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Northern Trust Corporation (NASDAQ:NTRS)

1Q08 Earnings Call Transcript

April 15, 2008, 10:00 AM ET

Executives

Bev Fleming - Director of IR

Steven L. Fradkin - EVP and CFO

Analysts

Mark Fitzgibbon - Sandler O'Neill & Partners

Michael Mayo - Deutsche Bank

Nancy Bush - NAB Research

James Mitchell - Buckingham Research

Thomas McCrohan - Janney Montgomery Scott

Robert Lee - Keefe, Bruyette & Woods, Inc.

Operator

Good day, everyone, and welcome to the Northern Trust Corporation's First Quarter 2008 Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to the Director of Investor Relations, Ms. Bev Fleming for opening remarks and introductions. Please go ahead, Ms. Fleming

Bev Fleming – Director of Investor Relations

Thank you, Abe. Welcome to Northern Trust Corporation's first quarter 2008 earnings conference call. Whether you are participating in today's conference call live or via replay, we appreciate the time you are taking to listen to Northern Trust's first quarter 2008 financial results.

Joining me on our call this morning are Steve Fradkin, Northern Trust's Chief Financial Officer; Aileen Blake, Controller; and Preeti Sullivan from our Investor Relations team.

For those of you who did not receive our first quarter earnings press release or financial trends report by e-mail this morning, they are both available on our website at northerntrust.com. In addition, this April 15th call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available through April 22nd. 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 2007 financial annual report and our periodic reports to the SEC for detailed information about factors that could affect the actual results.

Again, thank you for your time today. Let me now turn the call over to Steve Fradkin.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Well, thank you, Bev, and good morning, everyone. Let me extend my welcome to all of you listening to Northern Trust Corporation's first quarter 2008 earnings conference call. Earlier this morning Northern Trust announced first quarter reported net income of $385 million and reported earnings per share of $1.71.

Our first quarter reported results include two items related to our membership in Visa U.S.A. The first item is a $168 million pre-tax gain related to Visa's March initial public offering. This gain which is accounted for on the other operating income line of our income statement represents the mandatory redemption under Visa's certificate of incorporation of a portion approximately 4 million shares of our ownership in Visa. On an after-tax basis, the gain equaled approximately $105 million. Our remaining Visa ownership of 6.2 million class B share is at the present time equivalent to approximately 4.4 million class A shares. We anticipate further dilution of the class B shares as matters progress related to Visa's indemnified litigation.

The second item related to our Visa ownership is a $76 million pre-tax reduction in expense. This expense reduction reflected in the other operating expense line of our income statement equaled approximately $48 million on an after-tax basis. In connection with the IPO, Visa set aside $3 billion of the IPO proceeds in a litigation escrow account. Our proportionate share of the escrow account equals $76 million and is reflected in this quarter's income statement as a reduction in expense. Recall that in our results last quarter, we took a $150 million charge associated with our ownership in Visa. This charge represented our estimated portion of potential losses arising from certain litigation in which Visa is involved and for which we and other Visa members have provided indemnification.

This quarter's $76 million pre-tax reduction in expense represents a reversal of approximately half of the $150 million charge we took in the fourth quarter of 2007. As we indicated at that time, we did expect that our proceeds from Visa's IPO would more than offset any liabilities related to the Visa litigation. We continue to maintain a $74 million Visa indemnification reserve on our balance sheet. The aggregate impact of these two Visa-related items benefited pre-tax income by $244 million. The net after-tax benefit of these two Visa-related items equaled $154 million or $0.68 per share in the first quarter.

Excluding the benefit of the Visa IPO, Northern Trust reported record operating earnings per share equal to $1.03 in the first quarter representing a very strong increase of 23% compared to the $0.84 that we reported in the first quarter of 2007. Operating net income also equaled a quarterly record of $232 million, representing an increase of 24% year-over-year. This was our 13th consecutive quarter of double-digit year-over-year growth in operating earnings per share and our 12th consecutive quarter of double-digit year-over-year growth in operating net income.

Our operating performance in the first quarter of 2008 met all four of our long-term across cycle strategic financial targets. For the quarter, we achieved strong revenue growth of 19%, almost 250 basis points of positive operating leverage, 23% growth in operating earnings per share and an operating return on equity of 19.85%.

We’ve organized our conference call today into four sections. First, I will briefly offer a few market-related perspectives on the environment we encountered during the quarter and how it impacted our results. Second, for the benefit of those of you who maintain detailed models on Northern Trust, I will outline four items that you should consider as you evaluate our operating results this quarter. Third, I will review the quarter's financial performance focusing on those items that most impacted our results. And finally I will offer a few strategic perspectives on developments during the first quarter for each of our businesses. As always Bev and I will then be pleased to answer your questions.

Let me begin with the perspective on the financial markets. Once again the markets in the first quarter of 2008 experienced a variety of dislocations as the crisis in the credit markets deepened in the first quarter. Following similar market turmoil in the second half of 2007, uncertainty led to volatility and equity market declines. At Northern Trust, we have a strong business model with diversified sources of revenue. Some of our revenue line items notably foreign exchange trading and net interest income benefited from the market conditions and from actions that the Federal Reserve Bank undertook in the first quarter.

Currency volatility and related client volumes provided attractive opportunities in foreign exchange while spread income benefited from the Fed's 200 basis point reduction in the Fed funds rate during the quarter. Other revenue line items on the other hand were adversely impacted by market conditions. Trust, investment and other servicing fees, in particular were hurt by both lower equity markets and the impact of negative marks in one mark-to-market investment fund.

As our call progresses this morning, I will provide you with detail and perspective on each of these revenue line items. But, I think it's important to note that outside of today's call, that market conditions in the first quarter both helped and hindered revenue growth, as I'm sure you would expect in this tumultuous environment.

As you analyze our first quarter financial performance, I want to draw your attention to four items that impacted our reported results. These are in addition to the Visa matter that I already discussed. First, in the quarter we recorded a gain of $4.9 million on certain credit default swap contracts, that we use to mitigate risk... credit risk associated with specific commercial loans. We have made use of credit default swaps, as a regular part of our risk management discipline, and the value of the swaps has been mark-to-market each quarter. However, the gain, which is reflected on our income statement in the other operating income line item was larger than normal and so I want to drive to your attention.

Second, in the first quarter, Northern Trust recorded a gain of $4.9 million on the sale of our remaining shares of CME Group, which is the parent company of the Chicago Mercantile Exchange. The gain on the sale of these shares is shown on our income statement in the Investment Security Transactions line.

Third, the other operating expense line item includes $8.7 million worth of expense which represents the fair value of our liability related to the capital support agreements that we entered into on February 21st to support certain cash funds that invest in the Whistlejacket structured investment vehicle. I should add that no capital contributions were made to any of the funds as of March 31st.

The $8.7 million of expense represents the mark-to-market of the fair value of our liability under the capital support agreements in accordance with Financial Accounting Standards Board statement number 133. In line with this accounting standard, we will continue to mark-to-market the fair value of our capital support agreements each quarter until those agreements expire.

And fourth, we've recorded a tax benefit of $5 million related to our decision to indefinitely reinvest outside the United States, the prior earnings of two subsidiaries, not previously included in our past APB Opinion Number 23 elections. While we've had an ongoing quarterly benefit associated with APB 23 since the fourth quarter of 2006, the first quarter 2008 benefit was incrementally higher by $5 million as a result of the inclusion of these additional subsidiaries.

With that background, let me review the first quarter's key performance drivers. My comments that follow will be on an operating basis exclusive of the two Visa-related items that impacted both revenue and expense. I'll start with revenues focusing on the major items that impacted our results. We are very pleased with our top line performance in the first quarter of 2008, particularly given the backdrop of an ongoing turbulent macroeconomic environment.

Operating revenues in the first quarter equaled at $978 million, up an exceptionally strong 19% or $154 million compared to last year's first quarter. Operating revenues grew 1% or $5 million on a sequential quarter basis. The key line items that contributed to our revenue growth this quarter were trust, investment, and other servicing fees, foreign exchange trading income, and net interest income. Trust, investment, and other servicing fees increased 8% year-over-year or $38 million to $527 million. Within this line item, PFS trust, investment, and other servicing fees equaled $228 million in the first quarter, representing an increase of 6% or $14 million year-over-year. PFS... fee growth in PFS is driven in part by our ability to retain and grow our business with existing personal clients while at the same time winning new clients to PFS.

First quarter net new business in PFS was very strong representing our best quarter since the fourth quarter of 2006. We are very gratified to have started the new year in PFS with strong levels of gross new business in the quarter combined with our lowest level of distributed business since the second quarter of 2003.

Offsetting our strong new business however was a weaker equity market environment. Our PFS stakes, which represented 85% of our total PFS fees in 2007 earned fees primarily via a methodology that lags current markets by one month. Based upon this methodology, the S&P 500 declined 2% for the purposes of our first quarter fees, which resulted in a headwind to PFS fee growth. On a sequential quarter basis, PFS fees declined 2% or $4 million. The positive impact of strong net new business in the first quarter was more than offset by weak equity markets. The S&P 500 was down 8.3% using our PFS month lag fee methodology constituting a considerable headwind for PFS fees on a sequential quarter basis.

Fees in PFS are derived from the assets that we manage or custody for personal clients. PFS asset aggregation in the first quarter was strong as evidenced by our healthy new business results. PFS assets under management equaled $146 billion at quarter-end, up 5% or $7 billion from a year ago. Assets under custody in PFS equaled $322 billion on March 31, up 8% or $25 billion year-over-year. In considering the single-digit year-over-year growth rates, it’s important to note the backdrop of a tough market environment, which saw a 6.9% decline in the S&P 500 year-over-year.

On a sequential quarter basis, PFS assets under management were down 2% or $2 billion and PFS assets under custody were down 3% or $10 billion since year-end. Again, when compared with the decline of 9.9% in the S&P 500 during the first quarter, our performance on a relative basis reflects the strong net new business results that I mentioned earlier.

Switching to our institutional business, C&IS trust, investment, and other servicing fees equaled $298 million in the first quarter, an increase of 9% or $24 million year-over-year. C&IS fees include three primary revenue areas, custody and fund administration, institutional asset management, and securities lending. Let me discuss the performance of each in the first quarter.

C&IS custody and fund administration fees equaled a record, $175 million in the first quarter, up 24% or $34 million year-over-year. This strong double-digit custody and fund administration fee growth was driven by excellent new business, particularly in global custody and by higher transaction volumes during the quarter. As with our fees in PFS, the market environment influences our C&IS fee growth. Recall that C&IS custody fees are billed primarily on a one-quarter lag basis, thus our 24% year-over-year growth in custody fees was supported albeit modestly by equity market growth as evidenced by the 3.5% quarter lag growth in the S&P 500 and the 1.2% growth in the EAFE Index.

On a sequential quarter basis, C&IS custody fees increased 4% or $7 million as the impact of new business and currency rates more than offset the challenging equity market environment. Recall that one a quarter lag sequential quarter basis, the S&P 500 was down 3.8% and the EAFE Index was down 3.2%. An important credit contributor to C&IS custody fees is our ability to successfully aggregate client assets. Institutional assets under custody equaled $3.7 trillion at quarter end, up 6% or $203 billion from a year ago, yet down 4% or $143 billion versus last quarter.

The sequential quarter decline reflects the quarter's lower equity market values, as the S&P 500 fell 9.9% in the quarter and the EAFE Index fell 15.5%. International growth continued to be the key factor driving overall C&IS custody asset growth in the first quarter. Global custody assets equaled $2 trillion on March 31st, up 12% or $222 billion year-over-year as compared with the 16.9% decrease in the EAFE Index over the same period.

On a sequential quarter basis, global custody assets declined 4% or $78 billion reflecting lower equity markets as evidenced by a sequential quarter decline of 15.5% in the EAFE Index. Investment management fees in C&IS equaled $75 million in the first quarter, an increase of 4% or $3 million year-over-year.

Growth was driven entirely by new business, which more than offset the down draft of the broader market environment. New business results were strong in our manager-of-managers, quantitative management, and short duration assignments.

On a sequential quarter basis, C&IS investment management fees were essentially flat at $75 million reflecting good new business trends offset by lower equity markets. Managed assets for institutional clients equaled a record of $633 billion at quarter-end, up 3% or $16 billion compared with one year ago and up 4% or $24 billion sequentially. Managed assets held up very well in this difficult market environment, as new business transitions more than offset the headwind from the lower equity markets.

C&IS securities lending fees equaled $32 million in the first quarter, representing a decrease of 30% or $14 million compared with last year's first quarter and a decrease of 42% or $23 million compared with the fourth quarter of 2007. Securities lending collateral equaled $267 billion at quarter-end, down 10% or $30 billion versus one year ago and down 1% or $2 billion compared with December 31.

The year-over-year decline reflects the de-leveraging phenomenon that occurred during the second half of 2007, as well as lower equity market values. As we did in the third and fourth quarters of last year, let me pause for a minute, and provide some perspective around our securities lending results in the first quarter. Similar to our experience in the second half of last year, our securities lending results in the first quarter were adversely impacted by the ongoing disruption in the credit environment, particularly during the month of March.

It is important to know however that there were very positive offsets in our securities lending business during the first quarter, including strong demand for treasury securities and the federal reserve’s continued easing of the federal funds rate by 300 basis points since September of 2007. This noted the unusually high level of credit market dislocation once again negatively impacted the returns achieved in the one mark-to-market cash collateral investment fund used for securities lending. As of March 31, approximately 5% of our $267 billion in securities lending cash collateral was invested at our client selection and direction in this total return short duration fixed-income fund.

As I mentioned last quarter, this is our only meaningful fund that is structured as the mark-to-market fund and understanding this designation is essential to understanding the impact during the first quarter just as occurred in the third and fourth quarters of 2007. The consequences of being a mark-to-market fund during the first quarter of 2008 were again severe, even more severe than what was experienced in the second half of 2007. Pricing pressure on fixed income securities continued. Asset value changes, in this case asset value markdowns, flowed directly through to the total return of this fund thus impacting the earnings of a small number of our securities lending clients and Northern Trust 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 want to remind you of a few key points that we discussed with you last quarter in our third… in our last quarter's conference call.

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. Second, the fund has not used leverage. Third, the fund has a very high-quality profile. 65% of the securities held in it are either... rated either AAA or AA. Fourth, the fund is conservatively managed with an interest rate sensitivity of 49 days and a credit-based weighted average maturity of 1.63 years as of March 31. Fifth, the first quarter total return of the fund reflected negative marks on a broad mix of holdings. There does not exist at this time any permanent impairment of any holdings. All of the asset markdowns recorded in the fund during the first quarter are unrealized.

We expect given what we know at this time that all of the fund's holdings will mature at par. Because we expect all of the fund's holdings to mature at par, no actions have been taken to sell all or a portion of any holdings that have mark-to-market losses. Any future positive marks will be reflected in the yield on the fund and in the results in securities lending revenues reported by Northern Trust. And lastly, the fund has used the securities lending cash collateral option by only a small number, approximately ten of our 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.

As I did in the last two quarters, let me end this discussion of our securities lending performance by providing you with a perspective on what our results would have been had this collateral been invested in our most commonly used securities lending collateral fund. This comparison illustrates the magnitude of the impact that mark-to-market accounting can have in the current environment.

Again for the purposes of illustration, our securities lending results in the first quarter would have been $93 million higher than the $32 million fee amount that we reported had the clients in the mark-to-market fund been invested in our most commonly used pool. Therefore we would have reported year-over-year fee growth in securities lending of 174% as opposed to our actual reported decline of 30%.

Let me now shift the discussion to our other key revenue line items starting with net interest income, which accounted for 27% of revenues in the first quarter. As you analyze our net interest income performance, please note that effective this quarter, custody related deposit and overdraft amounts previously included within other operating income are now included within net interest income. Prior periods have been restated in our earnings press release and financial trends report. This reclassification was made to better align interest income from custody client overdraft and interest expense from sub-custodian charges with their related balance sheet classification.

Net interest income equaled a record $266 million, an increase of 24% or $52 million compared with last year. The year-over-year increase in net interest income was attributable to a higher level of earning assets and an 8 basis point increase in the net interest margin. On a sequential quarter basis, net interest income increased a strong 5% or $14 million, primarily driven by earning asset growth. Average earning assets equaled $60 billion in the first quarter, an increase of 17% or $9 billion year-over-year and 6% or $3 billion sequentially. Our balance sheet growth remains liability driven, which in turn drive the strong growth in earning assets.

Non-US office time deposits continued to be the fastest growing liability on our balance sheet averaging $34 billion in the first quarter, up 24% or $7 billion versus last year and up 8% or $3 billion sequentially.

This strong growth in non-US office time deposits is directly related to our international success in the institutional custody business, which I described earlier.

Our net interest margin in the first quarter equaled 1.79%, up 8 basis points from the prior year and flat sequentially. The year-over-year increase in the net interest margin was driven by wider spreads between overnight rates and one- to three-month rates, primarily driven by the 300 basis points of Fed rate cuts since September.

The final significant contributor to revenue growth in the first quarter was foreign exchange trading income, which equaled a record $113 million, up 68% or $46 million compared with the first quarter of 2007. On a sequential quarter basis, foreign exchange trading income increased 2% or $2 million. The key drivers of our quarterly results in foreign exchange were volume and volatility both remained very high in the first quarter due in part to the continued disruption in the financial markets.

Credit quality remained exceptionally strong at quarter-end with non-performing assets equal to only $36 million, down $1 million or 3% from a year ago. Non-performing assets increased on a sequential quarter basis by $6 million reflecting the addition of three small loans to non-performing status offset by the payoff of one non-performing loan. Non-performing assets equaled only 13 basis points of total loans at quarter-end.

During the first quarter, we recorded a loan loss provision of $20 million compared with no provision in the first quarter of last year and an $8 million provision in the fourth quarter of 2007. Approximately 40% of the $20 million provision reflects strong commercial loan growth this quarter. Another 30% of the provision reflects our decision to increase the credit loss reserve to reflect the weakening economic environment. The remainder reflects current quarter net charge-offs of $2.4 million and a credit rating downgrade on two additional exposures.

Now, let me shift my comments to a review of the key expense categories that impacted our first quarter performance. Expenses during the first quarter of 2008 equaled $535 million, which includes the Visa-related expense reduction that I mentioned earlier. Excluding that item, expenses equaled $611 million representing an increase of 16% or $86 million from the year-ago quarter. On a sequential quarter basis, excluding the Visa item, expenses were down 3% or $21 million. Compensation expense equaled $286 million and increased 17% or $41 million from the year-ago period. Approximately 40% of the year-over-year increase in compensation expense reflects higher staffing levels to accommodate growth and expansion.

Staffing levels equaled approximately 11,300 full-time equivalent positions at quarter-end, up 14% year-over-year. Our office in Bangalore, India now employees approximately 850 staff members, up from approximately 350 one year ago. The second largest contributor to the increased level of compensation expense year-over-year was higher incentive compensation due to better corporate performance. On a sequential quarter basis, compensation expense increased 1% or $4 million, primarily reflecting higher staff levels and equity-based incentives offset partially by lower current-year cash-based incentives as compared with the fourth quarter's true-up to reflect that year's corporate performance.

Employee benefit expenses equaled $57 million in the first quarter, up 1% or $1 million versus last year and down 8% or $5 million sequentially. The modest year-over-year increase and the sequential decline primarily reflect lower pension expense. Outside services equaled $94 million, an increase of 12% or $10 million compared with last year and a decrease of 14% or $15 million sequentially.

The year-over-year increase primarily reflects higher consultant, legal, and technical expenses, as well as an increase in volume-related global sub-custodian fees. The sequential quarter decline reflects lower consultant, depository and sub-custodian fees.

Equipment and software related expense equaled $54 million in the first quarter, up 6% or $3 million year-over-year and down 8% or $5 million sequentially. The year-over-year increase is primarily attributable to higher software amortization resulting from continued investment in technology. The sequential decline represents typical annual pattern where the expense associated with the depreciation and amortization of equipment and capitalized software is typically lower in the first half of the year compared to the second half.

Other operating expense, excluding the Visa-related benefit, equaled $78 million, an increase of 52% or $27 million compared with last year. On a sequential quarter basis, other operating expense decreased 4% or $3 million. The year-over-year increase of $27 million was driven primarily by three factors. Business promotion and advertising expenses associated with the Northern Trust Open golf tournament, the previously discussed $8.7 million charge associated with the capital support agreements, and higher year-over-year charges associated with securities processing activities. The sequential quarter decline reflects lower charges associated with securities processing activities offset by the charge related to the capital support agreements and higher business promotion and advertising.

Our reported provision for income taxes in the first quarter equaled $193 million resulting in a reported effective tax rate equal to 33.4%. On an operating basis, excluding the two previously discussed Visa benefits, our provision for taxes equaled $102 million resulting in an operating effective tax rate of 30.6%. This compares to a tax rate of 33.9% in the first quarter of last year. The lower tax rate on a year-over-year basis reflects the ongoing benefit of earnings generated in tax jurisdictions outside the United States with more favorable tax rates. Recall too from my earlier comments that the first quarter included a non-recurring tax benefit of $5 million related to our decision to indefinitely reinvest outside the United States the prior year earnings of two non-US subsidiaries.

Northern Trust repurchased 911,000 shares of common stock in the first quarter at a cost of $64 million. Diluted shares averaged 224.8 million. We can purchase an additional 7.8 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 17% versus one year ago to a record $4.6 billion at quarter-end. This performance represented our 80th consecutive quarter of increasing common equity, which equates to 20 consecutive years.

Let me close with a few perspectives on some of our overarching developments in the first quarter related to each of our major lines of business. In Personal Financial Services, we were very pleased to report strong net new business results in the first quarter especially given the backdrop of the challenging economic environment. We saw clear indications in the first quarter across the breadth of our private client franchise of a flight to quality as both clients and prospects sort out the expertise and hallmark financial stability that Northern Trust has demonstrated for more than a century. Consistent with that expertise in January, we published our third annual wealth in America report, which focused on issues facing US high net worth households as drawn from a national survey conducted by Northern Trust. Our annual wealth in America report is but one example of the leadership position that Northern Trust has established in the affluent marketplace and further underscores our understanding of the trends that will impact this business in the future.

In C&IS, we were also gratified to report a strong quarter of new business results. In fact, just yesterday we announced that Northern Trust was named as global custodian for $11 billion in assets for the Employees Retirement System of the State Of Hawaii. Earlier in April, we announced that we had been chosen by Handelsbanken as global custodian for their assets... for their clients in Norway, Denmark and Finland, which brought us an additional $15 billion in new client assets under custody, from the Nordic region.

And in March, we were pleased to report that Lincoln Financial Group selected Northern Trust as custodian for its defined benefit retirement plan totaling $1.1 billion in plan assets. We also announced several new leadership moves in C&IS reflecting both the outstanding talent that we cultivate within Northern Trust and our focus on attracting top talent from outside our organization. Biff Bowman, a 23-year veteran of Northern Trust was named region executive for our important and growing business in Europe, the Middle East, and Africa.

Paul Cutts, a 15-year employee... 15-year employee relocated from Amsterdam to our new office in Melbourne, Australia, where he will lead our efforts in that growth region of the world. And Jon Dunham joined us from one of our competitors as Head of North American Sales. These leadership changes in C&IS served to further strengthen our positioning globally in the institutional custody business.

In Northern Trust Global Investments, our asset management business, Steve Potter was named President in late March. Steve, who is already a member of corporation's management committee, had previously led our highly successful international business in C&IS. Prior to moving to London in 2001, Steve led the institutional group within Northern Trust Global Investments. He takes over leadership of NTGI at an exciting time, given our strong new business results and exciting new product initiatives, such as our recent launch of a unique series of international exchange traded funds and our introduction of the Northern Global Sustainability Index Fund, a fund that responds to the growing demand for socially responsible investment products.

In closing, it was a record quarter with strong double-digit growth in EPS and net income accomplished against a challenging environmental backdrop. Our accumulation of client assets, which represent one indicator of our success in maintaining and building the client franchise, again was strong relative to the environment. Revenue growth, particularly emanating from foreign exchange and net interest income was outstanding as was new business across PFS and C&IS. And while our results in the quarter, benefited on the margin from the CME, share gain, positive marks on certain credit default swaps and a one-time benefit in our tax provision, we also had to navigate through significant negative marks in one securities lending collateral fund, the fair value expense impacted the capital support agreements with a link to the Whistlejacket SIV, first year expense of the Northern Trust Open, and a higher provision for credit losses.

All said, we are very pleased with our results in the quarter. Before I conclude, I want to point out that our annual shareholders meeting begins at 10:30 Central Time this morning. As is customary with our first quarter calls, I will need to end today's call allowing sufficient time for all of us to get to the annual meeting.

Accordingly, please accept my apologies in advance in the event that we have to close off the question-and-answer session earlier than we would otherwise normally do. And now, Bev and I would be pleased to answer your questions. Abe, please open the call for questions.

Question and Answer

Operator

Thank you, Mr. Fradkin. [Operator Instructions] And we'll go first to Mark Fitzgibbon at Sandler O'Neill. Please go ahead.

Mark Fitzgibbon - Sandler O'Neill & Partners

Hi, good morning. Thanks for taking my question, Steve.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Hi, Mark.

Mark Fitzgibbon - Sandler O'Neill & Partners

The balance sheet grew by about $10 billion from the linked quarter and which I believe you pointed out was driven by foreign office time deposits. I wondered if you could talk to us about how you are pricing these deposits and I know it’s part of a whole relationship. What sort of hurdle rates of return you're looking for and give us a sense for maybe how large a component of liabilities you’d be willing to let the foreign office time deposits to become?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Well, I think Mark; I don't know that I can answer all your questions directly, but I think a couple of key things are important to remember. One that really is an outgrowth of the growth at our global custody business. So it is closely linked and obviously at any given point our clients had more or less cash. But that's an important component of the driver. Two, those are market competitive rates in the sense that the market is dynamic, it moves around. But these are large sophisticated institutional investors and if we can’t be competitive, we will not be able to attract those deposits. So, I would say the spreads on those will move around in-tandem with market conditions, but we do have to price those competitively; they are not viewed as compensating balances, might be in some other businesses. And we haven't put any limits on the growth. As I say it's an important part of what we do for our clients and we monitor it carefully. But we don't have any limits on it at the present time.

Mark Fitzgibbon - Sandler O'Neill & Partners

I guess what I am wondering though, Steve, is, the more you do of this kind of businesses over time that going to drag down returns because this is arguably a more price-sensitive line of businesses some of the other products and services that you sell.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Well, we have seen the mix in our net interest margin evolve over time as the proportion of loans on a relative basis they shrunk. So, that had… taking out were the fed goes up and down that has been a factor that we’ve had to contend with. But we still think this is an important part of our business mix and something we want to continue to attract.

Mark Fitzgibbon - Sandler O'Neill & Partners

Okay, and the last question I had is in PFS. It looks like there was a little bit more softness from the Illinois business in the quarter than what we’ve seen in the past. Were there any specific issues or changes that cause that drop in the Illinois business?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

No, I don't think there was anything specific. And again you have to be very careful of the market conditions. We feel very good about the franchise overall and in Illinois, and I can't think of anything specific that would have showed up in Illinois this quarter.

Mark Fitzgibbon - Sandler O'Neill & Partners

Thank you.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

You're welcome.

Operator

And we will go next to Mike Mayo of Deutsche Bank. Please go ahead.

Michael Mayo - Deutsche Bank

Hi, Steve.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Hi, Mike.

Michael Mayo - Deutsche Bank

Can you give more color on the securities lending revenues, should we expect this lower level to persist and just so I am hearing you correctly, I thought you said it would have been up 174% instead of a decline of 30%. So, I think that means you would have had $100 million or so more in revenue or $0.25 per share this quarter had you had the higher levels. So, please correct my math or my understanding?

Bev Fleming – Director of Investor Relations

Well, Mike, first to make sure you have the correct number. The number that Steve stated was $93 million in additional securities lending revenues that we would have had had this particular collateral been invested in our most commonly used pool. So it was $93 million and the math that we did was that securities lending would have increased by 174%. And the other thing I would point out is that as you saw, this will also obviously had an effect on our total revenue growth. Revenue growth for the quarter on an operating basis was up 19%, had we had that additional $93 million, it would have been up 30%.

Michael Mayo - Deutsche Bank

So, how should we think about that? Is that a one-time effect or should we assume a lower run-rate of securities lending revenues going forward?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Well, I think, Mike, there are a lot of ifs and buts around this and as you know we don't provide earnings guidance. I think that the key takeaway is that this is happening as a consequence of mark-to-market. The mark-to-market phenomena that we are experiencing, in theory and that's all I can give you on the assumption that there is no degradation in these securities those marks will reverse at maturity and we should... we and our clients will benefit from that in the future. But I don't think in the current climate, I or anyone else wants to make any projections about specifically when that will be or the magnitude of the effect.

Bev Fleming – Director of Investor Relations

And, Mike, just to the refresh everybody's memory on the call, this is the third quarter that we have had this phenomenon occur. In the third quarter when... the first time we explained it to you; the impact was a $36 million impact. In the fourth quarter, it was a $46 million impact and here in the first quarter, particularly with the difficulties experienced in the credit markets in the month of March, it was $93 million. So from that perspective, we certainly couldn't call it a one-time occurrence as you said. But we have been very clear I think that as Steve mentioned that we don't believe that the particular securities in this fund that currently holds negative marks, we don't believe that they will become permanently impaired, and we do believe that this will turn around as those… as either the credit market conditions improve or as those securities mature at par.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

The other piece to remember, Mike, is it's a broad number of securities. This isn't anchored to one or two individual securities. So, but again, we can't give you the guidance; we can explain what the phenomenon is and the magnitude of that phenomenon, but the timing of the recoupment, we’ll just have to let the markets do their thing.

Michael Mayo - Deutsche Bank

And the $8.7 million other operating expenses fair value of the capital support agreement, can you just give a little more color on that?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Sure. We use a standard option pricing methodology. Think about the capital support agreement as a commitment that has to be valued each quarter and we are using a option pricing methodology to calculate the value of that agreement which we put at $8.7 million in the quarter. We will again have to look at that until the expiration of those contracts but that was the phenomenon we experienced in the first quarter. Let me remind you however that there were no contributions made to any of the funds. So, no Whistlejacket securities were sold, were sold at a loss resulted in… resulting in a degradation of the NAV of the funds. This is merely the valuation of the CSA and its value, if you will.

Michael Mayo - Deutsche Bank

And do you think of your risk management of being extra sensitive to the capital markets, you already benefit or get hurt depending on the direction of the stock market to the extent that the credit markets go in that same direction. Aren't you just that much more sensitive to? How do you think about that in terms of a risk management?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Well, I think from a risk management standpoint, Mike, we think and worry about everything. We worry about disaster recoveries, we worry about credit cycles, we worry about interest rates, we worry about operating errors. It runs the gamut. So, certainly in a job like mine, we're very concerned about every facet of our business, I think the thing that we were trying to state at the beginning of this call, and I suspect you'll hear from others is the market environment has been particularly challenging, and I don't think I'm telling you anything you don't know, it's been very wild, very gyrating the equity markets, the fixed income markets, interest rates, and so forth. So, that is one dimension of our business that we have to think about from a risk management discipline perspective. But, there are certainly others that we'll have to contend with.

Michael Mayo - Deutsche Bank

Thank you.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

You're welcome.

Operator

And we'll go next to Nancy Bush. I believe it’s NAB Research.

Nancy Bush - NAB Research

Good morning, Steve.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Hi, Nancy.

Nancy Bush - NAB Research

This is an incredibly broad and hypothetical question, but I think it’s becoming increasingly important as we look at the trust and processing companies and see how they are benefiting this quarter from the rapid declines in interest rates. Sooner or later, this will turn around although none of us know is when, can you just give me your sort of general thoughts about what will happen when rates start to go up, particularly if they go up as quickly as they have gone down.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Well, I... again I don't want to provide guidance. But, I think we have tried to be very clear, Nancy that we absolutely did benefit on the net interest income line from this phenomenon. I think the important thing that I would drive you to and we've seen rates up and down over the last 20 years, you saw the phenomenon in the post September 11th era. And what we have found is that rates on the way down provide us with a very short-term benefit as they did this quarter. But, rates remaining very low for sustained periods of time provide us with more headwind. I think the key takeaway I would point to you to; however, Nancy, this quarter is the balance. While it's true that we did benefit on the net interest income line than the FX line, we also had to struggle through a number of things related to trust, investment, and other servicing fees and the mark-to-market and securities lending and so forth. So, it's not always going to stay at the same level, but I think we've got good balance to the business model that helps us manage through that cycle when we see net… softer net interest income.

Nancy Bush - NAB Research

Also, if I could just ask in PFS, I mean what are you seeing on the lower end of business? We've talked often about that, and sort of the entry-level PFS client, are you seeing any change in trends there?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

While, I think PFS is a very good story. If you think about where our fee growth in PFS has gone in recent years, back in 2003, our year-over-year fee growth in PFS was down 1.5%. In 2004, it was up 8%; in 2005, it was 9% year-over-year growth; 2006, 10%; 2007 15%. So... and remember that 85% of PFS plus or minus relates to that broad-based franchise. So, we feel very good about contraction that we've got, the positioning that we're in, and as I alluded to in my prepared remarks, I think the first quarter was really telling, I can't break out the data for you, but I can give you gobs of anecdotal stories about the flight to quality in the safe haven status that we had during some of the challenges in the first quarter. So, we like the momentum there. Obviously, the downdraft in the markets hurts us a little bit on the fee line and on the asset accumulation line. But, I think it's an outstanding story for PFS generally and for the… as you characterize at the lower level of our PFS franchise, in particular.

Nancy Bush - NAB Research

Thank you.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

You're welcome.

Operator

And we'll go next to James Mitchell at Buckingham Research.

James Mitchell - Buckingham Research

Hey, good morning.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Hi, Jim.

James Mitchell - Buckingham Research

Hey, I just want to, just to clarify on the losses, mark-to-market losses in securities lending. Is it the right way to think about it, you had about $175 million in cumulative losses over the last three quarters, and again is that all… if you're able to hold on to the assets till they recover or mature, is that $175 million should accrete back into earnings over time, obviously don't know when, is that the right way to think about it?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

You are correct.

James Mitchell - Buckingham Research

Okay. And is there any pressure from the invest, I guess the only way that doesn't work is if you're forced to sell these assets at these levels because investors pull out. How should we think about the risk of the investors in that fund or whether it's controlled by you or your ten clients that are in it? How do we think about the commitment to, I guess seeing it through to the end?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Well, that's right. If you… it’s not withstanding the quality of the investments, if you will. If the investors pulled out of the fund, we would be forced to sell, and therefore we would not recoup those unrealized losses. A couple of thoughts, one, remember that this is a small group of sophisticated investors. You’re only talked about ten clients here so, and they don't use this fund exclusively. So, I can't provide any assurance about what they're going to do. They have independent views and judgments to make. But, I think they definitely understand the nature of the issue here, the accounting that has taken place thus far, and the benefit that they at least theoretically will allure to the extent that they stay in the fund. But, we'll have to see what they decide over time.

James Mitchell - Buckingham Research

All right. And the maturity, it's about 18 months, it sounds like, right? And is that much of it is sort of back-loaded and we kind of have to wait and see over time or is it sort of more spread out, you start to some mature in a shorter term?

Bev Fleming - Investor Relations

Well, the weighted average maturity as you said is about 1.63 years, but the maturities are spread out starting here in 2008 and preceding down the road for several years. So, you need to focus on 1.63 as being a weighted average.

James Mitchell - Buckingham Research

Okay, right, right. Okay, and one last question, if I may, on the securities lending business, ex the sort of mark-to-market issues, volumes were flat as you mentioned, I guess down 1% sequentially. But, clearly the revenues on a “normalized basis” were probably up 15% to 20%. Now that's obviously from continued benefits on the spread side. Now, is that primarily from the fed cut and if we see less fed cuts maybe the spreads start to narrow again or is that… or there is something more complicated going on?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

We did benefit from the fed cut, and there is significant demand for treasury securities right now. So, yes there is an environmental effect that benefited the non-step, the non mark-to-market fund phenomenon.

James Mitchell - Buckingham Research

But, I mean, I'm just trying to get a sense of securities lending spreads move that quickly, if there is less cuts this quarter, it can step down the spread, it can step down to quickly or is it slower kind of a move?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

No, it's a pretty short-term phenomenon.

James Mitchell - Buckingham Research

All right.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

So, we absolutely did benefit, and if you didn't see that kind of move in future quarters, you would not see a dramatical change.

James Mitchell - Buckingham Research

Okay, great. Thank you very much.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

You're welcome.

Operator

And we will go to Tom McCrohan. I believe it’s Janney Montgomery Scott. Please go ahead.

Thomas McCrohan - Janney Montgomery Scott

Hi, Steve. Hi, Bev.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Hi, Tom.

Thomas McCrohan - Janney Montgomery Scott

There is a quick follow-up on that sec lending question. Just to clarify, there's unexpected rate cuts that really benefit you guys, is that right?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

That is correct.

Thomas McCrohan - Janney Montgomery Scott

Okay. So, fed just… if an anticipated fed cut, do you still get the benefit that just not as much?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Yes, it's the unexpected that is more dramatic, if you will.

Thomas McCrohan - Janney Montgomery Scott

Got it. The $20 million credit [ph] business this quarter and maybe you said this in your prepared remarks, I missed it. How much of the $20 million provision was allocated to the capital support agreement, if any?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

No, it's separate, none of it.

Thomas McCrohan - Janney Montgomery Scott

None of it?

Bev Fleming – Director of Investor Relations

None.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

So the provision of $20 million, about 40% of it relates to loan growth, we saw a terrific demand for credit; total loans were up 24% year-over-year. About 30% of it was a result of the, just the overarching weakening in the environment or our judgment of that. And then, the balance related to some downgrades.

Thomas McCrohan - Janney Montgomery Scott

Okay. And I might be comparing apples and oranges, but back in February when you disclosed in another conference call regarding the SIV exposure through ten of your internally managed funds. Was any of that related to the sec lending or was that completely separate?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

No, that --

Thomas McCrohan - Janney Montgomery Scott

The $4.5 billion of securities, SIV securities that are currently held in ten-year funds or any… has any of that had exposure related to the security lending collateral or that's completely separate?

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

I don't know if I can give you that by fund, what I can say is the… our overall exposure to SIVs is modest. And I think you should… I think, Tom, you should think about unless those securities lending related and more just as an asset in a short duration fund.

Thomas McCrohan - Janney Montgomery Scott

Okay. Fair enough. And the capital support agreements, it's not really supporting the collateral pool for securities lending right, it's supporting...

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

It's supporting any funds that has exposure to Whistlejacket.

Thomas McCrohan - Janney Montgomery Scott

All right. I hear you. And separate topic on the wealth management side, that trend, the revenue trend has just been great [inaudible] last five quarters. I was wondering you can just talk a little bit about what's driving the strength in wealth management and relatively has there had been in the past any migrations from clients that were not classified as wealth management, which is kind of a PFS client, and what the magnitude of that, maybe it’s not material where you have [inaudible] within your Illinois PFS segment then over time they get so large that, you kind of reclassify them as wealth management.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Well, a couple of things, one just to level [inaudible] on wealth management for us is those large families typically a couple of hundred million dollars and above in assets under custody. As you know and as we have stated before, we serve today a little over 20% of the Forbes 400 most affluent families, and Tom, you're right, the growth there has been steady and consistent and attractive. But, none of that growth is attributable to any, if you will, internal reclassification, so that's...

Thomas McCrohan - Janney Montgomery Scott

All right.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

That's a real growth, if you will.

Bev Fleming – Director of Investor Relations

And keep in mind, Tom, that we wouldn't arbitrarily do an internal reclassification of a client from one segment to wealth management, it's really the client's decision as to whether or not the service delivery and the technology they're getting, they want the wealth management product. So, it's not something that we would do arbitrarily when they reach $75 million or $100 million. The other thing I would point out is that our number of family relationships at the end of the quarter reached 400, which was up pretty nicely from where it had been in the previous quarter. So, we have had nice new business in the wealth management as well

Thomas McCrohan - Janney Montgomery Scott

Great, congratulations. And in a month from now, Bev and Steve, when you host your Annual Investor Day, can you give us any preview on the agenda, and what topics you might be discussing?

Bev Fleming – Director of Investor Relations

We thank you for bringing that up. We were going to say that at the close, but we're going to be holding our Investor Day here in Chicago on March 28th. The invitations were just mailed at the end of last week. We'll start with lunch, so for those of you that want to travel in the morning, you can do that, we'll start from lunch, proceed through the afternoon and then have a reception at the end of the day. Each of our business units will be making a presentation on their growth strategies, Steve, of course will be giving an update on our financial topics of interest, and of course our CEO, Rick Waddell will be giving his perspectives as well. So, May 28th beginning at 12 noon through a reception that early evening.

Thomas McCrohan - Janney Montgomery Scott

So we can expect that kind of similar to prior Investor Day format.

Bev Fleming – Director of Investor Relations

Yes, sir.

Thomas McCrohan - Janney Montgomery Scott

Great. Thank you.

Operator

And we do have another question in the queue. This is Robert Lee from KBW.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Thanks, good morning.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Hi, Rob.

Robert Lee - Keefe, Bruyette & Woods, Inc.

How are you doing? I know you have got to get to your Board meeting, but quick question on the loan growth, is it possible to get some color on what’s been driving that strong growth? Has it been just growth in the asset servicing business and maybe overdraft or how much of that maybe being driven by... I know you hired a lot of... a fair number of [inaudible] and what not, how much of that is being driven by kind of opportunities you're seeing in more traditional loan?

Bev Fleming – Director of Investor Relations

Rob, this is Bev. I think the strongest growth area that you will see, we'll put the table in our 10-Q as we always do is in commercial lending. And I think what we're seeing there is increased demand from clients for bank credits as other sources of liquidity have been drying up for them. We have seen as we look at the commercial loan growth, it is almost equally split between our large corporate client base, our middle market client base and our healthcare not-for-profit client base. So it's the same type of lending that we do for clients, high quality, which is, we’ve had higher demand because bank credit has been a little bit more in demand as liquidity sources elsewhere have dried up.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

To put it another way, Rob, it has not been as the consequences of here in Chicago where there has been a lot of LaSalle bankers going to other firms, it has not been a consequence of that, it is just demand.

Robert Lee - Keefe, Bruyette & Woods, Inc.

Great. Thank you.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

You're welcome.

Operator

And Mr. Fradkin, we have no other questions in the queue. So I would like to turn the call back to you for any closing comments.

Steven L. Fradkin - Executive Vice President and Chief Financial Officer

Well, let me again thank everyone for joining us for the first quarter conference call. We look forward to seeing you at our Investor Day on May 28th in Chicago and to updating you on our second quarter financial results on July 16th. Thank you very much.

Operator

Thank you. That does conclude the call. We do appreciate your participation. At this time you may disconnect.

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