Agenda Item: 1:00 pm
NORTHERN TRUST
Joint Meeting of the Retirement Boards
Meeting Date: 8/26/2014
Northern Trust Update
City of Fresno Fire and Police Retirement System &
City of Fresno Employees Retirement System
Jeff Porta, Senior Vice President
[email protected]
(312) 557-0474
Robert Ernst, Senior Vice President
[email protected]
(312) 444-5498
Don Anderson, Vice President
[email protected]
(312) 444-5386
Patrick Fitzgibbons
[email protected]
(312) 557-1819
A Unique Business Focus
Founded in 1889, Northern Trust is a market leader of asset servicing and asset
management solutions for institutions and private clients around the globe.
Corporate & Institutional Services (C&IS)
WORLDWIDE INSTITUTIONAL INVESTORS
Asset
Servicing
Asset
Management
Assets
under custody
US $6.00 trillion
Assets
under administration
US $3.5 trillion
Wealth Management
U.S. and European PRIVATE CLIENTS
Assets
under management
US $924 billion
A highly focused business model supporting two client bases across a
single operating platform
As of 6/30/2014
Source: Northern Trust
2
Northern Trust Profile
Founded in 1889, Northern Trust is a market leader of asset servicing and asset management solutions for
institutions and private clients around the globe.
Superior Capital Strength
Total equity (US$ Billions)
CAGR: 10%
Strong & Steady Credit Ratings
$7.9 $8.0
$7.1 $7.5
$6.3 $6.8
$4.9
$3.9 $4.5
$3.6
$3.3
$3.1
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Q2
2014
Northern Trust Corporation
Capital Ratios
Advanced Approach
2Q14
12.7%
12.9%
14.9%
6.5%
8.0%
10.0%
Common Equity Tier 1
Tier 1
Total
12.7%
12.9%
15.4%
6.5%
8.0%
10.0%
Leverage
7.6%
5.0%
Standardized Approach
The long-term ratings of both the Corporation and our main bank subsidiary,
The Northern Trust Company, are the highest assigned by Standard &
Poor’s and Fitch Ratings to any comparable U.S.-based banking institution

Northern Trust’s long-term ratings from Moody’s Investors Service are the:

second highest assigned to a comparable U.S.-based banking institution
at the holding company level, and

third highest at the main bank level
“Well Capitalized “
Guideline 3
1
Common Equity Tier 1
Tier 1
Total


85% of Northern Trust’s total securities
portfolio composed of triple-A rated
securities

Average re-pricing duration of <1year
Leases &
Loans
29% Money
Other
9%
Market Assets
29%
Securities
33%
2
As at 12/14/2013
As at 06/30/14
Asset Servicing Banks Historic P/E Ratio
1
Effective with the second quarter of 2014,
Northern Trust exited its parallel run.
Accordingly, the June 30, 2014 ratios are
calculated in compliance with the Basel III
Advanced Approach final rules released by
the Board of Governors of the Federal
Reserve on July 2, 2013.
2 Standardized Approach capital components
in 2014 are determined by Basel III phased in
requirements and risk weighted assets are
determined by Basel I requirements. The
ratios calculated under the Standardized
Approach comply with the final rules
released by the Board of Governors of the
Federal Reserve on July 2, 2013.
3 Well Capitalized guidelines shown above
have been proposed by the FDIC and if
approved would become effective on
January 1, 2015.
Outstanding Long Term Financial 5 Yr
CAGR
Performance
10 Yr
CAGR
15 Yr
CAGR
Trust Fees
4%
8%
8%
Revenues
-1%
7%
7%
Expenses
0%
8%
8%
Net Income
-2%
6%
5%
Assets Under Custody
13%
10%
10%
Assets Under Management
10%
6%
9%
S&P 500
15%
5%
3%
As at 12/31/13
3
High Quality Balance Sheet
California Locations
10 Offices
Santa Barbara
Montecito
Santa Barbara
1485 East Valley Road
206 East Anapamu
Menlo Park
2500 Sand Hill Road, Suite 150
San Francisco
580 California Street, Suite 1800
Mill Valley
575 Redwood Highway
Pasadena
201 South Lake Ave, Suite 600
Los Angeles
2049 Century Park East, Suite 3600
Newport Beach
16 Corporate Plaza Drive
San Diego
4370 La Jolla Village Drive, Suite 1000
La Jolla
1125 Wall Street
Marin County
San Francisco
Silicon Valley
Santa Barbara
Montecito
Pasadena
Orange County
La Jolla
San Diego
Washington
Minnesota
Wisconsin
Nevada
California
Illinois
Colorado
Michigan
Massachusetts
Connecticut
Ohio
New York
Delaware
Missouri
Georgia
Arizona
Florida
Texas
4
Public Funds Clients in California
Representative California Public Funds Clients:

City of Fresno – Fresno, CA

Kern County Employees’ Retirement Association – Bakersfield,
CA

City of Oakland – Oakland, CA

Los Angeles City Employees' Retirement System – Los Angeles,
CA

East Bay Municipal – Oakland, CA

Los Angeles Fire & Police – Los Angeles, CA

Fresno County – Fresno, CA

Orange County Treasurer – Santa Ana, CA

Golden Gate Transit Amalgamated Ret Board – San Rafael, CA


San Joaquin County – Stockton, CA

San Francisco City and County Employees' Retirement System –
San Francisco
Los Angeles Water & Power Employees Retirement Plan – Los
Angeles, CA

San Mateo County Employees Retirement Association –
Redwood City, CA


5
Alameda-Contra Costa Transit District – Oakland, CA
Stanislaus County Employees’ Retirement Association - Modesto, CA
Delivering A Broad Range of Solutions
Full array of capabilities to meet needs of sophisticated institutional investors.

Asset
Management





Asset
Enhancement
Asset
Reporting
Asset
Administration
Asset
Processing
6
Global index management
Quantitative active
Fundamental active
Target date
Multi manager
Cross-border pooling
(patent pending)

Trade execution
Cash management
 Transition management






Securities lending
Foreign exchange
 Commission management



Passive currency overlay
Risk monitoring and reporting
Trade execution analysis
Data warehouse

Investment accounting


Reporting and valuation
Performance analytics

Fund accounting
Transfer agency
Corporate secretarial





Safekeeping
 Settlement
 Derivatives processing
 Banking/Integrated
Disbursements

Exchange traded funds
Hedge funds
Private equity
Investment outsourcing
Liability driven investing


Trustee
Investment operations
outsourcing
Income collection
 Corporate actions
 Tax reclamation

NORTHERN TRUST
Northern Trust Global Securities Lending
City of Fresno Fire and Police Retirement System &
City of Fresno Employees Retirement System
Don Anderson, Vice President
[email protected]
(312) 444-5386
Background of the Lending Process
It promotes market efficiency and liquidity

Integral component of developed securities market for both domestic and international investors

Allows price discovery and the arbitrage of pricing inefficiencies

Supports the development of the capital markets by facilitating various investment strategies

Important part of risk management

Used for fail coverage to ensure smooth settlement cycles
Who lends securities and why?
Why do borrowers borrow
and lenders lend?

Long-Term, Institutional Investors

An investment tool to enhance portfolio returns

To offset or eliminate costs of custody and administration

Does not interfere with portfolio strategy – investment manager should continue regardless of
securities lending
Who borrows securities and why?

8
Investment banks (Prime Brokers), investment funds, prop traders, market makers and other intermediaries

Hedging

Short sell

Arbitrage strategies

Settlement obligations
The Life Cycle of a Loan
Securities Lending Authorization Agreement
Master Borrowing Agreement
1. Initiate Loan
Security
Availability
Client
Loan
Allocations
2. Negotiate Terms
Northern
Trust
3. Receive Collateral
(The beneficial
owner of
the securities)
4. Move Security
Non-Cash
Collateral
Cash
Collateral
5. Daily Mark to Market
6. Return Security
7. Return Collateral
9
Borrower
(The entity to whom
the securities are
lent, typically a
broker/dealer)
Understanding the Components of Securities Lending Income
Yield on
Cash Collateral
Investment
Reinvestment Spread:
Basis points earned from
reinvestment of cash collateral
(Yield on Cash Collateral
Investment – Fed Funds Rate)
Federal Funds
(or benchmark) Rate
Total
Intrinsic Value Spread:
Basis points earned
from lending security
to borrower, based on
intensity of borrower
demand
(Fed Funds Rate –
Rebate Rate)
Rebate Rate
(Positive, above 0%, is paid
to borrower. Negative, below
0%, is paid by borrower)
Reinvestment Spread + Intrinsic Value Spread = Total Securities Lending Spread
Total Securities Lending Spread x Loan Volume = Total Gross Securities Lending Income
10
Securities
Lending
Spread
How Revenue is Generated: Cash Collateral Loan
Example: Northern Trust lends $25 million of US Treasuries at par
The $25 million market value loan is for 30 days collateralized with cash (fed
funds at 0.15%)
11
1
Receive cash collateral valued at $25,500,000 (102%)
2
Cash collateral invested in a collateral pool at yield of 0.20%
$
3
Rebate paid to borrower at rate of 0.05%
$ (1,062.50)
4
Gross Revenue (gross spread 15 bps)
$
3,187.50
5
Monthly lender’s fee (@ 40%)
$
1,275.00
6
Net client earnings
$
1,912.50

Gross Spread = Lending Spread + Investment Spread

Lending Spread = Fed Funds – Rebate Rate

Investment Spread = Reinvestment Yield – Fed Funds
4,250.00
Program Philosophy & Overview
June 30, 2014
Emphasis on customization, automation and transparency
Philosophy




Lendable Base



Borrower Network




Global Team



Collateral Structure


12
Capital markets activity designed to enhance the return of an overall investment program
Extract intrinsic value from each loan
Customized collateral selection and participation to match individual risk tolerance
Does not interfere with investment strategy
$901 billion lendable securities for 370 clients
$112 billion loans outstanding
Diverse, global client base spanning 27 countries
53 approved parent borrowers
24-hour trading in 52 worldwide markets
Top 10 borrowers represent 74% of loan volume
Goldman Sachs, Morgan Stanley, Citigroup, Bank of America, JP Morgan Chase, Barclays PLC,
Credit Suisse Group, Deutsche Bank, HSBC Holdings PLC, The Royal Bank of Scotland
190 Securities Lending partners in Chicago, London, Toronto, Hong Kong and Bangalore
Managers average approximately 20 years industry experience
Experts are actively engaged in global industry groups (i.e. RMA, ISLA, PASLA and CASLA)
$116 billion in collateral ($79 billion cash, $37 billion non-cash). Approximately 41% of cash is held
in commingled pools, 59% is in separately managed accounts
Cash managed by Northern Trust Asset Management ($255.1 billion in total AUM for Short
Duration Fixed Income)
Managing Risk
Risk
Definition
Mitigating Factors
Borrower Risk
Borrower default combined with
insufficient collateral
 Rigorous credit committee review
of borrowers and exposure limits
 Daily marking of loans/collateral
 Borrower default indemnification
 Risk analysis tools (MSCI Barra)
to measure and calibrate exposure
Risk Management
is the cornerstone
of our program
Trade Settlement
Risk
Investment manager sells loaned
security and borrower fails to return in
time to settle the trade
 Timely trade notification
 Robust automated reallocations
 Trade settlement protection
Additional Risks with Taking Cash as Collateral
Cash Collateral
Reinvestment Risk
Cash collateral investment becomes
impaired or decreases in value
 Client approved investment guidelines
 Robust independent oversight of cash pools
and investments
 Dedicated team of fixed income research analysts
 Daily automated monitoring of portfolio guidelines
and compliance
Interest Rate Risk
Loan rebate rate exceeds earnings on
cash collateral investments
 Close daily communication between lending and
cash management teams
 Shared risk between Northern Trust
and client
 Weekly “gap analysis” and periodic
stress testing of portfolio
13
Borrower Risk Management
Our borrower selection follows stringent approval procedures and financial viability standards
 Overall Credit Risk - Established framework to size borrower credit limits to

reduce concentration risk via three tests: Credit exposure relative to the borrower’s
capital, size of our exposure to the borrower relative to other market participants,
and size of our exposure to the borrower relative to Northern Trust’s total lending
program
Ratings The majority of our borrowers will have a long-term individual or parentlevel credit rating of A- or better and a short-term rating of A-1 or better from at
least one NRSRO.

Financial responsibility and compliance - Each borrower and
parent borrower must provide audited financial statements, be
financially sound and in compliance with regulatory capital
requirements

Parent Organization - We also focus on the condition and
creditworthiness of the borrower’s parent organization
We employ a dynamic, ongoing risk and exposure management process for our borrowers


Provides oversight while
maintaining a responsive
capability to take actions as
needed

Monitors borrower
exposures derived from a
Value at Risk (VaR)
approach using each
borrower's loan and
collateral positions

14
Credit analysts review
market commentary and
data to analyse financial
stability
Supplements traditional
credit analysis by providing
insight into risk from
borrowers' Securities
Lending activity
Daily
review
Collateralized Product
Risk Committee
Quarterly
review
Annual
review

Securities Lending group presents on
each borrower to Counterparty Risk
Management Committee

Review financial performance of our 10
largest parent-level borrowers based on
their latest quarterly results, and all
borrowers capitalization, public rating of
the parent and compliance with our three
concentration tests

Present a comprehensive
analysis on borrowers and credit
limits to the Credit Policy

Wide-scale analysis includes
review of financial statements,
VaR, capital calculations, rating
agency analysis, and regulatory
compliance
General Recent Observations and Trends
 Demand from the Borrower Community
Equity Markets

 Loan balances continued to climb throughout the second quarter
supported by rising equity prices and higher volumes associated
with European yield enhancement trading activity.
 As equity prices rose, hedge funds closed out losing short positions,
resulting in lower on loan balances and narrower intrinsic spreads
on certain hard to borrow securities, though strong pockets of
borrower demand remain.
 European dividend season was in full swing during the second
quarter with pricing levels generally lower on a year-over-year
basis. Contributing factors included lower dividend yields in some
markets as well as borrower balance sheet constraints impacting
demand.

Fixed Income Markets
 U.S. Treasury yields remained subdued despite signs of potential
interest rate hikes in the coming year.
 The global regulatory environment continues to pressure borrowers
to reduce their balance sheets, impacting demand for lower intrinsic
value securities (i.e. US Treasuries).
 Demand for high grade sovereign debt (especially vs. alternative
collateral) remains high as industry regulation requires borrowers to
pledge high grade collateral versus other financial transactions.
 Market Drivers
 As equity prices continued to climb, market volatility dropped to levels not
seen since before the financial crisis, nearly 50% below historic averages.
 With equity markets pushing toward record territory, some investors added
to their long holdings of equities, contributing to an increase in short
hedges and borrower demand.
15
Collateral Reinvestment: Current Observations & Trends



16
Central Bank activity taking center stage – although different paths are emerging:

The European Central Bank (ECB) lowered its deposit rate to -10 basis points. This marks a first for a major economy to
have negative rates. Europe is facing deflationary pressures which should lead to an accommodative central bank for
some time to come.

The US Federal Reserve (Fed) is nearing completion of its bond buying (quantitative easing) program, and market
expectations are for a rate increase in mid to late 2015.

The Bank of England (BOE) is closest to raising its short-term policy rates in response to a strengthening economy and
quicker-than-expected reduction in unemployment. A rate hike is expected as early as the end of 2014.
Supply dynamics in the short-term markets remain under pressure:

The regulatory environment has caused financial firms to issue less short-term debt, while money market investors hold
a large supply of cash – both pressuring rates lower.

The Fed’s fixed rate full allotment repurchase agreement facility has proved vital to the short-term markets in providing
investments for money funds. Proof of it’s importance is demonstrated daily, averaging over $100 billion in usage, with a
peak at quarter-end of $339 billion.

The prospect of higher rates has not made it’s way to the short-term markets. The technical factors of supply and
demand are outweighing the fundamentals pointing to higher rates.
Current portfolio positioning:

Neutral portfolio duration to minimize the impact of future rising rates.

Strong overnight liquidity positions focused on repurchase agreements and time deposits of well-capitalized financial
institutions.

Longer-dated trades of floating-rate instruments as opposed to fixed-rate.
Brief Overview of Key US Regulatory Developments
Northern Trust is tracking global regulatory developments that may impact securities lending and is actively engaged with various federal agencies on these
regulations either directly or through industry groups.
Regulatory Development
Dodd-Frank
Volcker Rule - 619
Counterparty Concentration Limits – 165(e)
Anticipated Impacts
Next Steps
· The final regulation does not exclude securities lending cash collateral pools from the scope of Final Rules issued December 2013;
the Volcker Rule and therefore may curtail agent lenders’ sponsorship of unregistered cash
Conformance deadline July 2015
collateral pools.
· Lending agents may consider alternative strategies/structures for cash collateral reinvestment.
· Limits a bank’s combined credit exposure to a single counterparty to no more than 25% of the Awaiting final rules.
bank’s capital.
· Credit exposure calculations include indemnified securities lending transactions; agent lenders
may face constraints on providing indemnification and accepting sovereign debt as collateral.
Securities Lending Transparency – 984
· Requires SEC to increase transparency in securities lending.
· SEC expected to develop regulations that align with proposals from the Financial Stability
Board’s Workstream on Securities Lending and Repo.
Money Market Reform
Basel III
Capital
17
Awaiting proposed rules (overdue
since mid-2012); no clear timeframe
for rules to be issued
· SEC adopted rules for “prime” money market funds that involve requirements such as floating Final rules approved July 23, 2014,
NAV. Additional restrictions, such as redemption gates and liquidity fees will be at the discretion with 2 year compliance period.
of the fund board.
· Funds having over 99.5% invested in government securities are exempt from these new
requirements.
· Increased capital requirements will make it more costly for agent lenders to provide
indemnification.
Final US rules released in July 2013;
effective January 2015
Large Exposures
· Similar in concept to Counterparty Concentration Limits; restricts a bank’s combined credit
exposure to a single counterparty to a portion of the bank’s capital.
Leverage Ratio
· Indemnified securities lending activity to be captured in Basel III leverage ratio.
· Exposure for securities lending to be measured generally by current exposure, which should
be negligible given securities lending positions are over-collateralized.
· Additional leverage ratio impact for any guarantees or exposures beyond replacement
securities in US Agency proposal.
Final Basel III standard released April
15, 2014, but treatment of securities
lending exposures remains open;
awaiting final rules.
Basel III standards finalized Jan 2014.
US Agencies issued Notice of
Proposed Rulemaking on April 8,
2014.
Investment Profile: Core USA Cash Collateral Fund
June 30, 2014
Core USA 6/30/13
* Based upon traded basis from holdings reports
NOTE: This information was created using the best unaudited data available to us and may not be completely reliable, accurate, or timely. Data is prepared on a
settled basis, which may differ from traded basis data on the Cash Collateral Holdings report. “Traded Basis” reflects pending trades.
18
Fresno
Average Yield
Market to Book
Avg Loan Duration
0.24%
0.99999
65 Days
Historical Net Earnings Fiscal Years Ended June 30
CITY OF FRESNO
$2,500,000
$2,154,273
Int'l Equity
Int'l Fixed
$2,000,000
US Equities
$1,723,512
US Corp Bds
$1,500,000
$1,237,025
$1,105,631
$1,025,408
$1,015,208
$1,153,376
$1,000,000
$823,419
$500,000
$0
2007
19
2008
2009
2010
2011
2012
2013
2014
US Agencies
US Treasuries
Earnings Scorecard Year Ended 06/30/14
20
Earnings Performance Comparison
Year Ended 06/30/14 versus Year Ended 06/30/13
21
Performance Scorecard: Top Ten Earning Securities
22
Transparency and Information Delivery
Flexible, electronic reporting: Northern Trust provides you with customized reports to help monitor
your Securities Lending activity
Daily reporting
Monthly reporting

Performance scorecard:

Securities loaned – detail

Borrower utilization – summary by borrower

Account earnings and performance
Account utilization – loan detail, summary by
account

Security level detail

Client by asset type and account earnings

Date range comparison



Collateral – by security type, country and detail
holdings
Executive Summary

Historical statistics graph

Earnings statement - summary and detail
Securities Lending
Data Block on
Passport®
Helping to keep you
informed about your
Securities Lending
performance.
Facilitates the online
distribution of vital,
tailored information on
each client’s portfolio
holdings, characteristics,
investment performance
and commentary
23
Why Northern Trust
Northern Trust provides managed risk and proven performance supported by committed professionals.




24
Fully committed to
Securities Lending
A Core
Business
Capitalize on Northern Trust’s
Asset Servicing
and Asset Management
strengths
Stable and experienced team
dedicated to
Securities Lending
Unrivaled
Client
Focus
Dedicated relationship staff
demonstrating corporate
culture of exceptional client
service

Anticipate client needs and
proactively customize
solutions

Relationship focused, not
transaction oriented
Exceptional
Capital
Strength
Northern Trust
Global
Securities
Lending

Sustained financial strength
and stability

Important to work with a
stable and disciplined agent

Indemnification only as
strong as provider

Market expertise provided
by a single global team of
professionals

Technology efficiency
achieved through a single,
global proprietary trading
platform

Competitive advantage
gained via distinctive global
infrastructure
Unique
Global
Integration
Proven
Performance
Results

33-year track record of innovative solutions
supported by robust risk management

Focused on optimizing the intrinsic value of client
assets

Consistently exceeds industry benchmarks

In top 2 in trade value for Fixed Income and
Equities for Autoborrow
NORTHERN TRUST
Northern Trust Commission Management
City of Fresno Fire and Police Retirement System &
City of Fresno Employees Retirement System
Antwon McGruder, Vice President
[email protected]
(312) 557-3545
© 2013 Northern Trust Corporation
northerntrust.com
Commission Management Review – 2013
January 1, 2013 through December 31, 2013
Program Commission
$ 994,130.62
Rebate basis
$ 49,762.81
Rebate
$ 38,036.34
Rebate %
80 – Domestic
% CM trades of total
70 – International
9.75 %
Effective commission rate
26
Before rebate
1.31 cps (cents per share)
After rebate
1.26 cps
Effective Commission Rates – 2013
27
Commission Management Review – YTD 2014
January 1, 2014 through July 31, 2014
Program Commission
$ 650,545.63
Rebate basis
$ 25,031.33
Rebate
$ 18,681.85
Rebate %
80 – Domestic
% CM trades of total
70 – International
7.35 %
Effective commission rate
28
Before rebate
0.89 cps (cents per share)
After rebate
0.86 cps
Effective Commission Rates – YTD 2014
29
Commission Management Summary
 Current Environment
 Commissions have been falling for the last few years
 Providers excluding trades having commissions under a specified level, usually 3cps
 Many CM providers and participating brokers left the space
 Program economics tough in the lower commission environment
 Northern’s Commission Management, a smarter approach
 Northern Trust Securities restructured its Commission Management program
 Economics work for all parties
 All trades are eligible
 Rebate basis is 80% commission in excess of the executing brokers cost of trade processing
 Economics work for City of Fresno Retirement Systems
 Recaptured amount lowers effective commission
 Benefit to plan until there is no rebate available
 No rebate available means plan is trading at broker’s cost.
30
Disclosures
Please note that the reports have been created using the best available preliminary data. Please also note that the information
contained in the reports is preliminary (and therefore may not be completely reliable) and it is provided to you for your own internal
informative purposes only. Reports may also contain information provided by third parties, derived by third parties or derived from third
party data and/or data that may have been categorized or otherwise reported based upon client direction - Northern Trust assumes no
responsibility for the accuracy, timeliness or completeness of any such information. If you have questions regarding third party data or
direction as it relates to any reports, please contact your Northern Trust relationship team.
Evaluations are based on the asset allocation, actual historical spread and on-loan figures provided to Northern Trust. Consequently,
as changes in these factors occur and as trading patterns of the portfolio managers’ shift, actual earnings generated in Securities
Lending may be impacted.
CONFIDENTIALITY NOTICE: This communication is confidential, may be privileged and is meant only for the intended recipient. If
you are not the intended recipient, please notify the sender ASAP and delete this message from your system.
IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used
and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. For more information about this
notice, see http://www.northerntrust.com/circular230.
31
Disclosures
FOR INSTITUTIONAL INVESTORS ONLY: This material is directed to eligible counterparties and professional clients only and should not be
relied upon by retail investors.
CONFIDENTIALITY NOTICE: This communication is confidential, may be privileged and is meant only for the intended recipient. If you are
not the intended recipient, please notify the sender ASAP and delete this message from your system.
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