Good morning, everyone. My name is Vaishnavi, and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2022 earnings call for The Bank of N.T. Butterfield & Son Limited. All participants will be in a listen-only mode. If 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 a touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the call over to Noah Fields, Butterfield's Head of Investor Relations. Please go ahead, sir.
Thank you. Good morning, everyone, and thank you for joining us. Today, we will be reviewing Butterfield's third quarter 2022 financial results. On the call, I'm joined by Michael Collins, Butterfield's 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 third 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.butterfieldgroup.com. Before I turn the call over to Michael Collins, I would like to remind everyone that today's discussions will refer to certain non-GAAP measures, which we believe are important in evaluating the company's performance.
For a reconciliation of these measures to US 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. Butterfield continued to deliver strong earnings across our offshore network of banking and wealth management platforms. We demonstrated consistent and solid fee income and remained well-positioned for this period of rising market interest rates. We continue to see improving post-pandemic economic activity across our operating jurisdictions, with the vast majority of border restrictions having been relaxed and tourism and business travel improving. I will now turn to slide four, where we provide the third quarter highlights. Butterfield reported net income for the third quarter of $57.4 million or $1.15 per diluted common share and core net income of $57.6 million or $1.16 per diluted share.
Our core return on average tangible common equity was 31.6% in the quarter compared to 27.8% in the prior quarter. Our net interest margin improved 33 basis points to 2.59%, with the cost of deposits rising 18 basis points to 34 basis points. When compared to the last interest rate cycle, we are experiencing heightened US dollar deposit costs in the Channel Islands, which has grown in recent years through acquisitions and is a more competitive market than Bermuda and Cayman. The board of directors again declared a quarterly cash dividend of $0.44 per share. Share repurchases remained on pause in the quarter due to the elevated OCI loss marks, which has held the TCE to TA ratio to around 5%.
We continue to view share repurchases as an important part of capital management and plan to resume share buybacks as a path to our targeted TCE to TA range of 6%-6.5% emerges. During the quarter, we announced the strategically important acquisition of Credit Suisse's trust business in Singapore, the Channel Islands, and the Bahamas. This excludes business in Liechtenstein, which was sold to a separate and unrelated buyer. We're able to structure the acquisition as an asset deal, which will allow Butterfield to thoroughly due diligence each client before onboarding, and therefore reduce any reputational risk transfer. The deal meets all of our long-standing requirements for M&A.
For example, it is significantly focused on private trust, is within our existing geographic footprint with a forecasted IRR of more than 15%, with a total consideration of less than $50 million and is well below 8x EBITDA. The deal is also forecast to increase trust fee income, which should help maintain our significant and stable fee income ratio and will position Butterfield as one of the largest private client trust companies in Singapore. We are excited to welcome new clients and colleagues and anticipate the onboarding period to complete in the first half of 2023. I will now turn the call over to Craig Bridgewater to provide more details on the third quarter results.
Thank you, Michael. I will begin with slide six, which provides a summary of net interest income and net interest margin. In the third quarter, we reported net interest income of $91.2 million, an increase of 11.2% versus the prior quarter. The increase was due mainly to continued improvement of yields on all interest-earning assets, which was partially offset by higher deposit costs. Cash and short-term investment balances were down during the quarter, reflecting the lower deposit levels due to expected client withdrawals of pandemic-related deposits and a strengthening of the US dollar, which impacted FX translations of non-US dollar deposits. Average investment balances decreased by $136.6 million, primarily due to increased unrealized losses in the AFS portfolio as market interest rates climbed and declining pay downs and reinvestment rates.
New money yields on investments decreased slightly to 3.75%, down 10 basis points from 3.85% in the previous quarter. We made aggregate reinvestments of $90 million in the third quarter of 2022 versus $120 million in the previous quarter. The majority of securities purchased consisted of US Treasuries and Freddies with lower durations. Paydowns continued to decelerate with $145 million of portfolio paydowns in the third quarter of 2022 versus $172 million in the previous quarter. The average loan balance was up $56.2 million, driven by an increase in commercial loans in the Cayman Islands, which was partially offset by a weaker pound sterling.
Overall, year-over-year loan yields were up 57 basis points during the third quarter, primarily due to the impact of rate increases on our floating rate loans. We had new loan originations of $239 million, an average yield of 4.38% versus $387 million of originations at 3.63% in the second quarter of 2022. Turning to slide seven. Non-interest income was down 3.6% quarter-over-quarter, primarily due to the other non-interest revenues which did not benefit from the same scheduled recognition of unclaimed customer drafts and checks that occurred in the prior quarter. Banking income rose during the quarter due to switching fees assessed following a number of commercial loans moving from floating rate to fixed rate structures.
Trust fees declined slightly due to heightened activity-based fees in the prior quarter, which should not recur at the same level in the current quarter. Non-interest income continues to be a stable and capital efficient source of revenues with a fee income ratio of 35.6%, down from 38.9% during the second quarter, as growth in net interest income outpaced non-interest income as expected. Slide eight provides a summary of core non-interest expenses. Total core non-interest expenses were $81.8 million, in line with $81.9 million in the prior quarter, and slightly below our current expected range of $82-$83 million. We continue to evaluate the impact of inflation on staffing costs and have enacted targeted salary increases to maintain our competitive positioning.
The core efficiency ratio continued to improve to 57% and remains below our through cycle target of 60%. I will now turn the call over to Michael Schrum to provide a review of the balance sheet.
Thank you, Craig. Slide nine summarizes regulatory and leverage capital levels. Butterfield's capital levels continue to be above regulatory requirements. Our TCE to TA ratio of 5.0% is similar to that of the prior quarter and continues to be below our internal target range of 6%-6.5% due to higher long-term US dollar interest rates resulting in lower marks on our available for sale portfolio. As previously mentioned, TCE to TA is not a regulatory ratio for Butterfield, and the ex cash TCE to TA ratio remains 5.6% and ex OCI TCE to TA ratio improved to 8.2%.
We continue to anticipate that rate-driven OCI marks will keep this ratio below our internal target range for a few more quarters as US dollar interest rates rise, and this is expected to benefit net interest income. Our dividend payout ratio was 43.4% in the third quarter of 2022, and is currently slightly below the bank's through cycle target of approximately 50%. Turning now to slide 10. Butterfield's balance sheet remains conservatively managed with a high degree of liquidity. Period-end deposit balances reduced by approximately $600 million to $12.5 billion versus the prior quarter end. The decrease in deposits has been anticipated, and as you'll see on the next slide, the fall in deposits is a combination of foreign exchange translation and customer withdrawals.
Average deposit balances are also down approximately $600 million to $13.0 billion for the quarter. Butterfield's loan risk density of 34.9% continues to reflect the regulatory efficiency and conservative nature of our balance sheet. Turning to slide 11. Here we provide loan and deposit changes by volume and foreign exchange movements, as well as currency by segment. The chart on the upper left demonstrates the third quarter decrease in deposits consists of $350 million of actual deposit outflows and $260 million due to currency translation changes from the strong dollar. Loan volumes actually increased from a production standpoint, but that growth was negated by foreign exchange movement.
On slide 12, we show that Butterfield's asset quality remains exceptionally high with low credit risk in the investment portfolio, which is comprised of 96% AAA-rated US government guaranteed agency securities. Credit quality continues to remain strong with non-accrual loans holding at 1.2% of gross loans and a net charge-off ratio of 8 basis points. On slide 13, we present the average cash and securities balance sheet with a summary interest rate sensitivity analysis. The duration of the investment portfolio has decreased marginally during the quarter to 5.4 years from 5.5 years due to portfolio runoff.
We continue to expect asset sensitivity to result in improving NII as market rates increase. However, the sensitivity has reduced due to a higher level of 3-5-year fixed rate loans, a lower sensitivity of Bermuda loan base rates, and heightened US dollar deposit costs in the Channel Islands. The total value of fixed rate loans has increased by $866 million to $1.8 billion since year-end, which we expect will help mitigate rate-driven credit concerns over the medium term. Net unrealized losses in the AFS portfolio increased to $240.1 million from $152 million at the end of the last quarter, as long-term U.S. market interest rates continued to rise. I'll now turn the call back to Michael Collins.
Thank you, Michael. The strong results in the third quarter are reason for optimism. However, we recognize the potential for some challenges ahead, and we will continue to closely monitor the credit book as interest rates rise and the global economy potentially cools. We are very pleased to announce the acquisition of the Credit Suisse trust business in Singapore, the Bahamas, and Guernsey. We believe the deal structure provides us with flexibility and protection and should result in very high-quality business coming across. Our M&A strategy remains intact, and we continue to hold discussions with potential deal targets in the trust and banking sectors. I remain optimistic that we will continue to find deals and grow Butterfield through M&A and, to a lesser extent, organically. Our fee-generating business is capital efficient and helps us to consistently generate top quartile ROEs relative to US regional banks.
We also have a well-positioned balance sheet that, combined with rising interest rates, has allowed us to achieve a quarterly core return on tangible common equity of 31.6% in the third quarter of 2022. We also reported a core cost efficiency ratio below our target of 60% and third quarter expenses within our targeted range of $82 million-$83 million. Our strong and liquid balance sheet continues to maintain a loan-to-deposit ratio below 40%, while our $5.8 billion investment portfolio is more than 95% AAA-rated US Treasuries and agency securities. Butterfield continues to be well positioned to prosper and grow. Thank you. With that, we'd be happy to take your questions. Operator?
Thank you. We will now open the question-and-answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using the speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like 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 Timur Braziler with Wells Fargo. Please go ahead.
Hi. Good morning.
Good morning, Timur.
Maybe starting on the deposit side, very much appreciate slide 11. I think that's very helpful. But as you're looking at the deposit base and kind of what you still see in there as excess or surge deposits, can you just give us an update on what your expectation is of kind of balance sheet size and trajectory over the next couple of quarters there?
Thanks, Timur. It's Michael Schrum. We outlined the FX movement separately on that slide, both on the loans and deposit side. As we've talked about before, you know, we had about $1.4 billion in the form of surge deposits. We haven't really seen any movement in our core deposits, but we've certainly seen these chunky depositors withdraw over the past couple of quarters. I would expect that we should see some stabilization going forward on the balance sheet. You know, at the moment, we're expecting somewhere between $12 billion and $12.5 billion of deposits.
Where we end up, as you know, we can have normal variations in that, which kind of leaves you with a total balance sheet size of, you know, around $14-ish.
We've had about $1.4 billion of deposits exit the franchise over the last two quarters. Now a component of that has been FX, but do you think going forward, the pace of those surge deposits, I mean, if they haven't left yet, is the likelihood that they're, you know, gonna stay on the balance sheet for longer, or are we still expecting them to exit, maybe just not at the pace you were originally expecting?
Yeah. I think the pace has been a little quicker, but I mean, we were very conservative on the liquidity side, so you know, that certainly has been beneficial to us. You know, it's hard to predict exactly where we're gonna end up. There is normal variations in the deposit levels. So I would estimate that we probably have a couple of hundred more of sort of surge deposits, but they could come and go, you know, a couple hundred million more. You know, so it's just a little bit difficult to exactly predict, you know, if that in fact is gonna leave or if that is actually gonna hang around for a while.
It is worth noting, though, in the Channel Islands, we've had some success in converting some of those surge deposits into some of our fund products off balance sheet. So that's been helpful as well.
Got it. Okay. Looking at the increase in the cost of deposits from 20-44 basis points in the quarter, was that all driven by Channel Islands? Do you guys have the breakdown of deposit costs kind of by geography, what the Channel Islands were, Cayman and Bermuda?
Yeah, we do. This is Craig. In regards to deposits, yeah, you're right, the cost of deposits is largely driven by the Channel Islands. Obviously, we've kind of stated before that Channel Islands is a lot more competitive market than Bermuda and Cayman. Bermuda and Cayman, we've been really adjusting our fixed deposit rates, so nothing, we haven't paid anything on demand deposits or the core deposit book in Bermuda and Cayman. But obviously in Channel Islands it's a lot more competitive. Other big change about, you know, 13 basis points is actually attributable to Channel Islands of the change in the cost of deposits from the prior quarter.
Just last for me, kind of bigger picture question. After the last FOMC hike, how should we think about your asset sensitivity profile? Do you expect deposits to lag the last hike, or should we think of deposit costs stopping with the last FOMC hike, and then the asset side kind of continues to reprice and fixed rates rolling off, new production coming on? How should we think about margin, and deposit costs following the last hike?
I think for deposit costs, I think we were able to keep the cost of deposits down during this first phase of the rate hike. We've been pretty successful in kind of managing those costs really tightly. Obviously, other than the Channel Islands, where we have to react to the more competitive environment. We continue to adjust our fixed deposit rates in Cayman and Bermuda. We think we'll continue to react to market forces in those jurisdictions. I think at this point, we can continue to suppress the cost increases on the core demand deposits.
Going into Q1, depending on again where the Fed goes, we're gonna have to look very carefully as to, you know, whether we need to pay on demand deposits.
Okay, once the Fed actually.
I would just add, Timur, on the loan side, obviously, you know the story. It's you know we're finally starting to see the base rate you know changes that we did three months ago coming through as at the end of October. We're gonna start to see obviously loans repricing. I would say though that you know about 40% of the total loan book now has rolled into fixed. I think in terms of your original question around asset sensitivity, we actually view that as marginally helpful at this point in the rate cycle in that you know that is starting to add some protection from a down rate scenario. While we're continuing to see asset sensitivity, the NIM trajectory is gonna be still upward sloping but slower.
On the downside, we're starting to build some of that protection there from customer fixed loans.
Great. Thank you. I'll step back.
Our next question comes from Will Nance with Goldman Sachs. Please go ahead.
Hey, guys. Good morning. I wanted to ask on just the Credit Suisse deal, you know, realizing that you guys may not have final numbers yet because you need to kind of go client by client and underwrite. I guess, are there any stats you can kind of share on just the scale of the business that you are going to be evaluating and kind of, I guess, what the TAM is for this deal, if we think about, you know, some percentage of that of that business coming over the course of the year?
I think it's, sorry it's Michael Schrum. Good question. I think the reason why. We're actually getting through the consent process right now. The initial phase of the integration, if you will, was getting customer consents, so that we can actually review files and DD the files, and then make a decision about the outcome of that DD process, and then move on to an onboarding process. You know, we obviously do understand what the addressable universe of clients are, you know, which is sort of approximately 1,500 structures.
You know, having said which, I mean, there is an element of client decisioning in here as well in terms of is this a time to look at the overall relationship or are we happy to just kind of move along with Butterfield. Certainly as we get through to the onboarding process through our DD, we'll share more information around what our expectation is in terms of the population and some of the numbers around that. You know, if we end up with 50% or 60% of the population, you know, that is vastly different than maybe 80%.
It's a little bit tough to say right now, but the deal was structured in a way that we only pay for what we get. Ultimately, you know, it will be marginally accretive to the bank overall. It will be helpful for the Singapore business and for our trust business in general. It's just a little bit early to kind of see which way, you know, both the bank and the clients are gonna jump in terms of DD process.
We can say, Will, that the consent process is going well, so all the letters are out.
We're getting responses. We've had a number of client meetings, and so far the quality of the client base is as we would expect or even better. Some really good structure, really good names. We're really pleased where we are. Working with the employee base to bring them over, as Michael said, the best part about this structure is that we can pick and choose and pick the right clients and not take the ones that we're not quite comfortable with at this point. It's very difficult to estimate because we can't really tell until we get through DD through the first half of next year.
Got it. It's great to hear. Maybe on a different topic, you know, you mentioned the increasing percentage of the loan portfolio that's shifted over to fixed rate. Just wondering if you could provide a bit more details on, you know, how that process has evolved. I mean, is this something you guys are kinda proactively doing? Is it a function of some of the lending opportunities that you've come across that have just tended to skew more fixed rate? Any color for kinda where the loan volume has come from, and then, you know, what it's been sort of replacing on the balance sheet.
Yeah, good question. I would say we've been actively encouraging it. We've been offering 3- and 5-year fixed rate loans in peg currencies, so Bermuda and Cayman, for quite a while. But customer preference has always been floating rate in these markets traditionally. I think as we saw, you know, rates starting to go up quite rapidly, one of the ways that we saw an opportunity in the market is to talk to customers around protecting their cash flow and trying to understand what that meant, in terms of repayment terms, et cetera. Roundabout way of saying, you know, 90% of it is from existing floating rate, and 10% is net new.
We've sort of been encouraging the 3- to 5-year to kinda get customers through what potentially could be a you know difficult credit cycle or difficult period for them and actually being helpful to the bank at the same time. While it's reducing our asset sensitivity somewhat you know I think in the broader scheme it's probably at this point in the rate cycle pretty helpful overall to the bank.
Got it. Okay.
I'll just add this is correct. Really kind of the fixed rate loans have been a tool being used by both customers as well as our relationship bank . As Michael said, we have some outreach in regards to clients and just helping them to manage through this process. We have also had several inbound calls as well in all our jurisdictions, just looking to go from variable to fixed.
Got it. That makes sense. Appreciate you taking my question. Just a clarification, is this mostly on the resi mortgage side or is it both commercial and consumer?
It's both. Yeah.
Got it. All right. Thanks guys. Appreciate you taking my questions.
Thanks.
Our next question comes from Michael Perito with KBW. Please go ahead.
Hey guys. Thanks for taking my questions.
Morning, Mike.
Just really a couple follow-ups. Just one on the asset sensitivity NIM conversation. You know, as we look to just near term here, I mean, the margin was up about, I think 30 or 34 basis points quarter-over-quarter in the third quarter. So I mean, am I just conceptually kind of understanding you guys correctly, like in the fourth quarter here, if we assume the curve kind of plays out as expected right now, that you would expect that benefit to be lower but still kind of materially higher? I mean, like, I don't wanna ask too specifically, but are we talking more like 15-20 basis points just if the consensus curve kind of plays out?
Just trying to understand how much kind of is coming off from an asset sensitivity standpoint as you guys add some of those fixed rate loans and the deposit costs pick up on the Channel Islands.
Yeah. I think, I guess kind of maybe just kind of walk through how we think about it. It's kind of more about what the drivers are of NIM and I guess how we would expect that to expand over the next few quarters. You're right. We have less asset sensitivity, so we have more fixed rate loans. I think we're approaching kind of 40% of the portfolio being fixed rate. Obviously as we do have rate increases, then it's gonna be a bit muted in regards to how we benefit from those increases. We still have 75 basis points of announced increases in the Bermuda base rate. That's about kinda, you know, $1.8 million.
Oh, sorry, about $1 billion that will benefit from that additional 75 basis points. Then obviously we'll see what the Fed does going forward. That will also be tempered by also pressures on the cost of deposits as well. We do expect that to continue to go up. I think we'll still continue to see NIM expansion, but at a slower rate.
Yeah, Mike. Sorry, it's Michael Schrum. I'll just add to that. I think your thinking is the right way to think about it. You know, the asset sensitivity is mostly realized at the long end of the curve right now because that's unless that starts to move higher, you know, that third of the asset sensitivity is kind of sitting where it is and that's just gonna come through rollovers and pay downs in the securities book. The short end obviously is still gonna react, meaning that we still have $3 billion of cash sitting around, and that's still gonna react to whatever the Fed funds does, essentially.
Most of the asset sensitivity is gonna sit at the short end of the curve, and that's gonna obviously cause some NIM expansion, but not as pronounced as we've seen probably in the last quarter. I think that's right.
Okay. That was very helpful, guys. Thank you for clarifying. You know, just kind of a big picture question here. I mean, in your opening remarks, I think you guys even mentioned it. I mean, I know you've talked about it for years, kind of the 15%-25% ROE through the cycle and sixty percent, you know, on average efficiency through the cycle. You know, obviously the third quarter here very much kind of better than the top end of those ranges. I guess, you know, kind of a two-part question. One, I mean, I guess It seems like that will probably be sustainable near term here. Would you agree? Or are there any other areas, particularly with the $82 million-$83 million expense run rate?
It seems like that will remain the case, but just curious if there's anything else we're not maybe thinking about that could impact those ranges. Then secondly, just as you think about how the business mix has changed over the last 3-5 years from a geography standpoint and some of the different dynamics on the balance sheet, I mean, does the lower end of that through the cycle ROE range, you know, does that move higher with less of the asset sensitivity? I mean, do you think you're kind of reaching a higher, you know, forward outlook for kind of the profitability of the company with maybe a little less volatility? Or just curious how you guys are thinking about those dynamics. Thank you.
I'll start off and then pass it over. Yeah, we think it's sustainable. I mean, we've said 15%-25%. I mean, we're up over 31% today. You know, some of that obviously is OCI and the unrealized losses. You sort of normalize that, I think it does get us sort of into the upper mid to upper twenties. I think that guidance is still true.
You know, we look at this going back through multiple interest rate cycles over the years in different environments, the 60% efficiency ratio, which is driven by more people intensive 70% efficiency ratio for trust and maybe in the top of the cycle, like 50% for banking does get us to about 60% sort of through cycles. Obviously we're you know in the mid-forties and probably gonna outperform that. We don't like to sort of talk about it at the extreme upper end or extreme lower end. I think 15%-25% is still about right based on our business. It has changed since we have a bigger Channel Islands business that we talked about that's much more competitive.
You know, the environment looks a lot like Bermuda and Cayman, but it's much more competitive. NIM expansion is much more limited there. I'll let Michael.
Yeah, no, I was just gonna mention the OCI point, obviously, you know, helpful to the ROE overall, but as that comes back over the next, well, over the duration really of the AFS book, you know, just 3.7 years, you know, that's gonna start to dilute the ROE a little bit. So probably adjusted, we will view that as kind of a mid- to upper-20s ROE. In terms of the longer term question, you know, that's kind of what we've been trying to do, I guess, while still investing in the business in terms of generating more fee income from the trust acquisition, so stabilizing and growing non-correlated income to our home jurisdictions, you know, being our banking jurisdictions, Bermuda and Cayman and Channel Islands.
Whereas the trust fee revenue is annuity revenue, capital efficient and the underlying economic activity in that business doesn't correlate particularly to the domestic economic picture of where we are. Doing these small add-on trust acquisitions ultimately will help stabilize the fee income and give us, you know, better platform for capital return overall whilst making all of our jurisdictions profitable. You know, hopefully, you know, I think the asset sensitivity is maybe a cyclical component here. You know, we will still remain very asset sensitive, just the structure of our balance sheet being 40% lent, mostly floating rate, you know, just, it's just a structural asset sensitive balance sheet.
I think that will continue, but the stabilization of the stable component of the income statement should grow over time, and that's kind of where we've been aiming. If I could just speak on the question around expenses. I think obviously we've been seeing some really good expense management throughout 2022. We expect that to continue going into Q4. You know, we're going through our budgeting or planning process at the moment, we kind of see what 2023 looks like. We expect, you know, a bit of probably fresh salary inflation, being able to address that going into 2023.
As has been scripted in prior calls, we also will see our core banking system coming online in Q1 of next year. We'll begin amortization of that. We're doing some, you know, some capital improvement to our branches in Bermuda and Cayman as well. For Q4, I think we'll still be able to kinda stick to the guidance that we put out there. I guess the last thing I'd mention is that, you know, obviously we've been able to benefit from the volatility in the pound sterling exchange rate as well. You know, say 30%-35% of our expenses are denominated in pounds sterling. We've been able to benefit from that.
We have to just keep our eye on that exchange rate and how that affects the income statement.
Great. Thank you guys. That was all very helpful color. Thanks for spending time on my questions. Appreciate it.
Thanks, Mike.
The next question comes from David Feaster with Raymond James. Please go ahead.
Hey, good morning, everybody.
Morning.
You touched on the currency side. I mean, it's having some benefits on the expense front. It obviously weighed on the balance sheet this quarter. I know you guys do some hedging on sterling, but just curious, you know, given the volatility that we've had, has your thoughts on more fully hedging currency risk changed at all? Just curious, you know, your thoughts on that front.
Yeah, maybe I'll start off. It's Michael Schrum. You know, we view our direct investment in our sterling denominated subsidiaries as, you know, as a structural investment in foreign currency earnings, effectively. You know, we do use a fair market-value hedge for that. We use deposits that are naturally occurring in Bermuda in sterling to hedge that. We don't run a proprietary book at all. I think our view on the earnings derived from the Channel Islands and the UK is that over a full cycle, those earnings will vary with the sterling in terms of the dollar value of those. Ultimately, the average earnings are gonna come back.
We really measure those subsidiaries in the traditional sense in native currency on the ROE profile cost income ratio. We wouldn't wanna be on the wrong side of a hedge, right? That's a risk-taking position. We view that very much as an economic investment in those countries. I don't know if I answered your question there, David.
Yeah. No, that was helpful. Thank you. Maybe just curious how you think about, you know, you talked about. We're still sitting on $3 billion in cash. Just curious how you think about liquidity deployment more broadly and maybe some of the timing of it. I know you've been very disciplined, and you're still benefiting from rising rates, but just curious, how you think about liquidity deployment and maybe kind of what, you know, a normalized level of cash for you might be.
Yeah. Great question. It's Michael Schrum again. I'll start, and maybe Craig can pitch in as well. As you know, we're a deposit-funded balance sheet, retail, mid-market corporate. When we look at cash and short-term securities, because we operate across four different banking jurisdictions in a subsidiary structure, all of those subsidiaries need to retain sufficient resources, whether it be capital funding or liquidity, to satisfy their loan pipelines and inflows and outflows, respectively. That leaves a significant component of our assets in cash just to try and manage that because we don't have a Fed window or lender of last resort, really. We're really our own treasury. We manage those intercompany flows, you know, with Bermuda having a backstop as well.
The way we think about it is really about 20% of the balance sheet, probably, I would say on a backtesting basis, between 15%-20% of the total balance sheet is always gonna be in cash and short-term securities. At the moment, we're a little heavy. We've seen a lot of volatility. Obviously, we've seen deposits come off. As you said, 2-10 isn't particularly constructive at the moment. We're just really rolling into short. With the OCI hit, we're just rolling everything into short term at the moment for the next quarter, really.
Over the long term, our investment philosophy hasn't changed in that we need to buy some protection from the asset sensitivity in the securities book, and that's why we buy fixed rate securities, you know, through the cycle. For the next couple of quarters, we'll just roll into, you know, short-term securities. As we start to see things stabilize, OCI coming back, et cetera, then we'll have some more options, whether it's, you know, some further restructuring in the AFS book, we're always on the lookout for that, or whether it's just further deployment of cash into fixed rate securities longer term.
That makes sense.
That.
Yeah.
That I think is useful. It was in the formal comments, we kind of talked about our reinvestment rates. I guess the paydowns that we are seeing coming through. The paydowns are slowing down, but we're also slowing down our reinvestment rates as well, for some of the reasons that Michael just talked about in regards to, you know, stability of deposits, and just making sure we have adequate liquidity on hand. Then even just the investment environment being constructive as well, we just decided to just slow down our reinvestment rates for now, until things get a bit more stable.
That makes sense. You know, just lastly, touching on asset quality. Non-accruals did tick down a bit, but you know, obviously higher mortgage rates are probably weighing on cash flows from some of your clients. I know you guys are very proactive in reaching out to those that may have some cash flow issues. Just curious, you know, overall asset quality trends and what you're hearing from your mortgage clients given the higher rates. Just if you could touch on the overall health of the housing market across your footprint as well.
I'll kick off, and then I'm sure others will chip in as well. Again, in regards to asset quality, we're not seeing any indications at this point of any weakening asset quality.
We are having active conversations with all our customers. We've actually kind of looked at the book, looked at kind of the potential for payments to increase, some indicators of capacity of customers to be able to absorb those payment increases as well. We haven't seen any indication that asset quality is gonna be impaired in any way. Obviously, with the lag in adopting the Bermuda dollar base rate increases, our estimate is that if anything's gonna come through, we're gonna start to see it, kind of middle of Q1 going into Q2. We're obviously gonna keep a really good eye on it, and also consider that as we look at our CECL provisioning as well, whether we need any qualitative overlays, etc .
Right now it's pretty good, and we're happy about that.
Okay. That makes sense. Thanks, everybody.
Okay, thanks.
As a reminder, if you have a question, please press star then one to be joined into the queue. The next question is a follow-up from Timur Braziler with Wells Fargo. Please go ahead.
Hi. Thanks for the follow-up. Actually just keeping that conversation going from the last question. Looking at your London mortgage book, I mean, it seems like London housing market has been a bit of a mess. Maybe what are you seeing there for, a potential credit issues with just some of the reductions in value? And then maybe longer term, how are you thinking about that portfolio going forward? And is that gonna be a headwind to kind of balance sheet growth as some of that production over the last couple of years rolls off? Or is there an expectation that that book of business remains more or less flat going forward?
We're not seeing really any pressure so far in the London book. The market we're in, as you know, is Central London, so if there are any price decreases, it's nothing substantial. We've underwritten it very conservatively, so 60% loan-to-value, five-year interest only. It's been about five years, so a lot of those are rolling over and we're re-underwriting them, so we get another look at the credit quality. The timing's quite good, actually, but not seeing a lot of stress. Our plan is really not necessarily to grow that portfolio.
It's really trying to keep it steady, because as we said in the past, we don't want London to be, you know, more than a quarter of our total loan book, or we start looking like a very, very different bank. Where we are growing is rolling out our retail business in the Channel Islands. That's going quite well. We've got over 700 retail clients now, sort of approaching a couple hundred million jst rolling in mortgages, which is well ahead of our plan. I think we've talked about GBP 500 million over five years, and we're well on the way to that. We're rolling out our credit card products early next year.
We do think as we become more of a retail bank, particularly on the mortgage side, there's some really good retail deposit funding on both islands. We think over time, we can start to convert from getting deposits from some of the financial intermediaries, which as you know, are very competitive on the pricing perspective, to more retail funding that actually will provide us with spreads and margins that will never look like Bermuda and Cayman, but it'll start to look a little bit more like those two places. You know, London, we don't see stress at this point. We think it's really well underwritten. Try to keep it flat, but the growth is gonna come from rolling out retail mortgages in Guernsey and Jersey.
Got it. That's great color. Thank you.
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 very much, and thanks to everyone for dialing in today. We look forward to speak with you in the future. Thanks again. Have a great day.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.