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Edited Transcript of NTRS earnings conference call or presentation 23-Apr-19 2:00pm GMT

Q1 2019 Northern Trust Corp Earnings Call

CHICAGO Apr 24, 2019 (Thomson StreetEvents) -- Edited Transcript of Northern Trust Corp earnings conference call or presentation Tuesday, April 23, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mark M. Bette

Northern Trust Corporation - Senior VP & Director of IR

* Stephen Biff Bowman

Northern Trust Corporation - Executive VP & CFO

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Conference Call Participants

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* Alexander Blostein

Goldman Sachs Group Inc., Research Division - Lead Capital Markets Analyst

* Betsy Lynn Graseck

Morgan Stanley, Research Division - MD

* Brennan Hawken

UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst of Financials

* Brian Bertram Bedell

Deutsche Bank AG, Research Division - Director in Equity Research

* Brian Matthew Kleinhanzl

Keefe, Bruyette, & Woods, Inc., Research Division - Director

* James Francis Mitchell

The Buckingham Research Group Incorporated - Research Analyst

* Kenneth Michael Usdin

Jefferies LLC, Research Division - MD and Senior Equity Research Analyst

* Michael Roger Carrier

BofA Merrill Lynch, Research Division - Director

* Steven Joseph Chubak

Wolfe Research, LLC - Director of Equity Research

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the Northern Trust Corporation First Quarter 2019 Earnings Conference Call. Today's call is being recorded. At this time, I would now like to turn today's call over to Director of Investor Relations, Mark Bette, for opening remarks and introductions. Please go ahead, sir.

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [2]

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Thank you, Carrie. Good morning, everyone, and welcome to Northern Trust Corporation's First Quarter 2019 Earnings Conference Call. Joining me on our call this morning are Biff Bowman, our Chief Financial Officer; Aileen Blake, our Controller; and Kelly Lernihan from our Investor Relations team.

Our first 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 April 23 call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available on our website through May 21. Northern Trust disclaims any continuing accuracy of the information provided on 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. The 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 2018 annual report on Form 10-K and other reports filed with the Securities and Exchange Commission for detailed information about factors that could affect actual results. (Operator Instructions)

Thank you again for joining us today. Let me turn the call over to Biff Bowman.

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [3]

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Good morning, everyone. Let me join Mark in welcoming you to our first quarter 2019 earnings conference call.

Starting on Page 2 of our quarterly earnings review presentation, this morning, we reported first quarter net income of $347.1 million. Earnings per share were $1.48, and our return on common equity was 14%. As noted on the second page of our earnings release, this quarter's results included $12.3 million of severance-related and restructuring charges within expenses.

Before going through our results in detail, I would like to comment on some macro factors impacting our business during the quarter. Equity markets rebounded during the quarter following a challenging fourth quarter. Compared to the prior year, the S&P 500 ended the quarter up 7.3%, while the MSCI EAFE was unchanged. On a sequential basis, end-of-period markets were favorable, with the S&P 500 and the EAFE indices increasing 13.1% and 9.6%, respectively. Recall that some of our fees are based on lagged pricing, and those comparisons are challenging both versus 1 year ago as well as sequentially.

On a month lag basis, the S&P 500 and EAFE were down 2.6% and 9% on a year-over-year basis and down 4.7% and 4.1% sequentially. On a quarter lag basis, the S&P 500 and EAFE were down 6.2% and 13.4% on a year-over-year basis and down 14% and 12.5% sequentially.

U.S. short-term interest rates were modestly higher in the quarter on average, driven by the full quarter impact of the Federal Reserve December rate hike. On a sequential basis, average 1-month and 3-month LIBOR increased 15 and 7 basis points, respectively.

Currency rates influenced the translation of non-U. S. currencies to the U.S. dollar and, therefore, impact client assets and certain revenues and expenses. The British pound and euro versus the U.S. dollar ended the quarter down 7% and 9%, respectively, compared to the prior year. The year-over-year declines favorably impacted expense but had an unfavorable impact on revenue. On a sequential basis, the British pound ended the quarter up 2%, while the euro declined 2%.

Let's move to Page 3 and review the financial highlights of the first quarter. Year-over-year, revenue was flat, with noninterest income down 3% and net interest income up 9%. Expenses increased 3% from last year. The provision for credit losses was 0 in the current quarter compared to a credit of $3 million 1 year ago. Net income was 9% lower year-over-year.

In the sequential comparison, revenue declined 2%, with noninterest income down 3% and net interest income flat. Expenses increased 1% compared to the prior year. Net income declined 15% sequentially. Return on average common equity was 14% for the quarter, down from 16% 1 year ago and 17% from the prior quarter. Assets under custody and administration of $10.9 trillion increased 1% compared to 1 year ago and were up 8% on a sequential basis. Assets under custody of $8.2 trillion were also up 1% compared to 1 year ago and up 8% sequentially. The year-over-year performance was primarily driven by favorable markets partially offset by the impact of unfavorable moves in currency exchange rates. The sequential performance was primarily driven by favorable markets and new business.

Assets under management were $1.2 trillion, flat on a year-over-year basis and up 9% on a sequential basis. The year-over-year performance reflected higher markets and new business offset by lower period ending securities lending collateral. The sequential increase was driven by higher markets and new business.

Let's look at the results in greater detail, starting with revenue on Page 4. First quarter revenue on a fully taxable equivalent basis was $1.5 billion, flat compared to last year and down 2% sequentially. Trust, investment and other servicing fees represent the largest component of our revenue and were $929 million in the first quarter, down 1% from both last year and the prior quarter. Foreign exchange trading income was $66 million in the first quarter, down 16% year-over-year and down 15% sequentially. Both the year-over-year and sequential declines were driven by lower volatility as well as lower foreign exchange swap activity in our Treasury function. The sequential decline was also impacted by lower client volumes.

Other noninterest income was $64 million in the first quarter, down 16% compared to 1 year ago and down 15% sequentially. The year-over-year decline was primarily due to lower security commissions and trading income, higher Visa-related swap expense and lower miscellaneous income. The sequential decline was due to a leasing gain recognized in the prior quarter as well as higher Visa-related swap expense. Net interest income, which I will discuss in more detail later, was $430 million in the first quarter, increasing 9% year-over-year and flat sequentially.

Let's look at the components of our trust and investment fees on Page 5. For our Corporate & Institutional Services business, fees totaled $535 million in the first quarter and were down 2% year-over-year and flat on a sequential basis. The translation impact of changes in currency rates reduced year-over-year C&IS fee growth by approximately 2%.

Custody and fund administration fees, the largest component of C&IS fees, were $375 million and essentially flat on both the year-over-year and sequential basis. The year-over-year performance was driven by new business, partially offset by both unfavorable markets and an unfavorable currency translation. On a sequential basis, the impact of lower markets was mostly offset by new and favorable currency translation.

Assets under custody and administration for C&IS clients were $10.2 trillion at quarter end, up 1% year-over-year and up 8% sequentially. The year-over-year performance was primarily driven by favorable markets partially offset by the impact of unfavorable moves in currency exchange rates. The sequential performance was primarily driven by favorable markets and new business. Recall that lagged market values factor into the quarter's fees, with both quarter lag and month lag markets impacting our C&IS custody and fund administration fees.

Investment management fees in C&IS of $104 million in the first quarter were down 5% year-over-year and down 1% sequentially. The year-over-year decline was primarily due to the impacts of unfavorable markets. On a sequential basis, the impact of lower markets was partially offset by new business.

Assets under management for C&IS clients were $868 billion, down 1% year-over-year and up 10% sequentially. The year-over-year decline was driven by lower period end securities lending collateral, mostly offset by favorable markets and new business. The sequential growth was driven by favorable markets, higher period-end securities lending collateral and new business.

Securities lending fees were $23 million in the first quarter, down 13% year-over-year but up 5% sequentially. The year-over-year decline was primarily driven by lower volumes, while the sequential performance reflected slightly higher spreads. Securities lending collateral was $165 billion at quarter end and averaged $158 billion across the quarter. Average collateral levels declined 14% year-over-year and were flat sequentially.

Moving to our Wealth Management business. Trust, investment and other servicing fees were $394 million in the first quarter and were flat compared to the prior year and down 1% sequentially. The year-over-year performance reflected the impact of new business offset by the impact of lower markets. On a sequential basis, the impact of lower markets was mostly offset by new business. Assets under management for Wealth Management clients were $294 billion at quarter end, up 2% year-over-year and up 6% sequentially.

Moving to Page 6. Net interest income was $430 million in the first quarter, up 9% year-over-year. Earning assets averaged $111 billion in the first quarter, down 4% from the prior year. Total deposits averaged $91 billion and were down 7% year-over-year. Interest-bearing deposits declined 3% from 1 year ago to $74 billion. Noninterest-bearing deposits, which averaged $18 billion during the quarter, were down 19% from 1 year ago. Loan balances averaged $31 billion in the first quarter and were down 4% compared to 1 year ago. The net interest margin was 1.58% in the first quarter and was up 20 basis points from a year ago. The improvement in the net interest margin compared to the prior year primarily reflects the impact of higher short-term interest rates and a balance sheet mix shift.

On a sequential quarter basis, net interest income was flat. Average earning assets declined 1% on a sequential basis as deposit levels declined 2% from the prior quarter. On a sequential basis, the net interest margin increased 6 basis points due to the favorable impact of higher short-term rates.

As we have discussed in our most recent quarters, we did continue to see the opportunity for foreign exchange swap activity within our Treasury function. This activity has the impact of reducing our interest income relating to central bank deposits as we swap out of U.S. dollars but increase our level of foreign exchange trading income. For this quarter, we saw additional foreign exchange trading income of $13 million offset by $10 million less in net interest income.

Looking at the currency mix of our balance sheet, for the first quarter, U.S. dollar deposits represented 69% of our total deposits. This is equal to 1 year ago and down from 70% in the prior quarter.

Turning to Page 7. Expenses were $1 billion in the first quarter and were 3% higher than the prior year and up 1% sequentially. As previously mentioned, the current quarter included $12.3 million in expense associated with severance and other charges. For comparison purposes, note that the prior year and prior quarter included $8.6 million and $5.7 million in severance and other related charges, respectively. Excluding the called out charges, expense for the current quarter was up 3% from 1 year ago.

With respect to the remaining increase in year-over-year expense growth, the following items were key drivers within the categories: Compensation was higher primarily driven by base pay adjustments within salaries, which were effective in April of 2018. The impact of staff growth on salaries was more than offset by staff actions and our ongoing location strategy efforts. Employee benefits were lower compared to last year primarily due to lower medical expense as well as lower retirement plan costs. Outside service costs were higher driven by increased technical services and higher levels of legal and consulting costs, partially offset by lower third-party adviser fees and lower subcustodian expense. Equipment and software expense was up year-over-year mainly due to higher software-related spend. Other operating expenses were up from the prior year due to higher staff-related business promotion and other miscellaneous expenses partially offset by lower FDIC expense.

Shifting to the sequential expense view. Including the expense charges in both the current and prior quarter, expenses were flat compared to the prior quarter.

Compensation expense increased primarily, reflecting the higher expenses related to long-term performance-based incentive compensation due to divesting provisions associated with grants to retirement-eligible employees in the current quarter. This quarter's compensation included $30 million in expense associated with retirement-eligible staff. It is worth noting, due to changes in service requirements associated with performance share compensation, there will no longer be an additional component of the retirement-eligible expense impacting the second quarter as we have seen occur over the previous 2 years.

Employee benefits declined sequentially primarily due to lower medical and retirement plan costs partially offset by higher payroll tax withholding.

Outside services declined sequentially due to lower third-party adviser fees and consulting costs. The sequential decline in equipment software costs is primarily due to a prior quarter software-related charge.

Other operating expense declined $16 million from the prior period driven by lower business promotional expense as well as lower sequential costs associated with account servicing activities and other miscellaneous expenses.

Staff levels increased approximately 5% year-over-year and 2% sequentially. The staff growth was all attributable to staff increases in lower-cost locations, which include India, Manila, Limerick, Ireland and Tempe, Arizona, partially offset by reductions within our higher-cost locations.

Turning to Page 8. As we have discussed on previous calls, through our Value for Spend initiative, we are realigning our expense base with the goal of realizing $250 million in expense run rate savings by 2020. We continue to embed a sustainable expense management approach. We expect these efforts to slow our expense growth to be more closely aligned with our organic fee growth. Our first quarter results reflect approximately $45 million in expense savings, reducing the year-over-year expense growth rate by approximately 3 points. This would equate to just under $180 million on an annualized basis against the $250 million goal. We continue to cultivate a healthy pipeline of opportunities.

Turning to Page 9. A key focus has been on sustainably enhancing profitability and returns. This slide reflects the progress we have made in recent years to improve the expense-to-fee ratio, pretax margin and ultimately, our return on equity. The ratio of expense to fee is a particularly important measure of our progress as it addresses what we can most directly control. While this quarter's ratio of 111% does demonstrate the impact that macro environment, particularly lower equity markets, can have, we remain focused on continuing to drive organic growth in our business and managing our expense to improve our efficiency and productivity. When we look at our results for this quarter, absent the market impacts, we would say that our expense-to-fee ratio was comparable to where we were tracking in the most recent quarters.

Turning to Page 10. Our capital ratios remained strong with our common equity Tier 1 ratio of 13.5% under the advanced approach and 13% under the standardized approach. The supplementary leverage ratio at the corporation was 7.2% and at the bank was 6.6%, both of which exceeded the 3% requirement that became applicable to Northern Trust effective at the start of 2018. With respect to the liquidity coverage ratio, Northern Trust is above the applicable 100% minimum requirement.

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 the final Basel III rules.

During the quarter, we increased our quarterly dividend from $0.55 to $0.60, representing a 9% sequential increase and a 43% increase on a year-over-year basis. During the quarter, we also purchased -- repurchased more than 2.8 million shares of common stock at a cost of $257 million.

In closing, despite the challenging backdrop from the impact of lagged equity markets and flatter interest rates, our performance during the quarter was resilient, generating return on average common equity of 14%. Our balanced business model continued to generate organic growth with each of our client-facing reporting segments of C&IS and Wealth Management, contributing approximately 50% of our earnings. We are confident in our competitive positioning within attractive markets and our ability to continue to generate organic growth. Our focus remains on providing our clients with exceptional services, improving our productivity and driving profitable growth.

Before I conclude, as is customary for our first quarter earnings call, we will need to end today's call a bit earlier than in other quarters to allow sufficient time for all of us to get to our annual meeting, which begins at 10:30 a.m. Central Time this morning. Please accept our apologies in the event that we have to close off the question-and-answer period earlier than our normal practice.

Thank you again for participating in Northern Trust's first quarter earnings conference call today. Mark and I would be happy to answer your questions. Carrie, please open the line.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from Betsy Graseck from Morgan Stanley.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [2]

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I just wanted to understand as you're thinking through the operating levers that you delivered on this quarter, was there anything unusual in the expense line? I know you called out a couple of items. But then the follow-on is as you're thinking through 2Q and 3Q, can we expect the same kind of run rate that you delivered in 1Q?

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [3]

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So other than the charges that we called out in the expense lines, I would say it was pretty much expenses as normal, so pretty much core run rate in our expenses.

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [4]

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We did have a higher retirement-eligible impact and compensation of $30 million in the first quarter. But some of the other spend like business promo is sometimes a little bit lower in the first quarter too, but all in all pretty clean.

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [5]

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Yes. And we have the compensation expense in every first quarter which you can see flow through. But the rest of the other line items, I think, were pretty much as reported.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [6]

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I know you don't give guidance specifically, I'm not asking for that. I'm just wondering, the run rate that you're seeing in 1Q, do you think that kind of pace is something you can continue with? Or is there any kind of investment spend that you'd be ramping up on the back of this for 1Q?

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [7]

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Well, we continue to focus on our Value for Spend initiatives and to try to drive our expense base as hard as we can. But we also are growing, as you could see. And when you strip out the impacts of markets, it was pretty good underlying growth again in the quarter. So there is some expense that comes with supporting that growth. But I'd say in general, we think that the trajectory you saw here is something that we're going to -- is a decent run rate and that we're going to continue to try to improve it with our Value for Spend initiatives. But I think it's a pretty good run rate.

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Operator [8]

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Our next question will be from Alex Blostein from Goldman Sachs.

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Alexander Blostein, Goldman Sachs Group Inc., Research Division - Lead Capital Markets Analyst [9]

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So I know you obviously don't give -- I know you guys don't give guidance obviously, but I was hoping we can talk through some of the NIR dynamics as a jumping off point from here. So I guess, one, noninterest-bearing deposits down a little bit over $1 billion. I think as you talked about in the past, you thought that kind of that excess number was sort of in that $1 billion range. So should we be thinking of that being sort of done? Or do you guys think there's more to go? And broadly speaking, is there anything you guys can do from a kind of firm, specific, idiosyncratic perspective to protect the level of NIR from here? Or is this pretty much kind of peak NIR for you guys?

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [10]

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So let me walk through without providing guidance the way we're thinking about it. The first, Alex, is the volume of the balance sheet. And the thing we feel we can control most on the volume is through the continued organic growth in our custody business, primarily our AUC, which produces that growth in the balance sheet. And we've had pretty good results there, and we think if we can continue to do that, that the balance sheet should continue to grow with that inherent growth that we talk about in our custody business. As it relates to noninterest-bearing deposits that you talked about in this quarter and we talked in the past about that pool of a couple billion, I think, we've used is that of that runoff in noninterest-bearing deposits this quarter, half of it was from one client. So we still do have some sizable lumpy-type deposits that could be yield seeking, but we think it's inside the bucket that we told you in the past, the $1 billion to $2 billion of the noninterest-bearing. So we can control the volume. The second part of the forward look, if you will, without guidance is the mix. What we've seen in the mix of the balance sheet is we have seen interest-bearing deposits move from about 78% of the balance sheet to 80%. So that's a trend. I think that's a trend that we see in our industry amongst our competitors, and I think that's a market dynamic. So I'm not sure how much is controllable there, but we continue to look at that. And then the last piece that we still focus on is the spread or the yield that we can get from that, and I'll break that a little bit apart on the asset side. Look, we're still asset sensitive as a firm, and so if rates sort of flatten out from here. There is still the ability to have assets repriced higher for us. So that is a positive based on where we are. But then the liability side, the deposit beta and the pricing in the market is something we have to watch from a competitive dynamic. And I think we've been disciplined and we have a good process to watch that. And if we think it flattens out from here with no rate movements on the horizon, then there might still be the ability to grind up a little bit on the NIM over time. That's where we are. There's a lot of ifs in there, but we're -- if pricing and the competitive landscape holds stead, we still think we could see a grind up on the NIM.

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Alexander Blostein, Goldman Sachs Group Inc., Research Division - Lead Capital Markets Analyst [11]

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Got it. That's helpful. And then my second question around just the core fees. I mean, looks like custody and admin fees in particular came in quite strong relative to a challenging exit as of the end of last year. I know you guys highlighted new business, so maybe expand on that a little bit. Was this a quarter of outsized new business wins that sort of drove fees where we ended up obviously being for the quarter? Without obviously naming clients, but maybe you can just help us kind of characterize where some of that business is coming from.

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [12]

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Yes. We continue to see a strong pipeline across both of our businesses, both C&IS and Wealth then. Both produced, particularly versus first quarter of the previous year, strong performances. In fact, our C&IS business produced a much -- a really strong year-over-year comparison to the first quarter of last year on the new business front. And we continue to see a broad range of wins, both geographically, product line, client types, in both sides. In fact, on the Wealth side, our organic growth rate was at the higher end of the range as we've talked about as well in the first quarter. So pretty strong new business momentum. And then obviously the markets and others in the first quarter came back. And we have obviously some lag impacts, but we also have some month lag impacts, and so we saw the benefit of rising markets.

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Operator [13]

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Our next question will be from Michael Carrier with Bank of America Merrill Lynch.

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Michael Roger Carrier, BofA Merrill Lynch, Research Division - Director [14]

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Biff, maybe some of the expenses, given that you're at the $180 million, the $250 million, how should we be thinking about timing? I think you guys said through 2020, but are there any like initiatives in place that we should see, some steps along the way as we get into 2020?

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [15]

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Yes. So we've said the $250 million, we're continuing to push forward on that and making good progress as you can see. What I would say is that we're trying to build in the DNA and the culture here is that ongoing expense savings has to be a part of our regular routine. So while we've got a program defined that's $250 million, we also know that we have to embed culturally the ability to go in there and create economic savings from an expense standpoint on a longer-term basis than just 2020. We've got a program, we'll define it by 2020. But that discipline of taking some of the inflationary pressures out of our business through strong expense initiatives is embedding, and we can see it and it's becoming part of the culture. So we'll continue to track to the $250 million that we've told you about, but I think more importantly is embedding that discipline for forward-looking years beyond 2020.

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Michael Roger Carrier, BofA Merrill Lynch, Research Division - Director [16]

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Okay. And then just -- and the follow-up too on the last question in terms of the organic growth and even the fees, you tend to hold up or continue to hold up better than some of the peers out there. And maybe if you can just provide some color on some of the wins that you're seeing, maybe whether it's like asset mix, the client mix, just trying to get some color particularly on the C&IS side. And how much from like a competitive fee standpoint are you seeing versus maybe the mix, the product that continues to maybe hold up better than the industry?

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [17]

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Yes. So let me pull it apart a little bit on the C&IS side, I would say. First, let's take some regional. We've seen strong growth in our Australia market where we've moved up near the top portion of the league tables. I was just talking with Pete Cherecwich before I came in. So we're near the top of the league charts there in our growth from a geographical perspective there. Luxembourg is another area with the UBS acquisition and other new business where we've seen outsized geographic growth that's organic, it's strong. In the client type, I'd say let me highlight 2. We continue to do very well with hedge funds. Our acquisition and hedge fund services has allowed us to grow. I think last year, we cited and continues to see wins in the hedge fund space. I think we had the largest hedge fund launch that was launched last year was a -- is a Northern Trust client, we had a press release on that. But we've also done very well in the foundation, in the endowment space is another example. And we've brought what I would say is a product and a capability there, a front office solution for what I'll say a large in-house pools of money which is commonly or typically done in a foundation or endowment. So that's 2 examples of a client type and a geography where I think we're seeing outsized growth. We've got more of those we can highlight, but we just have a strong performance right now in the growth.

In terms of the second part of your question and the competitive nature of the pricing, look, this is a competitive business. I've been at the bank 34 years, it's been a competitive business for 34 years. I would say that we haven't seen it, at least in our client mix be outsized versus normal, which we would typically see somewhere a 1.5% to 2% type of fee pressures, which we assume in our organic growth rate. We had to overcome that. We've still seen that. And I think that in our client mix, that's what we've seen. I don't know that it's been higher than that right now, but it's also not lower and it seems pretty constant.

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Operator [18]

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Our next question will be from Steven Chubak with Wolfe Research.

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Steven Joseph Chubak, Wolfe Research, LLC - Director of Equity Research [19]

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So just wanted to unpack some of the remarks around the NII commentary and recognizing it's not a guidance. But I was hoping you could speak to your appetite to maybe extend the duration of the balance sheet given some concerns over the next move could be a Fed easing cycle and how we should think about against that backdrop maybe what the deposit trajectory could look like over the coming quarters if we are in a flat rate environment.

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [20]

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Well, what we say typically here is that we have a process where we go through and look at our own internal projections for interest rates and then we make decisions of how to position the balance sheet. I think it's fair to say that in the previous quarters, we've had some of the interest rate projections that I think are now being held more widely, and we have extended the duration in particularly the long-term portion of our securities portfolio. So we have that thought process and we do take actions when we see that. So that provides some protection against that down rate scenario. What I would also say is that if it behaves as normal, the deposit betas on a down rate cycle are typically pretty fast and pretty high. And we would anticipate that being the case here, too. So depending on just how that rate curve move happens and shifts, we could protect some of that spread and margin in a down rate scenario, plus with some of the actions we've taken on our asset sensitivity by adding the duration. So we have contemplated that, and I think we've got a lot of views from our investment management firm and our own chief economists that have views on the rate trajectory. So we take those all in and then make decisions on the overall ALCO, asset liability policy.

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Steven Joseph Chubak, Wolfe Research, LLC - Director of Equity Research [21]

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No, it's very helpful color. And just switching gears to the capital side. You guys continue to run with best-in-class capital ratios. I know you try to avoid deviating from some of your peers and try to manage to similar capital targets through the cycle. Just given some commentary from some of your trust bank peers about increased confidence, given some upcoming changes to leverage ratio as well as what appears to be maybe a more benign task than the -- in the coming exam, how you are thinking about your capital ask and whether you have increased confidence in your ability to maybe raise your payout target a bit.

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [22]

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Yes. So we're pleased to enter this cycle that we just submitted here in April from a position of real strength as you could see from our ratio and the flexibility that, that gives us entering that period of time. The SLR was not a binding constraint for us. So that changed in definition. While we will take regulatory definitions that end up easing the ratio for us in that case, it wasn't a binding constraint, so I pull back on that. What I would say is in the quarter, I think we had a payout ratio of 119% in the quarter that we cited. So I think in the environment we're in, we don't feel constrained with what we want to ask other than our own constraints, which are do we have enough capital to support the growth we foresee in the business? Do we have enough capital to withstand our own idiosyncratic stresses? Do we have enough capital to support our clients' needs and wants? And I think the answer to that with where we are currently positioned is a pretty strong yes with a 13% CET1. So again, we like the flexibility that gives us going into the review by our regulators.

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Operator [23]

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Next question will be from Brennan Hawken with UBS.

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Brennan Hawken, UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst of Financials [24]

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So the C&IS fee rate was -- saw a bit of a bounce here this quarter. And I know this is an imperfect way to model your servicing revenues, but it's the best we've got. So could you maybe help us -- I know that you flagged new business wins this quarter, and so I'm guessing that contributed to some of that servicing fee rate improvement. Is that right? And then were there other factors? Can you just help us sort of level set given that this is the way most of us model your servicing revs and how to think about that line from here?

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [25]

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It's Mark. I would say as we look at the asset servicing fees on a sequential basis, there was certainly the market drag mainly from both month lag and quarter lag. We're probably looking at about a 2% to 2.5% drag from markets, and then currencies were actually modestly better but very little. So really, the new business that we saw on the fee side would have been kind of offsetting that because the fees were basically flat during the quarter. So pretty strong on the new business side. I mean, it does become a function of the business that we're adding. I would say that we are going to look at the mix of business that we're adding these days. We probably are -- from a fee [bps] rate perspective, that new business is probably coming on at a higher level than what a traditional custody would be, for instance. And some of the moves that we've seen -- large moves on a year-over-year basis where there has been -- we talked about one transition last quarter would have been at a lower bps rate than what rating segment we're bringing on new global fund servicing business. So it kind of comes back to the mix of what's coming on and then kind of how the point in time assets look versus the fees that you kind of earn kind of as you go through the quarter.

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Brennan Hawken, UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst of Financials [26]

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Yes. Okay. That makes a lot of sense, Mark. And then next one is on NII and some of the comments that you've made here so far. So -- and this is sort of a cleanup, so I'm kind of dumping a couple of cleanups in here into one. When we think about -- I think you said that there was one large outflow with the noninterest-bearing that you still think nonoperating is 1 to 2. So was some of the outflow from the nonoperating? And just so we can kind of think about that. Or was this more competitive pressure? And then given the fact that you still think and NIM can grind higher and your deposits can grow, that seems to suggest that you guys feel pretty good about NII growth from 1Q as a starting point. Is that fair? Or do we need to be concerned about upward pressure on deposit costs?

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [27]

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Let me take the second question first on the upward pressure. That is a competitive dynamic. I think we feel that we have stayed abreast of the market and that we are -- we have competitive pricing in the institutional space today. But we have to observe the market. And I mean that, as you know, there's sort of very public -- our clients probably are aware of the market pricing from a relatively small number of competitors, and so that pricing is pretty transparent, particularly on the institutional side. So we'll remain competitive is all I can say. And if there's not upward pressure from others than I think on the deposit pricing there. And the first question was on the...

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [28]

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On the decline in noninterest-bearing. And on that, it -- I mean this was a situation where a client was seeking other yield enhancement on that money. But I would also add that of the decline, so call that half of a decline, there was also a decline that we saw. About 1/3 of the decline was not in U.S. dollar currency. It was actually in nonmajor currency around the world. So those were probably just more transactional frictions that those clients have kind of moving through the system, not necessarily an indicator of future trends because that wasn't part of some of the fee revs dollars looking for higher yields.

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Operator [29]

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Next question will be from Brian Bedell from Deutsche Bank.

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Brian Bertram Bedell, Deutsche Bank AG, Research Division - Director in Equity Research [30]

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Great. Let me just go back to the organic growth trends, so just especially in the custody and fund admin business. Looks like we should have a decent tailwind coming into the second quarter both on a markets basis. But also if you can just comment on the cadence of organic growth. It looked, like you said, very strong if that came in during the quarter, so we also have a little bit of a fee tailwind from that. And then to add onto that, maybe if you can talk about your front to back office integration, the open architecture approach. I know it's counter to State Street. I think you have a partnership with Bloomberg. How -- I guess how new is that effort? And should we expect that to be something that can enhance your organic growth over time?

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [31]

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Sure. Let me do the organic growth part first. I must split the businesses apart here if I could real quick. Yes, we saw -- we've talked as a firm of the range that we're comfortable with from an organic growth perspective. In any given quarter, we can be in that range, slightly lower, slightly higher. But then our businesses themselves can have different trajectories as well. Our Wealth business, as I said actually, I think, saw organic trajectory at a higher end of its historical range. But that's lower than what we talked to you about target -- it's a slightly lower organic growth business. And our C&IS business, if you exclude securities lending, which is heavily capital markets influenced, also was in the range that we've talked about for that business from an organic growth standpoint. It's hard to ignore the securities lending and asset management businesses, but when -- if you peel those out, we were in the organic kind of growth rate from a pure asset servicing business that we've seen. So that was a strength there. In terms of the value chain or the -- our positioning, what I would say is we don't believe we have to own every piece of the value chain. An example is an OMS, an order management system. It's -- I think it's our goal is to allow our clients to access our technology and allow them to communicate and process their trades in an efficient manner. It's a competitive landscape in the OMS space, and there's some very good providers out there. So we think being able to partner and integrate with those vendors is very important. We do have a relationship as we highlighted in our press release at the end of March with Bloomberg where we're doing just that. But that's an example of a very important vendor in the space that we've struck up a strategic partnership with and can bring that to bear. So I would say at the end of the day, we believe very much that we don't have to bring every piece of that component of the value chain and own it all the way through, that we can partner with some best-in-class providers in different spaces and make it work.

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Brian Bertram Bedell, Deutsche Bank AG, Research Division - Director in Equity Research [32]

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No, that's great color. And then just maybe just one on expense growth. Looking at the year-over-year basis, if I'm measuring this right, looks like about 3%, 3.5%, which would be tracking below your organic -- I believe, correct me if I'm wrong, but maybe slightly below your organic growth rate on a year-over-year basis. So is that mostly due to Value for Spend program coming through? Because I know you've tried to match that expense growth. I know it can't be on -- every quarter but would generally sound like you're tracking very well against that goal.

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [33]

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So what I would say is in all transparency and candor that, that growth rate is a little higher than that on an organic basis because we have some currency benefits. So...

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [34]

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About 4.5%.

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [35]

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Yes. So call it 4.5% type of a growth rate, which is in the range of where we've talked about organic fee growth rate. So I think they're reasonably well aligned. We'd like to get that organic growth rate and the expenses down a little lower, so we created leverage to what we've talked about. But in full transparency, the reported number had some currency benefit in it. Obviously, fees have some currency drag equal and offsetting to that, but we would have probably pinned it somewhere in the 4.5% type range from the quarter on an organic expense growth rate.

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Operator [36]

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Next question will come from Jim Mitchell with Buckingham Research.

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James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [37]

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Maybe just a follow-up on Wealth Management. You noted that you're at the high end of the organic growth range. I know you've been investing there to try to accelerate organic growth. Is that sort of early evidence that you're getting success? And maybe just talk a little bit more broadly about what you're doing to drive better organic growth there and what you think the traction is so far.

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [38]

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Yes. So I would -- I'd pick a couple of components to that. One, I think the technology that underpins that, the Goals Powered Solutions and the approach to the holistic advice, so the goals-driven Wealth Management, has really resonated with our clients. We've really seen that be a differentiator in the market and we've been told that consistently by our clients and other setters of influence that influence the wealthy individuals that we have a differentiated technology to bring to bear for people. So I think that's been really successful. And the other thing I would say is we've done a good job of attracting clients in what I will call our virtual markets. As you know, we've got physical offices and about 60 locations in most of the wealth centers around the country. But there are other cities where we don't have necessarily physical presence. And we've been able to create I'll call a virtual team type environment and really penetrate some -- I don't want to say secondary cities, but cities that aren't in the major metropolitan wealth centers but still have significant wealth without having to put physical footprints in. It's been a really successful strategy. That's 2 examples of really strong growth that are, I think, pushing us up towards a pretty significant organic growth rate relative to the industry in Wealth Management.

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James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [39]

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Okay. That's helpful. And maybe one other question on deposit betas. It seemed like this quarter, at least on an aggregate level, your deposit beta was -- has actually slowed versus the last 3 or 4 quarters. I think some of your peers are mentioning accelerating deposit betas and high competition. So just trying to get a sense of maybe the difference that you're seeing. Are you seeing that competitive pressure on deposit rates? It doesn't look like it. Just maybe talk to the deposit beta this quarter and where you think if anything's changed going into 2Q.

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [40]

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Yes. I caution you to look at 1 quarter's beta. We could be catching up, slowing down from previous moves that we've made. I think if you go back and look at our beta across the cycle, you would start with the rate cycles and hikes and go back to 2016 if you want to go back, our beta will look much more like you would expect across a longer horizon. So I think it's a little bit dangerous to only look at it from 1 quarter because we -- like I said, we could have slowed because we were comfortable with our positioning in a quarter or we could

(technical difficulty)

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James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [41]

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I think I lost you.

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [42]

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We'd be about 75-ish probably percent beta and then lower than that obviously on the retail.

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James Francis Mitchell, The Buckingham Research Group Incorporated - Research Analyst [43]

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Sorry. I think my phone got cut out for half of your response. I'll follow up later.

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Operator [44]

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Our next question will be from Ken Usdin with Jefferies.

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Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [45]

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Just a couple of quick follow-ups, cleanups, I guess. Biff, you mentioned earlier that the second quarter won't have the same stock-based compensation that the year-ago quarter had. Can you just tell us then again what was the magnitude of that a year ago? And so what -- how much will be absent this year relative to what was in last year?

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [46]

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Ken, it's Mark. We are having some audio difficulties on our end. Hopefully, what we're saying is coming through. But yes, you're right. So the last couple of years, you'll remember there was an extra expense that came through in the second quarter from the retirement-eligible grants. Last year, there was $11 million in the second quarter. So we had $32 million in the first, $11 million in the second a year ago. This year, we had $30 million in the first, but there will not be further retirement-eligible stock expense that would impact the second quarter because of the changes in the service requirements around the performance shares. So $11 million during the second quarter of last year, but this year we would not have that.

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Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [47]

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Got it. That's a nice year-over-year starting point helper. And then second one on the deposits. Biff, you mentioned that the customer-related deposits should be growing with the growth of the business. But obviously, the balance sheet has been net shrinking because again of that removal of liquidity and -- how has the core deposits been growing underneath the surface? And how can you help us like understand the inflows versus outflows in terms of trying to guess and estimate when that total earning asset base starts to bottom and turn the corner upwards?

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [48]

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Yes. Yes. Thanks. So the answer is at the core -- and it's hard to see in any of the financials we put out there, but I would say it's a general statement. At the core, we have seen that core operating balance has sort flattened out. It's hard to see, like you said, all the liquidity moving on and off the balance sheet, so it can be difficult to see. The other thing I would say too is when we say that the new business that we win comes with balances, some of the new business wins we've been having are administration in nature and they don't always come with balances. So the mix of business we win matters, too. Over time, we tend to win a broad-based mix of business, some which come with custody balances, some which come with administration. I would say we had more wins in the -- large wins in the administrative side that may or may not come with balances. It's one of the reasons you may see our AUC and AUC/A a little bit flatter but revenue still going up and fees going up because the mix of that business is different (inaudible) with the balances. So you got the dynamic of the win mix [matters] and then you've got the dynamic of the underlying balance sheet because that's what I would call the liquidity flows or the excess balances moving around. You've seen that in our competitors. Underneath, the core operating deposits continue to be pretty stable.

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Operator [49]

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Our next question will be from Brian Kleinhanzl, and he's from

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Brian Matthew Kleinhanzl, Keefe, Bruyette, & Woods, Inc., Research Division - Director [50]

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Just a couple of questions here. On the -- you had mentioned you're taking a while a bit more duration in the securities portfolio. Can you actually give what the securities duration is now and still how much is tied direct repricing on a (inaudible) basis?

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [51]

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So the duration of the portfolio has historically been closer to 1. And it moved up by 30% or something like that. The long end of the securities portfolio is longer than that. But (inaudible) of the portfolio has moved up by that 30-or-so percent. And the second part of your question broke up, I apologize. Can you repeat?

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [52]

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I think it may have been the exposure to the 30-day rates within the (inaudible)?

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Brian Matthew Kleinhanzl, Keefe, Bruyette, & Woods, Inc., Research Division - Director [53]

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Yes, how much reprices in the next 30?

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [54]

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Yes. So on the securities side, the short end of the -- I should say, if you split the securities portfolio in half, a little bit more than half is the shorter portfolio. And there, we would say a lot of that would be driven by the 1-month, 3-month type of LIBOR moves with a little bit more weighted toward the 1-month side. So it does -- that part of the securities does reprice pretty quickly. And when you get to the longer portfolio, obviously, not all that is going to roll over in 1 quarter or even 1 year. That's kind of over the course of -- if for instance, if you're sitting with, on average, 2 years securities and it was a nice even book, in theory that means that 1/8 of it would roll through every quarter. That's not to say where we're at, but that's just an example of what you would have if you were staying with a 2-year book when you look at the longer portfolio. Does that help? We're having some audio problems here.

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Brian Matthew Kleinhanzl, Keefe, Bruyette, & Woods, Inc., Research Division - Director [55]

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It does. And then just a second quick follow-up on the deposit runoff. I think in the past, you said that you've been able to capture as much as 2/3 of those deposits. Is that still -- is it now that's still true? Or is it a lot of that deposit runoff just running away from you in total?

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Stephen Biff Bowman, Northern Trust Corporation - Executive VP & CFO [56]

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I think we've said we've captured about half of it, can move into a money fund and then half (inaudible) to some other vehicle and (inaudible) investment vehicle somewhere else or would lead. I don't know that I know if that's changed dramatically from what we've seen. So I think it is still -- we've seen growth in our cash funds, as you can see, particularly on the institutional side when we saw growth in our cash funds. So there's clearly (inaudible) in the cash funds from the balance sheet, and we continue to look at an array of the opportunities for (inaudible) balance sheet (inaudible) cash funds. So we've been able to capture a meaningful portion through the company.

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Operator [57]

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And I'd now like to turn the call back over to our presenters to -- for closing remarks.

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Mark M. Bette, Northern Trust Corporation - Senior VP & Director of IR [58]

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Thank you for joining us for the first quarter call, and we look forward to talking to you again in July. Thank you.

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Operator [59]

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Ladies and gentlemen, this concludes today's teleconference, you may now disconnect.