Good day, and welcome to the Northern Trust Corporation Third Quarter 2023 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jennifer Childe, Director of Investor Relations. Please go ahead, ma'am.

Thank you, Melissa, and good morning, everyone, and welcome to Northern Trust Corporation's Third Quarter 2023 Earnings Conference Call. Joining me on our call this morning is Mike O’Grady, our Chairman and CEO; Jason Tyler, our Chief Financial Officer; Lauren Allnutt, our Controller; and Grace Higgins from our Investor Relations team. Our third quarter earnings press release and financial trends report are both available on our website at northerntrust.com. Also on our website, you will find our quarterly earnings review presentation, which we will use to guide today's conference call. This October 18 call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be made available on our website through November 18. Northern Trust disclaims any continuing accuracy of the information provided in this call after today. Please refer to our safe harbor statement regarding forward-looking statements on Page 12 of the accompanying presentation, which will apply to our commentary on this call. 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 enable 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, Jennifer. Let me join in welcoming you to our third quarter 2023 earnings call. Our results for the third quarter reflect solid execution against the challenging phase of this interest rate cycle, particularly as rates appear close to be peaking. Third quarter deposit levels were generally in line with seasonal expectations, but funding costs were significantly higher, putting pressure on net interest income. We're focusing primarily on those areas of the business that are most under our control.…

Thank you, Mike, and let me join Jennifer and Mike in welcoming you to our third quarter 2023 earnings call. Let's dive into the financial results of the quarter, starting on Page 4. This morning, we reported third quarter net income of $328 million. Earnings per share of $1.49, and our return on average common equity was 11.6%. Our assets under custody/administration and assets under management were down modestly on a sequential basis but up sharply on a year-over-year basis. Unfavorable markets and currency movements more than offset positive asset inflows relative to the prior period. Year-over-year levels benefited from favorable markets, currency improvements and asset inflows. On a year-over-year basis, currency movements had an approximate 90 basis point favorable impact on revenue growth, largely within our Asset Services division and a 100 basis point unfavorable impact on expenses. On a sequential basis, currency impacts were immaterial. Excluding notable items in all periods, revenue was down 2% on both a sequential quarter and year-over-year basis. Expenses were up 1% sequentially and up 5% over the prior year. This reflects an expense to trust fee ratio of 115%, down from 116% in the second quarter but higher than the 112% we posted in the third quarter of last year. Pre-tax income was up 1% sequentially, but down 20% over the prior year. Trust, investment and other servicing fees, representing the largest component of our revenue, totaled $1.1 billion, a 1% sequential increase and a 3% increase compared to last year. All other noninterest income was up 6% sequentially, but down 3% over the prior year. Net interest income on an FTE basis was $469 million. Down 10% sequentially and down 11% from a year ago. Our provision for credit losses was $14 million in the third quarter. Overall, our credit quality…

[Operator Instructions] And we can go with our first question from Glenn Schorr with Evercore.

That was like the price is right. I like it. Okay. So I appreciate the range of outcomes for NII next year that you can control. So I'll leave that aside for a second. But you mentioned your expense-to-trust fee ratio, your target and what you can do in terms of operating leverage in a better environment or normalize. I'm curious just what's the overall approach towards expenses as you enter budget season next year within that mindset of what your goals are? And how do you approach it with that much uncertainty around things that you can't control?

Yes. Well, as we enter, this is the time of year where we're thinking -- trying to get a sense of where the launch points will be. And I walked through a little bit of a financial model for you guys to think about. That if we're -- over time, we'll get lift from the equity markets and we should also have low to mid-single-digit organic growth. If we can get 100 to 200 basis points in fee operating leverage, that sets us up really well based on where our pretax margin is for good EPS growth over time. And so that's the goal that we -- it's one of the metrics that we look at really closely. And we're still in an inflationary environment where it's harder to get that that operating leverage if you're just looking at fees because the expenses are elevated and you don't get the benefit from higher rates on the trust fee line. But you can tell that we've spent an incredible amount of effort this year working the year-over-year expense growth rates down. And you go back to 2022 and printing a 9% growth. Coming into this year, we knew we had to do better than that, and we've been grinding that down each quarter, quarter after quarter. We first tackled it with working hard on labor. And you can see that's the biggest cost that we have. So we have to get that right. Headcount is down, and then another key element is technology. That shows up in equipment, software and outside services. That's still elevated above the rest of the company in terms of growth rate, but we've had a lot of accomplishments there, too. and expecting to have that growth rate be lower next year than it has historically. And so we think we can have another year next year that's similar to what we did in this year, which is to work that -- could continue to work that year-over-year growth rate down.

Exactly what I look for. You have tons of capital and you generate plenty also. But I'm curious, some of the big banks have articulated what they thought as is the RWA impact or all-in impact might be. I'm curious at your first glance -- what type of impact are we talking? I know that you mentioned it doesn't disrupt your model, and I agree. I'm just curious if you can help us box it in, in terms of [indiscernible] impact, if as is?

Sure. Yes, I'm going to give you a wide range of like 5% to 15% in RWA, and that will -- that's going to be impacted by a few different things. But one of the benefits that we have is the diversification of the business model. And so we've got -- obviously, the custody business comes with a lot of operational risk. That's really the most significant driver but we'll actually get some benefit from an RWA perspective in some of the loan treatments. Just given the nature of our underlying loans. And then there are some other dynamics that we have that should help on RWA as well on a relative basis. But it's -- we're thinking about it at this point, it could be anywhere from 5% to 15%. As we mentioned earlier, we feel really comfortable, and we see where our CET1 levels are and see where our liquidity is. And so we'll keep an eye on where our peers are. We'll keep an eye on what the business is doing, but we've got flexibility in other ways to manage that dynamic as well.

We can take our next question from Michael Brown with KBW.

Good morning, everyone. So I guess I wanted to start on the custody and fund admin fees. They were essentially flat quarter-over-quarter, I guess, a little bit softer than we expected. What are some of the key drivers that played out this quarter. And as you noted, the lower market levels present a bit of a headwind here for the fourth quarter, but you did talk about some positive dynamics on the new business front. So what are the puts and takes that we should think about over the fourth quarter and then heading into next year?

Sure. So first of all, the -- if you just look at the custody and fund admin line, and split it we talked about the fact that currency on a sequential basis was effectively a push year-over-year. It helped more than that roughly in the neighborhood of 1.5% to 2%. But if we just go back and look sequentially at how the quarter looked, the net new business was in Custody & Fund Admin Fees was a positive. It was low single digits, very low single digits, but positive. And then transaction volumes continue to be light. And we're starting to talk about that dynamic as something that might be more long term, just as our clients move more toward more indexing as opposed to active management. There's less trading activity, there's less reporting. There's less transitions. And so we did -- we're continuing to see a lower level of transaction-related activity. But the overall business is strong, again, net positive from an overall net new business perspective. And the pipeline, as Mike mentioned, looks strong.

Okay. And then if we just change gears to the deposit side, it sounds like the pressure there still remains. Could you just maybe unpack some of those underlying dynamics by client type and maybe just touch on where the pressure is perhaps the greatest and maybe where there's a bit less of a challenge. And are you seeing some elements of the deposit base that are seeing stabilization here? Or is it really kind of across the board?

Definitely feel it's stabilized in a lot of ways. It's hard to predict where it's going to go because obviously, it's been a volatile cycle and clients are clearly trying to figure out what to do from here. There's a lot of clients that are terming out their deposits. We saw in the wealth side, just to get at your question of how it's separated by channel, the wealth side, we saw a significant increase in term deposits. So clients are saying this is an opportunity to move out of checking and into CDs. And a part of that is the nature of our clients where they have large amounts of deposits. And so they can take a component of their deposits and think about that more strategically and less about the need to maintain that liquidity just for day-to-day payments. And then in the institute but -- interestingly on the wealth side, deposits are actually up if you think -- if you look 630 to 930, they're up somewhat. And so it gives us an indication that the pricing actions we took were worked really well. Clients are -- they continue to see the strength of the balance sheet. They like to deposit on Northern Trust's balance sheet. So that increase was meaningful. On -- in the institutional side, that's what drove the period-to-period and most of the average decline -- and that comes to a lot of clients is moving to different types of either longer duration or higher-yielding liquidity types. Overall, liquidity across the company was flat. Across the channels cumulatively. And so clients clearly are just saying Northern is the right place to be. They're moving from one overall liquidity mechanism to another. And as we look out, I think it's interesting to see that the balance is thus far in the quarter have held in just over $100 billion. And frankly, that's higher, and it's still early in the quarter, but that's higher than what we would have anticipated at this point. And the $430 million to $440 million, just to give some context there. that assumes that net interest margin would be relatively flat, up a couple to a few basis points, but deposits would have to come down an average in the $93 billion to $95 billion for us to get down to that $430 million to $440 million. And so at this point, thus far, again, it's varied -- we're 2 weeks into a 13-week quarter, the deposit levels are holding in higher than that.

And our next question will come from Alex Blostein with Goldman Sachs.

So just another one around deposits. you guys seem to have been a bit surprised, I guess, by this latest move in terms of kind of the catch up that you played there you articulated at the conference in September and obviously today. Do you feel like you caught up to where institutional pricing is? Or do you still think there might be incremental migration or kind of the need to increase price more? And then again, on the institutional side of things, is there a particular client base or channel internationally that's driving this pickup? Or is that fairly broad-based? Because your competitor set there is fairly limited, right? I mean we know there is 3 or 4. And at the end of the day, that's where you compete with on the custody side. So I'm just kind of curious where we are in that process?

It seems like we caught up. And we made -- if we get to what we thought we were going to be down about 5% in NII. We ended up down 10%. We saw that mid-quarter and hit right on the number what happened in the -- call it, the August time frame, we clearly saw that in general, the market was taking deposit pricing up. And we reacted to that. We're not again, we're not price makers. We're price takers. And so we reacted to that and it seems to very much have leveled out the deposit activity. And that's why you see things very kind of flattish. And then also into this quarter, stabilizing at levels we thought would be even higher. And so I think the big takeaway is it seems like the pricing is where it needs to be for clients to level things out. And the pricing actions that we took were in pretty small number but of big accounts. And you asked about geography, the bigger actions we took were in the U.S. custody book on the institutional side of the business and then in wealth, it was in MMDA. And so we took a targeted approach to increase those pricings in early early reactions look like we got it, we hit the mark well.

Got it. All right. Shifting gears a little bit, pretty constructive comments from you guys on the new business. We've heard that for the last couple of quarters. As you know, converting net to fees is always a little hard, and it's a bit opaque. So -- any way you can frame maybe the fee backlog and as we sort of work that through into revenues over the next, call it, 12 months, do you feel like you have enough scale in the business to onboard, especially some of these larger mandates a material pickup in expenses. So in other words, to Glenn's point, it sounds like you guys are aiming for, I don't know, 3% to 4% expense growth in '24. Is that doable with potentially more net new business?

It is. And we didn't give a number on the expense growth, just that we want to do better than what we did this year. And so with that backdrop, the growth in the asset servicing business, in particular, it's come with expenses. It's a less scalable business relative to wealth, which is obviously highly, highly scalable. That said, we were focused, as you can tell from what we've done this year, not just on top line growth but on managing the type of business that comes in. And so head count was such an incredible focus for us this year, the compensation line, an incredible focus, and so as we look at what business to bring on board, there's going to be a very strong scrutiny on looking at what expenses come along with it. The business is committed to do that. They're -- it's they're leading that effort saying that they're going to be very diligent about identifying what business to bring on. Michael O’Grady: Yes. And Alex, I would just add to what Jason is saying there is that's why we're driving so hard on productivity as well is because we have to have the capacity to invest in the foundation of the business and what we're building out, the investments we need to make. But then also, to your point, if you're going to bring on new business that has resources, you have to be able to offset a portion of that as well.

Got it. Okay. That all makes sense. And so I mean to put words in your mouth on the 3% to 4%. It just sounds like less than 5%. So maybe you’re thinking, okay.

Our next question comes from Brennan Hawken with UBS.

I would love to unpack a little bit because -- you walked through some of the -- it sounds like you walked through some of the underlying assumptions behind the $430 million to $440 million expectation for 4Q. It sounded like you were saying that it predicated a deposit base of 93% to 95% and NIM flat. Did I interpret that correctly? And does that suggest that you're sort of girding for further deposit declines even though they've been stable quarter-to-date?

Just to tweak the words. I mentioned that implies NIM would be up a few basis points, but the deposit levels you mentioned, are accurate. And so coming last quarter, we came into it thinking we were going to be down 5%, the market ended up being more competitive. And again, we've got we've got to react to what the market is doing. We don't set it. And so coming into this quarter, we just -- we did prepare for a further decline in deposits. And that could easily still happen. So not walking that back, which is saying that early stages of the quarter are indicating the deposit levels are higher than that. And we've also got -- even as we look out to next year, we don't think about this $430 million to $440 million as the run rate of there's reasons for us to believe that NII is going to go up from there. And just if you look at the runoff in the securities portfolio, and we're still trading securities that are yielding to and reinvesting at 5% and security is yielding in the 2s and reinvesting it above that. And so without taking more risk or duration. And so there are things that we can continue to do. We've also had the balance sheet positioned very defensively. We saw the decline in deposits that was happening and frankly, the stress in the banking industry in the spring and in the summer, and we positioned very defensively. We wanted to -- we have the ability to do that based on the strength of the balance sheet. We can stay short, we cannot stretch for NII. But as we feel more confident about the stability of deposits, the stability of the industry, we can use non-HQLA capacity. And so there's multiple levers we have to work on NII. So although we're trying to give you as much color as we can about fourth quarter, the interpretation shouldn't be that that's necessarily something that you should annualize thinking about 2024.

Okay. All that's fair. I guess the 2024 will depend on the competition for deposits. So we'll see how that goes. One follow-up here. You guys made reference -- and I apologize if you said it in the prepared remarks, the couple of overlapping calls here this morning. You laid out a Visa gain in the press release, but I didn't hear it quantified in the commentary. Is it possible to quantify that impact?

Yes. It's up $10 million to $15 million relative to second quarter. Second quarter was a slight loss. This was a slight gain. And that -- just a little bit of color the -- that relates to a derivative that we have associated with part of our Visa position. And as the -- our view of the length of that swap, extends or reduces that has an impact to the mark-to-market. And as there was news that was proposed by -- a news it was put out this quarter of Visa saying that they have a shareholder proposal to release half the shares. It reduces the amount of time in that swap. And so therefore, it changed the mark from what it normally -- what it otherwise would be.

And our next question comes from Ryan Kenny with Morgan Stanley.

So just in thinking through the puts and takes to NII, you mentioned taking securities yielding to and reinvesting at $5 million here's update us on how much AFS and HTM roll-off you're expecting per quarter going forward. And as those securities mature, are you mostly reinvesting that into cash?

I want to make sure I got the question fully. Can you repeat it for me? You just can't throw a little soft. I want to make sure I got it.

Yes. So as you as you're reinvesting securities from 2 into 5, could you let us know just how much AFS and HTM roll off you're expecting per quarter? And are you reinvesting that into cash?

Sure. A lot of the reinvestment recently has been in cash. And -- but again, as I mentioned just a few minutes ago, that's not necessarily where we'll be reinvesting it before. And as we look at the schedule, it probably averages the runoff averages about 2%, particularly let's just take the U.S. dollar-denominated amounts. And then overall, there's about close to a little over $1 billion a quarter across all the currencies that's maturing, that's reinvesting.

And moving on to our next question from Brian Bedell with Deutsche Bank.

Just one clarification on the other investment in -- or the other income that $68 million this quarter versus $55 million in the second quarter. Should we take that $55 million and think of that as a more normalized run rate given the noise on the Visa swap gain?

Yes, I think Visa is going to -- at some point in time, I think the noise in that line item will just go away. And there's Visa did announce that they didn't make this announcement. And so that should have an impact on the swap at some point. And so I think it shouldn't be -- again, it has tended to be a negative, that negative will go away. And so the prior run rates are probably too low and the current run rate might be too high. The best way to think about it.

Okay. Okay. Fair enough on that. And then just on the NII guide, just to clarify also the $430 million to $440 million. Is that FTE? And then -- well, let me just ask that first. That's FTE, correct?

Yes.

Okay. Okay. Great. And then just as we move into '24, some of the elements, obviously, a lot of ranges of what can potentially happen. But on the competition front, it sounded like that was fairly episodic this third quarter, it got resolved. And just sort of, I guess, your view on whether you think that might reemerge, of course, it's always tough to predict. But just in terms of the fact that you're able to defend it, higher rates but keep those deposits, would that seemingly be a disincentive for other providers to try to grab those deposits and not actually get them. And then what would you think of -- maybe this is tough to answer to you, but what level of deposits is at risk of that competition within the custody and the wealth business?

In the institutional business, let's start there. The -- a lot of those deposits are there for clients to be processing payments. And they not only have the end-of-day deposit needs, but intra-day needs as they have they can have intraday overdrafts. And so they've got to think about their liquidity, not just in today, but intraday. And we process a tremendous amount of payments across the system. And so that's why we always are talking about not just the traditional operational component, but the amount of dollars and velocity that we have in the asset servicing business, which is very high. The amounts that are more sensitive to rates tend to be very large clients that are making a decision on where to park large amounts of dollars and those tend to be negotiated. And that's kind of the top end, but that's also where there's lighter spread. In the wealth side of the business, clients are making decisions more from a product perspective, and they're moving between term treasuries, money market funds and traditional checking accounts. And we've seen increases in all non-checking account areas over this cycle. And we've seen CDs go from less than $1 billion to close to $4 billion. And that obviously has a really big impact when you think that, that's coming from a traditional checking account into a market rate CD there's hundreds of basis points of difference. And so if it gives you a little bit of a sense of -- on the wealth side, we've talked about 75% of the deposits overall that we have are in wealth, and -- I'm sorry, are in institutional and 25% in wealth. And so -- and then you see the type of movement that can happen if we're talking about $2 billion, $3 billion, $4 billion of movement of that of that $20 billion to $30 billion base, it's pretty meaningful. And but it's -- the good news, it has stayed with us, and we've done a good job of holding on to the deposits. Again, it's been deposits up this past quarter and overall client for the business flat from one quarter to another.

Our next question will come from Mike Mayo with Wells Fargo.

Yes, I'm a little confused on the NII guidance. So you're looking to be down 6% to 8% in the fourth quarter to $430 million to $440 million -- and -- but you said don't take that as a run rate. And so what kind of run rate do you think you'll have? Because I guess you're guiding down NII 20% year-over-year in the fourth quarter. So how much of that do you think you get back as you take those 2% securities and invest them in 5% and take all your other actions? And do you think the fourth quarter will be the low point or the NII inflection comes later? Or just A little bit more color on that, if you could?

Sure. Now, fourth quarter could be -- it could definitely be a low point and particularly thinking about some of the things that we mentioned, but just taking the securities runoff alone, the math gets to -- you get to over, call it, $10 million, $12 million, $13 million lift per quarter. Calling just from securities from just the securities maturing and reinvesting again in similar duration, similar credit profile and that's without us taking these other actions. And just as our clients are thinking about where are we in the yield in the overall rate cycle, we think about that as well. And we've -- again, we position we've had the balance sheet positioned in a pretty defensive manner. And this provides us an opportunity to start thinking about what do we do differently. But just the maturity schedule alone has kind of a, call it, a $50 million annualized lift to it. And that's just one of the levers that we have that we'll be working from.

In light of just more headwinds, though, than you had expected? I know you said no more expense plans, but -- and you have kind of bent the cost curve, which is the expression, I guess, of the year. Any thoughts up tightening up expenses even more than you've already done?

Yes. The productivity office, we launched just in this year from kind of a standing start, and we're going to get over $100 million within this $100 million of savings in this year, most of those are on a recurring basis. And so you see a lot of that reflected in the actions we took from a compensation perspective, but negotiations with consulting firms, how we're looking at demand for technology consumption, how we're managing real estate, and so we've pulled a lot of levers there and it couldn't have a higher sense of urgency on what we're thinking about from a productivity perspective. but we should be getting above 2% a year in help from productivity. And not going to stop uncovering opportunities and having difficult conversations about what we can stop doing or how we can be thinking about things differently. Michael O’Grady: My definitely continued focus on productivity, as Jason is saying. So I just want to emphasize that point. There are still plenty of opportunities to functionalize, automate, centralize a number of different, I'll call it, more fundamental structural things that we're doing already, but just have longer time frames to implement them. in order to get those savings longer term and a lot around technology that enables that. So it absolutely has been a focus, but will continue to be a focus. Particularly as the environment is so uncertain and not necessarily knowing what the direction of whether it's rates or markets are going to be.

And our next question will come from Gerard Cassidy with RBC.

Can you guys -- can we take a step back, we're obviously on the weeds in the quarter-to-quarter stuff for all of the banks, understandably so. But when you step back if we're now after one that’s since the financial crisis, let's call it 14 years of incredibly low interest rate environment with a little blip up in 2018, of course. But if we're now in a new environment for the next 3 to 5 years where the short end of the curve stays above 3% or 4%, maybe even 5% for nobody knows for sure. How does that maybe alter the way you guys have been running the business for the last 10 years in a 0% rate environment, to one now that is going to be 300 to 400 basis points higher at the front end of the curve? Or does it alter the way you run the business? Michael O’Grady: Gerard, it's Mike. I appreciate the question. And the answer is yes. It does alter the way that we have to look at the business. And just starting with some of your comments there just around low interest rate environment, higher interest rate environment, what aspects of that are cyclical versus maybe permanent changes. Jason mentioned some of the shifts in the way institutional investors invest and the implications on transaction volumes that may come with that. And as a result, beyond looking at the productivity of the business, which I think we've emphasized here, we also have to look at the pricing side of the business. to ensure that we are being appropriately compensated for all the high value-added services that we're providing, I'll take it to all our clients because it really isn't specific to just institutional clients or wealth clients. But if there was an expectation that you were managing a certain level of deposits as a part of an overall relationship, that was a part of the value you were receiving for all the services you're providing. If that's going to be different for some time period, then you have to be compensated in different ways. Now you know our model well enough to know it's not a consumer product or something where you change the pricing daily or even monthly. So it's something that you have to work through the longer-term way that your services are priced and the way relationships work. I mean we're always looking to retain relationships, but also very focused on expanding them. And the more we can do with the clients, the better the overall economics. So my point, which I think you're on to it is we do and have been looking at this holistically, both on the revenue side and on the expense side so that we can continue to look at meeting the financial targets that we have.

Very good -- and then as a follow-up, Jason, talking about, obviously, you're approaching your budgeting season, and I'm not asking you to obviously tell us what's going on yet. But can you frame out for us a year ago this time, when you were doing the budgeting for 2023 and you've -- as you pointed out, you guys have made progress in reducing the expense rate of growth. But can you frame out for us the outside factors that you were dealing with last year at this time, whether it's wage inflation or just inflation in general versus today, is it a little easier today or not just as tough the outside factors haven't really changed, and it's going to be a tough environment to put together a budget?

Last year, we were in a heavy, heavy inflationary environment that was hitting us in not just our labor costs, but also we were defending we were defending from others trying to take our talent a lot was one of the talking points that we had at the time. That had implications and we were just spending time on that as well. And then we were seeing inflation come in technology costs in a lot of different ways. So every budget year is really, really difficult. I have to say that the macro headwinds last year, I feel we're heavier than they are this year.

It appears there are no further questions at this time. Ms. Childe at this time, I will turn the conference back to you for any additional or closing remarks.

Thanks, Melissa. We'd like to thank everyone for joining us today, and we look forward to speaking with you again soon.

This concludes today's call. Thank you for your participation. You may now disconnect.