Northern Trust Corp. Q2 2008 Earnings Call Transcript

Jul.16.08 | About: Northern Trust (NTRS)

Northern Trust Corp. (NASDAQ:NTRS)

Q2 2008 Earnings Call

July 16 2008 12:00 am ET

Executives

Steve Fradkin - CFO

Bev Fleming - Director of IR

Analysts

Glenn Schorr - UBS

Mike Mayo - Deutsche Bank

Nancy Bush - NAB Research.

Brian Bedell - Merrill Lynch

Mark Fitzgibbon - Sandler O'Neill

Robert Lee - Keefe, Bruyette & Woods

Kenn Usdin - Banc of America Securities

Tom McCrohan - Janney Montgomery Scott

Operator

Good day, everyone. Welcome to the Northern Trust Corp's second quarter 2008 Earnings Call.

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, Sean. Welcome to everyone listening to Northern Trust Corporation's second quarter 2008 earnings conference call. Joining me on our call this morning are Steve Fradkin, Northern Trust's Chief Financial Officer, and Preeti Sullivan from our Investor Relations team.

For those of you who did not receive our second quarter earnings press release or financial trend report via e-mail this morning, they are both available on our website at northerntrust.com. In addition, this July 16th call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available through July 23rd. 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 Securities and Exchange Commission 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 Steve Fradkin.

Steve Fradkin

Good morning, everyone. Let me join Bev in welcoming all of you listening to Northern Trust's second quarter 2008 earnings conference call. We are very pleased with the financial results that we reported to you via press release earlier this morning.

For the second quarter, operating revenues were at record levels and exceeded $1 billion for the first time in our history. Trust investment and other servicing fees, foreign exchange trading income, and net interest income, which together equaled 93% of total revenues, all exhibited very strong double-digit growth in the second quarter.

We are also very pleased to report excellent balance in the quarter between revenue growth and expense growth. We achieved over 800 basis points of positive operating leverage during a challenging time for our industry. This success was due in no small part to our continued adherence to a very focused strategy built around some extraordinarily attractive businesses, coupled with very strong operating execution in the quarter. It was in summary, an excellent quarter for Northern Trust.

As with prior calls, we've organized today's remarks to address four basic areas.

First, I will outline one item that you should consider as you analyze our second quarter financial results. Second, I will review our financial performance in some detail, focusing on those items that most impacted top and bottom line results. Third, I will offer a few perspectives on the business momentum of Northern Trust, particularly when juxtaposed against the difficult market and economic environment currently facing the financial services industry. Finally, Bev and I will be pleased to answer your questions.

Let me begin by highlighting one item you should consider as you assess our performance. As discussed in our earnings press release issued earlier this morning, our second quarter net income was reduced by $87 million or $0.39 per share due to adjustments made within our structured leasing portfolio. These adjustments relate to structured leasing transactions that we've discussed with you in the past, and have previously disclosed in our filings with the SEC.

The $87 million, after-tax amount, impacted two line items on our income statement. First, net interest income was reduced by $29 million. This represents a reallocation of lease income under revised assumptions, regarding the timing of income tax cash flows related to certain leveraged leases. In accounting terminology, this is our so called FSP 13-2 adjustment.

Second, we increased our income tax provision by $58 million for potential interest and penalties, associated with certain structured leasing transactions. We made these adjustments after evaluating recent court cases against other tax payers that were decided in favor of the Internal Revenue Service, which has challenged the industry's tax position on certain structured leases. We continue to believe that our transactions are valid leases for US tax purposes and we will continue to defend our position vigorously.

With that background, let me review the second quarter's key performance drivers, beginning with revenues. We are very pleased with our topline performance in the second quarter of 2008, particularly, when compared with the extremely challenging conditions that have percept financial institutional across the globe.

Revenues in the second quarter equaled $1.1 billion, up a very strong 24% or $212 million, compared to last year's second quarter. For perspective, I might add that last year's second quarter revenues established a record level at that time. Revenues grew an equally strong 12% or $116 million on a sequential quarter basis.

The key line items that contributed to revenue growth in the second quarter were; trust investment and other servicing fees, foreign exchange trading income and net interest income. Trust investment and other servicing fees increased 21% year-on-year or $112 million to $645 million.

In our Institutional Business, C&IS trust investment and other servicing fees equaled $409 million in the second quarter, an increase of 32% or $100 million year-over-year and an increase of $111 million or 37% on a sequential quarter basis. 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 second quarter. C&IS custody and fund administration fees equaled $172 million in the second quarter, up 17%, or $25 million year-over-year. This strong double-digit custody and fund administration fee growth was driven by new business, particularly in global custody and fund administration, and by higher year-over-year transaction volumes during the quarter.

These strong positive trends were partially offset by the negative impact of unfavorable markets. Recall that C&IS custody fees are built primarily on a one quarter lag basis. Thus our 17% year-over-year growth in custody fees, experienced significant market-related headwinds as evidenced by quarter lag, year-over-year declines in the S&P 500 of 6.9%, and in the EAFE index of 16.9%.

On a sequential quarter basis, C&IS custody and fund administration fees decreased 1% or $2 million, as the impact of new business was more than offset by the challenging equity market environment. Recall that on a quarter lag sequential quarter basis, the S&P 500 was down 9.9%, and the EAFE index was down 15.5%. An important contributor to growth in C&IS custody fees is our ability to successfully aggregate client assets.

Institutional assets under custody equaled $3.6 trillion at quarter end, down 1% or $34 billion from a year ago, and down 0.7% or $24 billion versus last quarter. These year-over-year and sequential quarter declines reflect the quarter's lower equity market values, as the S&P fell 14.9% year-over-year and 3.2% in the second quarter, and the EAFE index declined 22.4% year-over-year and 2.1% in the second quarter.

Our success in international markets continues to drive growth in C&IS global custody assets. Global custody assets equaled $2 trillion at June 30, up 4.6% or $89 billion year-over-year. This growth compares very favorably, when you consider that the market environment declined significantly versus last year. For example, the EAFE index fell 22.4% from June 30, 2007 to June 30, 2008.

On a sequential quarter basis, global custody assets were essentially flat, as new business offset lower equity markets as evidenced by a sequential quarter decline of 2.1% in the EAFE index. Investor management fees in C&IS equaled $72 million in the second quarter, an increase of 1% or $1 million year-over-year. On a sequential quarter basis investment management fees declined 4%, as new business in our mutual fund manager-of-manager and quantitative management businesses was more than offset by the weak market environment.

Managed assets for institutional client equaled $609 billion at quarter end, down 2% or $14 billion compared with one year ago, and down 4% or $24 billion sequentially. Excluding securities lending collateral from C&IS assets under management, which I will discuss in the moment, managed assets for institutional clients actually increased 15% year-over-year and 1.5% sequentially, which represents very strong results in the down market environment.

C&IS securities lending fees equaled $150 million in the second quarter, representing an increase of 104% or $77 million year-over-year, and an increase of 370% or $118 million sequentially. Our securities lending performance in the second quarter benefited from wider spreads on a year-over-year basis, which were driven primarily by reductions in the federal funds rate over the past year.

On a sequential quarter basis, the traditional positive impact of the international dividend season was offset by narrower spreads on US Treasury Securities. In addition, both the year-over-year and sequential quarter comparisons were impacted by positive marks in one mark-to-market securities lending collateral fund, which benefited our second quarter performance by approximately $25 million.

As we've done in the three most recent quarters, let me pause for a moment and provide you with some perspective around our securities lending performance in the current market environment. First, let me start by reminding you that the unusually high level of credit market dislocation beginning in the summer of 2007 negatively impacted the securities lending results that we reported to you in the three prior quarters, beginning in the third quarter of 2007.

Returns achieved in one mark-to-market cash collateral investment fund used for securities lending were weak in those prior three quarters, as pricing pressure on fixed income securities persisted and asset value markdowns flowed directly through to the total return of this fund. In each of those three prior quarters, we discussed with you our belief that there did not exist any permanent impairment of any holdings, and that all of the asset markdowns recorded in the fund during those prior quarters were unrealized.

We said that we expected, given what we knew at that time, that all of the Fund's holdings would mature at par and that any future positive marks would be reflected in the yield on the Fund and in the resultant securities lending revenues reported by Northern Trust. That phenomenon is precisely what happened and added to our strong performance in the second quarter of 2008.

Positive marks reported in the Fund during the second quarter benefited our securities lending performance in the quarter by approximately $25 million, representing about 14% of the negative impact recorded in the prior three quarters. This $25 million represented approximately $0.07 of benefit to earnings per share in the quarter.

The positive impact of wider spreads and the $25 million mark-to-market benefits were partially offset by a lower level of securities lending collateral. Securities lending collateral equaled $238 billion at quarter end, down 21% or $62 billion versus one year ago, and down 11% or $29 billion, compared with March 31. On an average daily basis, securities lending collateral was down 15% year-over-year and 2% versus last quarter. The lower level of collateral on both the year-over-year and sequential quarter basis can be explained primarily by two factors. First, borrower demand for securities was lower because of deleveraging and borrower balance sheet constraints. Second market depreciation was a factor in the lower valuation of loan securities globally.

Let me close this discussion of our securities lending performance with the few remainders that we've discussed with you in the past about the one mark-to-market fund that has influenced our performance in recent quarters:

First this mark-to-market fund has followed its investment guidelines consistently and appropriately. No atypical portfolio management decisions have been made in the fund.

Second, the fund does not use leverage.

Third, 65% of the securities held in the fund are rated either AAA or AA. Approximately 70% of the funds portfolio is invested in corporate notes, with the remainder invested in asset backed securities and cash.

Fourth, the fund is managed with the conservative interest rate sensitivity of 50 days and a credit based weighted average maturity of 1.6 years as of June 30th.

Lastly, there does not exist at this time, any permanent impairment of any holdings. Asset value markdowns continue to be unrealized. We continue to expect, given what we know at this time, that all of the fund's holdings will mature at par. Therefore, as we experienced in the second quarter, any additional future positive marks will be reflected in the yield on the fund and in our resultant securities lending revenues.

Switching to our personal business, PFS trust investment and other servicing fees equaled $236 million in the second quarter, representing an increase of 5% or $12 million year-over-year.

Fee growth in PFS is driven in part by our success in retaining and growing our relationships with existing personal clients, while at the same time winning new clients to PFS. Net new business in PFS was again strong in the second quarter, representing our best quarterly result since the fourth quarter of the year 2000.

Offsetting our strong new business was a weaker equity market environment. Our PFS states, which represented approximately 85% of total PFS fees, earned fees primarily by a methodology that lags current markets by one month. Based upon this methodology, the S&P 500 declined 7.3% year-over-year for the purposes of our second quarter fees, which resulted in a significant headwind to PFS fee growth in the second quarter.

On a sequential quarter basis PFS fees increased 3% or $8 million. The positive impact of new business in the second quarter was partially offset by weak equity markets. The S&P 500 was down 1.6% using our PFS month lag fee methodology, constituting a moderate headwind for PFS fees on a sequential quarter basis.

Fees in PFS are derived from assets that we manage or custody for personal clients. PFS assets under management equaled $143 billion at quarter end, down 1% or $2 billion from a year ago.

Assets under custody in PFS equaled $326 billion on June 30th, up 2% or $7 billion year-over-year. It is important to note that once again the backdrop of a tough market environment, which saw a 14.9% decline in the S&P 500 year-over-year.

On the sequential quarter basis, PFS assets under management were down 2% or $3 billion, while PFS assets under custody were up 1% or $4 billion since March 31st. Again when compared with the decline of 3.2% in the S&P 500 during the second quarter, our performance on a relative basis reflects the strong PFS new business results that I mentioned earlier.

Let me now shift to the discussion to our other key revenue line times, starting with net interest income. Net interest income equaled $249 billion in the second quarter, representing a 19% increased when compared to the second quarter of 2007. As I mentioned earlier, second quarter net interest income included a $29 million reduction, related to our lease portfolio adjustment. Without this adjustment, net interest income would have equaled $278 million, an increased of 33% or $69 million compared with last year.

The year-over-year increased in net interest income was attributable primarily to two items. First, our net interest margin in the second quarter equaled 1.59% on a reported basis and 1.78% if the leasing adjustment is excluded. Our adjusted net interest margin increased 19 basis points from the prior year, driven by wider spreads between overnight rates and one to three month rates. Recall that the Federal Reserve has reduced the fed funds rate by 325 basis points since September of 2007, including a 25 basis point reduction in the second quarter of 2008 on April 30.

Second, average earning assets equaled $63 billion in the second quarter, an increase of 19% or $10 billion year-over-year. Our balance sheet growth remains liability-driven, which in turn drives this strong growth in earning assets. Non-US office time deposits continue to be a significant driven of growth in our balance sheet, averaging $36 billion in the second quarter, an increase of 29% or $8 billion versus last year. 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.

Final significant contributor to revenue growth in the second quarter was foreign exchange trading income, which equaled a record $127 million, up 56% or $46 million, compared with the second quarter of 2007.

On a sequential quarter basis, foreign exchange trading income increased 12% or $13 million. The key drivers of our quarterly results in foreign exchange were volume and volatility. Both remained high in the second quarter driven by uncertain economic conditions, and highly volatile asset, energy, and commodity prices.

Other operating income equaled $35 million in the second, an increase of 23% or $6.5 million year-over-year and 9% or $3 million sequentially. The year-over-year results include $2.8 million of valuation gains recorded on credit default swap contracts, used to mitigate credit risks associated with certain commercial loans.

In addition, the year-over-year results include a gain on the redemption of an equity investment and higher custody related deposit revenues. The sequential quarter increase was driven primarily by the equity investment gain and higher custody related deposit income.

During the second quarter, we recorded a loan loss provision of $10 million compared with the $4 million provision in the second quarter of last year, and a $20 million provision in the first quarter of 2008. The majority of the $10 million provision reflects strong commercial loan growth this quarter.

Credit quality has remained very strong at quarter end, with non-performing assets equal to only $34 million, down $1.3 million or 4% from the prior quarter. Non-performing assets equaled only 12 basis points of total loans at quarter end.

Now let me shift my comments to a review of the key expense categories that impacted our second quarter performance. Expenses during the second quarter of 2008 equaled $643 million, representing an increase of 16% or $88 million from a year ago quarter.

On a sequential quarter basis excluding the first quarter's non-operating item related to our membership in Visa USA, expenses were up 5% or $32 million. Compensation expense equaled $306 million and increased 22% or $55 million from the year ago period.

The year-over-year increase in compensation expense reflects higher staffing levels, and increased level of incentive compensation due to improved corporate performance and annual merit increases. Staffing levels equaled approximately 11,800 full time equivalent positions at quarter end, up 15% year-over-year. Our office in Bangalore, India now employs over 1,000 staff members double the staff level we had in India one year ago.

On a sequential quarter basis, compensation expense increased 7% or $20 million, primarily reflecting higher incentive compensation, our April 2008 merit increases, and increased staffing levels. Employee benefit expenses equaled $63 million in the second quarter, up 7% or $4 million versus last year and up 9% or $5 million sequentially.

The year-over-year increase of $4 million primarily reflects higher FICO insurance due to increased staffing levels. The sequential quarter increase of $5 million primarily reflects a higher discretionary match for our 401(k) plan driven by improved quarter performance and higher FICO insurance due to increased staffing levels.

Outside services equaled $106 million, an increase of 13%, or $13 million compared with last year, and an increase of 13%, or $12 million sequentially. The $13 million year-over-year increase resulted from higher consulting and technical expense. The $12 million sequential increase primarily reflects higher depository sub custodian and consulting expense.

Other operating expense equaled $72 million, an increase of 34%, or $18 million compared with last year. On a sequential quarter basis excluding the first quarter 2008 visa-related benefit, other operating expense decreased 8%, or $7 million. The year-over-year increase is primarily the result of higher charges associated with account servicing. The sequential decline was driven by a lower level of advertising and business promotion expense as first quarter expenses in these categories were higher due to the Northern Trust Open golf tournament.

In addition, other operating expense in the second quarter included $1.2 million in incremental expense associated with the fair value of our liability under the capital support agreements that we entered into on February 21st to support certain cash funds that invests in the Whistlejacket structured investment vehicle.

Recall that in the first quarter of 2008, we recorded $8.7 million in expense representing past quarters fair value of the capital support agreements. The additional $1.2 million 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 supported agreements each quarter until those agreements expire.

Speaking of expiration, we also announced in our earnings press release this morning that we've extended the expiration date of the capital support agreements to February 28, 2009 in order to allow the restructuring of Whistlejacket to reach resolution. I should add that no capital contributions have been made to any of the funds as of June 30th. Our provision for income taxes in the second quarter equaled $212 million resulting in a reported effective tax rate equal to 49.6%.

On an adjusted basis, excluding the extra incremental tax provision associated with the lease portfolio, our effective tax equaled 33.8% in the second quarter. This compares to an effective tax rate of 33.2% in the second quarter of last year. Northern Trust repurchased 40,000 shares of common stock in the second quarter at a cost of $3 million. Diluted shares averaged $225 million. We can purchase an additional 7.7 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 19% versus one year ago to a record $4.9 billion at quarter end. This performance represented our 81st consecutive quarter of increasing common equity, which equates to over 20 consecutive years.

Let me close with few overarching perspectives on Northern Trust's positioning in this challenging environment. From where we sit, it is indeed a challenging macro environment across many fronts. There are very few areas of refuge. Difficulties in the sub-prime sector, significant equity market declines, diminished liquidity in fixed income markets, overall market volatility, and an increasingly stressed credit environment represent just a sampling of some of the challenges.

At Northern Trust, we've always believed that the organization we represent is uniquely positioned within the financial services industry. That belief is probably more in evidence today across a variety of metrics than at any time we can recall in recent history. Like others, we are very mindful of the difficult market conditions, and certainly not immune to the challenges these conditions can inflict.

In times such as these, it is sometimes worth reflecting upon just a few of the underpinnings of our distinctive positioning. The Northern Trust that starts with an extremely tight business model, we continue to be a very focused company, targeting market opportunities with very attractive demographics and balanced risk profile.

We serve the needs of large global institutional investors in C&IS, and affluent families and individuals in PFS. This focus on growth markets and real clients with real ongoing needs is at the core of what we do, and positions us well for future growth opportunities.

Our success in earning the middle office outsourcing, fund administration and custody business of Hermes Fund Managers in the United Kingdom, this quarter is one example of that opportunity and our success. With this win, we were awarded the business of the largest pension fund in the United Kingdom, The BT Pension Scheme, which is the owner of Hermes. In serving Hermes, we will provide a full array of capabilities ranging from middle-office outsourcing to fund administration and accounting to custody. Our focus was also in evidence in our personal business, where we continue to investment in markets where we see attractive opportunities.

During the quarter, we announced the acquisition of Lakepoint Investment Partners, a private wealth management firm located in Cleveland, Ohio. This acquisition will build on our important base of clients in Ohio and strengthens our positioning in the attractive affluent marketplace in that state. Also, as I mentioned earlier, the second quarter of 2008 proved to be our best quarter for net new business in PFS since the fourth quarter of the year 2000. This is I think particularly noteworthy as an achievement when considered in context of a challenging market environment, which typically slows down prospect decision making.

We also remain focused on the conservative management practices and philosophies that have served us well across many cycles and over many years. Again, while certainly not immune from the challenging credit cycle that is currently plaguing the lending and securities portfolios of many, we believe that our conservatism has placed us in a far better position than most to manage through the current storm.

For example, the second quarter of 2008 represented our 81st consecutive quarter of growth in common equity, just one example of our distinctive positioning relative to peers. Of course, we remain focused on serving the needs of our clients, whether building new capabilities, providing consultative advice or simply working with clients to whether the storm. Clients have always been and will continue to be our number one priority. Working with clients in good times and amidst more challenging periods is what allows us to forge long-term, enduring and value added relationships.

In sum, we are very pleased with our current positioning from many vantage points and are gratified to be able to report strong financial results to you for the second quarter of 2008.

Now, Bev and I would be happy to answer your questions. Sean, please open the call for questions.

Question-and-Answer Session

Operator

(Operator Instruction). We will go first to Glenn Schorr of UBS.

Glenn Schorr - UBS

Hi. How are you? Can you hear me, okay?

Steve Fradkin

We can.

Glenn Schorr - UBS

Okay. Sorry about that. I like the streamline version. So, just to talk about the sec lending fund for a second, I just want to make sure; first on collateral, you mentioned that obviously the balances are down 11% sequentially, but just 2% on an average daily balance. I am not asking to comment necessarily on July, but obviously, we should see a little follow through, plus the typical seasonality on sec lending collateral in third quarter?

Steve Fradkin

Yes, Glenn, I think remember, you have to look at that in my view in the context of the market decline, which brings the value down in totality. When you talk about the seasonality, remember that on average over the last five years our securities lending revenues have declined by 19%. So, yes, there is a seasonal effect that will impact fees. But I think in terms of collateral levels, there is a big market value dimension.

Glenn Schorr - UBS

Understood. Then, this is definitely not the typical Northern thing to do but I will ask it anyway. Obviously you have a lot of confidence in the underlying collateral and that these are temporary impairments, nothing permanent in terms of the unrealized marks. He has such killer capital ratios, any thoughts of adding similar assets on balance sheet in the securities portfolio?

Steve Fradkin

Well, I think its funny Glenn over the years we've had dialogue about the securities portfolio and what we should do, and how we should manage the securities portfolio. If you go back a couple of years there were moments where we were fatigued for being too short duration, too conservative and so forth. We always said at that time that the securities portfolio is not our primary business, our primary business is serving large global institutional investors, and high-net worth clients, and we want to keep that securities portfolio safe, warm and dry. I think that has been proven to be a very good strategy for us. So we always consider all the alternatives in optimizing things but I would say that in all probability, we are going to stick to the same thing that has served us well, particularly in this environment.

Glenn Schorr - UBS

Fair enough Steve, I told you I take back the 100 times that I accuse you of being too conservative, I take it all back.

Steve Fradkin

Fair enough. Thank you.

Glenn Schorr - UBS

Last question is reasonable decline in what you have had on deposits, just curious with your outlook, how much flexibility you might think from here forward?

Steve Fradkin

It is really hard to offer any real insight into it, Glenn. I do not think I could add any color at this point.

Glenn Schorr - UBS

Okay. No worries.

Steve Fradkin

Thank you.

Glenn Schorr - UBS

Thanks.

Operator

Our next question comes from Mike Mayo with Deutsche Bank.

Mike Mayo - Deutsche Bank

Good afternoon or good morning for you.

Steve Fradkin

Hi, Mike.

Mike Mayo - Deutsche Bank

This might not be so easy or maybe it is. Can you disaggregate the core growth in C&IS if you back out the market value adjustment?

Steve Fradkin

Well, I think I will let you do the math. I think the one thing that I would say about the back up, this is a terrific and we've got terrific results year-to-date, and we feel very good as I outlined in my remarks. I think the one thing that I would say about C&IS, which we did highlight for you, is that on the C&IS trust fee side you have got $25 million of positive marks that are impacting us this quarter. So to the extent that you view that as non-core, and I think you absolutely could. I would bear that in mind as you evaluate our results.

Mike Mayo - Deutsche Bank

Or may be just assets under custody, it is only flat and you mentioned EAFE index down 2%. So, just core growth is 2%?

Steve Fradkin

I think, Mike, I am just going off the top of my head, because I do not have all the statistics in front of me. However, I think, what we've seen is that degradation in the S&P 500 pulled our overall assets down considerably. However, you are continuing to see on the global side of our business, even not withstanding a substantial decline in EAFE, year-over-year growth. So, you will have to cut your numbers the way you want to cut them, but we feel very good about the growth both on the fee side and on the assets under custody juxtaposed against the environment.

Bev Fleming

Mike, one thing that I might add to help you out there, if you look at our total assets under custody on a sequential quarter basis they dropped by about $20 billion, but keep in mind that the securities lending collateral dropped by about $29 billion. So more than the total amount of the decline was the result of securities lending. If you take that out of your equation you can see that that clearly we would have had net new business that came in and flowed in through custody assets that more than offsets the market impact.

Mike Mayo - Deutsche Bank

I just thought it might be a little bit more than to meet your own expectations?

Steve Fradkin

No, I think we are satisfied.

Mike Mayo - Deutsche Bank

Okay, going on the positive side, where are you winning the PFS business from? Where is that coming from, best quarters since 2000?

Steve Fradkin

Well, I think, our PFS business is really being on a roll. If you look at it in context, not just for the quarter but look where we've come from in the 2001, 2002 and 2003, when the markets were all down, and our year-over-year growth in PFS fees was essentially flat. You look at it in '04 its up 8.5% year-over-year, '05, 9%, '06, 10% and '07, 15%. We are seeing wins across the board. I think it is some combination of the normal things we've got, which is a great set of capabilities and service, and also the environment. There is no question that the, what I will call the normal way we think about disruption, from a client perspective, which is mergers, acquisitions, change of their relationship manager, that stuff, there is some of that. However, we are also seeing a new disruption, which is what I will call financial disruption, and safety and security, flight to quality, that sort of thing.

So the wins are across the board. They are in all regions. They are in our Wealth Management Group. As I alluded to in my call, when typically we see in more difficult environments a slowdown of decision making. So, I think, the new business success in the second quarter is really reflective of some very differentiated performance.

Mike Mayo - Deutsche Bank

Then lastly, the flight to quality, who would that be from in particular, I mean is it from other trust banks or wealth mangers or banks or who?

Steve Fradkin

Well, I think, again the wins are across the board, small institutions and larger institutions. I would rather not pick out any names in particular, but you can form your own judgments about the environment and who is struggling the most.

Mike Mayo - Deutsche Bank

All right. Thank you.

Steve Fradkin

You are welcome.

Operator

Our next question comes from Nancy Bush with NAB Research.

Nancy Bush - NAB Research.

Good afternoon.

Steve Fradkin

Hi, Nancy.

Bev Fleming

Hi, Nancy.

Nancy Bush - NAB Research.

Couple of questions; number one, Steve did you say that the $25 million that was regained on the collateralized fund, or whatever it was, was 14% of what you have given out there, is that correct?

Steve Fradkin.

Yes. Let me restate that so everyone is on the same page. Over the prior three quarters we had accumulated total negative marks of approximately a $184 million. This quarter we've the reverse phenomenon of a positive mark of $25 million. I am giving you round numbers. However, approximately then what we've clawed back of those negative marks accumulated over three quarters is 14%.

Nancy Bush - NAB Research.

Okay. In your statements there about you anticipate coming out without impairments on par et cetera, et cetera means that there is still 86% to be regained at some point, down the road.

Steve Fradkin

That is correct. Subject to all the caveats that nothing gets impaired, so forth and so on. However, yes, that is correct.

Nancy Bush - NAB Research.

Okay. Bigger question, given that it looks like the Fed has stopped lowering rates, and may indeed start raising rates at some point in the future, although we do not know when that will be, could you just take us through the geography of the P&L, about how the Feds view posture of doing nothing is going to impact you in the coming quarters.

Steve Fradkin

Well, I think Nancy, the way we typically benefit both in our net interest income and securities lending business is when Fed cuts rates, and particularly when the Fed cuts rates in an unexpected manner. However, that phenomenon for us is relatively short term, because we are very short in our portfolio. So there is no question.

Put another way, there is no question that we've benefited along with others from those rate cuts, more so than if you will, the normalized environment. So holding all those constant, I would expect some diminution of those kinds of growth rates. However, in a normalized environment, we still have seen, at least over time, this phenomenon of the growing size of the balance sheet. So even when our net interest margin can be relatively flat, we tend to grow net interest income, if the phenomenon of our growth in global custody assets in the foreign office time deposits and the redeployment works in our favor.

So, that is a long way of saying the Fed rate cuts have helped us. However, I think we still feel very good about our ability to grow our businesses, and hopefully grow net interest income along with that.

Nancy Bush - NAB Research.

Now, should they raise rates which would be insane, but they keep making those noises in an 'unexpected manner' do you therefore get hit?

Steve Fradkin

Yes. An unexpected increase in rates would diminish us, but again, the same phenomenon varies typically within a quarter, that phenomenon is through because we just are very short.

Nancy Bush - NAB Research.

Okay. Just one final question, you filed an 8-K today on the capital support, was that just for the extension of the capital support?

Steve Fradkin

That is correct. All we did same terms, same everything, we just extended the period. It was going to expire at the end of July and we extended to the end of February next year.

Nancy Bush - NAB Research.

All right. Thank you very much.

Operator

Your next question comes from Brian Bedell of Merrill Lynch.

Brian Bedell - Merrill Lynch

Hi, Good afternoon, folks.

Steve Fradkin

Hi, Brian.

Brian Bedell - Merrill Lynch

Hi. Just to start out with the breakout of the equity fixed income and cash in the C&IS and PFS asset management businesses, do you have them?

Bev Fleming

Sure. In the C&IS Institutional assets under management, equities were 38%, fixed income was 10%, and short duration was 52%. The personal business, PFS assets under management the breakdown was 43% equity, 25% fixed, and 32% short duration.

Brian Bedell - Merrill Lynch

Great, thank you. Then, just on the securities lending portfolio, is the size of that the same at around $13 billion or is that smaller at this stage?

Steve Fradkin

You mean the mark-to-market fund?

Brian Bedell - Merrill Lynch

Yes the mark-to-market, right.

Steve Fradkin

I think it is $11 billion should I recall.

Brian Bedell - Merrill Lynch

Okay. So for the driver of the recruitment of the $25 million, was that due more to reversal of unrealized losses or was it due more to pay downs from those securities, or even securities sales from the funds?

Steve Fradkin

Brian, I do not think it had anything to do with securities sales for the funds. I think it was some reversal, and there may have been some pay down, I am not sure.

Bev Fleming

However, the majority would have been the market environment, and so it is pricing on existing securities in the portfolio.

Brian Bedell - Merrill Lynch

Okay. So you saw on those particular securities, you really saw credit spreads tighten on those securities?

Steve Fradkin

Right. However, again, remember this can move around a lot. We've seen it move around in the prior three quarters and so we are pleased that it worked our way. However, it is still pretty volatile lot there.

Brian Bedell - Merrill Lynch

Right. However, going forward, tell me if I am wrong on this thesis. Essentially, as you are moving closer to the 1.5 year of average maturity, the pay downs in those securities should become a larger force and potentially overwhelm any negative marks that you would see. I know it is going to be lumpy quarter-to-quarter, but directionally we should see that.

Steve Fradkin

Well that is correct on average, but remember the duration is an average. However, yes in theory, that is right. As you get closer to maturity, you would expect holding all constant that they would be positive.

Brian Bedell - Merrill Lynch

Okay, great. Then on the new business trends, this is for both businesses really and maybe to start with the PFS business? The flight to quality aspect, whether do you think there is a lag in those assets moving over, so clearly the environment's been a little tough for two or three quarters here. Have you seen all of those assets already move, are you in conversations with potential clients where you think that will actually accelerate over the next couple of quarters or so?

Steve Fradkin

Well, I would say in terms of projecting the future, it is extremely difficult. As you know, one day you look at the screen and its all red and everyone is dour, and the next day its green and people are hoping we are in a different world. So, we always have difficulty forecasting this. I think the overarching view on PFS would be really rounded; it is a very strong quarter, the strongest since the fourth quarter of 2000. PFS net new business was up 20% year-over-year and 6% sequentially. We really saw very good new business in the Midwest, and in the Southeast. The increases there were strong double-digit increases. I think, some of the drivers behind that are really around this notion of safety and security of assets. We've got more sales activity going on. I think, we've gotten better at penetrating clients at the $25 million and above level. We've had lower loss business. So, there are varieties of factors that are contributing to this success. I do not think I could anchor to anyone in particular, but summarizing those in aggregate, I think we've just got good momentum, and we are pretty well positioned in that space.

Brian Bedell - Merrill Lynch

Right. It sounds like it is more of your own doing rather than the environment. The environment is gravy on top of that.

Steve Fradkin

Yes. I think that is a fair characterization.

Brian Bedell - Merrill Lynch

Right, okay. Can you make a broad statement on the C&IS business in terms of the new business there? I mean, imagine most of that is from outside the US. Can you characterize whether you are seeing RFPs increase, the momentum in RFP is increased?

Steve Fradkin

Yes, the C&IS business was softer in the quarter, but again as we always say with our net new business, it is pretty lumpy in terms of what we say and year-to-date through the second quarter, we are pretty consistent with where we were last year.

International is a huge driver cross selling to existing clients, be they domestic or international, continues to be very important. The pipeline is active. You all have seen that we announced a number of wins with the, out of fund-of-funds, hedge fund administration, Puerto Rico Electric Power, Hermes that I referred to, Hermes lands down for fund administration. So, I think the story there is much the same. We continue to be well positioned. We are winning extremely attractive mandates and again Hermes, we've long had market share in the UK of the top 200 pension funds of over 20% and even a higher percentage of the top local authorities. However, Hermes is a really terrific win. That is a brand name as good as you can get in the UK. So we are excited about the momentum we've got and the pipeline still strike us as attractive.

Brian Bedell - Merrill Lynch

It is pretty good, okay. Then, speaking of the foreign business, what do you think your flexibility to continue to reduce the rates on the foreign deposits is at this stage?

Steve Fradkin

Well, I think Brian, we are competing for those deposits, and while we've a stronger credit rating than many and we do get a flight to quality dimension, these are large sophisticated institutional investors and we've got to be competitive to earn their confidence. So, I do not think we've disproportionate pricing power if you would put it that way.

Brian Bedell - Merrill Lynch

Okay. Then can I ask one more question

Steve Fradkin

Sure.

Brian Bedell - Merrill Lynch

You would, okay. Just on the commercial loan growth that has been accelerating in the last couple of quarters or I should say loans overall. We are growing at about twice the pace still following the first half as we've seen in the last couple of years. Is that due you to bringing over some folks from LaSalle or is there a different philosophy about how aggressive you going to be at lending going forward?

Steve Fradkin

No I think it is not any, for the rest of the group vis-à-vis acquisition of LaSalle here in the Chicago area resulted I think in a flight, a number of their bankers going to many competitors. We were fortunate enough to pick up many people from LaSalle though not that many in the lending space. So our experience there is a not a function of picking up new bankers. I think, it is more function of our capital strength and capacity and relationships being disrupted elsewhere. So, we are in a position of strength. I think if you would have looked back couple of years ago, we were consciously managing down that the growths in our loan portfolio because we did not like the terms and we did not like the way terms were extending and covenants were weakening, and we managed lower loan growth. However, we've always said if the environment turns and it is more attractive, we will jump in and capitalize. I think that is what we've been doing. So, it is really been function of our interest in opportunities under these conditions and our capacity to take it up.

Brian Bedell - Merrill Lynch

Okay, great. Thank you very much.

Steve Fradkin

You are welcome Brian.

Operator

Your next question comes from Mark Fitzgibbon with Sandler O'Neill.

Mark Fitzgibbon - Sandler O'Neill

Good morning, Steve.

Steven Fradkin

Hi Mark.

Mark Fitzgibbon - Sandler O'Neill

First, I wondered if you could size force the amount of new business wins you had in the second quarter in C&IS?

Steve Fradkin

Because net new business in the way its calculated is a non-GAAP number we've stopped releasing those numbers. However, I would say Mark, the best I can give you is very consistent with where we were in the net new business for the first half of 2008, it is very consistent with where we've been for the first half of 2007. However, unfortunate we do not disclose numbers any more.

Mark Fitzgibbon - Sandler O'Neill

Okay. Then Steve your credit quality has been great, are there any areas that your loan portfolio that you are concerned about are ordering or trying to peer back?

Steve Fradkin

Well I think our credit quality has been really outstanding and we feel good about that. That said it is a very difficult environment and we are not immune to that environment. I think you heard some others talk about Florida and Arizona and we are seeing stress in the real estate markets generally. We are seeing a disproportionate amount of stress in the West Coast of Florida. However, again I want you to keep that in perspective, our asset quality metrics despite that continue to be far superior overall. So, it is tough out there but we are still feeling okay and if I had to pick a place, I would pick the West Coast of Florida is the one we got to keep the closest eye on.

Mark Fitzgibbon - Sandler O'Neill

Okay and then related to the CSA given that you have recorded to-date only a continued liability of only about nine, just under $10 million. Did you contemplate downsizing that CSA when you decide to extend it? Do you think it is likely that it will end up being a lot smaller than the $229 million?

Steve Fradkin

You know I think we did contemplate it, but Mark, it is just, it would probably cause more disruption and noise than is appropriate. I do not know what a final number will be. However, had we decided, even if we had thought we could downsize it, had we downsized it, there would have been a lot, you know, how did you get to that number and so forth and so on. So I think our view is we've got to just let this thing play its way out and in the end, the number will be what it will be.

Mark Fitzgibbon - Sandler O'Neill

Okay. Thank you.

Steve Fradkin

You are welcome.

Operator

Our next question comes from Robert Lee of KBW.

Robert Lee - Keefe, Bruyette & Woods

Thanks. Good afternoon at this point.

Steve Fradkin

Hi Rob.

Robert Lee - Keefe, Bruyette & Woods

Just a quick question. Most of mine have been asked, but I am just curious. The announcement yesterday from the SEC, on the changes to short-selling rules, I mean, if that was to be applied more broadly, do you in any way expect that that would have any impact on your sec lending business in terms of reduced rebates or just volumes?

Steve Fradkin

Rob, I think it is too early. There are dimensions of it that actually could be positive, but I think, given that that was just announced and we haven't had a chance to fully validate, I would probably refrain from giving an answer at this stage.

Robert Lee - Keefe, Bruyette & Woods

Okay. Fair enough. Another question I apologize if you went through this before because I had to step off for a moment. Could you maybe give us some color on what you are seeing in the domestic C&IS business? You talk obviously, the global business continues to go well with some large win as you mentioned, but can you talk a little bit maybe about the competitive landscape in the US, particularly in the pension business?

Steve Fradkin

Yes. We continue to see opportunities. The domestic pension business is certainly more mature as a business and at a different point in the cycle than opportunities outside the US. However, we continue to see some terrific opportunities, whether it is the result of public fund rebids or other factors, we continue to see terrific opportunities, particularly on the cross sell side. There are different ways to grow, one way is to win new clients and we are doing that. Another way is to bring more products to existing clients and we've seen some great examples particularly on the asset management side of bringing to our custody clients asset management capabilities.

So, we are very positive about it, we are also, although your question Rob, was focused on the pension funds, we are also seeing very good growth in what we call global fund services, which is the fund manager piece of both the domestic market and the markets outside the United States. So, we are still quite positive about the C&IS business both in and outside the United States.

Robert Lee - Keefe, Bruyette & Woods

Alright, great, that was it. Thanks a lot.

Steve Fradkin

Thank you.

Operator

Our next question comes from Kenn Usdin of Banc of America Securities.

Kenn Usdin - Banc of America Securities

Hi, thanks. Steve, just one quick question for you. The results in investment management on the C&IS side were a little lighter this quarter even with equity market comps on average a little bit higher, just any moving parts in that business line and some color on how that business is acting?

Steve Fradkin

Well, I think remember when you look at the assets under management, you want to take a look at how the securities lending collateral influence that, because our actual, not actual, but our assets under management excluding the down draft in securities lending collateral were actually up very nicely. So, I think that is one thing to take a look at there, Kenn. Anecdotally, we feel good about the asset management business. We've got Steve Potter firmly entrenched in his new role as President of NTGI. Again the pipelines there look good. I think one of the challenges is people are trying to figure out what to do in this market environment and that can slow down decision making, but no, we feel good.

Kenn Usdin - Banc of America Securities

So, why revenues? What were the drivers? Revenue has been down sequentially then, if you have a core underlying asset growth and positive equity comps, understanding that equities are not the entirety of the asset under management?

Steve Fradkin

I think, you got to remember also the timing, assets can go up, but if they come in late in the quarter you will not have any fees associated with that. So, again I can not lend on the head of a pin for you, but that is typically the phenomenon we've seen in the past, when you will see, if you will, core underlying asset growth but not as much fee growth, it is usually lagging when the assets are out.

Kenn Usdin - Banc of America Securities

Okay. Then one more follow-up on the new business that you are seeing in the PFS, any noted areas of the country where you are seeing either some incremental benefits from other weakened financial institutions or where you are seeing a flight to quality benefit?

Steve Fradkin

It is really national. Ken, I could give you 10 anecdotal stories, but they would be from every regions of the country. So I think that phenomenon is national.

Kenn Usdin - Banc of America Securities

Okay, great. Thanks a lot, Steve.

Steve Fradkin

You are welcome.

Operator

We will go next to Tom McCrohan of Janney Montgomery Scott.

Tom McCrohan - Janney Montgomery Scott

Hi, Steve. Hi, Bev. How are you?

Steve Fradkin

Hi, Tom.

Bev Fleming

Hi Tom.

Tom McCrohan - Janney Montgomery Scott

Are you seeing any market opportunities, given the weakness, so very apparent, the obvious weaknesses out there to possibly acquire or enter any new markets on the PFS side?

Steve Fradkin

Well, I think we did not enter a new market, because we've been in Cleveland for sometime, but we did take advantage of some opportunities in that market with an acquisition this quarter of Lakepoint. I think the environment is disruptive. We are always looking at M&A opportunities, as you know we are not a big acquirer in general, but we look at a lot of things. We will consider all opportunities. There are certainly plenty around there. However, we've done this transaction in Cleveland. We want to get that one firmly in and running well. We will continue to look at opportunities. So, I would say, we are steady on that front, but there is no shortage of opportunities to at least look.

Tom McCrohan - Janney Montgomery Scott

So, it sounds like the opportunities have not increased just, to say its steady?

Steve Fradkin

I would say the opportunities have probably increased. The number that we've availed ourselves is pretty steady.

Tom McCrohan - Janney Montgomery Scott

Okay, fair enough. Can you quantify the SIV exposure? Some of the news agencies have taken out a story that there was another that was also in default. Looks like they are going to have a replacement agent, looks like it is going to be Goldman Sachs. They are valuing those securities, at least the early indications, like $1.60 or $1.62. Can you give us an update like on how Whistlejacket, is that getting close to resolution, where they are going to have a new replacement agent, and are there any indications on what they are going to value those securities out? That will be helpful.

Steve Fradkin

Well I would say, one, our SIV exposure overall has come down dramatically, as some of these have matured, but we still have some. I cannot comment on the Chainian and Whistlejacket, Deloitte is the receiver; they are working through that. We are on the creditor committee and actively involved with them. However, I really cannot give you any information beyond that at this time.

Tom McCrohan - Janney Montgomery Scott

Okay. Lastly on the credit side, it is just been phenomenal story for you, holding line on credit cards. Can you remind us on the residential mortgage portfolio, since you did bring up western Florida and Arizona, how much of your residential mortgages is concentrated in those two areas and any metric like loan-to-value that you can share with us will be really helpful.

Steve Fradkin

I do not know if I have that, Tom. I think our residential mortgage portfolio in aggregate is typically in the high 30% of our total loan portfolio. I do not think we've any thing on what piece is Florida, and then you have got a big chunk in the Midwest and Illinois and then Florida, it is significant for us, but again I want to make sure our comments are in the right context. The question that I was answering was, where do you see the most stress today in the loan portfolio and that I think it is accurate to say that west coast of Florida, but our credit metrics are very, very strong and so that is a relative response.

Bev Fleming

Tom, I do not think it would surprise you to hear that we've very conservative loan-to-value policies and ratios and that our business as with all of our businesses is relationship-oriented, targeting traditional PFS clients. So, even in the mortgage portfolio, you would expect the mortgage portfolio would profile along the lines that what a traditional PFS high net worth client would look like.

Tom McCrohan - Janney Montgomery Scott

Great. Thanks for taking my questions.

Operator

Alright. We've another question from Brian Bedell of Merrill Lynch.

Brian Bedell - Merrill Lynch

Just wanted to have a quick follow up. Just on expenses, a couple of things just on the outside services, whether we should be thinking of that as an inflated trend for second quarter or a more normalized run-rate at this stage. In conjunction with that, just what you are seeing in terms of your ability to hire staff to service the new business particularly in PFS, is there any constraints there?

Steve Fradkin

Well I think one; our staffing overall Brian we've been building, were up in the order of magnitude 15% year-over-year in staff across the company. So at least from my advantage point we are building, and I would say in that regard we are getting access to tremendous talents. We always try and bring talent into the company, but the environment is such that I think we are feeling particularly good about the profile of the kinds of the people that we are able to bring into this enterprise.

In terms of consulting expense, it really does vary so I do not know that I could give, I know that I could not give you a run-rate on that. It seems as though when we finish one project we are on to the next, so difficult to forecast what is the embedded run-rate. However, you know I think overall, again expenses year-over-year up 16%, but when you look at those relative to our revenue growth they are very well managed and we are mindful of the environment and trying to do the best we can there. However, I think we are doing a pretty good job of managing the discretionary expenses well within the context of revenues, of building the staff to enable to deliver on the commitments that we are making to clients, but each quarter will brings its next new challenge. So we feel good for now but on to the next one.

Brian Bedell - Merrill Lynch

Right, just sounds like at least on the asset services you can look at the true revenue environment and trouble that to some degree unless you embark on some gigantic project.

Steve Fradkin

To some degree, but its very difficult, the ship is sailing through the water and it is very difficult to make a hard right hand turn. You just got to remember, many of the initiatives where we've consultants and so forth, they are not initiatives that you start in the quarter and end in the quarter; they tend to be significant projects that roll off over time. So can we trouble our expenses? Absolutely to some degree, but we can turn them on the dime.

Brian Bedell - Merrill Lynch

Right, okay. Great thanks so much

Steve Fradkin

You are welcome.

Operator

We've no further questions on the phone at this time. I would like to turn the conference over to Steve Fradkin for closing remarks.

Steve Fradkin

So, let me again thank you for joining Northern Trust for the second quarter 2008 conference call, and we will look forward to updating you on our third quarter financial results on October 22. Have a great day. Thank you.

Operator

Ladies and gentlemen, that concludes today's presentation. Thank you for your participation. You may disconnect at this time.

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