Apr 15, 2014
Executives
Michael O’Grady – Chief Financial Officer Beverly Fleming – Director, Investor Relations
Analysts
Ken Usdin – Jefferies Brennan Hawken – UBS Marty Mosby – Guggenheim Ashley Serrao – Credit Suisse Luke Montgomery – Sanford Bernstein Cynthia Mayer – Bank of America Merrill Lynch Glenn Schorr – ISI Mike Mayo – CLSA Robert Lee – KBW Gerard Cassidy – RBC Geoffrey Elliott – Autonomous Research
Operator
Ladies and gentlemen, thank you for standing by. Good day, and welcome to the Northern Trust Corporation First Quarter 2014 Earnings conference call.
Today’s call is being recorded. At this time, I would like to turn the conference over to the Director of Investor Relations, Bev Fleming, for opening remarks and introductions.
Please go ahead.
Beverly Fleming
Thank you, Paula. Good morning everyone and welcome to Northern Trust Corporation’s First Quarter 2014 Earnings conference call.
Joining me on our call this morning are Mike O’Grady, Northern Trust’s Chief Financial Officer, Jane Karpinski, our Controller, and Alison Quaintance from our Investor Relations team. For those of you who did not receive our first quarter earnings press release or financial trends reported via email this morning, they are both available on our website at northerntrust.com.
In addition and also on our website, you will find our quarterly earnings review presentation, which we will use to guide today's conference call. This April 15 call is being webcast live on northerntrust.com.
The only authorized rebroadcast of this call is the replay that will be available through May 14. 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 expressed or implied by these statements because the realization of those results is subject to many risks and uncertainties that are difficult to predict. I urge you to read our 2013 annual report and other reports with the Securities and Exchange Commission for detailed information about factors that could affect actual results.
During today's question and answer session, please limit your initial query to one question and one related follow-up. This will allow us to move through the queue and allow as many people as possible the opportunity to ask questions as time permits.
Thank you again for joining us today. Let me turn the call over to Mike O'Grady.
Michael O’Grady
Thank you, Bev. Good morning everyone and let me join Bev in welcoming you to Northern Trust’s First Quarter 2014 Earnings conference call.
As usual, I’ll review our results for the quarter, after which Bev and I would be happy to answer your questions. Starting on Page 2, this morning we reported first quarter net income of $181 million and earnings per share of $0.75, which was up 12% over last year and 7% over last quarter.
Our reported return on equity was 9.3% in the first quarter, better than last year’s first and fourth quarters but below our target range of 10% to 15%. Let me draw your attention to three specific items which will help you evaluate our performance this quarter.
First as noted in our press release this morning, net investment security losses were $4 million this quarter due to an other than temporary impairment of certain Community Reinvestment Act eligible securities. Impairment was taken on four CRA pools backed by residential mortgage loans.
Second, our results in the first quarter of last year included a $12.4 million write-off of certain fee receivables recorded in other operating income and $1.8 million in restructuring and integration-related charges. Third, recall that our reported results in the fourth quarter of last year included a charge of $19 million in connection with an agreement to resolve certain longstanding class action litigation.
Excluding these items across the relevant periods, earnings per share rose 7% year-over-year and 1% sequentially. Environmental factors which impact our businesses and our clients were mixed in the first quarter, continuing trends which persisted in 2013.
Equity markets were higher year-over-year in the U.S. and Europe with the S&P 500 up 19% and the EAFE Index up 14%.
Bond markets, however, were down year-over-year as the Barclays U.S. Aggregate Bond Index was down almost 4%.
(Audio gap) equity markets were mixed with the S&P 500 up 1% and the EAFE Index flat, while bond markets were up about 1% sequentially. Client assets under custody ended the quarter at $5.8 trillion, up 15% over last year, and assets under management ended at $915 billion, up 13%.
On a sequential basis, client custody and managed assets were up 3%. Currency volatility, which influences foreign exchange trading income, was lower in the first quarter, having decreased each month in 2014 to multi-year lows.
FX industry market volumes were lower versus last year but higher sequentially. Short-term interest rates remained at very low levels and continued to pressure our net interest margin and result in fee waivers on our money market mutual funds.
Three months LIBOR averaged 24 basis points, down 6 basis points year-over-year and down 1 basis point sequentially. The Fed fund’s effective rate at 7 basis points was half the level it was at the same time last year and down 1 basis point sequentially.
Average overnight repo was 5 basis points in the quarter, down 10 basis points year-over-year and down 4 basis points sequentially. With those comments providing context on the environment, let’s move to Page 3 and discuss the financial highlights of the first quarter.
Starting with the year-over-year comparison, revenues were up 7% and expenses were up 5%. Revenue growth was the result of higher trust, investment and other servicing fees and net interest income.
Expenses rose due to increases in compensation and benefits, outside services, and equipment and software. As a result, reported net income was 11% higher year-over-year.
Excluding the specific items I mentioned previously, net income was 6% higher year-over-year. Compared to last quarter, revenues were essentially flat and expenses excluding the fourth quarter settlement charge were down 1%.
Growth in trust, investment and other servicing fees was offset by lower net interest income and the other than temporary impairment item that I mentioned earlier. Expense management was led by lower outside services and other operating expense.
As a result net income, excluding the specific items mentioned earlier, increased approximately 1% sequentially. Earnings per share was $0.75 and our return on equity was 9.3%.
With that background and summary, let’s get into more details behind our first quarter results. Turning to Page 4, first quarter revenues on a fully taxable equivalent basis were approximately $1.05 billion, up 7% year-over-year and flat sequentially.
Trust, investment and other servicing fees, the largest component of revenues, were $679 million in the quarter, up 8% year-over-year and 1% sequentially. Fees in our corporate and institutional services business increased 9% year-over-year and 2% sequentially while fees in our wealth management business grew 6% year-over-year and were down 2% sequentially.
Higher equity markets and new business were both drivers of growth with higher money market mutual fund fee waivers offsetting. Fee waivers were approximately $33 million in the first quarter, an increase of $10 million over last year and $2 million sequentially.
The higher waivers were primarily due to the gross yield of the funds declining by approximately 6 basis points on average from the prior year and 1 basis point sequentially due to lower overnight repo rates. I’ll go into further detail on trust fees shortly.
Foreign exchange trading income was $50 million in the first quarter, down 16% year-over-year and down 1% sequentially. Currency volatility was lower in the first quarter, having decreased each month in 2014 to multi-year lows.
Client trading volumes, however, were slightly higher year-over-year and were flat sequentially. Other non-interest income was $65 million in the first quarter, down 10% year-over-year when adjusting for last year’s fee receivable write-off, and down 7% sequentially primarily reflecting the other than temporary impairment item.
Net interest income, which I will also discuss in more detail later, was $254 million in the first quarter, up 9% year-over-year and down 2% sequentially. With that backdrop, let’s look at the components of fee revenues on Page 5.
For our corporate and institutional services business, fees totaled $379 million in the first quarter, up 9% year-over-year and 2% sequentially. Custody and fund administration fees, the largest component of C&IS fees, were $252 million in the first quarter, up 13% year-over-year and flat sequentially, while assets under custody for C&IS clients were $5.2 trillion at quarter-end, up 15% year-over-year and 3% sequentially.
Growth in fees and assets primarily reflects higher equity markets and new business. The sequential quarter comparison also reflects lower sub-custodian recoveries.
Investment management fees in C&IS of $75 million in first quarter were down 1% year-over-year and flat sequentially. Assets under management for C&IS clients were $698 billion, up 16% year-over-year and 5% sequentially due to higher equity markets and higher cash and securities lending collateral levels, as well as the transfer of $7.6 billion in assets under management from wealth management to C&IS in the first quarter.
The transferred assets represent defined contribution accounts and target date funds which emanate from our growing third party distribution and are more appropriately categorized as institutional assets. C&IS investment management fee growth was dampened on a year-over-year basis by higher waivers on institutional money market mutual funds.
Waivers impacting C&IS fees equaled $15 million in the first quarter, $6 million higher year-over-year primarily reflecting the lower gross yield achieved in the underlying funds that I previously mentioned. Additionally, investment management fees in C&IS reflect the impact of a reduction in AUM from a central bank client which occurred in the fourth quarter.
Since 2008, we had been managing approximately $7 billion for this client. Those assets moved out of our funds in the middle of the fourth quarter and therefore diminished fee growth in the first quarter.
Securities lending fees were $23 million in the first quarter, up 2% year-over-year and 4% sequentially. The year-over-year increase primarily reflects higher volumes as securities lending collateral increased 15% year-over-year and 14% sequentially to $117 billion.
Other fees in C&IS were $29 million in the first quarter, up 8% year-over-year and 27% sequentially, in both comparisons due to higher benefit payments and investment risk in analytical services. Moving to our wealth management business, trust, investment and other servicing fees were $300 million in the first quarter, up 6% year-over-year and down 1% sequentially.
Assets under management for wealth management clients were $217 billion at quarter-end, up 5% or $11 billion year-over-year and down 2% sequentially. As I mentioned earlier, in the first quarter we transferred $7.6 billion in assets under management from wealth management to C&IS, the major in equity assets.
This reduced the growth rate in assets under management by 4 percentage points year-over-year and 3 points sequentially. In addition, cash balances within wealth management AUM were $5 billion lower year-over-year and flat versus year-end.
The year-over-year increase in wealth management fees was primarily due to higher assets under management partially offset by higher wage fees in money market mutual funds and the impact of fee reductions in certain of our mutual funds. The sequential decline in wealth management fees was due to the reduction in assets under management as well as two fewer days in the quarter, higher money market fund fee waivers, and the impact of fee reductions in certain of our mutual funds.
Fee waivers in wealth management totaled $17.6 million in the current quarter compared to $13.4 million in the first quarter of last year, and $16.2 million in the prior quarter. Moving to Page 6, net interest income was $254 million in the first quarter, up 9% year-over-year and down 2% sequentially.
The year-over-year increase in net interest income was driven by a larger balance sheet as clients’ interest-bearing deposits averaged $63 billion in the quarter, up approximately $7 billion or 12% year-over-year, and short-term borrowings and non-interest bearing demand deposits were each higher by approximately $1 billion. This higher level of funding compared with the year ago was primarily invested on the asset side in Federal Reserve deposits at 25 basis points.
Partially offsetting the impact of a larger balance sheet was a lower net interest margin which at 1.12% in the first quarter was down 3 basis points year-over-year. In the sequential comparison, average earning assets and the net interest margin were both essentially flat.
As a result, the 2% decline in net interest income reflects two fewer days in the first quarter when compared to the fourth quarter. The yield on the securities portfolio decreased 4 basis points sequentially, primarily reflecting smaller adjustments to premium amortization in our mortgage-backed securities portfolio due to changes in prepayment speed assumptions.
Adjustments to premium amortization were less favorable in the first quarter at approximately $3 million, $7 million lower than the $10 million in the fourth quarter. The adjustments in the first quarter increased the net interest margin by approximately 1 basis point compared to 4 basis points in the fourth quarter.
Offsetting the less favorable impact to the premium amortization adjustments to net interest income was a shift in the mix of earning assets from lower yielding interest-bearing deposits with banks and Federal Reserve deposits to higher yielding securities. Turning to Page 7, expenses were $768 million in the first quarter, up 5% year-over-year and down 3% sequentially.
Similar to previous periods, expense growth is primarily driven by a combination of the costs and investments to supports the growth of the business and those required to meet more stringent risk management compliance and regulatory requirements, along with other expenses that can vary by quarter. Compensation expense increased 7% year-over-year, primarily reflecting staff growth and annual merit increases.
Staff levels increased 5% year-over-year with about half of staff growth supporting the growth of global fund services in C&IS, a business which is experiencing above-average growth and in which we are investing for future growth across traditional hedge and other fund structures. The majority of the remainder of staff growth was in our operations and technology area, as well as in control functions.
On a sequential basis, compensation expense increased 2% primarily driven by the accounting for annual equity-based awards. Recall that there is a requirement to immediately expense options granted to retirement-eligible employees.
Staff growth was less than 1% sequentially. Employee benefit expense was 6% higher year-over-year and 1% higher sequentially as higher payroll tax expense more than offset lower pension expense.
The year-over-year comparison also included higher expense associated with medical benefits. Outside services expenses increased 11% year-over-year and decreased 5% sequentially.
Consulting, sub-custodian expense, and technical services expense were all higher year-over-year but lower in the sequential quarter comparison. Certain categories within outside services expense are seasonal or vary by quarter, and as you recall, consulting expense was higher in the second half of 2013 primarily related to regulatory initiatives.
While we expect these trends to continue, they moderate in the first quarter of 2014. Equipment and software expense was higher by 11% year-over-year and 3% sequentially.
Spending on a variety of technology initiatives continues as we keep apace with supporting a variety of data and reporting needs for our clients and implement tools to enhance the efficiency of our partners while also managing a full docket in the regulatory and compliance arena. Occupancy expense was up 2% versus the prior year and 1% sequentially.
Other operating expense decreased 14% year-over-year and decreased 13% sequentially when adjusted for the fourth quarter settlement charge. Both comparisons primarily reflect lower charges associated with accounts servicing activities, which can be uneven from quarter to quarter.
The sequential quarter comparison also included seasonally higher business promotion and marketing costs associated with the Northern Trust Open. Turning to Page 8, we continue to be focused on enhancing productivity and efficiency in order to improve profitability and returns.
This takes the form of specific initiatives such as those included as part of driving performance over the last two years, which produced quantifiable results; however, it is also achieved through a chance in the mindset of every Northern Trust employee to incorporate productivity into every aspect of our respective roles. Whether someone is in client servicing, portfolio management, product development, operations, technology, or one of the corporate functions, all of us have the opportunity to execute more efficiently.
Deploying our capital productively is a component as well. The financial benefit created through greater productivity allows the company to simultaneously increase profitability and invest in future growth opportunities that we expect will produce targeted returns over time.
Ultimately, our success in achieving our overall productivity goals can best be measured by our return on equity, and pre-tax margin is a significant contributor. We track both closely; however, given the impact macro-environmental factors can have on pre-tax margin, we also closely track the ratio of expenses to fees.
Although by no means immune to external factors, we believe it’s a useful metric to gauge our progress. As Page 8 demonstrates, in 2011 when our return on equity was 8.6%, our pre-tax margin was 24.2% and the expenses to fee ratio was 131%.
Since then, we’ve made progress in reducing the ratio to 115% last year and 113% in the first quarter. Capital, outlined on Page 9, remained very strong with common equity Tier 1 and Tier 1 capital ratios of 12.8% and 13% respectively.
Based on our interpretation of the final Basel III rules released by the Federal Reserve, on a fully phased in basis our common equity Tier 1 capital ratio under the standardized approach would be approximately 11.1%, and under the advanced approach would be approximately 11.7%. Both of these ratios are well above the fully phased in requirement of 7%, which includes the capital conservation buffer.
The supplementary leverage ratio is estimated to be approximately 5% at the holding company, which is above the requirement applicable to Northern Trust. As Northern Trust progresses through fully phased in Basel III implementation, there could be additional enhancements to our models and further guidance from the regulators on the implementation of the final rule, which could change the calculation of our regulatory ratios under final Basel III rules.
As we announced in March, our 2014 capital plan received no objections from the Federal Reserve. In it, we requested authority to increase our quarterly common dividend to $0.33 per share.
At its regular meeting later today, our board of directors will consider formal approval of the planned dividend increase which is expected to be payable July 1. In the first quarter, we repurchased 2.6 million shares at a cost of $163 million.
In addition, our 2014 capital plan provides for the repurchase of up to $425 million of common stock between April 2014 and March 2015. In closing, the first quarter demonstrated continued progress on a number of fronts but with more work to do as we progress through 2014.
With institutional clients, momentum was strong across regions. Announced wins in the quarter included Australia’s Energy Industry’s superannuation scheme and Canada’s IWA Forest industry pension plan.
Our hedge fund servicing business continues to manage through a period of rapid growth and client take-on as well. In addition, in early April we closed out the $55 million contingent purchase consideration related to our 2011 acquisition of Omnium from Citadel.
In completing this about two years earlier than contemplated in the original purchase agreement, we solidified our relationship with this important client of our hedge fund servicing business. At the same time, we also expanded our partnership with Citadel’s technology arm, which has become a key strategic partner of Northern Trust.
With wealth management clients, new business was better than last quarter in all geographic regions and the global family office group, although it fell short of the prior year which was particularly strong due to uncertainties of the changing tax and investment environment. While our performance in wealth management this quarter was hampered by higher money market fund fee waivers and other factors, the business is well positioned both strategically and competitively.
From a financial perspective, while we have improved our profitability across recent periods, we remain focused on achieving returns in our target range. Before I conclude and as is customary for our first quarter earnings call, we will need to end today’s call to allow sufficient time for all of us to get to our annual meeting, which begins at 10:30 Central time this morning.
Please accept our apologies in the event that we have to close off the Q&A period earlier than our normal practice. Thank you again for participating in Northern Trust’s first quarter earnings conference call today.
Paula, please open the line for questions.
Operator
(Operator instructions) We’ll take our first question from Ken Usdin with Jefferies.
Ken Usdin – Jefferies
Hi Mike and Bev, how are you? Good morning.
Mike, can you give us a little more color on the custody business? Obviously there’s great growth on a year-over-year basis and there’s really good AUC growth sequentially, but the revenues were only up just slightly and I was wondering if you could detail whether some part of it might have been transaction activity or any other pushes and pulls that there might have been that would have withheld it from a better growth rate.
Michael O’Grady
So the custody business continues to grow well, and as you saw from the custody and fund administration fees is actually a nice quarter as far as growth, and that just reflects the continued strong new business that we talk about as it works its way through the fee line. I would say that as far as factors within the quarter, keep in mind that as strong as the equity markets may be, only about half of the assets under custody relate to equity so they don’t—they won’t fully reflect that.
So having a growth rate in fees that is similar to assets under custody is actually the positive impact of net new business.
Ken Usdin – Jefferies
Okay, but was there something that either was strong in the fourth or that didn’t come through in the first, because all that, given the growth that you’re mentioning and the onboarding of new clients, the revenues were only up less than $1 million sequentially. So I’m just thinking about from a prospective, is there something that either wasn’t in there that might be going forward, or just something that maybe is lagging in terms of its revenue recognition?
You had the good positive comp locked in from this quarter as well.
Michael O’Grady
Yeah, so on a sequential basis, all the trends that I mentioned there continue. However, Ken, one of the things that also runs through that line is sub-custodian recoveries.
So where we’re utilizing sub-custodians throughout the world, when we get certain charges we pass those charges along to our clients, given that we’re the global custodian, and those can tend to vary, as we’ve talked about, from quarter to quarter, and recoveries were higher in the fourth quarter of last year and lower in the first quarter of this year, which trimmed a little bit from the growth rate.
Ken Usdin – Jefferies
Okay, got it. My second question – Mike, the outside services and the other expense lines were much better controlled on a year-over-year basis than they had been.
To your point about seasonality, I just want to understand, how do we understand especially for those two lines which have been the biggest growth areas over time, you mentioned trends expected to continue but I want to just ask you what you mean by that. We can expect continued growth in outside services and in other, or are we now coming off of a peak-ish type of number that we saw in the fourth?
Michael O’Grady
So outside services includes a number of sub-categories within that, so that’s everything from consulting fees to technical services, which we use the technical services often as part of onboarding new clients. That includes legal expenses in there as well, and just any other third party service that we’re contracting for.
That’s why the trends can move around from quarter to quarter. What we’ve seen, though, over the last several quarters, particularly I’d say about the last two quarters, is that consulting has been a big driver for an increase in that category overall, and if you recall, the first and second quarters of last year, consulting was relatively low, whereas it picked up a fair amount in the third and fourth quarters as we addressed a number of the regulatory projects that we had underway.
What we saw in the first quarter is that the consulting expenses were lower than the fourth quarter, and I think you can expect that in the sense that there were a number of initiatives that we needed to complete by the end of last year, and yet we’re higher than we were a year ago and that’s just because the list of regulatory projects that we’re working on still remains relatively long. The mix has changed, so many of the things that we were working on last year are different this year, so last year a number of the projects included things like the resolution plan and certainly more of a focus on CCAR, whereas in 2014 we’re spending more time and resources on such initiatives as AIFMD, which has ramped up somewhat in the fourth quarter but also in the first quarter.
Ken Usdin – Jefferies
Okay. So—okay, I get it.
So maybe we’re at this new level, but not necessarily going back to where we were, and it just depends on the progression of this mix shift that you’re alluding to.
Michael O’Grady
It definitely depends on all of those categories and what that mix is. The other thing I would say about the consulting line and just regulatory costs in general is that at this point in time, we don’t necessarily know what all of the requirements and projects will be between now and the end of the year, so it’s really difficult to be able to know exactly what those costs will be.
Ken Usdin – Jefferies
Okay, I understand. Thanks, Mike.
Operator
Moving on, we’ll go to Brennan Hawken with UBS.
Brennan Hawken – UBS
Good morning. So question on the AUM- it sounds like ex-noise in your C&IS and wealth management, I get to maybe roughly a 2% C&IS sequential growth rate and then just slightly positive in wealth management.
Is that right? I was trying to note down all the noise you were walking through there, Mike.
Michael O’Grady
Yes, sequential, I think if you take into account the transfer that we talked about, on C&IS you would be closer to 4% and on wealth management you’d be closer to 1%.
Brennan Hawken – UBS
Okay, and it also looked like the asset management fee rate in C&IS took a bit of a hit, so can we talk about whether or not this noise, was it the timing of some of these re-classes that might have had an impact there, or did these changes happen in the beginning of the quarter and therefore is this the new run rate that we should think about for the asset management business in C&IS?
Michael O’Grady
So as you point out, the fee rate is still shy of that, and there are a number of factors that contributed to it. One is just slightly higher money market fee waivers.
Two is that at the beginning of the quarter, we did re-price some of our mutual funds in the multi-manager space. That was as of January 1, so that’s in the run rate, if you will, now.
Then also, the day count in the first quarter does impact the fees that are generated from the mutual funds, and then there’s a slight mix change which we’ve been talking about over time, which is even as clients take on more equity exposure, they’re doing it more through passive product as opposed to active products, which have different fee levels. So those are really the factors that are driving the difference between AUM growth and fee growth.
Brennan Hawken – UBS
That’s helpful, thanks. And then the other question here, maybe could you give some color on demographics of your wealth management business and how that compares today versus maybe five or so years ago?
Have we seen a meaningful change there at this point?
Michael O’Grady
Well, I can’t quote specific statistics for you based on demographics, but I can tell you that we clearly have evolved our strategy with regard to the target market that we’re focused on, and so certainly the expectation is that the demographics are slanting more and more up market. So even putting aside the global family office business which deals with the largest families and wealth, the wealth business overall in all of the regions has also turned its focus to the level above $20 million of liquid net worth.
Importantly, it’s not just approaching more clients within that target range; it’s also trying to provide the types of services that are particularly of interest to that target market, so whether that’s from a banking perspective, a fiduciary needs perspective, or also just their approach to their investments, it is more up market-focused. So as a result, just the new wins and the clients that we’re bringing on fit that demographic more than they do what I would consider a much broader wealth or high net worth demographic five years ago.
Brennan Hawken – UBS
Okay, thanks for taking my questions.
Operator
Moving on, we’ll go to Marty Mosby with Guggenheim.
Marty Mosby – Guggenheim
Good morning, Mike. I was going to ask a technical question about the share repurchase.
The $163 million was about over 2.5 million shares, but when you look at the outstanding shares in the report, they’re only down about 800,000, so I was curious what the difference was between that.
Michael O’Grady
Yeah, the difference is just that in any time period, there are exercises of employee-related shares and options, and so that can offset some of the shares that we repurchase; and that’s the case in the fourth quarter as well.
Marty Mosby – Guggenheim
But that was stronger than what you would typically have probably seen—we’ve seen in past quarters.
Michael O’Grady
Yes, and part of that, Marty, is it is going to be related to the level of the stock price, so options that were granted a number of years ago were out of the money for some time period. In the fourth quarter with the stock price being higher, that provides a greater incentive for employees to exercise the options.
It also just depends on the remaining time that’s in the options as well, and certainly as options get closer to expiration, which will happen towards the end of the year, then the employees tend to exercise those options before they expire.
Marty Mosby – Guggenheim
And then lastly, the shift from the shorter term money with banks and the Fed into the treasury portfolio, what kind of duration are you buying into? What’s your thought process there at this point?
Michael O’Grady
So our duration on the securities portfolio was very stable with where we were in the fourth quarter, so right now, as I’ve mentioned previously in the fourth quarter, we were at about 14 months as far as the duration for that portfolio and we’re still in that range. We did increase the size of the securities portfolio during the quarter just because we’ve seen increased custody deposits and stability in those deposits, and I would say at this point that obviously like everyone else, we’re looking at interest rates and what the expectations might be, but our position is relatively stable as opposed to one where we’re necessarily looking to either increase or decrease the duration on that portfolio.
Marty Mosby – Guggenheim
Got you, so just a shift between the shorter term and then the securities, given what you’re looking at as more long-term funding out of the deposit base?
Michael O’Grady
Exactly.
Marty Mosby – Guggenheim
Thanks. All right, thank you.
Operator
We’ll go to our next questioner, and that will be Ashley Serrao with Credit Suisse.
Ashley Serrao – Credit Suisse
Good morning, Mike. First, a question on regulation.
As we come towards the end of the SLR rule-making process, do you believe that the rule as it stands today will impact business decisions in any meaningful way? And then an update on how you’re thinking about other regulation, especially in Europe – I know you addressed the expense angle with AIFMD, but maybe some thoughts on revenue opportunities as well.
Michael O’Grady
Sure. So with regard to the supplementary leverage ratio, I do believe that that will have an impact on business decisions, not necessarily because it has such a great impact on Northern Trust but I think that it will impact the market.
And the areas where I would expect to see impact would be certainly just with the size of the balance sheet being very relevant and having higher levels for the largest banks, just being able to take on deposits, for example, as a different capital implication than it previously did. So I think that will affect the market overall and certainly will affect the way we think about client deposits and what the appropriate pricing is for that deposit.
At this point, the supplementary leverage ratio does not present limitations to us, so it hasn’t caused us to do anything that we wouldn’t have previously done; but I think that that will evolve, as I mentioned, with the market over time. And then a second area that I think it could potentially have an impact is on what I’ll consider off-balance sheet commitments, whether that’s line of credit or just credit facilities to corporations; and again, given the fact that those are included in the denominator of that ratio, I think that it could have an impact not only on the extension of credit to corporations but also the pricing of that credit, and certainly that’s something that, again, we look at very closely because that is a way in which we’re deploying our capital for our clients.
And then I think the other question, Ashley, was with regard to regulation more broadly, things like AIFMD. I would say that we, like others, are investing in that area to make sure that we’re in a position to provide those services to our clients.
So far, that’s gone very well as far as the implementation of what we think the required needs are. What is being required being a depository in that marketplace is very similar to services that we’ve provided for clients for a long time period, both in the U.S.
but also in Europe for USDs (ph), so this is really an expansion of that and it is just requiring an expansion of our capabilities to serve the clients. But overall, we think that that’s actually something that will be a positive because it’s more that we can do for our clients and also a service that they’ll value and will also pay for.
Ashley Serrao – Credit Suisse
Great, thanks for all the color there. My quick follow-up is on other expenses.
Typically you would expect 2Q to be a bit lower, given the non-trust expenses roll off. Should we be expecting the same magnitude of a drop that we’ve seen historically given the lower than usual account services expenses this quarter?
Thanks.
Michael O’Grady
As you pointed out, we had a particularly good quarter, I would say, with regard to the charges associated with operating activities, and that’s something that is impossible to predict. Certainly our objective is to minimize those, but it’s not something that we have visibility into.
But as I mentioned, it was very good in the first quarter, so hard to determine whether we’ll be able to repeat that. That category includes, as you know, a number of other items as well and that’s why it’s a broad other category, which when you look over time there’s more variability to that category.
So there’s no particular increase or decrease that we necessarily would expect.
Ashley Serrao – Credit Suisse
Great. Thanks for taking my questions.
Operator
Moving on, we’ll go to Luke Montgomery with Sanford Bernstein.
Luke Montgomery – Sanford Bernstein
Morning guys. Just a quick one on CCAR.
Now that you’ve been through the process, just any lessons you’ve learned, things that maybe you would do differently or could have done differently for next time. And then also along with that, perhaps you could comment on whether the uncertainty going into this time, maybe more conservative on your capital return request than you might have otherwise been.
Michael O’Grady
Sure. So CCAR, as we talked about a lot last year, we needed to make a number of changes and enhancements to our process relative to the CapPR process and feel that we were successful in implementing those and we’re certainly pleased with the outcome.
Having said that, we still have more work to do on that front. As has been much talked about, there’s the quantitative aspect of it, which we think that we perform well, but then there’s also the qualitative aspect, and in those areas we continue to improve the modeling that we do.
We continue to improve the way in which we communicate our plan to the regulators. We definitely involve a broader group of people within the company, whether that’s different parts of business management as we develop stress scenarios but also the engagement of our board, so it’s a very comprehensive, as it’s titled, process and I think that we learn the importance of making those investments to be able to meet with the regulatory expectations, but we also understand that those expectations continue to move up.
So we have plans in place, even though we have not received specific feedback with regard to our plan at this point, and we’ll get that later in the month. That hasn’t held us back from continuing to improve on our processes.
As far as the second part of your question, Luke, it’s clearly too early in our minds to think about what our capital action request will be. Again, we haven’t even either sat down with the Fed to get a detailed set of points for feedback, nor have we received a letter, so just very, very early in the process.
Luke Montgomery – Sanford Bernstein
Okay, that’s helpful. And then perhaps just a quick update on Bridgewater – I think that’s still coming on next quarter, right?
So maybe a reminder about how we should be modeling the revenue impacts since the assets won’t be in assets under custody, and then a general sense of any trend toward shadow servicing deals in general – do you think there will be more opportunity there? How difficult has this deal been to onboard, and has it changed your appetite to bid for those in the future?
Michael O’Grady
So I’ll actually start with one of your last points there, which is just the complexity of onboarding a situation like this. It has gone well, albeit coordinating between the client and another provider is complicated, so at this point our expectation is that we will go live on that in the third quarter.
To your point, when that happens, those will be assets under administration and then we’ll begin to recognize the revenue and expenses related to that as well. At this point, I would say that there is more discussion than activity with regard to shadow administrators.
We think it’s something that will be applicable in the marketplace going forward, albeit it for a select set of large institutions or hedge funds like Bridgewater. So we definitely think it’s a positive.
We’re clearly pleased with that opportunity, and so we continue to look for more opportunities like that.
Luke Montgomery – Sanford Bernstein
Okay, thanks a lot.
Operator
We’ll move to our next caller, and that will be Cynthia Mayer with Bank of America Merrill Lynch.
Cynthia Mayer – Bank of America Merrill Lynch
Hi, thanks a lot. Maybe just circling back to the fee reductions on multi-manager mutual funds, can you give us a sense of how many assets and funds that involves and some of the thinking behind that?
Also, I think you had mentioned—previously mentioned maybe last quarter that you were reversing discounted fees in wealth management, so wouldn’t that offset some of that?
Michael O’Grady
So the first part, Cynthia, this related to three multi-manager funds which had AUM of approximately $4 billion related to that, and the rationale for the change in pricing was to just ensure that those products continued to be priced competitively within the marketplace. As you would expect, we constantly are monitoring pricing and the costs of our funds, and from time to time feel it’s appropriate to look at reducing the fees on the fund.
So that’s what it related to. As far as the discounts, the discount is what I would consider kind of an ongoing initiative.
We did not necessarily reduce discounts, for example, across the board in the first quarter. It’s something where right now, it’s happening more on what I would consider kind of an account-by-account basis where if we determine that the level of work and value that’s being delivered is not aligned with the discount, then that’s an opportunity.
But we didn’t really see any benefit, significant benefit from that in the first quarter that would offset the change in pricing.
Cynthia Mayer – Bank of America Merrill Lynch
Okay, great. I apologize if you mentioned this, but how is your pipeline looking for C&IS?
Michael O’Grady
Pipeline continues to look very good. I would say that the level of market activity is good, so there are many opportunities which we are currently either in dialogue in or that we’re actually in the RFP process for those, so that’s really a positive.
We’ve been very pleased with our win rate on that front as well, so on the institutional side, I would say very good. As I mentioned on the wealth management side, if you go back a year ago, we were really coming off a time period where it was very high level of activity and new business in the wealth management business, and then it tailed off through the end of the year.
Coming into 2014, it’s improved off of where it was at the end of the year but it’s still not at the very high levels that we saw a year ago. Overall, though, I would say that if you think about the risk appetite for our client base and if you were to talk to some of the investment professionals for us, like various people within asset management or within the wealth management business, I think what they would tell you is that the beginning of this year, there was a fair amount of uncertainty in the marketplace which caused a little bit of a pause in activity, whether that’s some of the geopolitical activities or just the volatility in the equity markets.
So we didn’t see a pullback necessarily but we didn’t see as much advancing on that front.
Cynthia Mayer – Bank of America Merrill Lynch
Great. Thank you so much.
Operator
Moving on, we’ll go to Glenn Schorr with ISI.
Glenn Schorr – ISI
Thanks very much. I guess I’m trying to tie together all of the pieces of the puzzle for investment management because we heard about a transfer, some price cuts, and then some internal transfer stuff.
If I look at assets versus fee growth over, let’s say, the last five years instead of worrying about the last quarter or year, fees grow less than assets, but that’s a function of active to passive which you should be capturing. So I guess I’m looking for any kind of summary comment of how the asset management business is doing in your mind, the passive as it should be well positioned, especially with your client base, but it’s hard to see with a lot of the different moving parts – sorry.
Michael O’Grady
Sure, I think it’s certainly a fair question, and over time—over a longer time period, as you suggested, assets under management have certainly grown at a nice growth rate for us, which is a result of, as we’ve talked about, a strong equity market environment but also new business. On the fee side of the equation, we’ve had the negative impact of the fee waivers which right now, we’re at basically the highest run rate level that we’ve seen.
It did go down if you went back a year ago, obviously, and some quarters before that, but it’s gone back up to a higher level now just because the very shortest end of the curve is very low, and that’s where a lot of the funds within those funds are invested. So that’s been a drag on the growth rate, and I would agree that we certainly have benefited because of the move from active to passive, so you’ve seen that in the asset growth, and a category that is growing the fastest within that is the equity index business, and that’s a combination of both the equity markets again going to a high rate, but also that’s a particular area where we’ve had success with inflows.
The other part of that, however, is that the index business comes at a lower fee rate than our average fee rate, and certainly lower than active equity, so it does bring down the revenue yield, if you will, on the assets under management. I think those are the longer term trends.
I think that within wealth management, you did see through 2012 and 2013 the benefit of fee simplification, which was a lift to that yield on the assets under management. As I mentioned before, at this point it’s been two years since we did have an overall increase in those fees, but you’ve seen that now the growth or the positive benefit of that trail off.
As I mentioned, we look at incrementally addressing discounts on the accounts, but we have not looked at actually increasing fees. Finally, I would just say, again, benefiting from some of those trends but also part of the trends more broadly are just fees on investment product overall, so it’s very important for us to make sure that we’re offering products at competitive fees and so that’s resulted in some of the activity this past quarter, but if you went back, there’s been other quarters where we also have reduced the fees on some of our investment product.
Glenn Schorr – ISI
Got it, and maybe I’ll do one quick, short one on expenses as well. Again, you went through a bunch of moving parts, but the results are actually pretty good both sequentially and year-on-year in terms of positive operating leverage.
Do you sense a turning of the corner, and I know that’s market dependent, I know it’s rate dependent, but things look like in the most control you’ve had in a little while. I don’t know if I’m reading too much into things, but just curious to get your thoughts.
Michael O’Grady
Yeah. I definitely am not in a position to be able to comment on whether we’ve turned a corner.
I would just say that 2012, 2013, we were very focused on driving performance, which was primarily initiative-based, as I talked about. We continue to have a number of initiatives on that front, but more importantly I would say some of the things that were more initiatives before, Glenn, now are part of just business as usual.
What I mean by that is going back two years ago, we looked at some of our procurement categories and said, how can we reduce our expenses here? What are some areas that essentially we can attack as a project to reduce those, and we were successful in that; whereas now, that’s become just part of normal practice is looking at our expenses in procurement from a strategic standpoint and making sure that every negotiation that we do on a large vendor contract goes through the same rigor.
So in some ways, we’re getting continued benefit just on an ongoing basis, so I’d like to think if there’s a corner that we’ve turned, the corner that we’ve turned is just in the mentality of how we approach efficiency and productivity, but not necessarily anything that enables us to say that the expense trajectory, by definition, will change.
Glenn Schorr – ISI
Okay, I appreciate it. Thank you.
Operator
Moving on, we’ll go to Mike Mayo with CLSA.
Mike Mayo – CLSA
Hi. Could you just elaborate more on the sub-custodian fees fourth quarter to first quarter, maybe a dollar amount or who are you dealing with, if you can disclose that, and how are those relationships?
Michael O’Grady
Yes, so we deal with sub-custodians all over the globe, and it’s particularly in areas where we are not inclined to actually be a primary custodian, so that’s the nature of it. We’re the global custodian, and then we have the sub-custodian networks.
With regard to the costs, there are certain of those costs which are absorbed but there are certain which per agreements with our clients get passed on. With that network, the timing in which we receive the cost is not always as smooth and predictable as we would like, so I can’t obviously comment on specific names of the sub-custodians that result in the higher levels, but I can tell you, for example, that there are certain just geographies that in the quarter ended up being higher than what we expected, so as a result we had less that we recovered in the fourth quarter.
But I would say, Mike, that’s a line that just over time, quarter to quarter, moves up and moves down, but the longer term trend I would say is one where if anything, we’re picking up efficiencies in the cost of our sub-custodian network.
Mike Mayo – CLSA
Okay. Separately, your earning assets grew 12% this quarter, 11% last quarter, but before that it was kind of flat or down the prior few quarters.
So is anything changing with the balance sheet?
Michael O’Grady
Yeah, there is no question that some of our larger custodian clients are placing more deposits with us, some just with the growth in the business but I would also tell you that some of these deposits are large, chunky deposits which even within that, I wouldn’t characterize them as all being the same. As you would expect, we follow them very closely and when I say not the same, I would say some of them, for example, are money managers who at this point in time just have excess cash and placing it at the bank in a deposit is preferable for them at this point in time.
As you would expect, if they have a different view on the market going forward, they may deploy more, and we’ve seen that in the past with different clients. But it is just a higher level of deposits with our custodian clients at this point that’s driving the increase in the balance sheet.
I wouldn’t necessarily, Mike, look from quarter to quarter again to expect that it is going to necessarily go up or go down. It’s just a longer term trend.
It goes in fits and starts a little bit, but as long as we continue to expand the business, we certainly expect that the deposits will also expand.
Mike Mayo – CLSA
Thank you.
Operator
Our next question will come from Robert Lee with KBW.
Robert Lee – KBW
Thanks, good morning. I’d like to go back to the SLR for just a quick question.
You mentioned you’re 5% of the holding company. Can you just conceptually—you know, if you guys have gotten this far, how should we be thinking about where you’d like to run your SLR?
What kind of cushion you’re thinking that would be appropriate for Northern? Would it be running it at 5, 5.25, 5.5, and then maybe if you could kind of update us where you are kind of the bank level?
Michael O’Grady
Sure. So as far as—let me take the second part first, which is with regard to the bank level.
The bank level is approximately in the same neighborhood that the holding company is as well. As you know, you can affect the level of capitalization at the bank differently than the holdco to the extent that you downstream from the holdco into the bank.
But at this point, we’re comfortable with the level of capitalization at both the bank level and the holding company level, and I would say as far as where we’re targeting the SLR, I would say similar to our other ratios. We look at all of them collectively and just over time determine what is the level that we feel we need, first from an internal perspective, second from a regulatory perspective, and that’s an area that particularly with the SLR right now, I would say we have a fair amount of room given that the requirement for Northern Trust is at 3%, and as we pointed out we’re above 5% there.
So there is room there on the regulatory front, but then the third category we talked about or consideration is just the level of our peers as well, which a number of our peers will be held to the higher level of 5%. So that’s definitely a consideration as we look at it.
We have the ability to be below that 5%, so I think in some ways that gives us more flexibility, but I wouldn’t necessarily say that it allows us to not have to consider it. We definitely have to take it into our consideration.
Robert Lee – KBW
Okay, great. That was helpful.
Maybe shifting back to the asset management business, I’m curious if you could update us—I guess maybe it was 18 months or two years ago, I forget precisely, you had kind of re-launched your ETF initiative. I believe you have at least several billion of assets there now.
Could you maybe update us on that on how that business is going, maybe kind of what extent you see that contributing to some of the organic growth there, and just kind of really just update us on where that stands.
Michael O’Grady
Sure, be glad to. Our ETF business, as you mentioned, is FlexShares, and as of the end of the quarter the assets under management in FlexShares was $7.6 billion, so it’s been very successful for us given that it was a re-launch, but it was a re-launch from a standing start and it’s been an effort where we are focused on not necessarily competing in what I would consider the more commodity or general ETFs, but rather ETFs that we think are structured in a way that they are particularly appealing for our clients.
It’s important for us because as we talk about the trends within the asset management industry and talk about things like going from active to passive, we want to be in a position where we’re able to provide the right products for our clients, so part of these trends have resulted in the ETFs going above the $7 billion, as I talked about. It’s something that we certainly like the strategy there.
We’ve rolled out a number of new funds which, at this point, are low levels of AUM but certainly that we have high expectations for.
Robert Lee – KBW
Maybe just one follow-up question, if I could, on the ETF business. Are you sourcing most of those assets maybe through your private client business to the extent you’re including them in your asset allocation or model portfolios or whatnot, or are you seeing more of those assets come in through a third party source?
Michael O’Grady
Yeah, it’s a combination of both, so as I mentioned, part of it is we do structure these products so that they are appropriate and useful for our existing wealth management clients, but we also have a very focused third party effort here to distribute those funds directly to new clients of Northern Trust where the only product they may have, for example Robert, would be the ETF. So at this point, most of the AUM has come from our wealth management business, but the expectation is that we’ll continue to grow the business both from that source but then also directly with new clients.
Robert Lee – KBW
Great. Thanks for taking my questions.
Operator
Next we’ll go to Gerard Cassidy with RBC.
Gerard Cassidy – RBC
Thank you, good morning. Mike, you guys have the ROE target of 10 to 15% for Northern Trust, and as you pointed out earlier, you’ve had some very strong growth in assets under custody as well as the global custody assets, and this quarter as well assets under management were quite strong.
Is it—and your ROE, unfortunately when you back the last five years with the exception, I think, of ’09 has been consistently under 10%, below your range. Is it simply a matter of interest rates, because I know you have the fee market waivers as a drag on earnings, so it is really we’re waiting for interest rates to rise for you to get into that 12, 13% ROE consistently?
Michael O’Grady
Yeah, I would say that we are not waiting on interest rates to rise. They may rise, they may not rise, and at this point as to when they’ll rise, we wouldn’t know even if you told me it was certain that they’re going to rise.
So our focus has been on improving the profitability absent that. Certainly, the low interest rates have presented the drag they have, but part of the reason why we have the slide there that points out the expenses to trust fees ratio is because although, again, that’s not completely immune from external factors so the money market fee waivers does impact that ratio, because it lowers the fees.
But it is a way that we think we can control the profitability more, and that’s why we are focused on trying to bring that ratio down to make the core fee business more profitable for us. Over the last nine quarters, we’ve been successful looking year-over-year in bringing that ratio down to 113% now from 131% going back to 2011.
So to get into the target range of 10 to 15%, we need to continue to focus on bringing that down absent what may happen in the environment.
Gerard Cassidy – RBC
Where would that ratio have to go to get you, because I’m looking at your trends package here and it’s just been so challenging for you folks and your peers – it’s not just Northern Trust. Does that expense to fee number have to break 100% to get you over the 10% into 12% ROE territory?
Michael O’Grady
Yeah, as you mention, there’s lots of other factors related to it, so there’s not a specific number I would give you. But at the same time, I would say we do not necessarily need to reach a particular point – you mentioned 100% or to go below that – in order to get into our range.
Gerard Cassidy – RBC
Okay, and then the second question is on your stock buyback this year that you were approved for. Are you expecting to spread that out over a 12-month period, or is it going to be more front-end loaded, back-end loaded?
And then the second part of that – what do you see for your incentive comp for this coming year for your employees? How much stock will you be distributing to eligible employees?
Michael O’Grady
I’ll take your second question first just with regard to incentive comp and the composition there. As you would expect, that is ultimately determined by the compensation committee of the board of directors, and they finished up the past year but they are early stages of how they would look at this year, going into it, and ultimately I don’t know what their thinking is on that front.
But clearly they are trying to provide the right mix to reward employees for the right type of activity and performance, and there’s nothing that really changed significantly in the past year with regard to the mix there other than, I would say, making it more performance-oriented and making sure that it’s aligned with our corporate targets. As far as the share repurchase, as we’ve talked about before, there are a number of factors that go into determining the amount of stock that we’ll repurchase in a particular quarter, and we do not have a particular strategy that we’re going to communicate with regard to whether it’s even or front or back-loaded, just given the fact that there are a number of factors that go into it.
Gerard Cassidy – RBC
Thank you.
Operator
Our final question will come from Geoffrey Elliott with Autonomous Research.
Geoffrey Elliott – Autonomous Research
Hello. In terms of the shift from assets from active to passive business, particularly on the wealth management side, what can you do to ensure that as clients’ risk appetite returns, that still (audio interference).
Michael O’Grady
Geoffrey, I think I missed the last part of the question. Geoffrey?
Operator
Just one moment. I’m sorry, please continue, Mr.
Elliott.
Geoffrey Elliott – Autonomous Research
Hello. So the share of equities in wealth management AUM has been increasing pretty significantly, but I guess because of the shift from active to passive products, that hasn’t really been benefiting the fee rate, so what can you do to ensure that you benefit as clients’ risk appetite returns?
Michael O’Grady
So we clearly benefit to the extent that our clients benefit, and so our objective is to provide the best wealth management services and expertise to them, and we feel that as it has been true historically, we’ll benefit along with them to the extent that they do well. As far as the trends, though, we also try to position ourselves well for the trends, and with the shift from active to passive, we actually think we’re well positioned in the sense that we capture a large portion of the assets as they shift them around, given that we’re well positioned in passive, but then further, very specifically the ETFs were directed at ensuring that we have products that meet those needs as well.
So we will continue to do things like the ETFs where it’s in product development in our asset management group. They’re very focused on what are products that our clients will find useful as we go forward so that we can not only make sure that they are successful but that, as I mentioned, we can financially share in that success.
Operator
Was there anything further, Mr. Elliott?
Geoffrey Elliott – Autonomous Research
Hello, can you hear me?
Michael O’Grady
Yes.
Geoffrey Elliott – Autonomous Research
On the last call, you mentioned that you expected to get back into the 10 to 15% ROE target range this year. Do you still expect to do that after reporting the 9.3% for the first quarter?
Michael O’Grady
The 10 to 15% range is our target range, and clearly the objective for not only me but for the company and management and all the employees is to be in our target range, so that is definitely what we continue to endeavor to do.
Geoffrey Elliott – Autonomous Research
Okay, thank you very much.
Operator
I’ll turn it back to our presenters for any closing remarks.
Beverly Fleming
Thank you all for joining us today. We look forward to updating you on our second quarter performance in July.
Have a good day.
Operator
That does conclude today’s conference. We’d like to thank everyone for their participation.