Executives: Mark Bette - SVP, IR Biff Bowman - CFO Jane Karpinski - Controller Kelly Moen -

IR
Analysts: Glenn Schorr - Evercore ISI Brennan Hawken - UBS Brian Bedell - Deutsche Bank Alex Blostein - Goldman Sachs Geoffrey Elliott - Autonomous Research Ken Usdin - Jefferies Betsy Grasic - Morgan Stanley Brian Kleinhanzl - KBW Gerard Cassidy - RBC Capital

Markets
Operator: Good day, and welcome to the Northern Trust Corporation Fourth Quarter 2016 Earnings Conference Call. Today’s call is being recorded. At this time, I would like to turn the call over to Mark Bette. Please go ahead, sir.

Mark Bette: Thank you, Alicia.

Good morning, everyone, and welcome to Northern Trust Corporation’s fourth quarter 2016 earnings conference call. Joining me on our call this morning are Biff Bowman, our Chief Financial Officer; Jane Karpinski, our Controller; and Kelly Moen from our Investor Relations team. For those of you who did not receive our fourth quarter earnings press release and financial trends report via email this morning, they are both available on our website at northerntrust.com. Also, on our Web site, you will find our quarterly earnings review presentation, which we will use to guide today’s conference call. This January 18th call is being webcast live on northerntrust.com.

The only authorized rebroadcast of this call is the replay that will be available on our Web site through February 15th. Northern Trust disclaims any continuing accuracy of the information provided in this call after today. Now, from our Safe Harbor statement, what we say during today’s conference call may include forward-looking statements, which are Northern Trust’s current estimates and expectations of future events or future results. Actual results, of course, could differ materially from those expressed or implied by these statements because the realization of those results is subject to many risks and uncertainties that are difficult to predict. I urge you to read our 2015 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.

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 Biff Bowman.

Biff Bowman: Good morning everyone.

Let me join Mark in welcoming you to Northern Trust fourth quarter 2016 earnings conference call. Starting on page two of our quarterly earnings review presentation this morning, we reported fourth quarter net income of $267 million. Earnings per share were $1.11, and our return on common equity was 11.9%. Our assets under custody administration and under management increased 11%, 10% and 8% respectively compared to the prior year, reflecting favorable markets and our continued success in winning new business. A number of environmental factors impact our businesses as well as our clients.

Before going through our results in detail, let me review how some of those factors unfolded during the fourth quarter. Equity markets performed well during the quarter. In U.S. markets, the S&P 500 ended the quarter up 9.5% year-over-year and up 3.3% sequentially. In international markets, the MSCI EAFE Index was up 2.3% year-over-year and up 6.7% sequentially.

Recall that some of our fees are based on lagged market values and third quarter markets were also up compared to the prior year, as well as sequentially. In bond markets, the Barclays U.S. Aggregate Index was down four-tenths of a percent compared to last year, and down 3.8% sequentially. Currency volatility, as measured by the G7 Index, was 8% higher than the fourth quarter of last year and six-tenths of a percent higher sequentially. Foreign exchange market volumes were mixed in the fourth quarter.

As reported by one interbank broker, volumes were up 2% sequentially, but now 3% compared to one year ago. You’ll recall that the currency volatility and client activity influenced our foreign exchange trading income. 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.

Dollar strength tempered custody asset growth and related fee growth, while benefiting expense growth, both for the year-over-year and sequential comparisons. The British pound ended the third quarter 16.5% lower than one year ago and 5% lower sequentially. The euro ended the quarter 3.2% lower than one year ago and 5.8% lower sequentially. U.S. short-term interest rates were higher during the quarter.

Most evident in three-month LIBOR which averaged 92 basis points in the quarter compared to 79 basis points in the prior quarter, and 41 basis points one year ago. Elsewhere, after 25 basis points reduction during the third quarter, the Bank of England total official bank rate steady in the fourth quarter. Let’s move on to page three and review the financial highlights of the fourth quarter. Year-over-year, revenue increased 7% with non-interest income up 6% and net interest income up 11%. Expenses increased 6%, producing 1.2 points of positive operating leverage.

The provision for credit losses was a credit of $22 million. Net income was 11% higher year-over-year. In the sequential comparison revenue was up 2% with non-interest income up 1%, and net interest income up 6%. Expenses were up 4% compared to the prior quarter. Net income was 3% higher sequentially.

Return on average common equity was 11.9% for the quarter, up from the 11.1% reported one year ago, and up from the 11.7% in the prior quarter. Client assets under custody of $6.7 trillion increased 11% compared to one year ago, and were flat on a sequential basis. In the year-over-year comparison, solid new business and favorable market impacts were partially offset by the currency translation impact of a stronger dollar. For the sequential comparison, the impact of the stronger dollar fully offset the favorable impact of markets and new business. Assets under management were $942 billion, up 8% year-over-year and flat on a sequential basis.

Favorable market impacts in new business throughout the year-over-year growth. Let’s look at the results in greater detail, starting with revenue on page four. Fourth quarter revenue, on a fully taxable equivalent basis, was approximately $1.2 billion, up 7% from last year and up 2% sequentially. Trust, investment and other servicing fees represent the largest component of our revenue and were $794 million in the fourth quarter, up 6% year-over-year and up 1% from the prior quarter. Lower money market mutual fund fee waivers were an important driver of the performance compared to last year.

Fee waivers were essentially zero in the fourth quarter compared to $20.5 million one year ago. Fee waivers were not a factor in the sequential comparison. Foreign exchange trading income was $50 million in the fourth quarter, up 10% year-over-year and up 8% sequentially. Both comparisons benefitted from higher client volumes, as well as higher volatility. Other non-interest income was $65 million in the fourth quarter, down 5% from last year and down 6% sequentially.

Other operating income in the current quarter included charges of $8.1 million related to the decision to exit the portion of a non-strategic loan in this portfolio. The prior quarter’s results included a charge of $5.4 million related to this portfolio. The decline compared to the prior year was primarily driven by the $8.1 million charge in the current quarter, partially offset by growth relating to the Aviate acquisition, which closed during the second quarter. The decline, sequentially, was primarily due to the larger charge in the current quarter related to the loan and lease portfolio. Net interest income, which I will discuss in more detail later, was $329 million in the fourth quarter, increasing 11% year-over-year and up 6% sequentially.

Let’s look at the components of our trust and investment fees on page five. For our corporate and institutional services business, fees totaled $457 million in the fourth quarter, up 7% year-over-year and 1% on a sequential basis. Custody & Fund Administration fees, the largest component of C&ISs, were $303 million, up 6% compared to the prior and up 1% sequentially. Both the year-over-year and sequential comparisons benefitted from new business and favorable equity markets, partially offset by the unfavorable impact of currency exchange rates. Assets under custody for C&IS clients were $6.2 trillion at quarter-end, up 11% year-over-year and flat sequentially.

These results primarily reflect new business and favorable markets, partially offset by the unfavorable currency exchange rates. Recall that land and 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 $94 million in the fourth quarter were up 10% year-over-year and flat sequentially. The year-over-year growth was driven in large part by lower money market mutual fund waivers. As was the case in the prior two quarters, fee waivers in C&IS were essentially zero during the fourth quarter compared to $8 million one year ago.

Assets under management for C&IS clients were $694 billion, up 7% year-over-year but down 1% sequentially. Securities lending fees were $25 million in the fourth quarter, 13% higher than one year ago and 9% higher sequentially. The year-over-year increase was driven by increased spreads, primarily relating to the widening of the spread between the LIBOR and overnight rates. The sequential growth was driven by improved spreads, as well as higher volumes. Security lending collateral was a $112 billion at quarter end, and averaged $119 billion across the quarter.

Average collateral levels decreased 4% year-over-year and were up 5% sequentially. The decline in volumes compared to the prior year was across most asset classes. The sequential increase of volumes was influenced by market appreciation, increased demand for U.S. treasuries and a larger supply of securities available to lend. Securities lending activities has been impacted by the regulatory landscape as actions have been taken by agent lenders and borrowers to calibrate capital usage.

Other fees in C&IS were $34 million in the fourth quarter, up 1% for both year-over-year and sequential comparisons, reflecting higher fees from investment risk and analytical services, benefit payments and other ancillary services. Moving to our Wealth Management business, trust investment and other servicing fees were $338 million in the fourth quarter, up 6% year-over-year but flat sequentially. Within Wealth Management, the global family office business had strong performance with fees increasing 19% year-over-year and 4% sequentially due to lower money market mutual fund fee waivers compared to one year ago, as well as favorable markets and new business. Performance within the regions also benefited from lower money market fee waivers compared to last year, as well as favorable markets and new business. Money market mutual fund fee waivers in the Wealth Management were essentially zero in the current quarter, which was equal to the prior quarter and down $13 million year-over-year.

Assets under management for Wealth Management clients were $248 billion at quarter end, up 9% year-over-year and 3% sequentially. Moving to page six, net interest income was $329 million in the fourth quarter, up 11% year-over-year. Earning assets averaged $108 billion in the fourth quarter, up 3% versus last year, driven by higher level deposits and short-term borrowings. Demand deposits, which averaged $26 billion, increased 1% year-over-year and non-U.S. office interest bearing deposits, which averaged $52 billion, were up 2% year-over-year.

Loan balances averaged $34 billion in the fourth quarter and were flat compared to one year ago. The net interest margin was 1.2% in the fourth quarter and was up nine basis points from a year ago. The improvement in the net interest margin compared to the prior year primarily reflects a higher yield on earning assets due to higher short-term interest rates. On a sequential quarter basis, net interest income was up 6% as average earning assets were up 1%, while the net interest margin increased 6 basis points sequentially, driven by lower premium amortization and higher short-term interest rates. Premium amortization was $10 million in the fourth quarter compared to less than $1 million one year ago, and $20 million in the third quarter.

Turning to page seven, expenses were $874 million in the fourth quarter, up 6% year-over-year and up 4% sequentially. Compensation expense of $391 million increased 7% year-over-year and increased 2% sequentially. Both the year-over-year and sequential growth was attributable to staff growth, base pay adjustments, which were effective October 1st, and higher performance based compensation, partially offset by favorable translation impact of changes in currency rates. Staff levels increased approximately 6% year-over-year. The growth in staff was all attributable to lower cost locations, which include India, Manila, Limerick and Tempe, Arizona.

Employee benefit expense of $77 million included $4 million relating to non-U.S. pension settlements. Benefit expense, including this item, was up 12% year-over-year, primarily reflecting higher medical cost, payroll taxes and pension related expense. On a sequential quarter basis, benefit expense was up 6%, driven by higher pension related expense, partially offset by lower medical costs. Outside services expense of $161 million was up 4% compared to the prior year, driven primarily by higher market data costs within technical services.

On a sequential quarter basis, outside services expense was up 2% primarily driven by higher consulting expense relating to regulatory work, as well as initiatives such as cyber security. This was partially offset by lower sub-custody costs. Equipment and software expense of $121 million was up 3% from one year ago and up 5% sequentially. Both the year-over-year and sequential growth were primarily driven by increased software amortization, continuing our technology strategy as we invest to support clients, improve employee efficiency and meet regulatory compliance requirements. Occupancy expense of $47 million was up 7% from one year ago and up 6% sequentially.

Growth in occupancy expense has been driven by higher rent, as well as $2 million early termination penalty recorded in the current quarter. Other operating expense of $78 million increased 4% year-over-year, primarily related to higher FDIC costs and advertising. Sequentially, the category increased 9%, primarily due to increased business promotion and advertising expense. Advertising spend during the quarter was strategically focused on wealth management markets and our ETF FlexShare products. It is worth noting that on a full year basis our total business promotional spent was down 2% from the prior year.

Our loan loss provision was a credit of $22 million in the fourth quarter. The credit provision in the current quarter was primarily driven by improved credit quality in the underlying data used in the quantitative portion of the inherent allowance for credit losses that resulted in a reduction in the allowance described to the residential real-estate and private client portfolios. The credit provision was partially offset by an increase to a specific reserve in the commercial portfolio that was charged off during the current quarter. Credit quality during the quarter remained strong with non-performing assets totaling $165 million compared to $181 million in the prior quarter, and $188 million one year ago. Non-performing loans to total loans equaled only 47 basis points at quarter end.

Turning to the full year, our results in 2016 are summarized on page eight. Net income was $1.03 billion, up 6% compared with 2015 and earnings per share were $4.32, up 8% compared with the prior year. On the right margin of this page, we outline the non-recurring impacts that were called-out in our second quarter 2016 earnings release. The net revenue impact of these items was $96.6 million, while the expense related charges were $82.6 million. The page also outlines the non-recurring impact from the second quarter of 2015, which included net revenue impact of $82.1 million and an expense charge of $45.8 million.

We achieved a return on equity for the year of 11.9%. This performance was within our target range of 10% to 15%, and an improvement from our 2015 performance. Full year revenue expense trends are outlined on page nine. Trust, investment and other servicing fees grew 4% in 2016. Lower fee waivers and new business across segments and geographies contributed to this result, partially offset by the impact of unfavorable equity markets and unfavorable currency exchange rates.

Foreign exchange trading income declined 10%, primarily reflecting mixed volumes across the year compared to prior year. Other non-interest income was down 2% from last year, and was down 3% if adjusted for the items I called out on the prior page. Net interest income increased 15%, and was up 13% if you exclude the items I called out on the prior page. The growth in net interest income was primarily driven by higher short-term interest rates, coupled with earning asset growth. The net result was growth in overall revenue in 2016 both on a reported basis and also if you exclude the items I called out on the prior page.

On a reported basis, expenses were up 6% from the prior year, adjusting for the expenses charges, the expense charges in both 2015 and 2016 that I mentioned in the prior page. Expenses were up 5% from 2015, reflecting investments in staffing and technology to support the growth of business, as well as to comply with the evolving regulatory requirements. Turning to page 10, a key focus has been on sustainably enhancing profitability and returns. This slide reflects the progress we’ve made in recent years to improve the expense to fee ratio, pre-tax margin and ultimately our return on equity. The ratio of expenses to Trust and investment fees is a particularly important measure of our progress as it addresses what we can most directly control.

Reducing this measure from what it was previously as high as 131 in 2011 to the levels we see today is a key contributor to the improvement and our return on equity. This metric remains an important parameter of our progress and we remain committed to lowering it on a sustainable basis going forward, from continuing to win new business to drive fee growth, and driving productivity within our expense base through our ongoing initiatives focused on location strategy, procurement and technology. Turning to page 11, our capital ratios remained solid with common equity Tier 1 ratios of 12.4% and 11.8% respectively, calculated on a transition basis for both advanced and standardized. On a fully phased-in basis, our common equity Tier 1 capital ratio under the advanced approach would be approximately 12.1% and under the standardized approach would be approximately 11.5%. All of these ratios are well above the fully phased-in requirement of 7%, which includes the capital conversation buffer.

The supplementary leverage ratio at the corporation was 6.7% at the bank and 6% -- at the corporation with 6.7% and at the bank 6.0%, both of which exceed the 3% requirement which will be applicable to Northern Trust in 2018. With respect to the liquidity coverage ratio, Northern Trust is above the 90% minimum requirement, effective as of January 1, 2016, and is also above the 100% minimum requirement that became effective on January 1, 2017. 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. In the fourth quarter, we repurchased 823,000 shares of common stock at a cost of $65 million. In closing, in 2016, we continue to grow the firm profitability for our shareholders, deliver comprehensive solutions for our clients and improve our technology and infrastructures to ensure the sustainability of our momentum.

From a financial perspective, we delivered return on average common equity of 11.9% for the full year, moving further into our target range of 10% to 15%. We produced $1.03 billion of net income, surpassing the $1 billion mark for the first time in our corporation’s history. In addition, we returned $778 million to our shareholders through dividends and stock repurchases, while maintaining strong capital and liquidity ratios. Our C&IS business continue to demonstrate strong growth in 2016. Total revenue grew 8% and trust fees grew 5%, even with the strong dollar hurting fees by 2%.

We continue to build on our product solutions and capabilities evidenced by our Aviate acquisition. Our Wealth Management business grew revenues 6% year-over-year and continued to produce attractive margins, achieving 38% pre-tax margin for the year. Our focus on large markets pay dividends as we saw strong growth in location such as New York City and Houston. We were also pleased to be named best private bank by Professional Wealth Management and The Banker magazines. Our asset management business had success as well as evidenced by the strong growth and reflects shares ETFs, with assets growing from $7.6 billion at year-end 2015 to almost $12 billion by the end of 2016.

Lastly, we continue invest in innovation and technology. Our efforts around robotics, artificial intelligence, distributor ledger, cloud and others continue to advance and are set to help us operate more efficiently and create superior solutions for our clients. Thank you again for participating in Northern Trust fourth quarter earnings conference call today. Mark and I will be happy to answer your questions. Alicia, please open the line.

Operator: Thank you, sir [Operator Instructions]. We’ll go first to Glenn Schorr of Evercore ISI.

Biff Bowman: Hi, Glenn. Hello?

Operator: Glenn, please check your mute function, you might be on mute.

Glenn Schorr: So I guess, I just want to talk about -- well it could be just some timing differences and some fee compression between AUC, AUM year-on-year and sequentially and in the fee rate.

So it’s the age old question of, if assets under custody and assets under management are up 11% and 8% year-on-year, Trust fees were like up maybe 6%. I’m curious, if you could talk to just what’s mix versus what’s timing versus lag pricing?

Biff Bowman: So, we’ll be composed that a bit. The first thing that I would say, overtime, the correlation between AUC and fees holds up, but in any given quarter, we could have large inflows or outflows that could skew that. So, that’s one factor to start there, but more specific. As we’ve grown our global fund services business over the past three to five years, the traditional lag that you’ve seen in fees has actually start to migrate away from quarterly lags and more to a balanced or 50-50 type one-month versus three-month type lag overall on our fees.

So, you need to consider perhaps a different lag impact in the market when we do that. Also in this quarter, currency impacts were quite meaningful in the fourth quarter. So, that correlation between the assets under custodies and the fees were impacted meaningfully by the currency, particularly the Sterling weakening sequentially. So, combined all of those, explain what I think you’re referring to as maybe disconnect between the AUC growth and the actual fee line. I would end with, in the wealth space too, there is still continued compression.

So, the compression that you see, particularly in the wealth from migrations, from active to passive has helped mute some of the correlation between the AUC and the fees.

Mark Bette: Glenn, the other thing I would add to is with AUC and AUM, obviously, those were point in time. So they don’t always think up with how fees might build or accrue for over the course of the quarter. But we have the C&IS side when we look at the fund or the custody in the fund number type revenues versus the AUC over a longer period. We’ve seen what we think the fee rates there to hold up pretty well.

Glenn Schorr: And maybe just one purposely simple question on the expense side, I think each of the line items are a little higher than I thought than I think other people thought. Could you talk about what you think are good jumping-off point as we go forward versus not? Like, I know, we have the employee benefits special issue but…

Biff Bowman: So, if I could, perhaps there is three items that I think are worthy of special mention in the quarter. The first is the $4 million pension settlement accounting issue that you see in benefits. It’s a quite technical accounting issue, but it is, in essence, if there are departures and/or outflows from our pension plans, and these were in the UK or Europe. It can trigger what is known as settlement accounting, which requires the booking if you will, the unrealized gains or losses in the portfolios.

It’s a relatively technical accounting issue that we saw happen in this quarter for the first time since I’ve been CFO. The second item that I think is worthy to call out is we did take an action on the occupancy line, a $2 million settlement to allow us for an early exit from space. So, we think it has a longer term benefit, but came with $2 million line item in occupancy. And there is a last item that I will call out is we had a significant sequential increase in business promotion that you would see approximately $5 million above what, if you look at historical run rates for us. And that was really an opportunistic business decision we took to add additional advertising and marketing in support of two of our very important growth initiatives, which is around our mega market strategy and in particular our flex share ETFs.

And the pricing in the market, the timing, was attractive and a decision was done to take that in the fourth quarter. So, that was $5 million increase that was within our control, the one that we felt would generate the right return for all involved. I would suggest those were items that are worthy of special mention for you to think about your models going forward.

Operator: We'll go next to Brennan Hawken of UBS.

Brennan Hawken: So, wanted to touch-base, it seems like with the AUC movement in C&IS, I know, you touched on FX in your prepared remarks, Biff, but maybe unpacking that a little bit.

Was that the driver of why we saw more or less flat sequential AUC, despite equity markets that were generally positive? Or was the headwind primarily given the rising yields, and therefore pressure on prices and bond markets?

Biff Bowman: No, the impact was almost all currency sequentially. In fact, I think, it was about 2 points sequentially for C&IS and that would have been a more normalized sequential growth rate historically. So, it was almost all explainable by currency sequentially for C&IS.

Brennan Hawken: Sequentially, 2 percentage points of growth, have you actually said?

Biff Bowman: That's correct.

Biff Bowman: And then next, second question here.

Have you noticed any changes in risk appetite in your Wealth Management client base over the past few months given some of the significant moves we’ve seen in the market? And how durable, if you’re seeing any changes, how durable do you think those changes might be?

Biff Bowman: So I think there's been amongst our client base a bit of sense of optimism, if I could say that. Post election we have seen some positive flows into the equities in the fourth quarter. And we had slightly negative fixed income flows. So I would generally say that we have seen a positive demeanor towards risk, assets in the portfolio. And we think about the term money and motion.

So, our wealth clients think about either investment or in their own businesses or opportunities to do more M&A. We have just generally seen a tonal improvement, but not actual events happening at this point. But from an asset flow, we did see some move to equity some out of fixed income in the quarter, but a general tonally view from our wealth clients. Particularly given they also may be more optimistic about taxes which frees-up a disposable income as well.

Operator: We'll go next to Brian Bedell with Deutsche Bank.

Brian Bedell: Biff, maybe just focusing on the balance sheet., maybe if you can just review or refresh the leverage to LIBOR, say versus the 10 year in the loan and leases bucket in terms of getting through the 1% towards. How that might impact if we get commensurate move in LIBOR with the next debt hike?

Biff Bowman: I'll take a walk-through the balance sheet a little bit and the impacts from the rising rates, I think the best way to tackle. So if you look at our balance sheet, and I'm going to start with the securities portfolio and I know you talked long term leases, we'll get to that. If we look at the securities portfolio, roughly half of our securities portfolio, roughly half of the $45 billion, is what being the short-term portion of the portfolio. Those assets reprice relatively quickly and certainly under a year.

And they are heavily impacted by one month and three months LIBOR movements, and more by one month than three month. So the way we think about that is, over the fourth quarter, one month LIBOR averaged, I believe, 60 basis points. If you use a point in time today, I won't project the average for the first quarter. I'll let you do that in your models. But that's closer to 78 basis points today.

We anticipate seeing the benefit of that flow-through in the securities portfolio, inside that year timeframe, we saw it relatively quickly. So, that's a positive, if you will, for the short-term portion of our securities portfolio. On the loan portfolio, we have a very short duration, if you will, as well on the loan portfolio with a meaningful portion. Mark, will get you the exact number here if we get through it. But a meaningful portion floating, I think, around 75% floating…

Mark Bette: 75% repricing within one year…

Biff Bowman: Yes.

So the benefits there are from three month LIBOR should flow through relatively quickly on that portion of the portfolio as well.

Brian Bedell: And are there floors to get through on those loans so that we should see more of the repricing in future quarters?

Biff Bowman: We'll get back to you on that. I don't believe so, but I want to confirm that when we follow back-up.

Brian Bedell: And then just on the core business in terms of, I guess, as we think of investment through going to next year. I know you want to keep that expense, because fee ratio improved upon that.

But I would say how do you think about incremental margins to higher rates in terms of how you feel about project spend in building out the, mostly the assets servicing business, I guess, I would be thinking about?

Biff Bowman: Here’s the way we think about that. And to improve the expense to fee ratio, we obviously have to drive fee operating leverage. So our fees have to grow faster than our expenses. In periods of time where net interest income or foreign exchange is constrained, we view that we need to widen out that fee operating leverage to produce the types of returns our shareholders expect. If net interest income and other items strengthen, then that, we still want to improve and maintain that fee operating leverage and improve it, as I said.

But the width of that or the amount of that operating leverage is something that we look at controlling, if I could. So, we still are absolutely committed to growing our fees faster than our expenses, and we did not achieve that for the full year last year. And I can assure you that that is something that is a focal point of the management team. If we do have the benefit of rising rates, we believe that they should widen out the total operating leverage for the firm, but we still want to see that expense to fees improved, even in improving rate environment, that's a key metric for us internally.

Operator: We'll go next to Alex Blostein of Goldman Sachs.

Alex Blostein: Just sticking up on that last point around the operating leverages, so to your point expenses to core fees were flattish, or that ratio didn’t really improved in fact over the last two years, I guess now. Despite the fact that this year you guys did for coupon, 100% of money market fee waivers in equity markets were generally a little bit more supportive, bumpy but overall it's probably somewhat supportive. I guess what are the reasons why we haven’t seen better operating leverage on sea side of the equitation in 2016? And since you think about 2017, what are some of the initiatives that you’re trying to put into place to, just to your point, to still focus on improving it?

Biff Bowman: So, you’re right, we had the benefit of fee waivers. Markets actually while up in absolute total the way they manifested themselves with the very rocky start, ended up not really being added and there were slight contractor year-over-year. And currency was also a meaningful contractor.

So, they partially offset the waivers. So you’re right in that comment. More importantly in the question is what are the initiatives, and we’ve talked about many here. But let me try to give you something a little more tangible that we anticipate helping them. We are in production now with three areas where we are relying or using robotics to improve our efficiency right now.

In 2016, those were probably in proof-of-concept, and were probably accruing expenses to get ready in 2017 actually in the fourth quarter of 2016 late, we put those in, and we actually now have robotics working on three key functions. There is a pipeline of other areas inside of our enterprise enablement operation where we are looking at things like further robotics, artificial intelligence, and that pipeline will manifest during the course of the year. But I hope it’s a tangible example to show that maybe the expense accruing for those in 2016, we will start to get the operational benefits of those in 2017 as they go up in running in live. And we continue to look at things, like our procurement function. One of the larger drivers of our outside service ramp this year was in market data.

We continue to look at ways to reduce our market data cost from a procurement perspective as well. And what I will say sort of a usage perspective, are we using it appropriately.

Alex Blostein: And then shifting gears, I wanted to touch on just the wealth management business. Again, it looks like outside of the global family office, revenues are down a little bit, kind of flattish over the last three quarters, or so. And I understand that the timing and certainly the mix-shift between active to passive is weighing on this.

Can you help us dissect that a little bit more, just thinking through the movement from active to passive, what are the relevant fee rates within that revenue category that we need to think about, and either bucket? And what is the percentage, maybe elastics that are active versus passive, for you guys right now? Because it feels like that fee rate continues to drift lower?

Biff Bowman: Let me break the components down a little bit. The active to passive shift that we talk about, we’ve absolutely seen that move up, but we don’t give that number out. So we’ve seen that move up from a modest percentage into something much more meaningful as we’ve seen that shift each year. And so that is one of the drivers. But we break it down a little bit into, what I would say, are the asset management fees and the advisory fees that we charge our wealth clients.

The advisory fees has held relatively stable. We’ve seen less of a compression in what we can charge on the advisory line. It’s in the compression around the active to passive movement or other asset management products that has driven some of that flattening that you suggest you see in Wealth Management and we see as well in Wealth Management. So an example would be we’ve seen flows out of our actively and actively priced multi-manager mutual fund family into more passive solutions. That is absolutely a fee compression issue along that change.

Advisory fees, however, to our clients, while under constant competitive environment really been able to remain fairly flattish. So, you got to break it into two, it’s really more of the asset management piece that’s driving that compression as opposed to the fees in total.

Alex Blostein: But we don’t know the relative sizing of the bucket range?

Biff Bowman: Actually, I don’t have the breakdown. We’ll think about that number.

Operator: We’ll go next to Geoffrey Elliott of Autonomous Research.

Geoffrey Elliott: Could you help us understand the magnitude in million dollars of the benefit from a 25 basis point increase in short-term rates? It just feels like from the disclosures in the 10-Q and so on, it’s a little bit hard to get to a number. So can you help us to think about what sort of benefit we should see, and then how that breaks-down between what you’ve already got in 4Q and what’s still to come in 1Q?

Biff Bowman: So, we can’t give the exact guidance. I’m trying to repeat a little bit of what we said. If you look at our balance sheet and look at the pacing with which we would see the benefit of one month and three month LIBOR, largely impacting the short-end of the securities portfolio. And you can do your own calculations on that, and get to what the improvement in that is.

The other exercise I would suggest that you look at is if you look at our improvement in net interest income year-over-year and take the balance sheet and make it comparable in size or look at any mix shifts, that’s all information that you would have. You can see what that drove in terms of the year-over-year improvement from the first 25 basis point hike. What I would suggest is that they just could be different with a second rate hike, and maybe that’s another factor in there. Also, the other thing would be to look at what the premium amortization is year-over-year and the impact of that that potentially could have on that year-over-year. It depends on the data, but the 25 basis points that we just saw will definitely be beneficial to our net interest income.

And we don’t provide that guidance any further than that, we’ll let you do that in your own model.

Geoffrey Elliott: I guess, maybe to focus on this a bit more. You gave some simulations, and the case and cues around for rates, 100 basis points higher, 200 basis points higher. But they don’t really seem to marry up with what we see in the financials, and there actually is a moving rate, I mean, I think on the 200 basis points, you’ve actually got a negative impact in there. So, is there anything you could do around the modeling assumptions on that sensitivity disclosure to get it a bit closer to what we see in reality, because otherwise it just feels like a disclosure that isn’t of a lot of value because it doesn’t seem to match up with what we have observed, in term the asset sensitivity seems to be a lot higher?

Biff Bowman: Well, first I would suggest that the disclosures that we put around our sensitivity of earnings are solely disclosure is done from a risk lens.

It has above a projected curve, the returns above a projected curve. And the beta assumptions in there are derived from a risk lens from a conservative lens. So your assessment that it may or may not reflect exactly what would happen, it needs to be taken from an perspective of the risk disclosure. And I really can’t say much more than that, that’s where we’re at.

Operator: We’ll go next to Ken Usdin of Jefferies.

Ken Usdin: Just wondering, can you quantify for us, both on a fourth quarter and full year basis, what the impact of FX was on revenues and expenses?

Biff Bowman: Yes, we can. On revenues, for the full year, I believe it was 1% of an impact from foreign exchange drag on revenue, and similar on expenses.

Ken Usdin: And was it bigger, I meant year-over-year fourth quarter. I am just wondering if there was a bigger burden in the fourth.

Biff Bowman: Yes.

So that was more on a full year basis. For the fourth quarter, on a year-over-year basis, the total revenue impact was closer to 0.5% with Trust fees being almost 2 percentage points, and then expenses also being 2 percentage points. As we’ve talked about before, we do have a natural hedge with revenue and expense coming through in the current season and we had a hedge, the difference in accordance with GAAP. So, we do see a net new pretax impact, generally. But it does impact, as you suspect, mostly the Trust fee and the expense growth.

And then on a sequential basis, the Trust fee impact was almost 1 point of growth, which was also in line with what the expenses were as well.

Ken Usdin: So my follow-up is then just, if there was a 2% helper on the expense side then the fourth quarter even at some of the items, expense growth number was just really high. And just to your earlier point about managing expenses to Trust fees on a year-over-year basis, going forward, and now having that kind of nice helper on the NII side to alleviate some stress on that. I guess, the question is, you mentioned some of the initiative you’ve been investing in. But I think you guys had also talked about some other regulatory stuff still catching up this year, whether it was living will and additional CCAR expenses.

So, is there anything else that you can help us understand that just might allow an absolute number of expense growth to be under better control as we go ahead as opposed to just focusing on the leverage equation?

Biff Bowman: So let me start with the regulatory portion of it. We are another year or in our fourth year of CCAR, and we continue to mature and have the right maturity base around something like that. And that was a -- has been a meaningful ramp in expense in '15 and '16. We are anticipating that that, the steepness of that curve flattens out, and maybe completely flattens out around the cost there. We haven't gotten feedback on our resolution plan at this point.

So, I'm hesitant to give you any kind of feedback on whether our regulatory spend will go up or down from that. So that's an area in the regulatory spend where we certainly hope and particularly given maybe the regime with the new president elect. Perhaps, we could get some reprieve on the regulatory spend or certainly the trajectory slowing on that line item. And we continue to move on things like I said in procurement, particularly around market date and others, to help drive that expense growth rate that you’re talking about further and further down.

Ken Usdin: And one last just quick one, could you just talk about the impact of rates on either the pension expense outlook and premium am?

Biff Bowman: Yes, I will start with pension.

The rates that we would have, the discount rate would be down from 4.71% to 4.46%. So net of that plus our expected return on our portfolio coming down. The net impact is very-very modest expense increase year-over-year, very modest, I think.

Mark Bette: Yes, and you'll see that when we do our 10-K disclosures as well. And then there is one other part, Ken, I think.

Ken Usdin: Just on premium am, as you think, contemplating them?

Mark Bette: Yes, on premium am, if you believe that that will slow down the refinancing, that should be beneficial to the premium am in our portfolio, if we think that will slow down, again, the refinanciangs that you see, which intuitively makes sense, unless there's some type of rush before a rising rate environment that impacts that. But we had seen historically the fourth and first quarter are the more favorable, and then the second and the third are where we see more unfavorable impacts from that, just from a seasonal perspective. But the rest, I guess, would be based on what we're seeing in the markets from housing and refinance.

Operator: We'll go next to Betsy Grasic of Morgan Stanley.

Betsy Grasic: I just wanted to follow-up on one of the comments you made earlier around the project that you've got with robotics.

And I wanted to understand what that was, what that kind of test phase is all about. And when and how you plan on rolling that out into production?

Biff Bowman: Yes. So, we actually have three areas of production, but one I discussed with our Chief Operating Officer today is, if you think about a function, such as reconciliations they have a very automated component-tree to it. We have looked at certain elements of our reconciliations, and this proof-of-concept testing, if you will, in 2016 and are now actually utilizing certain elements of reconciliations with robotics type solution. So that's one example.

There were actually two others in production, and I'll leave those to let you know in future quarters. But that's one that we were comfortable discussing here. So, we were in somewhat at expense mode and now we hope to start to see some of the economic benefits of those as they come online, if you will, during '17 and '18.

Betsy Grasic: Are these, like marginal benefits or are these more big enough to enable you to scale faster, or actually bring down costs?

Biff Bowman: So, in the early quarters, it would probably be incremental to what you said, and on the margin. But we believe that the portfolio of these opportunities is something that will be able to help us address the expense structures that you're talking about.

Anyone individual may have some incremental approach, but we've got a portfolio that we're investing in over this year and next year. And we believe the combination is helpful to that expense, the fee [technical difficulty].

Operator: We'll go next to Brian Kleinhanzl of KBW.

Brian Kleinhanzl: I had a quick question on the tax. I know with the change in accounting now for compensation, there's lot more volatility in the tax line.

But how should we think about that going forward now, especially with the ramp in the stock price? Does that impact as well, so that now we look out to '17 and '18, we should be lower than we are at least in the fourth quarter?

Biff Bowman: Sure. Yes, you're right. We did the early adoption ASU 2016-9, which is for share accounting. It was beneficial for the entire year, I think, to the tune of about $12 million of provision. And that was largely a factor as we saw larger equity transactions in the back half of the year.

So, that helped improve that benefit. But another thing, perhaps more core to improving the tax rate too is, as we have greater earnings from abroad and we bring more legal entities into our APV23, which we look at from time-to-time and assert to, that too has the benefit of lowering the effective tax rate. So, we worked pretty hard this year to work on those things that could help improve the effective tax rate. So, I think if we look, we don't give guidance. But some of those items produce permanent tax benefits or tax benefits if we accrue earnings in those entities.

Operator: We'll go next to Gerard Cassidy of RBC Capital Markets.

Gerard Cassidy: Question on broader picture, I think, this year you were going to start to see the baby-boom generation start to be forced to take money out of there, their defined contribution plans because of the age requirement. How do you guys look at that over the next three or four years affecting any of your businesses on the assets under custody in terms of having customers have to take money out from the funds that are managing that money?

Biff Bowman: That’s a good question, I saw the same article. I think the first-generation of baby-boomers have reached that mandatory withdrawal age, right I think, this year. So, we think throughout that we bring a holistic capability.

I mean, we really think about what I would say is a life-driven Wealth Management approach. And it recognizes that as you reach certain stages in your life, maybe this is the mandatory withdrawal stage. We got other products and capabilities and help them understand the tax consequences and the reinvestment of that, if you could, from a defined contribution or other plan into other assets that quite frankly marry with where they are in the stage of their lifecycle. So, the question would be, I think, does it impact our AUC and our C&IS business, or does it impact our Wealth Management business. It’s going to impact both, right.

So, I can give you the wealth perspective. On the C&IS side, as those assets come out of defined contribution plans, we have a smaller book of business around defined contribution than we do define benefit in general. But we do have a meaningful defined contribution. The pension portion is not as driven by this as the mandatory withdrawals from defined contribution. So, I think, I want to make sure you were asking about it from a wealth perspective or from a AUC in our custody business perspective, to make sure I answered it the right way there.

Gerard Cassidy: No, you did. And thank you for addressing in both the areas, I appreciate that. And getting back to robotics, obviously, you talked about how it’s going to maybe reduce expenses and be more efficient, especially in reconciliation and things like that. Is there any use. Because I know you’re very high-touched in talking in Wealth Management.

But is there any use of robo-advising for you guys at some point in the future, do you think?

Biff Bowman: So we certainly monitor that world. And as we think about inter-generational components to our existing wealth, many want to use something that looks that way. We would believe that our Goals Powered solution application is a form of a high technology, high touch component. It is a very sophisticated way using technology to address the holistic wealth needs of our clients. And so when we think of the assets we have that utilize Goals Powered solutions, it’s quite frankly bigger than the sum of almost all the large robo-advisors you would think of.

It's much larger than those in total. We just haven’t necessarily marketed it externally as a robo-advisor or a fin-tech solution. It very much is a high tech rolled-out solution in our wealth space, and has been very widely praised by advisors and widely praised by our clients in terms of its applicability to both, what I’d say current generation and future generations that use it. So, it’s a powerful and important tool.

Operator: And we have no further questions.

That does conclude our conference for today. We thank you for your participation.

Biff Bowman: Thank you all. Thanks Alicia.