Good day and welcome to the Northern Trust Second Quarter 2022 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jennifer Childe. Please go ahead.

Thank you, Kevin. Good morning, everyone and welcome to Northern Trust Corporation's second quarter 2022 earnings conference call. Joining me on our call this morning are Mike O'Grady, our Chairman and CEO; Jason Tyler, our Chief Financial Officer; Lauren Allnutt, our Controller; and Mark Beatty and Briar Rose from our Investor Relations team. Our second 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 July 20th 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 August 17th. 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 11 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.

Thank you, Jennifer. Let me join in welcoming you to our second quarter 2022 earnings call. We generated solid results in what turned out to be a more volatile and uncertain market and macroeconomic backdrop than we've experienced in some time. New business momentum continued to be strong and our capital position remains robust. Revenue increased 12%, EPS grew 8%, and we delivered a return on average common equity of 15.7%. Second quarter results benefited significantly from higher interest rates and the elimination of money market fee waivers related to low rates. The weaker equity and fixed income markets began to impact our fees and client levels, and due to the lag in our billing cycle, this impact will continue in the third quarter. We saw a 7% sequential decline in average deposits; however, these were largely non-operational in nature. Our clients continue to see us as a valuable partner for their liquidity needs. Our expenses increased 9% compared to the prior year, reflecting inflationary impacts across our cost base, particularly within our Compensation and Equipment and Software lines. Despite this inflationary pressure, we achieved three points of positive operating leverage in the second quarter. In Wealth Management, we continue to see healthy levels of engagement with new and existing clients. Growth within our Global Family Office was particularly strong. In Asset Management, consistent positive flows into our FlexShares ETF complex helped to partially offset equity market headwinds and broad-based liquidity outflows in our institutional channel. At $21 billion, our FlexShares assets under management were up 13% year-over-year. We also saw strong growth in our alternatives offerings in the quarter. Notably, we were recognized by Asia Asset Management's 2022 Best of the Best Awards as the Winner of the Best ESG Manager in Asia, Best Factor Investing Manager in APAC, as well as the Best Application of ESG. Our Asset Servicing business continued to see positive new business momentum and the pipeline remains robust. Notable wins announced in the quarter included Wilmington Trust and U.K.-based International Biotech Trust. Our Integrated Trading Solutions capability continues to be an area of strength. We also continue to see strong interest in our Investment Data Science product suite. In closing, as we navigate these volatile and uncertain times, we remain laser-focused on serving our clients, generating profitable long-term growth, and delivering value to our stakeholders. Before I turn it over to Jason to review our financial results in greater detail, I would like to note that we plan to publish our 2021 Sustainability Report in the next few days. I'm very proud of the progress we've made in our sustainability journey and serving as a force for change. Highlights for the report include our commitment to be net zero by 2050, a summary of our community support initiatives and the launch of a more holistic business diversity program. I'll now turn the call over to Jason.

Thank you, Mike. And let me join Jennifer and Mike in welcoming you to our second quarter 2022 earnings call. Let's dive into the financial results of the quarter starting on Page 2. This morning, we reported second quarter net income of $396.2 million. Earnings per share were $1.86, and our return on average common equity was 15.7%. Results for the quarter included a $20.3 million pension settlement charge within the employee benefits expense category. Also recall from last year, we implemented accounting reclassifications to certain fees at the beginning of the year, which will continue to impact the year-over-year comparisons as noted on this page. Our effective tax rate was 26.7%, which compared to 24.3% in the prior year and 23.8% in the prior quarter. The increase is largely related to our international earnings mix, including reserves for uncertain tax positions. We now expect our effective tax rate to be approximately 24% to 25% on a go-forward basis. Let's move to Page 3 and review the financial highlights of the quarter. Year-over-year, revenue was up 12% and expenses increased 9%. Net income was up 8%. In the sequential comparison, revenue was up 3% and expenses were up 1%, while net income increased 2%. The strengthening of the U.S. dollar resulted in a reduction in our year-over-year revenue and expense growth rates of approximately 2%, and a reduction in the sequential growth rates of approximately 1%. The provision for credit losses was $4.5 million in the quarter. Return on average common equity was 15.7% for the quarter, up from 13.7% a year ago and up from 14.2% in the prior quarter. Let's look at the results in greater detail starting with revenue on Page 4. Trust, Investment and Other Servicing fees, representing the largest component of our revenue, totaled $1.1 billion and were up 6% from last year and down 2% sequentially. All other remaining non-interest income declined 2% from both the prior year and the prior quarter. Net interest income, which I'll discuss in more detail later, was $470 million and was up 37% from one year ago and up 21% sequentially. Let's look at the components of our Trust and Investment fees on Page 5. For our Asset Servicing business, fees totaled $643 million and were up 5% year-over-year and down 3% sequentially. Custody and Fund Administration fees were $434 million, down 5% year-over-year and down 4% sequentially. The year-over-year decline was primarily driven by unfavorable currency translation, partially offset by new business. The sequential decline was driven by unfavorable currency translation, as well as unfavorable markets. Assets Under Custody and Administration for Asset Servicing clients were $12.8 trillion at quarter end, down 13% year-over-year and down 12% sequentially. Both the year-over-year and sequential declines were primarily driven by unfavorable markets and unfavorable currency translation. Investment Management fees in Asset Servicing of $148 million were up 47% year-over-year and up 1% sequentially. The year-over-year performance was driven primarily by lower money market mutual fund fee waivers and the previously mentioned accounting reclassification, partially offset by client outflows. Sequentially, the increase was primarily due to lower fee waivers, partially offset by client outflows and unfavorable markets. There were no fee waivers relating to low interest rates in the second quarter results compared to $28 million in the prior quarter and $50 million in the prior year quarter. Assets Under Management for Asset Servicing clients were $950 billion, down 19% year-over-year and down 13% sequentially. Both declines were driven by unfavorable markets, client outflows and unfavorable currency translation. Securities Lending fees were $22 million, up 11% year-over-year and up 14% sequentially as wider spreads offset the impact of lower volumes. Average Securities Lending Collateral levels were down 7% year-over-year and down 5% sequentially. Other trust fees were $39 million, up 7% compared to the prior year and down 11% sequentially. The sequential decline was primarily driven by higher seasonal benefit payment services fees in the prior quarter. Moving to our Wealth Management business. Trust, Investment and Other Servicing fees were $501 million and were up 8% compared to the prior year and down 1% from the prior quarter. There were no fee waivers in relation to low interest rates in the current quarter compared to $23 million in the prior quarter and $29 million in the prior year quarter. Within the regions, the year-over-year growth was driven by lower money market mutual fund fee waivers and new business. For the sequential performance, the decline within the regions was primarily driven by unfavorable markets, partially offset by lower fee waivers. Within Global Family Office, the year-over-year growth was driven by lower fee waivers, new business and favorable markets. The sequential increase was mainly related to lower fee waivers, partially offset by unfavorable markets. Assets Under Management for our Wealth Management clients were $353 billion at quarter end, down 5% year-over-year and down 11% on a sequential basis. The year-over-year decline was driven by unfavorable markets, partially offset by client flows. The sequential decline was driven by unfavorable markets and client outflows. Moving to Page 6, net interest income was $470 million in the quarter and was up 37% from the prior year. Earning assets averaged $140 billion in the quarter, down 1% versus the prior year. Average deposits were $129 billion and were up 1% versus the prior year, while loan balances averaged $41 billion and were up 12% compared to the prior year. On a sequential quarter basis, net interest income grew 21%. Average earning assets and average deposits both declined 7%, while average loan balances were up 3%. The net interest margin was 1.35% in the quarter, up 38 basis points from a year ago and up 30 basis points from the prior quarter. The increases from the prior year and prior quarter were both driven primarily by higher average interest rates, a favorable balance sheet mix and $7 million in non-recurring interest received from certain non-accrual loans. Turning to Page 7. Expenses were $1.2 billion in the second quarter and were 9% higher than the prior year and 1% higher than the prior quarter. The current quarter's expenses included a $20.3 million pension settlement charge within the employee benefits category, while the prior year quarter included a pension settlement charge of $17.6 million. Also included in the quarter is the impact of the previously mentioned accounting reclassification, which increased other operating expense by $10.4 million compared to the prior year. Excluding these impacts, expenses were up 8% versus the prior year and flat sequentially. Compensation expense was up 12% compared to the prior year and was down 3% sequentially. The year-over-year growth was primarily driven by higher salaries, as well as higher cash-based incentives. The sequential decrease was primarily due to the prior quarter's equity incentives, including $49 million in expense associated with retirement-eligible staff, partially offset by higher salaries. Both the year-over-year and sequential comparisons benefited by favorable currency translation. Excluding the previously mentioned settlement charges, employee benefits expense was down 1% compared to the prior year and down 5% from the prior quarter. Outside Services expense was $213 million and was down 2% from a year ago and flat sequentially. The year-over-year decline was primarily driven by lower third-party advisor and technical services costs, partially offset by higher consulting expenses. Equipment and Software expense of $204 million was up 14% from one year ago and 5% sequentially. The year-over-year and sequential growth were both primarily driven by higher software costs due to continued investments in technology, as well as higher amortization. Occupancy expense of $51 million was down 2% from a year ago and flat sequentially. Other operating expense of $90 million was up 33% from a year ago and up 13% sequentially. The year-over-year increase was driven by the previously mentioned accounting reclassification and higher business promotion and other miscellaneous expense, partially offset by lower supplemental compensation plan expense. The sequential performance was primarily due to higher business promotion and staff-related expense. Turning to Page 8. Our capital ratios remain strong, with our common equity Tier 1 ratio of 10.5% under the standardized approach, down from the prior quarter's 11.4%; our Tier 1 leverage ratio was 6.7%, up from 6.5% in the prior quarter. An increase in net unrealized losses on the available-for-sale securities portfolio was a primary factor in this quarter's decline in capital ratios. Accumulated other comprehensive income at the end of the current quarter was a loss of $1.5 billion with the loss in the second quarter totaling approximately $600 million. During the quarter, we declared cash dividends of $0.70 per share, totaling $148 million to common stockholders. As announced yesterday, our Board of Directors approved an increase in our third quarter dividend to $0.75 per share. The current environment continues to demonstrate the importance of a strong capital base and liquid balance sheet to both weather the uncertain economic conditions and to support our clients' needs. We remain laser-focused on providing exceptional client service, while executing on our strategic priorities to grow the franchise and create long-term value to our shareholders. Before we open it up to questions, I'd like to take a moment to thank Mark Beatty, who is transitioning from heading Investor Relations to his new role as CFO for our Shared Services Group. Mark, thank you for your leadership, your partnership and your unwavering commitment to serving our analyst and investor community over the past six years. I know I speak for all of us when I say we've learned so much from your insights and perspective. So thank you. And with that, please open the line for questions.

And the first question today comes from Alex Blostein of Goldman Sachs.

Good morning, Alex.

Hey Jason. Good morning, everybody. I'd like to echo your prior comments for Mark as well. It was great working with you, and good luck in your next role. Maybe to start with the NII related questions — you've spoken in the past about deposit outflows about a month ago. They seem like they have continued a little bit in June. So maybe help us unpack the sources of where you guys are seeing some deposit outflows, the mix between interest-bearing and non-interest-bearing, any comments on how things are standing so far in the third quarter? And any broader commentary you might have around where deposit levels could ultimately trough?

Sure. So I'll give you some thoughts. Don't hesitate if you want us to touch on a different component of it. First of all, just taking a longer-term perspective, deposits have been strong since the beginning of the pandemic, including relative to peers in the industry. So the institutional channel has declined in the last few months, but it appears that we may have peaked later. If you go back to the beginning of the pandemic, our deposits are still up meaningfully. We started the pandemic at about $90 billion, and you see now, we're around $130 billion. Going forward, the strategy is very consistent: remain focused on retail and operational institutional deposits. The retail deposits are effectively all operational. Our second quarter deposit volumes were down 6.5%. Let me unpack where those sub-channels came from. More than half of that decline was in non-operational financial deposits. Generally, that is the most rate sensitive channel by far. It's also the fastest declining category for us; it was down over 11%. The second fastest category of decline was actually other non-operational deposits, which declined about 5%. If you focus on the wealth channel and the institutional deposits that are operational, the decline was just 3%. Another dynamic to think about is that within that period, we had tax payments, and so you'd expect some decline coming from that. That highlights the focus that the vast majority of the decline has come in non-operational deposits. As for where we are in the quarter, deposits have been down from the average of second quarter, but they seem to be leveling off. The decline we saw in the second quarter was largely in the month of May. Since then, deposits have stabilized at about $120 billion. That's a lot, but I'll stop there; that should give you a sense of how deposits have been trending.

Great. Is it fair to assume that the outflows you've seen, albeit smaller outflows so far in the third quarter, are also non-operational? And is there a way to frame what you think the total size of the non-operational deposits bucket is and how much of that could ultimately still leave?

I'll answer the first, which is what we've seen so far this quarter: 85% of that has been non-operational. So continuing that theme that those deposits are non-operational. We haven't talked externally about the mix of operational and non-operational deposits. We can think about that and whether in future quarters we want to provide that detail, but I think this is a lot for you to work from at this point.

And this is Mark. As a reminder, the non-operational deposits wouldn't all be at risk. We had plenty of them before the pandemic. But that is where we've seen the flows and movement so far.

Got it. All right, thanks. I'll hop back in the queue.

We can go to Steven Chubak of Wolfe Research.

Steve?

Hi, good morning. I wanted to start off with a question on the NIM outlook. Looking at the last rate cycle, your NIM peaked somewhere in the low (ph). I saw a nice uplift this quarter. With loans composing a similar percentage of the balance sheet today versus the last cycle, and higher terminal Fed funds and higher non-U.S. rates contributing as well, is it reasonable to expect higher NIMs this cycle? Any way you could help us frame peak NIM potential given some of those tailwinds?

Sure. If you go back to mid-2019, we were over 160 in the middle of that year. You're highlighting the right things to look at on mix; there is no reason we shouldn't achieve or even surpass that level. The only caveat would be if you saw a very significant change in the yield curve, but we're not anticipating that. So no reason why we couldn't achieve or surpass that 160-ish level. As you're thinking about the starting point though, we had about $6 million to $7 million in interest income that came from recovery of those non-accrual loans. The starting point should be adjusted for that $6–7 million in interest income from recoveries on non-accrual loans. Regarding betas, for the second quarter, betas are right at 25%. Looking into the third quarter, the betas could be twice that, but not 100%. So we're still seeing an attractive increase. We're trying to give both volumes and betas so you have the building blocks as you model NII going forward.

Thanks for that color, Jason. As a quick follow-up on capital: you've noted in the past that you want to run with capital levels consistent with your G-SIB peers despite the lower regulatory requirements. Given the AOCI volatility and strong loan growth that has consumed some capital, could you provide updated thoughts on target CET1 — whether the 10% to 11% range is where you want to be — and how that informs your appetite to potentially accelerate buybacks, especially if lending begins to slow in a rising rate backdrop?

You're right that competitively we like a strong position relative to G-SIB peers. When clients deposit large sums, they're effectively lending to us, and we want our balance sheet to reflect strength. We look at CET1 and the leverage ratio together. We look good on a relative basis and have plenty of room relative to regulatory limits. We'll continue to look at things competitively and evaluate opportunities for buybacks versus other opportunities like loan growth. We were deliberate in assessing returns on the loan growth we executed. Also note that loan volume can be spiky and currency markets move, which impacts RWAs. So all these things come into play. In general, we feel good about capital levels, though historically we have been in a higher range.

That's great. Best of luck, Mark, in the new role, and thanks so much for taking my questions.

Thanks, Steve.

The next question comes from Glenn Schorr of Evercore.

Hi, Glenn.

Hi, hello there. So in the quarter, operating leverage is welcome, but we know what's coming with the lag in deposit pricing and lower fees. I wonder if you could give us any thoughts on expenses on a go-forward basis? I know on any given quarter you will have ups and downs, but share your thoughts on the jumping-off point for expenses and the possibility of operating leverage for the full year.

You're right it's hard to look at a single quarter, and this year it's harder to think aggressively about full-year operating leverage. Rates have a big impact on net interest income over time, while the impact on expenses shows up quicker. We need to stay focused on expenses. A few highlights on the expense side: Compensation — the base pay adjustment came into play in the third quarter and fall, and that's about a $20 million lift quarter-over-quarter (it's usually half that amount). Headcount was higher and we had some off-cycle adjustments, bringing another roughly $10 million. Currency helped significantly, around $5 million to $10 million. A big component is the cash-based incentive accrual; as we do better, cash-based incentives will rise. Equipment and Software was a $10 million lift quarter-over-quarter; amortization increased by about $5 million and we'll see another sequential lift into the third quarter. Software rental and support costs are higher — some inflationary and some from higher consumption. We're anticipating another similar rise. So looking into the third quarter, you'd see a similar step-up from second quarter to third quarter as we experienced from first to second.

Okay. That is definitely helpful. And a quick follow-up on deposits and NII: you noted the investment portfolio turns over so you get NIM benefit over time. Can you grow NIM from here in the near-term if betas are doubling? How should we think about that in the short term?

Definitely. The balance sheet is positioned so a significant portion of loans (about 75% floating) and a big chunk of the securities portfolio reprices within a year; cash is short. The asset side is significantly floating. Even if we give up just half the increase on the deposit side, there's plenty of room to grow NIM and NII significantly in a rising rate environment from here.

Awesome. Thank you for that. Appreciate it.

The next question comes from Mike Mayo of Wells Fargo Securities.

Hi, Mike.

Hi. A part of your NII guide is higher, but you're not telling us how much higher, because you tell us your sensitivity to lower stock markets and the impact on fees, but you're not giving us the NII guide. One component is loan growth, up 12% year-over-year. Some investors hold Northern as a safe haven during a recession because your loan losses tend to be a fraction of the industry. What are you seeing in loan growth among your retail customers? How much appetite do you have to expand that? Are you noticing more competition because peers are more vocal about growth? And would Northern experience fewer loan problems in a recession because your clients are high-end?

On loan growth, rates should slow relative to the last two years. The prior growth was initiative-driven — we communicated more with clients and positioned to be a liquidity provider through loans. Growth has been largely in that channel and credit appetite hasn't changed; we're deliberate about maintaining credit standards. Credit indicators haven't changed — increases this quarter were in inherent reserves, not specific reserves, and we actually had small net recoveries. Early signs are good. Regarding recession impact: we don't want to proclaim victory, but indicators remain favorable and we haven't changed our appetite.

One more big-picture question: a concern going into a recession is the negative wealth effect. Since you deal with the highest-end customers, what's the behavior of your customers after such a decline in personal net worth?

You're exactly right that portion of our client base has different dynamics. We came off a period with significant asset value increases and a high level of liquidity and monetization opportunities like selling businesses or real estate. That dynamic has changed as markets decline. You see reduced IPO activity and valuations are lower, changing their attitudes about selling. That said, many of these clients hold high liquidity and are in a position to be very long-term investors; we see many deploying capital into markets, investing liquidity raised earlier. The wealth effect benefits our business when wealth increases, but the client base is somewhat more resistant on the downside. It remains a less favorable environment than when markets are strong, but it doesn't cause immediate client departure in most cases.

All right. Thank you.

The next question comes from Michael Brown of KBW.

Hi, Mike. How are you?

Hi, good morning. Thanks for taking my questions. The AUC/A decline was a bit greater than expected this quarter and above some of your peers on a sequential basis. Can you expand on key drivers? You called out wins in the quarter. Was there any material lost business? Or was it truly just FX and markets at the AUC/A levels this quarter?

Did you say AUC/A? Yes. Nothing significant from a flows perspective to call out. Mathematically, currency translation was about a 2.5% hit and market levels another 8%. So the vast majority of the movement was from those two factors. The core business had nothing notable from a flow perspective.

Okay, that's helpful. And as a follow-up, one of your peers talked about a plan to reprice aspects of their servicing business due to wage pressure and capacity constraints. Is this a dynamic you are seeing? Any opportunities to reprice your business higher in coming quarters or a year given inflationary pressures?

We tend to approach client relationships differently — we look to ensure balanced relationships that generate value for both client and us. There are many dynamics: services that generate fees and other activity like balances and FX that produce different economics. Relationships shift and sometimes that involves changes in activity rather than fee changes. We're less programmatic about broad fee increases. Over time asset levels up create pressure on fees to trend down, and inflation increases expense. Interest rate benefits offset some of that. We focus on longer-term relationships and incrementally pricing where appropriate, but we don't typically run sweeping repricing programs.

Thanks, very interesting perspective Mike. Appreciate it.

The next question is from Brennan Hawken of UBS.

Good morning, Brennan.

Good morning, thanks for taking my questions. Congrats to Mark — it's been a real pleasure working together. Curious: you gave a lot of color on non-operational deposits and runoff versus operating deposits. Deposits were under pressure but NIM was strong this quarter. Can you help frame spreads for non-operating deposits versus operating deposits? That might help triangulate NII.

Sure. A few high-level items: about 75% of loans reprice within 90 days, roughly a third of securities are floating, and cash is very short. Non-operational financial deposits require high liquidity and generally remain overnight — they are the most rate sensitive and are often priced near Fed funds minus something, so spreads are tight. Operational deposits allow you to invest longer and are less spread sensitive; they have better economics and can be invested in longer-duration securities as they mature. That's why the distinction matters: economics and behavior of operational versus non-operational deposits are very different and will lead to different outcomes for NII over time.

Thanks, that's helpful. On beta: you said betas could be twice the second quarter to third quarter, i.e., roughly 50% in the third quarter. Is that an incremental quarter beta rather than cumulative? And does that increase in beta contemplate the reduction in the very rate sensitive non-operational deposits running off? As those run off, will that contain upward pressure on beta?

A lot there. Yes, to the extent non-operational deposits run off, that insulates betas somewhat. Our commentary on third-quarter betas reflects incremental expectations for the quarter. We're not targeting a specific long-term beta; instead we react to client behavior and aim to retain valuable operational deposits. The 50% comment was an incremental quarterly assumption based on what we see and project for mix. There's uncertainty, but the 50% is an overall projection based on current and projected mix.

I appreciate the color.

The next question is from Brian Bedell of Deutsche Bank.

Good morning, Brian.

Good morning, thanks very much. Also echo comments for Mark. On two expense lines: is the typical seasonal lift in Outside Services in the second half likely to repeat? And regarding marketing, in lieu of the Golf Open, you mentioned reallocating that spend to marketing initiatives — is that a second-half event, or spread across the year so we shouldn't see a spike?

On Outside Services, there tends to be a second-half lift. Some expenses are volume-related — market data and transaction-related services — and can dominate seasonality. In the second quarter volumes were down slightly offset by higher consulting and legal. Going into third quarter, those dynamics continue and we'll see which dominate. On marketing, Mark?

On marketing, Brian, we are spending throughout the year, so there's no major seasonality like you had with the Golf tournament. It's spread across the three businesses.

That's great color. And Mike, a follow-up on alternatives: what are you seeing from your wealth client base in terms of demand for illiquid products — private equity, private credit, impact funds? How much have you added on-platform? And might there be a revenue impact for Northern even if you're not managing those products but merely offering them?

We aim to provide a full set of alternatives for clients, offering both third-party and our-managed vehicles. In wealth management, private credit and a broader set of alternatives are in demand. Growth was pronounced at 50 South Capital in Asset Management, where we offer funds of funds; clients have shown strong interest in diversified alternatives exposure. Alternatives typically have attractive financial profiles for us and deepen client relationships, so we expect alternatives to be an area of long-term growth despite volatility across categories.

Good, thank you.

Next question comes from Ken Usdin of Jefferies.

Good morning, Ken.

Hey, good morning. Given rising rates and the OCI, can you talk through where your securities portfolio duration is and what you're seeing on incremental pickup versus rolloff? How are you thinking about mixing the portfolio and protecting OCI?

Duration is down to about 2.6 years from 2.7 years. From a reinvestment perspective, we've been going shorter; as maturities come due we're keeping powder dry given market volatility and anticipating higher rates, so we're not reinvesting longer on the curve right now.

Related to capital and OCI, have you been moving things from AFS to HTM? Are you rethinking duration and how to protect incremental AFS? How would you expect existing OCI to return to capital over time?

We moved about $7 billion from AFS to HTM post-quarter close. That should protect roughly half of the exposure we've had on OCI. In terms of recouping the OCI hit, it should take about 3.5 years to recover, maybe a little longer, but that gives you a sense of the trajectory.

Okay, got it. Thanks a lot, Jason.

Our next question comes from Betsy Graseck of Morgan Stanley.

Good morning.

Hi, good morning. A few items: first on the average balance sheet, repo yields went up and I wanted to make sure I understood that. Also the 10-Q's 100 bp parallel shift sensitivity seems different than what happened this quarter; can you explain assumptions in the 10-Q versus real-world movements? And lastly, you mentioned non-operational deposit outflows stabilizing — how do you think those depositors behave going forward as the Fed continues to raise rates; should we expect further outflows as the Fed moves higher?

Betsy, part of the repo yield change is driven by a gross-to-net change we made. That impacted both asset and liability side presentation. It was driven by a netting change both on the asset and liability side.

On the 10-Q, it's a model and shock scenario based on the forward curve. The modeled shock may differ from what actually occurred in the quarter because the market moved differently from the forward curve and timing matters.

Timing matters a lot. We came into the quarter with some lift and mix benefits — about 8 basis points from mix alone. Shock scenarios make assumptions on betas and other factors; reality doesn't always match those assumptions. Our current betas were 25% in Q2 and other dynamics led to the NIM increase.

On non-operational depositors: do they optimize each time the Fed moves? Should we expect another outflow as the Fed continues to raise rates?

That channel of depositors tends to have relationships at multiple institutions and will seek yield as appropriate. Non-operational deposits are often tied to broader relationships; sometimes we want them, sometimes not. We emphasize the distinction because economics and behavior differ across deposit types and that is important when thinking about NII.

Okay. Thanks so much for the color.

Our next question is from Vivek Juneja of JPMorgan.

Hi, thanks for taking my question. How much benefit did you have to expenses from FX translation?

On a year-over-year basis it was about 2% and on a sequential basis about 1.5% for total expense.

Most of that shows up in which lines?

Most of it is in compensation and benefits, and some in Equipment and Software. Probably two-thirds within comp and benefits.

On Asset Servicing AUM: assets servicing AUM fell 19% linked quarter, much more than Wealth Management AUM. Any color on that? Did it seem more than markets dropped?

We had outflows in the Money Market mutual fund business; that business had grown significantly since pre-pandemic and declined in the quarter from a flows perspective.

All right. Thank you.

The next question is from Jeff Harte of Piper Sandler.

Good morning, Jeff.

Hey, good morning. How do you expect funding cost of non-U.S. interest-bearing deposits to move with the ECB hiking? Could we see near-term pressure on NIM or NII as the ECB moves from negative toward higher rates?

We expect higher betas in that channel, especially for clients previously in negative-rate environments; they will be more aggressive as rates normalize. Mark, any magnitude comments?

Euro deposits are about 5% to 6% of our total deposits, so it's modest in magnitude.

Any guess on how much higher betas might be there?

It's hard to be precise. Those betas could be quite high, potentially 75% to 100% in that channel. It's 6% of total deposits, so the overall NII impact is limited. That gives a modeling sense, but it's an estimate.

Sure.

Next question is from Alex Blostein of Goldman Sachs.

Thanks for taking the follow-up. A top-of-house view on operating leverage: historically we've thought about expense as a percentage of fees. In the environment today — choppier markets and rising inflation — what's the new normal for that expense-to-fees ratio over the next year or two? You mentioned that higher NII will show up in comp through incentives, so that will pressure that ratio. How should we think about that? Any expense initiatives contemplated beyond 2022?

We're focused on a pretax margin in the low-to-mid 30%s, which supports our ROE targets. We're also watching the expense-to-trust-fee ratio, which faces pressure when markets are down and inflation is up. That said, we remain focused on keeping that ratio in the range we've targeted. We're executing productivity initiatives across businesses, particularly Asset Servicing, and will pursue further productivity and efficiency opportunities next year.

Great. Very helpful. Thanks, Mike.

Next question is from Gerard Cassidy of RBC.

Hi, Gerard.

Hi, Mike, Jason. Have you been able to model the impact of quantitative tightening on deposit flows? With QT ramping, have you approached that and what are the implications?

We have modeled it and looked for correlations, but our client base is granular and diverse, so it's hard to throw out a clean correlation. Clients view cash as an asset allocation decision; predicting core operational deposit behavior is more tied to overall asset levels and market levels rather than macro Fed dynamics alone.

Thank you. As a follow-up, given market disruption, there may be opportunities to acquire businesses at attractive prices. Historically Northern has been opportunistic on acquisitions. If an attractive asset sale arises in the next 12–18 months, would you consider it?

Historically we've been opportunistic and have added capabilities during dislocation. Our primary focus is organic growth, but we will consider acquisitions that accelerate strategic priorities.

Great. Thank you. Mark, good luck in the new role.

Thanks, Gerard. Appreciate it.

We can go back to Vivek Juneja of JPMorgan.

Hi, a follow-up on capital: is there a level below which you would not want to see CET1 go? What do you intend to do to avoid it going below that, given market uncertainty?

We have multiple guardrails. We have not been repurchasing shares recently; we increased the dividend. We're not aggressively trying to increase capital right now. We feel comfortable where we are; there is plenty of room from a regulatory perspective. We continue to discuss capital positioning with the Board and will balance buybacks, dividends and growth opportunities as appropriate.

Thank you, and Mark, best of luck.

Thanks, Vivek. Appreciate it.

And to Mike Mayo of Wells Fargo Securities.

Hi, Mike.

Yes. As we tweak our earnings models, looking at Page 38 of your proxy and peer groups, some peer trust banks have tax rates about 500 basis points lower than yours. You noted the effective tax rate is a sizable expense. What can you do to better manage taxes? And Mike, would you consider moving headquarters to lower taxes like some firms have?

Tax rate matters. Key reasons for our higher rate: a high percentage of domestic wealth management income which carries higher domestic taxes; presence in high-tax states like Illinois, California, New York; fewer tax credit investments; less tax-exempt income; and limitations on U.S. foreign tax credits which is increasing our difference relative to peers. We will look for ways to reduce the tax rate over time; it's an area we're working on.

We're headquartered in Chicago and proud of it. Decisions about headquarters consider many stakeholders: clients, employees, and community. We monitor potential options, but we also focus on being part of the community and improving Chicago as a place to live and work.

Thank you.

Next question is from Alex Blostein of Goldman Sachs.

Hi, Alex.

Thanks for taking the follow-up. One more on operating leverage: any additional thoughts on expense-to-fee ratio and long-term initiatives? Thanks.

We're focused on pretax margins in the low-to-mid 30%s and maintaining the expense-to-trust-fee ratio in a reasonable range. Productivity efforts are ongoing, especially in Asset Servicing, and we will continue to pursue scale and efficiency initiatives.

Great, very helpful. Thanks, Mike.

The next question is from Gerard Cassidy of RBC.

Hi, Mike. Quick follow-up: can you expand on what you might do if an attractive acquisition opportunity arises?

We are opportunistic, but our primary focus is organic growth. We will consider acquisitions that clearly accelerate our strategic priorities and add value to clients and shareholders.

Thanks, and Mark, good luck.

Thanks, Gerard. Appreciate it.

We can go back to Vivek Juneja of JPMorgan for any follow-ups.

One more follow-up on capital: is there a level of CET1 below which you wouldn't want to fall, and how would you prevent that?

We have guardrails and a Board that guides positioning. We paused repurchases earlier and increased the dividend. We balance capital return with growth opportunities and will act prudently. We feel comfortable with current levels and will manage capital holistically.

Thank you, and Mark, best of luck.

Thanks, Vivek. Appreciate it.

And to Mike Mayo of Wells Fargo Securities if there's anything else.

No, that was it for me, thanks.

Ladies and gentlemen, that concludes today's question-and-answer session. I would like to turn the call back to Mark Beatty for any additional or closing remarks.

Okay. I think we're all good. So thanks everyone for joining us. Appreciate it and we'll talk to you next quarter.

Congratulations, Mark on a great run. And thank you everyone.

Thanks very much.

Thanks everybody.

Ladies and gentlemen, that concludes today's conference call. We thank you for your participation. You may now disconnect.