Q1 2022 Bank of N T Butterfield & Son Ltd Earnings Call

Okay.

Good morning, My name is Andrew and I will be your conference operator today.

At this time I would like to welcome everyone to the first quarter 2022 earnings call for the bank of N T. Butterfield <unk> son limited.

All participants will be in listen only mode.

You need assistance. Please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions to ask a question. You May Press Star then one on your telephone keypad to withdraw your question. Please press Star then two please.

This event is being recorded.

I would now like to turn the conference over to Noah fields, Butterfields head of Investor Relations.

Good morning, everyone and thank you for joining US today, we will be reviewing Butterfield first quarter 2022 financial result on the call.

I'm joined by Michael Combs, Butterfield, Chairman and Chief Executive Officer, Craig Bridgewater Group, Chief Financial Officer, and Michael Schrum, President and group Chief Risk Officer. Following their prepared remarks, we will open the call up for a question and answer session.

Yesterday afternoon, we issued a press release announcing our first quarter results. The press release and financial statements along with a slide presentation that we will refer to during our remarks on this call are available on the Investor Relations section of our website at Www Dot Butterfield group Dot com.

Before I turn the call over to Michael Collins, I would like to remind everyone that today's discussions.

Certain non-GAAP measures, which we believe are important in evaluating the company's performance for a reconciliation of these measures to U S. GAAP. Please refer to the earnings press release and slide presentation.

Today's call and associated materials may also contain certain forward looking statements, which are subject to risks uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements.

Additional information regarding these risks can be found in our SEC filings.

I will now turn the call over to Michael Collins.

Thank you Noah and thanks to everyone joining the call today, we had an excellent start to the year with strong first quarter financial results continue to demonstrate the benefits of furniture with leading market positions and well regarded offshore jurisdictions, we continue to focus on our profitable banking and wealth management franchises in Bermuda.

Cayman Islands, and the channel Islands.

The bank also benefits from our specialized financial services offerings in the Bahamas, Switzerland, Singapore and the UK.

Where we offer mortgages the high net worth clients with properties in Prime Central London.

We are encouraged by the progress we're seeing across our jurisdictions as leisure and business travel increases and the islands. Once again welcome cruise ships and an increasing number of tourists.

Before we get into a discussion of the operating performance I would like to officially congratulate both Craig and Michael on their new roles.

Greg as bandwidth Butterfield since October 2019, when he joined as group head of finance from KPMG in Bermuda, where he was a partner and leader of their banking and asset management practice.

As a new member of our Executive Committee, we look forward to Craig's continuing contributions to Butterfield as group Chief Financial Officer, where he will provide leadership and technical banking and financial expertise.

I'm also happy to recognize Michael scrum as Butterfields, new President and Chief risk Officer.

Many of you know Michael and I am pleased to have him take on this new role replacing <unk>.

We have agreed to remain as a consultant for a period and transition.

I would like to thanks, you bet towards contributions and particularly as brisk leadership during the Covid pandemic.

More details are available in the press release issued yesterday.

I will turn now to slide four we provide a summary of first quarter highlights.

<unk> reported net income for the first quarter of $44 4 million or.

Or <unk> 89 per diluted common share and coordinate income of $44 7 million.

Or <unk> 90 per diluted share.

Our core return on average tangible common equity was 21, 9% in the quarter compared to 18, 8% in the prior quarter.

Our net interest margin improved three basis points, 2.0% to 3%.

The board of directors declared a quarterly cash dividend of <unk> 44 per share while share repurchases continued at a modest pace.

I will now turn the call over to Greg Bridgewater to provide more details on the first quarter results.

Thank you Michael.

I will begin with slide six which provides a summary of net interest income and net interest margin for the.

First quarter, we reported net interest income of $75 9 million.

An increase of $1 4 million or one 9% versus the prior quarter the.

The increase was due mainly to improved investment margins on U S Agency mortgage securities improved rates on short term liquid assets due to the higher U S dollar rates and increase yields on the loan portfolio.

Higher investment margins were mainly driven by lower prepayment speeds that reduce the periodic amortization charge and reinvestments of runoff at higher yields.

Investment balances decreased by $39 $6 million due to unrealized losses in the portfolio as market interest rates climbed.

New money yields increased significantly to $2, 67% up from 1.08% in the previous quarter.

The average loan balance was $41 1 million lower due to facility repayments and lower pound Sterling exchange rate.

Loan yields were up eight basis points during the first quarter with blended rates for loan originations at three 9% 400 $676 million.

New loans up from 382% to $239 million of originations in the fourth quarter.

Turning to slide seven.

Noninterest income remains robust and was down $2 8 million compared to the seasonally elevated fourth quarter of 2021.

Benefited from higher credit card fees from increased spending and travel with typically experienced around the year end holidays before.

The fourth quarter of 2021 also had stronger trust fees due to the onboarding of new business and increased activity based fees in the quarter.

The first quarter of 2022, so improved foreign exchange fees and volumes as we continue to market, our FX services across treatment lines.

Noninterest income continues to be stable and capital efficient aspect of our business model with a fee income ratio of 39, 5% during the first quarter.

Slide eight provides a summary of core noninterest expenses, which benefited from lower technology and communications related expenses as we completed parts of the amortization period for the bank's legacy banking system in the fourth quarter of 2021.

Total core noninterest expenses were $81 $6 million down from $83 7 million in the prior quarter and slightly below our targeted range of $82 million to $83 million per quarter.

The lower expenses and higher revenues, we were pleased to see the core efficiency ratio improved to 63, 7% moving closer towards our through cycle target of 60%.

As we look out to the rest of the year, we would expect expenses to remain broadly in the $83 million range and the efficiency ratio to continue to benefit from increasing revenues, primarily due to expected rising interest rates.

I will now turn the call over to Michael Schrum to review the balance sheet.

Yes. Thank you Craig slide nine summarizes the regulatory leverage on leverage capital levels Biofuels capital levels continued to be strong and well above regulatory requirements. Our TCE to ta ratio of 5% remains below our internal target range of six to six 5% due.

Due to the continuing elevated deposit levels and lower mark to market values in our available for sale portfolio due to higher long term U S dollar interest rates.

I would like to reiterate that this is.

It's not a regulatory ratio and if you gross up for cash <unk>, the TCE to Ta ratio would be 8% compared to a seven 8% at year end on the same basis.

We continue to anticipate that.

Temporary interest rate driven OCI marks in the available for sale portfolio. We will keep this ratio below the target range for a period.

S dollar interest rates keep increasing.

This should in turn benefit net interest income.

Turning now to slide 10.

<unk> balance sheet continues to be strong and conservatively managed with a high degree of liquidity there.

Deposit balances held steady at $13 9 billion.

Versus the prior quarter and remain higher than the $13 $4 billion more than a year ago.

As Craig mentioned the movement in the investment portfolio. During the quarter was made up of reinvestment of pay downs offset by changes in fair value of securities held.

Butterfield low risk density of 33% continues to reflect the efficiency and conservative nature of our balance sheet.

On slide 11, we show that our product field asset quality remains exceptionally high with low credit risk in the investment portfolio, which is comprised of 95% are AAA rated U S government guaranteed agency securities.

Credit quality continues to remain strong with non accrual loans holding at one 2% of gross loans and the net charge off ratio of one basis point.

On slide 12, we present, the average cash and securities balance sheet with a summary interest rate sensitivity analysis.

Slowing prepayment speeds helped to extend the duration of the investment portfolio to $4 nine years from four two years.

Additionally, during the first quarter, we transferred $650 million of existing debt securities from <unk> to HTM as a way to help mitigate the OCI impact from negative marks on the securities held.

We continue to expect asset sensitivity to result in improving Eni.

As market rates increase.

Net unrealized losses increased to $133 5 million from $21 8 million.

As at the end of last year as long term U S dollar rates rose significantly in the quarter.

I'll now turn the call back to Michael Collins.

Thank you Michael since our last earnings call in February the war in Ukraine has become a worldwide focus with severe implications for global security the financial markets supply chains and input prices. We are very saddened to see the devastation occurring in Ukraine and remain committed to implementation of all international sanctions.

Butterfield maintains a conservative risk profile and maintained robust predictive controls that have meant that the identified exposure to targets of sanctions has to date in Melbourne we.

We have been prepared for situations such as the one we see now with Russia for some time.

Our business generally contain very few clients, where the Russian ties and we therefore do not expect the current geopolitical conflict and related sanctions to preserve significant reputational or financial exposure for debate.

With that said, we continue to monitor for new sanctions and review of our client base to ensure we comply fully as this develops.

Biofuel operates in some of the best offshore jurisdictions. However, they are small and offer limited organic growth opportunities as Butterfield maintain significant market share.

As a result, we also aspire to grow through selective accretive M&A.

We continue to actively work with potential targets and remain committed to pursuing opportunities.

Our focus remains on our current geographic footprint and private trust businesses and appropriate banking and financial services businesses, and the channel Islands, particularly Guernsey and Jersey and Singapore.

We have looked at a number of opportunities in the past year. However at this point, we have not concluded a deal or two either price or AML risk.

We have visibility into a number of potential opportunities and we continue to pursue these where appropriate.

The first quarter of 2022 showed the continued strength of Butterfield, leading position as an offshore provider of banking and wealth management with significant market shares in home markets, which are now opening up to post COVID-19 tourism.

We continue to support clients with a central financial services generating capital and efficient fees. In addition to our net interest income, which we expect to grow in an environment that is shaping up to be very constructive for asset sensitive banks, such as Butterfield. Thank you and with that we'd be happy to take your questions operator.

We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad.

If youre using a speakerphone please pick up your handset before pressing the keys to withdraw your question. Please press Star then two.

At this time, we will pause momentarily to assemble our roster.

Our first question comes from Alex toward all with Piper Sandler. Please go ahead.

Hey, good morning, guys.

Good morning, Alex.

First off congratulations to Michael and Greg on your promotion.

Was hoping Craig you could give us a little bit more on the asset sensitivity I was wondering if you had at your fingertips. The cash flows that are expected in the securities portfolio over the next quarter or next year or any metrics you can help us.

And then sort of what rates are going off or coming off that versus the reinvestment rates I think you alluded to earlier.

Yes, sure thanks very much for the congratulations much appreciate it.

You would see in our disclosures, you'll see the asset sensitivity disclosures in there and what we're modeling.

Currently we are reinvesting the paydowns. So we're not actually looking at putting additional liquidity into the investment portfolio at the moment.

Really because of whats happening with OCI.

In rates and kind of looking to see where rates go.

Again, you can see.

Utility in the presentation there.

So thats kind of how we're modeling out and just kind of maintaining liquidity at the moment.

Okay. Okay, and then if we look at it and we'd see that the four year duration.

Expectation that roughly a quarter of the FX book, we'd see cash flows this year.

Yes, so at the moment.

Youre going to see where rates go and see the OCI volatility goes.

At the moment, it's likely going to put more into HTM as we go forward, depending on kind of when the markets go.

Okay.

And then when I look at the loan yields tick up in the loan yield both in commercial and consumer this quarter are we seeing the early parts of <unk>.

The rate sensitivity and the impact from the March hike.

And maybe the movement in terms of the short end of the curve before that you then.

Or is there something in there that's kind of.

Some fees or something that maybe pushed those yields a little bit higher.

Then they would have normally been.

So I think what you are seeing is I guess do we pricing along with market interest rates, particularly with regards to our UK and channel islands portfolios as well as kaman.

And as you know for Bermuda, we have the Bermuda base rates.

That's one that we will adjust as we as we see fit as market interest rates.

Change.

And as a reminder, for the limited base rates in women at loans, There's a 90 day notice period around those.

So they do see changes in the Bermuda base rate.

Back in 90 days.

Related to the implementation of that.

Okay, Great and then just a final question for me when you're talking about M&A and you look at the TCE ratio at 5%.

Does that change the way you think about M&A I know you know regulatory ratios, obviously very healthy but.

But just because I know that that sort of the optical ratio has been something of a consideration with buybacks in the past does it does it also changed the outlook on potential M&A.

Yes, Alex Hi.

Michael Schrum.

Thanks for Europe Shout out earlier I think.

As we've talked about before before lots of this M&A pipeline is really has a.

At 12 to 18 months digestion timeline. So it doesn't really change the work that we do day to day, so to speak in terms of.

And in terms of the hurdle rates, obviously, there would be.

The same as they were before we are pretty high hurdle rates as you know.

We haven't.

Sort of internal IRR of 15%, which corresponds to the high quality capital stock in order for accretion. So we're pretty picky on that so I would say it doesn't really change how we view the pipeline or trying to complete a deal.

Have lots of room in the capital stack.

I mean, obviously.

There's nothing immediate.

About.

It does.

For us it really just we continue to just.

Look at things obviously.

<unk> investment because as you saw this quarter.

Similar to many other banks in the market and so that does kind of raise questions about valuations et cetera, but I would say no. It doesn't really change how we think about it.

RCI implications of the Mark to market, obviously pushes down the ratio, but because I don't know if upside the earn back is much quicker as really to the.

The value of the deposits. It has increased quite significantly and Alex you remember most of the trust acquisition, we look at or under $50 million, usually well under $50 million. So in the absence of something transformational as the vast majority of things. We look at are not that expensive.

Great. Thanks for taking my questions.

Thanks, Alex.

Again, if you have a question. Please press Star then one.

Next question comes from Tim, Switzerland, with K B W. Please go ahead.

Hey, good morning, Thanks for taking my questions.

Morning, Tim.

Could you guys talk about the drivers of the loan transfer Q1.

And kind of how that.

If the trends change over the course of the quarter or anything like that and what you've seen more recently and like is there any seasonality in Q1, because loans have been lower I think for the last three years or something I was just wondering if there's any seasonality there.

Yes, Tim it's Michael Schrum, sorry, if there's some FX in there as you know we have a significant London.

Prime Central London.

Loan book, which is underwritten at 65 LTV.

Yeah.

Mostly interest only.

Loans, so they rollover over three to five years.

That's hard to bank of England base rate, obviously, when we get translation differences coming through you probably noticed that the Sterling dollar Sterling has been a bit weaker over the quarter and particularly at the end of the ended the quarter.

That does push on our loan balance a little bit and is that part of the portfolio has grown significantly that starts to put an impact.

I think Craig spoke about the originations early on but.

In terms of other trends that we're seeing we just had a couple of paydowns on the corporate side.

In Bermuda, I think Theres a lot more detail in note six to our financials as well.

Okay I got it.

Are you able to quantify the impact of the FX at all or maybe give us a rule of thumb like Sterling.

Now moves up or down a certain percent the impact that has on loan balances.

Yes, I mean, well.

Yes, I don't have it to hand, but roughly speaking, we got a $1 billion for Sterling.

Sterling.

And it's a similar impact on the deposit side right. So at the end of the quarter translation, we use quarter and translation.

So if you look at that.

Dollar Sterling rate.

At 31 December 31 March on this kind of a side what was the delta there and then multiply by around one portfolio 1 billion. Then you kind of get to that number. So I think it was probably a bit it was kind of like.

$50 million ish range this time around.

That's not a real.

That's not a real loan repayment, that's just a translation.

Okay I got it yes, it's easy enough to calculate once you have the loan balance number I guess.

How do you expect paydowns to trend with the rates moving higher does that do you think that it will help slow it down at all with.

Our floating rate exposure does is it really not that much of an impact.

Are there any categories in markets, where it can be.

Do we start moderating more than others.

Yes, Tim.

I'll kick off and maybe Craig can you just talk about the loan portfolio, but in the investment portfolio I would say, we're fully extended now in terms of the.

Convexity or negative convexity in our portfolio.

So we're not a great swimming so much higher in the first quarter or was this cost duration to move our quite significantly, but we should be pretty fully extended on that side, so prepayment speeds.

<unk> slowing down.

And.

Again from memory, you've got a couple of hundred million.

At this point a quarter in terms of cash flows coming off that book I know, obviously, it just be reinvested at higher rates.

And on the loan portfolio.

We expect.

Any kind of significant changes in behavior.

Honestly monitoring as we looked at potential increases in interest in market interest rates.

And capacity of our customers to continue to pay.

And having a real good eye on making sure that if there is any potential problems.

<unk> addressed those early early in the process.

Okay, great. Thanks.

Last question for me you guys ended the quarter, a pretty large cash the cash position they increase get him out on.

In the period basis on average but.

If youre not planning on purchasing.

<unk> Securities is there anything else you can do with those loan balances that might help push up the yield or are you just going to say I know youre expecting some deposit outflows as well at some point, but.

Are there any alternative ways you could increase the yield there beyond just the coming rate hikes.

Yes.

Maybe I'll just kick off and I think.

When were seeing this larger move in forward rates, obviously, you've seen it.

That puts on the marks and so that leaves us with the feeling even more conservative about our cash position. We're also expecting some outflow I think.

We obviously keep getting that replace but with more corporate inflows. So it doesn't really show up anywhere.

But if you look over a five year period, our balance sheet should really sort of increase broadly in line with market increases and we've seen obviously search deposits come on at the end of 2020.

Do you expect at some point for those to start flowing off a little bit and maybe.

Maybe that will happen sooner now the rates going up so we just stay a little bit more conservative whether it's liquidity management or share repurchases capital conservation. Obviously, the dividend is our number one priority that came back down into the 50% payout range. This quarter. So that was good to see but I think from where we're sitting today.

With a two tenant I don't know a kitchen sub 20 basis points yesterday.

And a bias upward bias in in short rates.

It just seems like.

Good idea to not buy more OCI risk if that makes sense.

Yes totally understand.

Thanks for taking all my questions.

Thanks.

This concludes our question and answer session I would like to turn the conference back over to Noah fields for any closing remarks.

Thank you Andrew and thanks to everyone for dialing in today, we look forward to speaking with you again next quarter have a great day.

The conference has now concluded. Thank you for attending today's presentation you may now disconnect.

Yes.

Okay.

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Okay.

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