steve Fradkin

International continues to be terrific, global custody assets up 31% year-over-year, pipelines are strong, had a great win with State of Tennessee, which was a $29 billion public fund and tempo is consistent with past quarters.

Mike Mayo - Deutsche Bank

And pipelines are strong. Do you ever quantify that as some of your competitors do?

Steve Fradkin

No, we don't give any metrics on number of clients in the pipeline or profits in the pipeline or dollar value. But we continue to feel very good and as you said the market is consolidating, there is a small group of players there. So, there is I think plenty of opportunities for all of us.

Mike Mayo - Deutsche Bank

Alright. Thank you.

Steve Fradkin

You're welcome.

Operator

We will take our next question from Mark Fitzgibbon with Sandler O'Neill. Please go ahead.

Mark Fitzgibbon - Sandler O'Neill

Thank you for taking my question. First let me echo my congratulations to Bill and Rick on their new roles. Steve, I wanted to first just ask the securities lending question in different way. How much would you estimate that one mark-to-market fund affected the securities lending line in this quarter?

Steve Fradkin

Well, again Mark if you think about it, we reported results that were down 19% year-over-year. If you impute and this is rough math, but if you take the exact same holdings as resided in that fund and their status and you put them in a custom account, which is not mark-to-market, that result would have swung us from being down 19% to up 70%. So the transparency of a mark-to-market fund had a dramatic affect on reported result. And again, I think the key point here is absence impaired holdings or a change in what we know, is that that should be a tail win for us, again difficult to predict exactly when it will hit, but it should strengthen our securities lending results over the next 15 months or so.

Mark Fitzgibbon - Sandler O'Neill

Okay. And then the second question, I had relates to assets under management which were down, I think about $5 billion or 1% linked quarter, was that a function of performance within the products or was it a function of fund flows or fund outflows actually?

Steve Fradkin

Sorry. The assets under management was really just a function of the securities lending collateral and the de-leveraging that we saw. So, it wasn't really what you might think of this traditional core asset management.

Mark Fitzgibbon - Sandler O'Neill

Okay.

Bev Fleming

Mark, if you take securities lending out of the total assets under management, the sequential growth goes from a decline as you mentioned of 5% to actually an increase of 2.4%. And I am sure that the Equity 500 was up a little less than 2%, and we are not exclusively equity managers. So, I think actually we feel quite good about that, when you take into account the de-leveraging phenomenon in securities lending.

Mark Fitzgibbon - Sandler O'Neill

Okay. And then, also I noticed your non-U.S. loans have risen fairly rapidly, and are just approaching $2 billion now. Could you give us a sense for the kind of loans that you are making outside the U.S?

Steve Fradkin

A lot of that Mark, relates to the fund administration business that we acquired several years ago from FSG. These are liquidity lines. These are not traditional, if you will corporate loans. These are all attendant to the business we undertake with fund managers. So, it's a very, very clean portfolio and one that we are very comfortable with.

Mark Fitzgibbon - Sandler O'Neill

And the last question is, I wondered if you can give us a sense for what the pipeline looks like in the C&IS business, is it increasing, decreasing, stable and maybe where is that coming from?

Steve Fradkin

I think the pipeline is terrific. And we have attempts to imply a level of precision on increasing, decreasing, relative to last quarter. But I'd say, it's very strong, we've got a lot of great activities. Great opportunities, they are all around the globe. They cross a wide array of segments. And I think that's one of the things you got to think about. You got to think about the whole world, opportunities in virtually every country. You got to thing about the wide array of segments from insurance companies, to foundations, to endowments, to fund managers, to pension funds, a whole host of opportunities. And then you have to think in terms of the relatively small number of firms globally that are equipped to serve those opportunities. And I think, when you look at it in that construct you can understand just how big the opportunities are, I think for all of us.

Bev Fleming

And Mark if I could add one point on your question about our non-U.S loan portfolio, when we issue our 10-Q in a few weeks, we include a table on loans and one of the things that you'll see in the table and you would have seen in the past is that, included in that non-U.S line item in addition to what you would consider to be traditional lending as Steve described, would be short-term advances associated with processing of Custody assets. So, and that you will see when we issue our 10-Q that that line item, short duration advances actually was a significant driver of the growth in non-U.S loans.

Steve Fradkin

So, there is a traditional overdraft phenomenon associated with being custodians to these funds.

Mark Fitzgibbon - Sandler O'Neill

Thank you.

Steve Fradkin

Welcome.

Operator

We will take our next question from Jason Goldberg with Lehman Brothers. Please go ahead.

Jason Goldberg - Lehman Brothers

Thank you. You mentioned security process related charges, it standardizes [quite to], that you guys are not doing something on timely basis and can you quantify that?

Steve Fradkin

Sure. Jason, we have as you know, we process trillions and billions and at any given point. Though there is a lot of automation and a lot of high quality, there will be losses associated with mis-processing, mis-input, not timely handling a corporate action or what not, and so, we did have a modest degree of that this quarter. It's a normal part of the business, you can't get away from it but, and we'll go and system starts. So, that is an aspect that we had to deal with this quarter, but I don't look at it as a major factor in anyways signaling a trend.

Jason Goldberg - Lehman Brothers

Okay. You don't care to quantify it?

Steve Fradkin

No, we're not quantifying it.

Jason Goldberg - Lehman Brothers

And then you mentioned the Wealth Management, that's throughout this quarter it sounded like?

Steve Fradkin

Sorry. Say that again Jason.

Jason Goldberg - Lehman Brothers

You mentioned an adjustment in the Wealth Management line or it sounds like may be it was a throughout or something you can expand on?

Steve Fradkin

It was just a prior period adjustment to what we have, the instance that comes to mind, we had a client come-in very late in the second quarter and we misquoted them in terms of assets under management versus assets under custody, we caught it after we had released results. So, it's just a prior period adjustment to what we had said last quarter. I think the key point Jason is, you wouldn't want to look at the reported downdraft sequentially as indicative with the trend because it's just an adjustment.

Jason Goldberg - Lehman Brothers

Got you. And then, I guess any thoughts on eliminating the mark-to-market funds from your sec lending offerings?

Steve Fradkin

This is a client-driven decision, if clients want to be in a pooled vehicle with this kind of profile, it really has to be a mark-to-market fund. So there is not a lot of discretion. To the extent that if you want to be in a fund with this characteristic, you couldn't make this account, if you couldn't appropriately make this accounts to dollar NAV. The question would be, do clients want separate accounts, rather than participating in a pooled vehicle? And obviously if they do want that, we would be happy to accommodate them. But again, I think you would want to look closely, if this is a timing phenomenon.

Jason Goldberg - Lehman Brothers

Got you. And then, also, if I guess what would be the normalized, I guess tax-rate I know the last couple of quarters a bit -- have been a bit, at not the normal?

Steve Fradkin

Well, we’ve traditionally been at 35% plus or minus tax-rate, as you may recall back in 2006 we talked about the implementation of APB 23 and how that would likely on average overtime bring it down a point. We've been lower than that more recently. Again in this quarter at 30.8%, but we also have this, the one time state tax benefit. So, I don't know that I can give you absolute guidance on that.

Bev Fleming

The one thing that you can do Jason, is you can adjust the 30.8% for the $5 million tax law change impact and that would get you to 32.5% for the quarter. So, it would be appropriate to remove that $5 million from your thinking going forward because that was affected by just this tax law change.

Steve Fradkin

And again, this is going to move around a bit, because of the growth in our -- to the extent that our international business rose at a more rapid rate and the business in those tax beneficial jurisdictions that will have a more dramatic effect. So, there will be a little bit of movement in the tax-rate.

Jason Goldberg - Lehman Brothers

Okay, and then just lastly, I guess year-to-date the operating leverage is running at bit negative, you guys have a long history of positive operating leverage, particularly when the markets are higher, and I guess you have just any just thoughts around expense management?

Steve Fradkin

Well, I think essentially we were neutral this quarter 19% revenue growth, 19% expense growth, I think if you -- depending on what adjustments you want to make, I think we are modestly positive year-to-date, but you are right the operating leverage is much closer to neutral than it is to significantly positive. I guess on the expense front Jason, I would offer a couple of observations. One, remember that we have a fair amount of volume associated growth; we've got a lot of activity sub-custody fees, sub-advisor fees. So, as our assets grow as we win new clients, we are just, that is part of the scenario that we have to deal with.

We've also brought on a fair number of staff, you're seeing our headcount is up 11% year-over-year and the overall, not withstanding the third quarter turmoil, the competition for talent has been high and that drives some of our expense. And we are continuing to invest on a variety of fronts in capabilities, if you look at our back and middle office outsourcing, if you look at our pooling, you look at derivatives, alternative asset processing and alike, some of the things we are doing on the technology, our geographic expansion, our expansion in India.

So, as always, we are trying to balance the expense growth within the construct of our revenue profile and so far, I think we've got it where we wanted to be. But, it is not as positive as we've been in the past quarters, but again we look at that as a time and space thing and we feel now is the right time to do some things that are going to help our clients and the market opportunities that we are seeing.

Jason Goldberg - Lehman Brothers

That's helpful. Thank you.

Operator

We will take our next question from Glenn Schorr with UBS. Please go ahead.

Glenn Schorr - UBS

Thank you. Just one quickie, that the yield on PFS assets as in perfect as the calculation it is, but assets are growing at a lot quicker pace than the revenues. I am just curious on how much would you attribute that towards things like open architecture versus specific products that clients are more interested in these days?

Steve Fradkin

I think Glenn, you have to remember that our PFS assets include the wealth management, in fact the wealth management being the very, very large end of the market. And so when you try and look at the sort of the managed asset equation, it's going to get skewed a bit because when we bring on these very large wealth management clients, while we almost always are managing some assets, it’s a relatively smaller proportion. When you manage money for $5 million client, you tend to manage all of it directly or through open architecture. When you take on a $5 billion client, we manage -- have investment management fees for 15% to 20%. So I think if I understand the root of your question, the phenomenon you're seeing is the dramatic growth in our assets under custody, driven by our wealth management franchise.

Glenn Schorr - UBS

Is it fair to say, then the real question becomes, is the like-for-like margin stable enough? In other words, within wealth management specifically the yield on incremental assets, similar to what's on the books for other wealth management customers?

Steve Fradkin

I don’t have the signs in front of me, so I am just going to give you a directional observation. But we have not seen in our PFS business a degradation at all of the pre-tax profit margin. Now, again you have to remember some of it gets skewed because using the wealth management example, you can take on a very large family that has a very significant single stock concentration, and so the assets can go up quiet dramatically. But the fees won't go up as dramatically and they may be affected in part by a single stock concentration as well. So if you look at our pre-tax profit margins at the corporate level, at the segment level they've been rock solid and consistent so I don't see any degradation at this point.

Glenn Schorr - UBS

Okay that’s helpful, thank you.

Steve Fradkin

Welcome.

Operator

We'll take our next question from Gerard Cassidy with RBC Capital Markets. Please go ahead.

Gerard Cassidy - RBC Capital Markets

Thank you, and good afternoon, Steve.

Steve Fradkin

Hi, Gerard.

Gerard Cassidy - RBC Capital Markets

Can you guys give us any color on how the foreign exchange markets are behaving so far in this month, I know it’s early, only a couple of weeks, but are you guys seeing any follow through on increased volatility in volumes like you saw in the third quarter?

Steve Fradkin

Well, you know I don't really have any comments on the fourth quarter. What I would say is A, we had a terrific third quarter results, $92 million up, 74%. I think all of you know 74% year-over-year and 14% sequentially, all of you know that that was a very unusual phenomenon relative to history. Just to put that, Gerard, in context for you, in 1998, our full year foreign exchange trading results were in the $100 million to $304 million range. So really a very, very strong quarter and you just oppose it sequentially, if you look at the last six years, on average we have seen a 23% decline from second quarter to third quarter in foreign exchange, as compared with our 14% increase. So, it was very unusual period, August was clearly a significant contributor to that, but we'll have to see, you know its a very difficult line to predict. So we'll have to see what everyone wants to do in the fourth quarter.

Gerard Cassidy - RBC Capital Markets

Sure. Wasn't there a period, I don't know if it was '04, where we had this happen once before the third quarter outdid the second quarter, because traditionally as you pointed out, everybody's foreign exchange revenues dropped in this quarter meaning your competitors and yourself. I thought this happened once before?

Steve Fradkin

I don't have the data going back. It certainly can happen and as you know there is a lot of variability around foreign exchange in any given quarter. But I think it's fair to say on average over time all of you take a summer holiday and it slows things down for us. This quarter that was not the case and it was not the case in a pretty significant way.

Gerard Cassidy - RBC Capital Markets

Okay, and the second question was; I know you address the CME Group stock gains. Is there still more on your books, unrealized gains in that particular security or ownership position?

Steve Fradkin

Yes. We continue to own about 13,000 shares rather of the CME Group stocks.

Gerard Cassidy - RBC Capital Markets

Okay. Thank you.

Steve Fradkin

Welcome.

Operator

We will take our next question from Tom McCrohan with Janney Montgomery Scott. Please go ahead.

Tom McCrohan - Janney Montgomery Scott

Hi Steve. Hi Bev.

Steve Fradkin

Hi Tom.

Bev Fleming

Hi Tom.

Tom McCrohan - Janney Montgomery Scott

I've a question on India. When do you think we will start to see, or you'll start to see some of the benefits from moving more of your staff to India? With staff costs up 18% year-over-year, I was kind of wondering when you're going to see the growth rates in staff costs come down a little bit?

Steve Fradkin

Well, I think Tom, we are already seeing the benefits of India in terms of a stable workforce, in terms of a talented workforce, in terms of our primary mission which was to have an operation center in the time zone as opposed to replacing staff elsewhere. So we feel very, very good about India. It has been an incredible success story for us and we anticipate that that will continue to be a growth area for us.

So, in terms of the overall growth picture the other thing Tom to remember is that India though it's successful, though it's growing and though it's important is not a replacement for operating in London, Chicago, New York, LA and many other expensive centers. So as our business grows, we still need talented people in what I'll call more expensive places and we have to hire them. So, I would not encourage you to look at India as a direct offset for staff elsewhere. Our staff is growing everywhere around the world, its just growing in India faster.

Tom McCrohan - Janney Montgomery Scott

Okay, well just trying to get a read on your thoughts kind of longer term capability to generate operating leverage. Is this kind of a new model where staff cost, because the fight for talent is so fierce in those kind of geographies you talked about and the skill levels you need to just permanently become more of this one sophisticated though. You're just paying a heck a lot more for people you have to run your fund administration business, assets management that's what we're kind of seeing and they're going to be a factor over the next couple of years.

Steve Fradkin

Well, Tom, I think we go through lots of cycles both within quarters and across years. And I guess my response would be, as always we are trying to balance the revenue and expense equation. And I think we've done a very good job of that historically. We won't get it every quarter, we won't get it every year, but certainly 16 out of 19 years we've done it. And year-to-date depending on how you want to do your calculation, I think we are right there thus far. But it is fair to say we are continuing to invest in the business.

We had a top line revenue growth of 19% and we are working hard to keep up with the demands of those clients and what they need. So rest assured we are very mindful of the balance that we want to have. Its one of our strategic financial targets on average overtime across cycles, whatever terminology you want to use and we are working to manage to it. But it can't be the only thing that we think about in managing the business. So, you know, India is a piece of that but certainly not all of it.

Tom McCrohan - Janney Montgomery Scott

That's great. And then just on business disruptions, I think I want to ask a follow-up, have you seen any new business wins this quarter as a consequence of or is a benefit of some of the industry merger and acquisition activity both on a high network side and the client side?

Steve Fradkin

Well, I can't speak for the client's reason as to why, so I would [be lows] to make that attribution. What I'd say is, we continue to like our position demographically without disruption. From what I've seen I can see some clients that have moved, my guess is, if not exclusively because of disruption but that's probably wasn't additive. But you know there hasn't been a sea-change in the environment and as we've talked about in the past calls, we wouldn't expect that. We expect this to the extent that disruption is additive task, we expect it to happen over time, one client at a time. So I think there are some anecdotes that I can point to but it's not a wholesale sea-change.

Tom McCrohan - Janney Montgomery Scott

Fair enough. Thank you.

Steve Fradkin

You're welcome.

Operator

We will take our next question from Robert Lee with KBW. Please go ahead.

Robert Lee - KBW

Thanks, good afternoon.

Steve Fradkin

Hi, Rob.

Robert Lee - KBW

Hey. Two quick questions, the risk of beating a dead horse the Sec lending. Understanding how it should reverse over time, I am assuming that depends on that taken to that is the assumption that the 10 or so investors in that fund maintain there investments and don't choose to liquidate in which case it ends up sort of -respectively locking in the lower values?

Steve Fradkin

That's correct. You would need that to happen and you would of course you need to not have any impairments on any of the holdings. I think on the client dimension of that, these are sophisticated clients that understand that phenomenon and I can't speak for them but, that's an accurate statement.

Robert Lee - KBW

Okay. And secondly, and I apologize if you had addressed this before. But, can you talk a little bit about Fed rate cut? And how we should be thinking about your net interest margin, if the Fed is pursing on the course of cutting Fed funds rate, would it have much of an impact or you're relatively neutral at this point?

Steve Fradkin

We think on an annualized basis Rob, that it would be relatively neutral. We're short, we're relatively well matched and so, when you look at it on an annualized basis, it's not a significant driver for us.

Robert Lee - KBW

Okay, great. That was it, thank you very much.

Steve Fradkin

Thank you, Rob.

Operator

We will take our next question from Brian Bedell with Merrill Lynch. Please go ahead.

Brian Bedell - Merrill Lynch

Hi. Good afternoon .Most of my question have been asked, answered. But, just on the sec lending once again. Steve, you said, actually if I heard you right, you said about a 70% increase year-over-year, if it were not for the markdown on the book?

Steve Fradkin

That's correct.

Brian Bedell - Merrill Lynch

So, it was about $36 million in additional Sec lending revenues. So that would have been depending on what kind of operating margin you're putting on that, get a $0.08 or $0.09 of EPS this quarter?

Steve Fradkin

But why, I won't do that math for you but I'd say, yes it would've dramatically changed results.

Brian Bedell - Merrill Lynch

Right. And given you by my calculations well over another 100 additional basis points of operating leverage. But, what you're saying is over the next 18 months, is when those securities within that pool mature. Is that correct?

Steve Fradkin

Well, I think what we believe is that over the next and -- again, this is not, its sounds more pinpoint then it is, but we believe that over the next 15 months or so we would see the head win that we experienced this quarter become a tail win. Again to Rob's point, that assumes that the clients don't lead the fund and force us to realize losses and it assumes that no credit degradation, no default on any of the securities. But, yes, difficult to predict but over the next 15 months or so.

Brian Bedell - Merrill Lynch

Right. So, if they were to redeem that and you realized about it, you have already marked them down, so you would not realize additional losses, you mean that the market hasn’t changed?

Steve Fradkin

I believe that's correct.

Brian Bedell - Merrill Lynch

Okay. And then secondly, just given that that your normal run rate was closer to $70 million in the quarter would suggest that, once again there is several cents of EPS that we would back into your normalized run rate. I know it's very difficult to predict Sec lending quarter-by-quarter include, this quarter was strong but clearly your core trend's run rate is significantly higher than that?

Steve Fradkin

Well again, we don't give guidance so I can't help you with that, but what I can say is, as I tried to suggest you, the construct of this vehicle is critically important to understand the accounting. And if you just look at the headline, but don't understand why it happens, you might have in my view at least the wrong contexts around at least what we think is going on for us and perhaps for others.

Brian Bedell - Merrill Lynch

Right. But, I guess the other question would be, given that this does create volatility in your Sec lending business, just having a mark-to-market fund is it something that you would consider either letting a run down, so that you don't have that option anymore for client or you just stick with treasuries or is it something that you could keep, you keep going?

Steve Fradkin

Well, I think couple of points on that Brian. One, remember this was an extremely, extremely unusual period. We haven’t, we've had volatility in other quarters, but it hasn't manifested itself as dramatically. So, I think you do probably have an outlier in terms of the event. Two, its client driven, if clients want to be in a pooled vehicle with this kind of profile, it has to be mark-to-market. So, we could only do that if clients said to us, we want a custom account, we don’t want to be in pooled vehicles and obviously if they did we would be happy to help them with that.

Brian Bedell - Merrill Lynch

Right, but your client shared in the loss, and in this as well, is that correct?

Steve Fradkin

Correct.

Brian Bedell - Merrill Lynch

Right. So, may be going forward may be still the client will use this type of product I would think?

Steve Fradkin

I am not sure about that, I think these are pretty sophisticated clients. They understand what happened with credit spread and again, I am imputing across a number of people, but I think most of them understand that this and believe that this will revert and are comfortable with that.

Brian Bedell - Merrill Lynch

Right. I will get that back. Okay. Just a couple question, some questions have that were asked before, did you say there was a $3 million loss in other operating income on the sale of the equipment from Isle of Man in third quarter?

Steve Fradkin

We had a, $3 million last quarter and we had a very modest, I would say it was about $1 million this quarter in addition to that.

Brian Bedell - Merrill Lynch

In other operating income.

Steve Fradkin

Yes.

Brian Bedell - Merrill Lynch

Right okay. And then similar things with other operating expenses, does include some of the charges for the securities processing activities. I know, you didn’t want to frame that, but clearly the $4 million increase was at least partially due to that. I would assume?

Steve Fradkin

That’s correct.

Brian Bedell - Merrill Lynch

Right, okay.

Steve Fradkin

And again, that’s, obviously we don't want any, or if we have them, we want them to be as small as possible but you just can't process trillions, billions and millions of transactions, and never have any of that, so that's something we are still.

Brian Bedell - Merrill Lynch

Are part of the business trends of the trade, and then do you, you talked about some small sub-prime positions in portfolios. Can you just elaborate on that? Are these portfolios on the balance sheet or are these in investment management products?

Steve Fradkin

Our sub-prime, if you step back and look at it, Brian, from a corporate level on this total picture, sub-prime is extremely modest and not of concern. On the credit front loan portfolio, no direct exposure to any amount of line broker or originator or sub-prime mortgages, and we have no exposure to any organization whose business is exclusively in sub-prime lending. If you look at the securities portfolio, the balance sheet, our sub-prime exposure is really relative to the overall investment portfolio is minimal. And the holdings that we do have, are of sub-prime asset backed securities. They are at the front end of the capital structure, very short average lives from our vantage point not at all of a concern.

And then, within our asset management business, we have very to minimum exposure in our active equity mutual funds and separate accounts, no discernible exposure in our fixed income mutual funds or separate accounts. So, we feel very, very comfortable with, and we don't like the environment that it’s causing, but from a corporate standpoint, we just don't see it as a major issue for us.

Brian Bedell - Merrill Lynch

Alright great. That's helpful. And then, just on the, in terms of the NIM expansion in the quarter, I know the money market as the yields went up pretty significantly, in line quite sort of the major driver, the yields going from 450 to 487. What was the major lead, sort of the main cause of that?

Steve Fradkin

We had on the NIM, I guess first you got to go back and remember that in the second quarter we had reduced our net interest income by about $7 million, because of the adoption of FSP 13-2, the Leveraged Lease matter. So, you've got to remember that that was the first half year effect degradation in the first quarter. So, if you adjusted that, we reported a net interest margin of 1.58 in the first quarter, it would have been, sorry, in the second quarter, it would have been 1.61, and then, so I think that was a prominent aspect of the differential.

Brian Bedell - Merrill Lynch

Right. But you still got a pretty good yield jump on your money market assets, it would be in that specific line is there more allocation to [buy broad-based] products within that?

Bev Fleming

The money market assets on our balance sheet, Brian, are predominately time deposits with foreign banks. So you would be seeing impact of those, the Euro and the Sterling in there.

Brian Bedell - Merrill Lynch

Okay. So that's good then with the Fed environment, right? Because then, if you have any kind of extension of duration with time deposits, especially if they are at international yield and then you have the Fed cutting rates late in the quarter that could reduce your liability funding in certain areas on the funding sides, while your asset yields periodically would depreciate as much. So, that should bode well for clearing.

Steve Fradkin

But remember, our duration is still pretty short.

Brian Bedell - Merrill Lynch

Yeah. I know, I was just looking for the near-term directional impact. I know, you don't typically give color on future direction of NIM. But I'm just trying to get a sense of that. Okay, great. And then, just last on the tax rate, same lending there, I know you don't give guidance on that, but what is the case -- it seems like your tax rate has been trending down, and that has been driven by a greater business in international jurisdictions which might have lower tax rate. What would be the case for the tax rate going up? Is there any kind of good case for that or should we consider your growing international business overtime, it's growing at a more rapid rate than your US business as positive for potential decline in the tax rate over time?

Steve Fradkin

Yeah. The tax rate is going to move around, but I think Brian you've got it right. At the end of the day, the driver of the -- forget this quarter, but just on an average, more recently, the driver of the decline has been our adoption of APB 23, and the growth of our international business which is consistent with that. So, difficult to predict exactly where it would land, but we did say that when we adopted in 2006, that we thought directionally it would improve our tax rate overtime and that certainly seems to be the case.

Brian Bedell - Merrill Lynch

Great. Thanks very much.

Steve Fradkin

You're welcome.

Bev Fleming

Cynthia, if there is anybody in the queue I think we've probably got time for may be one more and then we'll let people get back to work.

Operator

And we do have one final participant in the queue. And we will take our last question from Ken Usdin with Banc of America Securities. Please go ahead.

Ken Usdin - Banc of America Securities

Thanks. Hey guys, I promise to make it real quick.

Steve Fradkin

Thank you.

Ken Usdin - Banc of America Securities

Two quick ones. First of all, just on the credit front, you've build the reserve a little bit through the last couple of quarters. NPA just fell down. I am just wondering, any migration strength that you are seeing like in the 7-8 buckets or any change in the quality of the portfolio underneath that's causing a fruition?

Steve Fradkin

The answer is no. Our 7 and 8 rated loans -- we are at $76 million at quarter end, compared with 75 last quarter. So, we have not had a significant change in the view there.

Ken Usdin - Banc of America Securities

Okay. And the second one is just on the institutional asset management front, was the sec lending collateral decline, the sole reason for AUMs to be down sequentially?

Steve Fradkin

Yes.

Ken Usdin - Banc of America Securities

Okay. And any color on just how fund flows were in the institutional asset management business ex-sec lending?

Steve Fradkin

Well, we don't do fund flows like the mutual fund company, but if you took out that degradation, our institutional assets under management were up little over 2% exactly.

Bev Fleming

And we talked about short duration and quantitative being the two drivers there.

Ken Usdin - Banc of America Securities

Yes, right. Okay, great. That's what I was looking for. Thanks again.

Steve Fradkin

Okay. Well, thank you all. It's been a long call. We appreciate your listening in and your questions and we look forward to giving you an update at our next quarterly conference call. Have a great day.

Operator

Ladies and gentlemen, this will conclude today's conference call. We do thank you for your participation and you may disconnect at this time.

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