Jul 18, 2012
Executives
Beverly J. Fleming - Senior Vice President and Director of Investor Relations Michael G.
O'grady - Chief Financial Officer and Executive Vice President
Analysts
Alexander Blostein - Goldman Sachs Group Inc., Research Division Kenneth M. Usdin - Jefferies & Company, Inc., Research Division Howard Chen - Crédit Suisse AG, Research Division Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division Brian Bedell - ISI Group Inc., Research Division Gregory W.
Ketron - UBS Investment Bank, Research Division Cynthia Mayer - BofA Merrill Lynch, Research Division Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division Andrew Marquardt - Evercore Partners Inc., Research Division
Operator
Good day, everyone, and welcome to the Northern Trust Corporation Second Quarter 2012 Earnings Conference Call. As a reminder, today's conference is being recorded.
At this time, I would like to turn the conference over to Director of Investor Relations, Bev Fleming, for opening remarks and introductions. Please go ahead.
Beverly J. Fleming
Thank you, Lisa. Welcome to Northern Trust Corporation Second Quarter 2012 Earnings Conference Call.
Joining me on our call this morning are Mike O'grady, Northern Trust Chief Financial Officer; Rick Kukla, our Controller; and Allison Quaintance from our Investor Relations team. For those of you who did not receive our second quarter earnings press release or financial trends report by email this morning, they are both available on our website at northerntrust.com.
In addition, and also on our website, you will find our quarterly earnings review presentation, which we will use to guide today's conference call. This July 18 call is being webcast live on northerntrust.com.
We only authorize rebroadcast of this call as the replay that will be available through August 15. Northern Trust disclaims any continuing accuracy of the information provided in this call after today.
Now for our Safe Harbor statement. What we say during today's conference call may include forward-looking statements, which are Northern Trust's current estimates and expectations of future events or future results.
Actual results, of course, could differ materially from those indicated by these statements because the realization of those results is subject to many risks and uncertainties. I urge you to read our 2011 annual report and our periodic reports to the Securities and Exchange Commission for detailed information about factors that could affect actual results.
Thank you again for joining us today, and let me turn the call over to Mike O'grady.
Michael G. O'grady
Good morning, everyone. Let me join Bev in welcoming you to the Northern Trust second quarter 2012 earnings conference call.
Our second quarter results of earnings per share of $0.73 and a return on equity of 9.9% reflect continued progress on many fronts. Growth in trust, investment and other servicing fees was strong, driven by new business from both personal and institutional clients.
Execution on our driving performance initiatives remains a critical priority, and we made further progress in the second quarter on both the revenue and expense side, and profitability improved with our pretax margin increasing to 27.7%. This performance was against the ongoing backdrop of a mixed operating environment.
Equity markets were weak in the second quarter, following positive performance in each of the 2 preceding quarters. The S&P 500 was down 3%, and the IFA was down 7%.
This weakness had a negative impact on the market value of client assets, as did the strengthening of the dollar. Assets under custody ended the second quarter at $4.6 trillion, down 1% sequentially but up 3% year-over-year, and assets under management ended at $704 billion, down 2% sequentially but up 3% year-over-year.
Fees, overall, benefited from the prior quarter's positive market performance, given that some fees are calculated on the basis of month or quarter lag asset values. Foreign exchange volatility in volumes continue to be low, impacting our foreign exchange trading income.
Interest rates remain low, placing continued pressure on our net interest margin and resulting in ongoing fee waivers on our money market funds, albeit lower in the second quarter than the first quarter. The U.S.
economy's slow recovery has led to continued improvement in the credit quality of our loan portfolio. Nonperforming assets declined for the fourth quarter in a row, and our loan loss provision was $5 million, unchanged from last quarter and down from $10 million one year ago.
And we saw some modest loan growth both sequentially and compared to last year. Let's move to Page 2 and discuss the financial results for the second quarter.
Net income of $180 million and earnings per share of $0.73 both increased approximately 11% sequentially and 18% year-over-year. Our return on equity of 9.9% was better than last quarter and one year ago and just below our long-term target range of 10% to 15%, signifying good progress on our productivity and profitability efforts.
The sequential quarter improvement was primarily the result of revenue growing 2% and expenses declining 1%. Trust, investment and other servicing fees, the largest component of our revenues, grew 5% but were offset partially by reduced foreign exchange trading income and net interest income.
The decline in expenses was primarily due to lower compensation benefits and other expenses. Higher trust, investment and other servicing fees and net interest income drove the year-over-year comparison, which was again impacted by the reduced level of foreign exchange trading income.
The year-over-year comparisons for both revenues and expenses were also impacted by the inclusion of the Bank of Ireland Securities Services and Omnium acquisitions, which closed in June and July of 2011, respectively. Before getting into more detail, I'd like to highlight 3 items, which impacted the comparisons between periods.
First, we recorded $3.6 million in restructuring acquisition and integration charges during the second quarter. This compares to $3.9 million last quarter and $22.6 million one year ago.
Second, our results for the quarter included software write-downs at $10.5 million. Our first quarter results also had an unrelated software write-downs of $4.6 million.
There was no such item in the year earlier period. Third, our second quarter results included net investment security gains of $500,000, reflecting $21.5 million in realized gains from the sale of treasury notes and $21.1 million in realized losses from the sale of auction-rate securities.
In the comparison periods, net investment losses of $2.4 million and $16.6 million were recorded in the first quarter of 2012 and second quarter of 2011, respectively, primarily due to other-than-temporary impairment charges in our securities portfolio. With that background and summary, let me get into more details behind our second quarter results, beginning with trust, investment and other servicing fees on Page 3.
Trust, investment and other servicing fees were $606 million in the quarter, up 5% sequentially and 9% year-over-year. For C&IS, our institutional business, trust, investment and other servicing fees totaled $338 million in the second quarter, up 7% sequentially and 10% year-over-year.
While equity markets were weaker in the second quarter, some of our custody and investment management fees are calculated based on a quarterly lag methodology. Given that markets were up in the first quarter, with the S&P 500 up 12% and the IFA up 9%, sequential performance benefited from the quarter lag market.
C&IS custody and fund administration fees were $215 million in the second quarter, up 2% sequentially and 13% year-over-year. And the sequential quarter increase was attributable to new business and higher first quarter equity markets, offset partially by the impact of a stronger dollar.
The year-over-year increase was primarily the result of higher fund administration fees related to the acquisitions, as well as new business, offset partially by the impact of a stronger dollar. C&IS investment management fees were $72 million in the second quarter, up 16% sequentially and 3% year-over-year.
The sequential quarter increase reflects lower fee waivers, new business, primarily in index management, and higher quarter lag markets. In the year-over-year comparison, new business, primarily an index and fund management, drove the increase.
Waived fees, associated with institutional money market mutual funds and impacting C&IS, were $7 million in the second quarter, down from $10.6 million in the first quarter and $7.5 million in last year's second quarter. Lower fee waivers on our institutional money market mutual funds primarily reflect higher gross yields achieved in the underlying funds.
Securities lending fees were $31 million in the second quarter, up 43% sequentially, reflecting the traditional second quarter impact of the international dividend season, which resulted in wider spreads, but down 1% compared with last year. Borrower demand remain soft as securities lending collateral of $94 billion decreased 3% sequentially and 12% year-over-year.
C&IS assets under custody were $4.2 trillion at quarter end, down 1% sequentially but up 3% year-over-year, while C&IS assets under management were $528 billion at quarter end, down 2% sequentially and up 3% year-over-year. We continue to be pleased with the pace of new business in C&IS, with our results in the first half of 2012 being our best ever.
That said, new business was unable to offset weak second quarter equity markets and the impact of a stronger dollar. Moving to our personal business, PFS, trust, investment and other servicing fees were a record $267 million in the second quarter, up 4% on a sequential quarter basis and 7% year-over-year.
The sequential quarter increase reflects new business, lower fee waivers and the impact of equity markets on fees. The year-over-year increase primarily reflects new business, the impact of a change in our fee structure, which was effective January 1 and lower fee waivers.
Money market fund fee waivers and PFS were $10 million in the second quarter, which compares with $14.9 million in the first quarter and $15.2 million in the year earlier quarter. Lower PFS fee waivers reflect higher gross yields achieved in the underlying funds as well.
With respect to market impact, our PFS regions use a one-month lag methodology and on that basis, equity markets were up approximately 5% on a sequential quarter basis in the second quarter. Global family office fees are calculated based on a one-quarter lag methodology.
The 12% increase in the S&P 500 in the first quarter favorably impacted global family office fees which, along with lower fee waivers and new business, drove a 12% improvement in fees for the quarter. PFS assets under management were $176 billion at quarter end, down 2% sequentially but up 2% year-over-year.
New business in PFS was solid across all regions, and the global family office group yet was unable to offset the impact of weaker markets on asset level in the second quarter. Total revenues are summarized on Page 4.
Total trust, investment and other servicing fees, which I just highlighted, were $606 million for the quarter, up 5% sequentially and 9% year-over-year. This growth was offset by clients and other revenue categories.
Foreign exchange trading income was $59 million in the second quarter, down 4% compared with last quarter and 27% year-over-year. The sequential declines reflect a continued low level of currency volatility.
The year-over-year decline also reflects lower client volumes. Other operating income was $34 million for the quarter, which is down 11% sequentially and 19% year-over-year.
The sequential quarter decline was primarily due to lower level of commercial banking fees, as well as lower other miscellaneous items. The year-over-year reduction also reflects lower commercial banking fees, as well as a leasing gain recorded in last year's second quarter.
All the other fee revenue categories collectively were down 3% sequentially and up 1% year-over-year. As I mentioned earlier, our second quarter results included net investment security gains of $500,000 resulting from the sales of the student loan auction rate securities and treasury securities.
Net investment losses of $2.4 million and $16.6 million were recorded in the first quarter of 2012 and second quarter 2011, respectively, primarily due to other-than-temporary impairment charges. Net interest income was $264 million in the second quarter, down 1% sequentially and up 3% year-over-year.
The sequential quarter decline in net interest income was primarily the result of lower level of average earning assets, which declined 3% or almost $3 billion sequentially. This decrease in earning assets more than offset the 4 basis points sequential increase in our net interest margin, which was 1.28% in the second quarter.
The margin improvement reflects a mix shift in both earning assets and funding. On the funding side, demand deposits represented a higher proportion of our total funding in the second quarter compared with the first quarter as interest-bearing deposits declined.
On the asset side, average deposits held with the Federal Reserve Bank declined $4 billion. So in total, revenues on a fully taxable equivalent basis were $999 million, up 2% sequentially and 5% year-over-year.
Now let's look at second quarter expenses on Page 5. Total expenses in the second quarter were $717 million, 1% lower than the prior quarter.
Compensation expense, the largest component of expenses, declined 2% sequentially, primarily due to lower share-based compensation. Recall that stock option expense is typically higher in the first quarter of each year, due to the requirement to immediately expense options granted to retirement-eligible employees.
Staff levels on a full-time equivalent basis were up less than 1% with last quarter, with hiring in the second quarter concentrated in the Asia-Pacific region. Excluding acquisitions, staff levels are essentially the same as one year ago.
Other operating expenses also declined sequentially by 14%, primarily due to our traditional level of higher first quarter expenses associated with the Northern Trust Open. Partially offsetting these sequential declines was higher equipment and software expense, due primarily to the software write-down.
Equipment and software expense, absent software write-downs in each of the last 2 quarters, would have increased 3% sequentially, reflecting ongoing investments in technology. Outside services expense also increased sequentially reflecting higher sub-custodian and consulting expenses.
Expenses were up 2% year-over-year, primarily reflecting the impact of last year's acquisitions, as well as higher equipment and software expense due to the write-down. Our progress in the first half of 2012 on managing expenses has been positive, and we remain focused on the expense-related goals outlined in our driving performance initiatives.
Let's move to Page 6 for an update on Driving Performance. In January, we indicated our goal to improve pretax income by $250 million by the end of 2013, with over half the $250 million coming in 2012.
In the second quarter, we achieved more than $35 million in pretax income improvement, split roughly 40-60 between revenue and expense. On the revenue side, we have already implemented a number of initiatives.
As we mentioned in April, a new pricing structure in PFS was successfully instituted on January 1 and is on track in providing revenue enhancements in 2012. In C&IS, we have begun to see success as we take a coordinated set of actions generally on a client-by-client basis to explore clients needs, evaluate how we are servicing them and determining opportunities to broaden or deepen relationships.
We expect these efforts to continue to drive incremental revenue growth going forward. On the expense side, process optimization is the most significant contributor to our profit improvement plan over the long term.
Because process optimization efforts are complex, the majority of this value will be delivered in 2013. One example of a process area where we've already begun to deliver savings is procurement, and we expect to continue to identify opportunities to reduce procurement spend going forward.
Technology efficiency initiatives are well underway in delivering value in line with the long-term total but as we've mentioned, this will represent 5% to 10% of the total. Finally, corporate-wide initiatives are already contributing significant savings in 2012 as many of these initiatives were successfully implemented in the first half of the year.
Based on the financial results a for driving performance achieved to date, we remain on track to meet our 2012 and 2013 targets. Let me turn to make a few comments on the strength of our balance sheet.
On Page 7, we outlined the 3 key components of earning assets, all of which have been consistently managed with a conservative orientation. Just to remind you, our lending strategy, which represents $30 billion in earning assets, is focused on our clients with the majority of loans to PFS clients.
While the loan growth has been moderate through this economic cycle, we did grow loans by over $400 million in the second quarter and by $1 billion compared with last year. Conservative underwriting practices across the diversified portfolio have resulted in loan quality significantly better than industry averages, and our credit quality metrics improved again in the second quarter.
Nonperforming loans decreased 22% sequentially to $240 million at quarter end. Improvements were most evident in the commercial real estate portfolio.
Nonperforming assets were 0.89% of total loans and Other Real Estate Owned, down from 0.98% in the first quarter. Net charge-offs were $3 million, down from $6 million last quarter.
Our loan loss provision was $5 million in the second quarter, unchanged from last quarter and down from $10 million recorded in the second quarter of 2011. As a result, the allowance for credit losses assigned to loans and leases was $300 million at quarter end, representing 1% of total loans and leases and 1.3x our nonperforming loans.
Our Securities portfolio, which was about $29 billion at quarter end, continues to be managed in high-quality fashion, with 87% of the portfolio invested in U.S. Treasury, Agency and AAA securities.
The portfolio at quarter end had a maturity duration of a little over 2 years and repricing duration consistent with last quarter. As I mentioned earlier, during the second quarter, we sold certain lower rated student loan auction-rate securities, thereby, reducing the overall risk of our Securities portfolio.
You may recall that these securities were purchased from clients beginning in late 2008 when the market for auction-rate securities became less liquid. As of June 30, 2012, the remaining balance of auction-rate securities in our Securities portfolio was $107 million.
Interest-bearing deposits with banks at $18 billion, our third largest earning asset category, continued to be managed conservatively as well. Duration remains short at less than one month on average.
Eurozone exposures within this portfolio had been monitored and managed closely. At the end of the second quarter, we had approximately 5 billion exposure to banks in the Eurozone.
We continued to place deposits with a select group of stronger banks at short tenors [ph] . Capital, outlined on Page 8, remained very strong with Tier 1 capital and Tier 1 common ratios at 12.9% and 12.4%, respectively.
We estimate that our Tier 1 common ratio under the Basel III advanced framework, as we currently understand the regulations including the impact of the proposed rules issued by the Federal Reserve on June 7, would equal 12.9%, exceeding all anticipated requirements. Under the common stock repurchase authorization approved by the Board of Directors in March, we repurchased approximately 800,000 shares of common stock for $36 million during the second quarter.
And following our Board of Directors meeting yesterday, we announced the declaration of our quarterly dividend of $0.30 per share which, as you recall, we increased in the second quarter. Let me wrap up by reiterating a few key points made during today's call.
Our second quarter financial performance demonstrate solid progress on executing our strategies. Northern Trust's core businesses, asset servicing, asset management, wealth management and banking are performing very well on a global basis.
We are delivering client-focused, value-added solutions and are consistently recognized in the marketplace for superior service to clients. For example, Northern Trust was named Custody and Securities Services Provider of the Year for the third consecutive year at the UK Pensions Awards and received the Global Custody Award, also for the third year in a row, at the UK Financial Times Pension & Investment Provider Awards.
In our personal business, we were recently named Best Trust Company by Family Office Review, and we continue to hold the award for Best Private Bank in the U.S. from the Financial Times Group.
These awards symbolize our commitment to providing our clients with excellent service and innovative products, which are the key drivers of our sustained new business success. Two initiatives that exemplify recent successful growth strategies are the continued build-out of our growing presence in Australia and the launch of FlexShares, our family of exchange-traded funds.
Since entering the Australian market in 2006, assets under custody have grown to AUD $137 billion. And we have been selected as asset servicer by such prominent clients as the Commonwealth Superannuation Corporation, the Military Superannuation Board and Queensland Investment Corporation.
And FlexShares recently surpassed $1 billion in assets, a milestone achieved less than one year after launch. Our strategy, our brand and our financial strength continue to position us very well to serve our clients, grow the business and deliver value to our shareholders.
Thank you again for participating in Northern Trust Second Quarter Earnings Conference Call. Lisa, please open the line for questions.
Operator
[Operator Instructions] And we'll take our first question from Alex Blostein with Goldman Sachs.
Alexander Blostein - Goldman Sachs Group Inc., Research Division
So I wanted to start with, I guess, your commentary on cost savings and the progress made so far. So if you strip out, I guess, a couple of one-offs, I mean, it looks like the pretax margin this quarter was around 29%, maybe a little over 29%, Mike, how should we think, I guess, about that as we progress through the next kind of 1.5 years?
And what do you guys see yourself kind of finishing 2013 from a pretax margin perspective?
Michael G. O'grady
Yes. So clearly, you've seen, Alex, that we have had a focus on managing our cost and have had success in doing so for a couple of quarters here.
We will continue to do that, continue to focus on that. You also saw the driving performance initiatives delivering the savings that we had hoped for.
The breakdown there for this period was 40% revenue, 60% expense. So beginning to see more of it coming from the expense side of the equation.
So that helped on the margin side. The other thing I would point out, though, is each quarter does have certain items that -- or they're seasonal or just impact particular quarter.
So in the first quarter, as you know, we have Northern Trust Open, we have certain equity awards that get expensed in the quarter. So it's never going to be just a complete, smooth trend across all quarters but certainly, our objective is to stay on the path that we've been on in trying to manage those costs closely.
Alexander Blostein - Goldman Sachs Group Inc., Research Division
Got it. And then, I guess, the second part of the initiatives, and I'm not sure if that's come in through already.
Maybe there's a little bit more to go, but from the revenue perspective, it looks like your fee rates increased almost across every sort of category, whether you look at C&IS custody fees, investment management fees or on PFS side. Can you help us understand, I guess, how much of that is a reflection of the new fee schedule?
How much of that is a roll-off from the fee waivers? And is there anything else going on with the type of business that you're winning that just kind of comes in with a slightly higher fee rate versus what you've seen before?
Michael G. O'grady
I think you've hit on the key categories. So for PFS, no question, and we talked about it there.
We are seeing the benefits from the new fee structure that was implemented on January 1. And I would say importantly there, Alex, is the fact that it's been executed in a way that it has essentially worked the way that we had planned it out.
So from a client retention standpoint and from being able to maintain that fee level, it's gone well. I think on the C&IS front, you're beginning to see the positive impacts of a similar program on that front, albeit structured very differently.
So that process, as we've talked about very much client-by-client, but we've put a very organized program around that such that we make sure that we're measuring not only how we roll that out but our progress on that front. And so you saw in this quarter some benefit on the fee side from situations where we've been able to have those discussions with the clients and be able to, what I call, realign the value proposition with them.
So that -- those are the primary drivers. As far as the mix of business, I would say on the PFS front, if you look at the asset mix for that client base in the quarter, it was, for the most part, in line with where it was in the previous quarter.
So not much of a shift, if you will, in the asset allocation. So it's largely consistent.
And similarly on the C&IS side, I wouldn't say that there's any particular trends in the type of business because we are winning kind of across all the sectors. I would say that we've had particular success with hedge fund services, and so we expect that we'll have higher growth there, which will affect that mix.
Alexander Blostein - Goldman Sachs Group Inc., Research Division
Got you. And then just the last one for me.
NII, I guess, obviously tends to be, I guess, a little bit volatile with the rates and the size of the balance sheet, but it seems like you guys exited the quarter with earning assets a little bit higher than the average. How should we think about the progression, I guess, of NII from here between, I guess, you trying to manage the NIM, and as well as the growth trends and the balance sheet overall?
Michael G. O'grady
Well, as you saw in the quarter, we saw the impact of when the assets do go down, the earning assets, during that time period. So essentially, what happens, there's a number of factors always but if you boil it down, on the funding side, we had lower interest-bearing deposits, and those are coming off on average about 24, 25 basis points for those.
Those were largely being deposited at the Fed. So you saw, likewise, a similar decrease in the average balance of our Fed deposits.
And those, as you know, are 25 basis points as well. So essentially, that part of the earning asset mix that's coming off is a lower yielding portion of it or spread for it.
So that's what benefited primarily -- I would say, that's what benefited the net interest margin during the period. Going forward, as you correctly pointed out, Alex, we actually entered the quarter with a higher level.
Having said that, it continues to move around just as it moved around in the first quarter. As our clients, both personal and institutional certainly, deal with the situations in the marketplace, both in the U.S, but certainly what we're seeing more of recently is in Europe with the euro, those balances can move around.
So as I've said before, difficult to give you a particular trend that we're seeing and just we will continue to manage each component of both the funding side and the asset side to try to maintain the NIM.
Operator
And we'll now go to Ken Usdin with Jefferies & Company.
Kenneth M. Usdin - Jefferies & Company, Inc., Research Division
Mike, I just wanted to ask you for a little more color on the Institutional Asset Management business. I know there was some help from fee waivers but you had a really good revenue result on down average assets.
So can you talk a little bit about product mix in that business, mandate flows, et cetera?
Michael G. O'grady
Yes, as you pointed out, there were a couple of items there on the fee waiver front that helped in the market, helped a little bit. But we did see the impact of net new business on that.
And if you recall, last quarter we talked a little bit about just the timing of when new clients come on. And so we did have the benefit of some of that activity happening earlier in the time period.
So nice wins. As far as the mix, as I mentioned, we had a couple large wins in the index area.
But if you look at our asset mix in the institutional business, as well as the personal business, very diversified, which is something that has been a conscientious strategy to move that direction. And I think you're seeing the benefit of that as the markets move around.
Kenneth M. Usdin - Jefferies & Company, Inc., Research Division
Okay. Second question just on capital, you mentioned 12.9% on the Basel III under the NPR.
That's -- if I'm recalling, that's not much of a delta. Could you just confirm that?
But secondly, of the 13% still growing each quarter, there wasn't really that much buyback this quarter. When do we start to see the share count start to really come down?
And how do you -- do you think any differently about future CCAR submission and capital usage?
Michael G. O'grady
Let me try to take those in a couple pieces. First of all, as far as the change quarter-over-quarter in that Basel III Tier 1 common ratio, the primary driver for the change is that during the period, we did, obviously, have a profitable quarter.
And if you recall, we had 2 dividends declared in the prior quarter, in the first quarter, so all of that net income, or virtually all of it, essentially went to equity. So we saw an equity increase from that.
As I mentioned in selling the auction-rate securities, that also reduced our risk weighted assets. So those were the 2 biggest drivers of the increase in the ratio itself.
As far as the new NPRs that are out there, for us, as the advanced approaches bank, the NPR is generally aligned with prior guidance from the Basel Committee. There's certainly changes.
So the simplified supervisory formula approach definitely impacts part of our risk-weighted assets. But on balance, the increases and decreases from that particular approach essentially have a neutral impact for us on a risk-weighted assets perspective.
So that's how it's affected. To you next point on the share repurchase, we so far had been repurchasing the shares consistent with the capital plan that we submitted and was approved by the Fed, and we'll continue to do that.
If you recall, we said that we would be -- we have the authorization to repurchase $240 million up to the end of the first quarter, so there's still $190 million remaining on that. And we will continue to look to repurchase according to the plan.
Kenneth M. Usdin - Jefferies & Company, Inc., Research Division
Okay, great. And there's one little thing, just on other fees.
You mentioned there's a miscellaneous stuff, was that a bit of an anomaly this quarter? Just give a little color on that.
Michael G. O'grady
Yes. So that category, as you know, does include a number of miscellaneous items.
So it is difficult to forecast, whether it's internally or externally. As I mentioned, we did have a reduction in the commercial banking fees.
And really what that is, is just there was less pure refinancing activity in the time period, and that's one of the drivers of fees for the commercial banking area. So frankly, that component in and of itself can change just depending on the level of activity.
Beyond that, the year-over-year comparison, as I mentioned, included a gain that we had on a lease residual on the prior year period. So you have items like that, that just cause the numbers to move up and down.
But I would say no particular fundamental change in what's in that category.
Operator
And we'll go next to Howard Chen with Credit Suisse.
Howard Chen - Crédit Suisse AG, Research Division
Mike, just wanted to clarify 2 points on capital. One, do you have a Tier 1 common Basel III target and then second, is your expectation to exhaust that $240 million by March 2013?
Michael G. O'grady
So as far as the target, what I would say, Howard, is, similar to what we've said before, we don't have a specific target. We certainly like all the other banks to continue to work through all of the new rules and regulations, try to address those that we think are not appropriate or don't necessarily measure capital or risk in the right way.
So that will continue to evolve and will need to continue to evolve with that and as to what the regulatory requirements are. We do feel that we are very adequately capitalized as you could imagine at this point in time.
And we certainly have to look at the competitive environment or marketplace with regard to capital levels. So we take into account a number of factors.
We do not have one single point target. And as you know as well, there are multiple ratios as well which not only the regulators in the marketplace but we also take into account.
So that's on the target front. As far as the $240 million, that's our authorization.
As always, we evaluate share repurchases based on circumstances at the time in the sense of our view on the state of the business, our capital levels, other alternatives, et cetera. But at this point in time, I would say, as far as the capital plan, our expectation is all else equal to continue to execute on the plan that we've submitted, which is up to the $240 million.
Howard Chen - Crédit Suisse AG, Research Division
Okay, great, Mike. And then on the loan growth, you cited I hear you on the disciplined underwriting standards, but I was just wondering if the growth we've seen over the past few quarters is related to any specific initiatives that you have in place, or is it focused on any particular region or customer profile?
Michael G. O'grady
Sure. It's not a specific initiative.
Having said that, where the loan growth has come from, Howard, is mostly from our commercial and industrial area. So we have had success in adding new clients on that front, and that's where you've seen more of the growth.
There other categories on the personal side as well, but that's the largest driver.
Howard Chen - Crédit Suisse AG, Research Division
Great. And then final one for me.
I asked you this last quarter, I thought I'd check in again. Just post some of the fee schedule adjustments you've made as part of a long-term plan, are you seeing any customer attrition?
Michael G. O'grady
It's actually been, I would say, very good on the customer attrition front. And I give credit to my colleagues both on the personal side and the institutional side for just how they've executed the new fee arrangements on the PFS side.
And then certainly with C&IS, how they're actually going about this in a very organized, programmatic way.
Operator
And we'll go next to the Mike Mayo with CLSA.
Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division
I'm looking at Slide 2. So assets under custody are down 1%, assets under management are down 2%, but your revenues are up nicely, the processing asset management fees are up.
Is the sole reason the new fee schedule, or is there something else happening?
Michael G. O'grady
The new fee schedule is definitely a part of it. It's one of the factors.
Another factor is certainly that relative to markets, fees -- some of our fees, Mike, as you know on a quarter-like basis, some of them are on a month-like basis. For example, in the PFS region.
And there are also other fees that are not necessarily asset-based. So as much as I do think there are longer-term trends in those ratios, they're not necessarily lockstep from quarter-to-quarter.
But I would say that you have those factors that, overall, it's also the underlying just growth of the business, net new business that we're seeing over time.
Beverly J. Fleming
And also, Mike, I would just add the impact of the fee waivers as well, which were lower this quarter than they were last quarter. So that would be another element as well.
Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division
Do you want to give any cautionary language around the upcoming quarters because to the extent that the fee reflect the onetime step-up and the markets weren't as strong and you have a lagging pricing, does that mean the second half of the year might not be as good?
Michael G. O'grady
Definitely don't have a specific view nor would we give one on the second half of the year, Mike, but needless to say, and everybody on this call knows the environment that we're currently in continues to be challenging with regard to interest rates, FX volatility, choppy equity markets. So we continue to be in what I consider a challenging market, but don't know what the rest of the quarter will hold for us.
Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division
Are you getting some sort of flight to quality benefit? Why are you getting the new business that you're getting?
Michael G. O'grady
We think that's part of it, but we think this is part of our broader franchise and strategy and brand. So it's everything, and it's a lot of effort in trying to add to our business and build on it.
Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division
And then lastly, you saw that Goldman Sachs looks to expand its private bank. I mean, to me, it says they're going after your client.
And then you have JPMorgan looking to accelerate its growth in the private bank, how do you think about those longer-term threats?
Michael G. O'grady
Yes, well, they're also near-term competitors for us in the sense that we compete against both of those institutions right now on the personal side. We did note, of course, the article yesterday with regard to Goldman Sachs.
But I'm not sure that, that necessarily is going to change the competitive environment. Frankly, we think that we're in a very attractive business, and we're not surprised that other banks would look to try to compete in this business.
But we feel pretty good about our own competitive positions and have been doing it for quite a while.
Operator
And we'll go next to Brian Bedell with ISI Group.
Brian Bedell - ISI Group Inc., Research Division
On the -- just on the balance sheet. If could you talk a little bit about -- Mike, you were talking about obviously trying to keep the net interest margin roughly stable.
If you could talk about some strategy as we move into this second half? Again, not predicting it for the second half, but with regard to what types of rates you're reinvesting on, any GSE part of the book?
And also, the improvement on yields on the other securities going from 121 to 138, what was the main driver of that?
Michael G. O'grady
Okay. Let me try to take it here, Brian.
As far as overall and how we look at it, as I mentioned when I kind of break down the balance sheet for you. First, this is part of the loan portfolio.
There's no question that the loan growth that we've seen in this quarter and year-over-year is a positive when it comes to the yield on our portfolio or our balance sheet overall. So that is a positive and to the extent that we can continue to grow that with our clients, we would look to do that and would expect to get a positive benefit on that portion of the portfolio.
In the Securities portfolio, you asked the question as to where we're reinvesting in the quarter? Reinvestment rate was basically in line with the yield on the portfolio right now.
So by balancing duration, because you saw the duration didn't really move in the quarter in different types of securities, we been able to maintain that approximate 90 to 100 basis points on the Securities portfolio. And then finally, on the last portion there, which is the deposits with bank, that part, very short term in nature.
As I mentioned, that is an area where it's certainly a challenge, given that it's going to impact -- be impacted by short-term interest rates. In the second quarter, we all know that longer-term rates came down more significantly than the short end, the very short end of the curve.
So much of it just depends on what happens on the very short end of the curve. And we are first and foremost focused on liquidity and credit quality as we make those placement decisions.
Brian Bedell - ISI Group Inc., Research Division
Okay. Yes, that's very helpful.
And then just if you could talk a little bit about the initiatives or the efforts to reprice the custody and fund administration business. I know it's more -- you make it more of an effort with the pension plan.
If you can talk about where you stand in that relative to -- earlier in the year, the conversation is going better. We started to see more effective repricing of that.
Michael G. O'grady
Yes, let me take that and kind of give you a description, if I could, of what we're doing on that front because you are correct. I think that this area is picking up more momentum relative to on the personal side, which started right out of the gates this year.
But as I've mentioned a number of times, this is a very structured global program that we've rolled out that has multiple work streams to it. The first one is definitely trying to assess the individual relationship.
So much has changed over the last several years as we know in the environment. So it's trying to line up the services we're providing now relative to what the expectations were before.
So a lot of analysis goes on that front end. The next piece of it is we've actually been training all of the RMs, if you will, in how to handle these situations with the clients.
And so, right at this point, for example, there's over 200 of the RMs that have specifically gone through the program in order to make sure that we're doing this in a way that we maximize on client retention. And then as far as client communication, we've been having those discussions with the client.
And I would say roughly now, we probably had about 1/3 of the conversations that were ultimately going to have, and we're tracking those very closely. Not just that we're having the conversations, but the type of feedback that we're getting and using that knowledge, if you will, for the future conversations that we have.
And then finally, I would say that we're trying to do this in a way that it isn't just a once every several years that we look to align or realign the value proposition with client. So it's trying to do it in a way that is sustainable.
And what we're seeing so far as far as the early successes I mentioned, they kind of fall into 3 categories. One is that you have situations where we look for and with the client find other opportunities to serve them.
So if we're already providing something on the asset servicing side that there are opportunities in the asset management side. Second is there are specific circumstances where it does involve a fee increase, given that the mix of business had changed.
In other words, there's certain activities whether it's securities lending or FX or something else that they are doing less of that they anticipated on doing more, and then we adjust the other part of the relationship equation. And then finally, there are certain things that are not necessarily revenue-oriented but they may be services that we're providing that are costly on our end that are not necessarily viewed as high-value add on the client end.
And so we work through with them as to where they do value the services and to the extent there are certain things that are not as important to them. We can look to modify that in a way to reduce our cost.
So very comprehensive and, as I would say, not only has it started to pick up momentum here but this will carry through not only through the end of the year, but we'll see the benefits, I think, mostly in 2013.
Brian Bedell - ISI Group Inc., Research Division
That 's great. That's very helpful.
Just lastly, on the new business on the C&IS custody and fund admin side, can you just give us a sense of where you're seeing it mostly, I guess in terms of global, in terms of hedge fund administration and middle office outsourcing relative to straight custody arrangement?
Michael G. O'grady
Yes, I would say, it's a very nice mix across what you said there. So we are winning new business.
I mentioned the growth and success we've had in Australia. So certainly Asia Pacific has been a positive.
In Europe, we had a number of wins during the quarter in Europe. And then likewise, in the U.S., in North America, as far as the type of business, as much as it continues to be broad-based, I would say we've had particular success, as I mentioned, with the hedge fund administration part of the business there.
So relatively broad-based, and I would expect that, that type of mix will continue, although you never know where you're going to be more successful.
Operator
And we'll go next to Greg Ketron with UBS.
Gregory W. Ketron - UBS Investment Bank, Research Division
Mike and Bev, question on the margin. I know you covered this a number of different ways, Mike, but when you look at the earning asset yields and think about repricing risk, is your sense that we're pretty much through the repricing risk as you look across the loan book and into the securities area.
And if not, and if you go to the interest-bearing fund side, you're down to 25 basis points that you're paying net cost on interest-bearing liability side. Is there a further room that you think you could reduce this cost?
Michael G. O'grady
Yes, so if we go through it the way you suggested, first of all, on the loan side of the equation, we did see the yield come down there a little bit as we do continue to see some refinancings. And the refinancings are coming at lower rates.
However, I would like to think that we're towards the back end of that certainly. It doesn't mean that there can't be more pressure on that, but as I even mentioned the impact we've seen on the commercial banking fees, it's because most clients have -- who are interested in refinancing, whether that's personal or institutional, have largely done that or had the opportunity to do it.
So I'd like to think bank end on the loan portfolio side of it. The Securities portfolio, again, is more market-driven.
We're certainly continuing to look at how we balance duration in that portfolio in a way to maintain the yield as best we can. It certainly gets challenging as we see treasury rates come down essentially across the curve.
And then on the shortest end, as far as the deposits, we have been able, certainly in the U.S., with the Fed deposit, the 25 basis points, that certainly provides some level, if you will, I think not only at the Fed but also in the marketplace for the short end. As we've seen, though, in Europe, with the euro now overnight rates being 0, that has an impact on the marketplace and can bring those short-end deposit rates down.
So that's how I would see the kind of the trends, if you will, that we're seeing on the asset side. On the deposit side, as you mentioned, we're already relatively low on our deposit rates and our funding side.
Is there room to go lower? Probably a little bit, depending on where market rates go based on some of the comments I just made previously where we see on the other side of the equation.
But there really isn't that much room on the funding side as well. So that's the balance or the challenge that we have on that front.
Gregory W. Ketron - UBS Investment Bank, Research Division
Okay. That's helpful.
And looking down the road, which seems like a long ways off and rates eventually do go up, say, if the short end were to go up 100 basis points, you have the money market fee waivers and then the balance sheet repricing. Do you have a sense for how much asset sensitivity you would have under that scenario?
Michael G. O'grady
Yes, we are asset-sensitive as you pointed out. And without quantifying it, I would say that as you pointed out, the money market fee waivers which -- we give those numbers so it's easy enough to quantify what those dollars are that essentially would -- if we hold the waivers there.
And I think, to your point, if we saw 100 basis point move in there, our expectation is that we would no longer have those waivers. So you can quantify that.
And then on the margin side of the equation, we're at 1.28% right now. Our historical average is closer 1.75%.
I don’t necessarily think if market rates go up 100 basis points that we would see that full impact, but again I think there's -- anybody could do math around what the impact would be to the extent we're even to get a 25 basis points increment in our net interest margin.
Operator
And we'll now go to Cynthia Mayer with Bank of America Merrill Lynch.
Cynthia Mayer - BofA Merrill Lynch, Research Division
On the asset management side, can you give any sense of whether the flows are increasing or decreasing relative to previous quarters? And also, are they mostly passive at this point?
Michael G. O'grady
Yes. I would say that because of the very diversified nature of our assets under management, there are positive and negative flows depending on the category.
There's none of them, Cynthia, where I would say we're seeing significant flows one way or the other. I do think when you look at our overall levels though, it does indicate, particularly given that markets are down, that on a net basis, we are continuing to win business.
Cynthia Mayer - BofA Merrill Lynch, Research Division
Okay. And any -- what's your outlook there in terms of, I guess, in terms of private client flows?
Michael G. O'grady
Private client flows, again, I would point you the same direction as far as just looking at our asset levels with the markets down sequentially, the assets were also down sequentially but not as much as the markets. Some of that is mix and some of that though also because the net new business has been positive.
And again in this quarter, it was likewise a very good quarter.
Cynthia Mayer - BofA Merrill Lynch, Research Division
Great. Okay.
And then just a quick question on other operating expense. I apologize if you mentioned this, but what drove most of the sequential decline?
I think in the release it mentioned reduced business promotion other miscellaneous expense, but I'm just wondering is that a sustainable level, or is there something else in there?
Beverly J. Fleming
Well, Cynthia, the sequential quarter comparison this year and in recent years would've primarily been the result of the Northern Trust Open.
Michael G. O'grady
That drives the majority.
Cynthia Mayer - BofA Merrill Lynch, Research Division
Right. Right.
So I should really look at it year-over-year.
Michael G. O'grady
Correct.
Cynthia Mayer - BofA Merrill Lynch, Research Division
Okay. And last question is just on the new fee schedule for PFS.
Is there, under the new fee schedule, more of a delta in fees between fixed income and the equity than there used to be so that if equity markets were to rise or people were to become more risk-drawn, would you get more of a lift there than you used to?
Michael G. O'grady
Well, I'm not going to necessarily comment to the specific levels of the fees on the products, Cynthia, just because I don't have them and I don't know them. But I would say that I -- that it does change that dynamic that you're talking about, and it is something where we move from a bundled fee, which to your point is going to be more kind of on average, if you will, to one that now is more differentiated because as much as we have an account management fee, that account management fee is smaller, obviously, than what the overall bundled fee was.
And then the remainder are based on products. Now those product fees are very much just market-based.
So equities versus fixed income and all the various different types of products are just consistent with market level fees. So to your point, you could make whatever assumptions you wanted about changes in markets, and I would have the expectation that our fees would behave differently than they did under a bundled fee.
Operator
And we'll go next to Gerard Cassidy with RBC Capital.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
Mike and Bev, question for you coming back to capital. Clearly, you guys have one of the best Tier 1 common ratios out there, which obviously you want to maintain.
Once we all understand what the final capital rules are, do you think you would come out to shareholders and point out where you want to be relative to those rules, so we could look at the return on equity and get some judgment on how you're going to get to that 10% to 15% target that you have?
Michael G. O'grady
Yes, I think as you pointed out, Gerard, I think you made the phrase, once we all understand how all the rules are going to work, I think we and everybody else looks forward to that day. And in fairness, not only are all the banks but the regulators I think are working through this as well to get to the right place.
So that is certainly something that we continue to not only monitor in the sense of how are the rules developing but then to your point, where do we want to be relative to the regulatory required levels. So that's also evolving.
And then as I've mentioned earlier, we don't necessarily have a target ratio so we don't pick one particular ratio, and then say that we try to drive everything because we do think that it is a multidimensional, multi-variable situation that you need to look at. I mean, obviously leverage ratios are very different than risk-based ratios and you have different risks that required capital within the risk-based ratios depend -- based on the advanced methodology.
So I think it's tough to necessarily have a single point target. And we also take into account, and will take into account at that point what I consider the competitive marketplace, right?
So we have to make sure that we are positioned from a franchise standpoint for our clients and for our businesses in a position that continues to give clients and prospective clients the appropriate view on Northern Trust that we have a very strong balance sheet and strong capitalization. So my point in all that is there's a lot of factors even now, and difficult if not impossible to predict how those are going to develop and then based on that, determine where we would end up with that.
And so we'll continue to take all that into account as we think about the appropriate amount of capital for us in order to also generate the return range that you just mentioned.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
In terms of, I guess this is more philosophically right now because things are still uncertain, both in the macro environment we live in plus with the rules. We all don't know what the final rules are.
But once we get there, conceptually, could Northern actually look to give back to shareholders on an annual basis upwards to -- if the capital is not needed, again, you're at the level you feel very comfortable at, give back to shareholders up to 100% of earnings and buybacks and dividends? Or is that something that conceptually or philosophically just wouldn't fly?
Michael G. O'grady
Well philosophically, the way we look at the dividends is that we do provide a certain portion of our earnings back to our shareholders on ongoing basis. The way we look at share repurchases though is more around our capital structure at the time or the level of capitalization and other alternatives.
And so to the extent that we feel that we are either below where we want to be or above where we want to be, that can affect the amount of share repurchases that we think are appropriate in returning capital to shareholders. And the outcome of that could certainly be that if you calculate a ratio of whatever actions you take, it could be above 100% of our net income.
So in other words, we don't look at all of our capital actions just relative to net income. I view that more as kind of an output for the overall capital return to shareholders.
It's more around making sure our capital position is in the right place. And so the answer to that would be yes.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
Good. And then another source, of course, of excess capital, as acquisitions with Northern over the years has done successfully, what are you -- are you guys hearing anything in terms of opportunities that in the spaces that you look to, to grow through acquisition, or is it pretty quiet right now?
Michael G. O'grady
Yes, there's certainly activity. I mean, we saw one of our competitors make an acquisition yesterday in a space that we compete.
So there is some level of activity. I expect that we'll continue to see that, but there's nothing I would say, Gerard, that's unusual in the sense of either being extremely low or quiet or being extremely active.
To me, it's a natural flow of opportunities, which we certainly take a look at and evaluate and determine if we think that they can add to the franchise. If they fit strategically or provide for us the capability that we don't have and if we can do so in a way that we find financially attractive.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
And then just finally, a side question, when does the contract for the Northern Trust Open come up for renewal with the PGA?
Beverly J. Fleming
Gerard, I might have to follow up with you on that. I think we have 2 or 3 more years, but I'm not positive on that.
Operator
And now we'll take our last question from Andrew Marquardt with Evercore Partners.
Andrew Marquardt - Evercore Partners Inc., Research Division
Just back to expenses, can you just give us an update on the driving performance, and I know you're, I think, on track to meeting your goal of over 50% this year. But given the tough kind of macro environment that all are facing, is it possible to have additional levers there to still meet what I think you said in the past in terms of getting to positive operating leverage this year, is that possible?
Michael G. O'grady
The way I would answer that, Andrew, is the driving performance initiative that we have, the focus there is, as we've said, to be more productive over time both on the revenue side and on the expense side. On the expense side, it's to do things that will produce recurring benefits.
And so all of those categories are things that we expect to continue going forward. Depending on the economic environment and the market environment and financial performance, we also have to look at near-term levers, as you mentioned, that can be pulled in order to react to that, but those are viewed in a separate category.
So regardless of the environment, we'll continue to execute on driving performance and then beyond that, we also are certainly focused on the current environment to determine if there's other things that we need to do. So hopefully, that addresses your question there.
Andrew Marquardt - Evercore Partners Inc., Research Division
Got it. And do you think that in this type of environment where it does seem like the top line is getting tougher, is it possible, is it reasonable to expect positive operating leverage as the driving performance is currently laid out?
And what kind of run rate you're at right now? Should we expect that?
Michael G. O'grady
Sure. Well, operating leverage obviously has to do with revenue growth rate and our expense growth rate.
So yes, it becomes more difficult to the extent that you're in a challenged revenue environment. But that's why we've launched into driving performance earlier this year is because not knowing what that revenue environment is, we want to be able to create positive operating leverage even in a difficult revenue environment.
And I think you saw an example of that this quarter on a sequential basis and on a year-over-year basis but sequential basis where we had positive operating leverage about 3%. So that's still the focus, is to try to achieve that, not knowing or not being able to predict exactly what happens on the top line.
Andrew Marquardt - Evercore Partners Inc., Research Division
Got it. So it sounds like it's still someone on the table that may be less confident in getting to positive operating leverage this year, is that a fair characterization?
Michael G. O'grady
I would just say that everything that we've talked about with driving performance and improving productivity and improving profitability, absolutely still on the table, we feel very good about how we're executing on it, and that hasn't changed. What we don't know is what's going to happen in the broader environment the back half of the year.
Andrew Marquardt - Evercore Partners Inc., Research Division
Great. That's helpful.
Just one last to kick that question on credit and asset quality. Obviously, not that big.
Obviously, a little bit I guess flat in terms of credit cost this quarter. Is that a good kind of run rate?
Sorry, if I missed that, if that was commented earlier in terms of what -- how should we think about the provision cost?
Michael G. O'grady
Sure. So as you mentioned, we had $5 million of provision in the quarter, and that reflected the fact that our nonperforming loans came down 9%, nonperforming assets down 7%.
So continued positive trends. We had $16 million of gross charge-offs in the quarter, and we had recoveries of $13 million.
So net charge-offs only $3 million, which we had a good quarter on that front as well. In the first quarter with $6 million, so that's what that reflects to the extent that we continue to see that -- those types of trends, I would expect that the provision will continue to track like that as well.
What we can't do, as you know, is predict what is going to happen on the credit front. But so far, as I did mention a little bit earlier, Andrew, this is our fourth quarter in a row of positive developments on the credit front.
It's not always that smooth. It can tend to be a bit choppy.
So difficult to say if that trend will continue, but we certainly hope so.
Beverly J. Fleming
Lisa, I believe you said that, that was the end of the questions. So we thank you for joining us today and look forward to speaking with you on October.
Michael G. O'grady
Okay. Thank you very much.
Operator
Ladies and gentlemen, that does conclude today's conference call. Thank you for your participation.