Earnings Call: Q1 2021

Apr 29, 2021

Good morning. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q1 2021 Earnings Call to the Bank of NT Butterfield and After today's presentation, there will be an opportunity to ask questions. 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. Thank you. Good morning, everyone, and thank you for joining us. Today, we will be reviewing Butterfield's Q1 2021 financial results. On the call, I'm joined by Butterfield's Chairman and Chief Executive Officer, Michael Collins and Chief Financial Officer, Michael Schrum. 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 Q1 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. Please note that in the Q1 of 2021, we did not record any non core items. As a result, any references to prior period core results are comparable to U. S. GAAP results in the Q1 of 2021. For a reconciliation of any non GAAP 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. On Slide 25 of the presentation, we've also included a list of potential factors relevant to the implications of COVID-nineteen for the bank. 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. During the Q1 of 2021, Butterfield continued to achieve strong operating results and delivered high returns with an actively managed low risk profile. We provide market leading financial products and services to clients seeking banking, wealth management, trust and custody services in our primary markets of Bermuda, Cayman and the Channel Islands, where we have longstanding significant and stable market shares. Also deliver trust and wealth management services through our offices in Singapore, Switzerland and the Bahamas. In the United Kingdom, we offer mortgages to high net worth clients with properties in Prime Central London. As you will see on Slide 4, Butterfield continues to report strong results with net income and core net income of $41,600,000 or $0.83 per share and a return on tangible common equity of 19.3%. We had stable net interest income and fees with improving expense trends. Based on an improved economic forecast and steady loan performance, we had a credit reserve release of $1,500,000 in the Q1 of 2021 compared to a recovery of $2,400,000 in the prior quarter and a provision of $5,200,000 in the Q1 of last year. We are encouraged by the improving economic and interest rate outlook across our operating jurisdictions as we emerge from a COVID-nineteen pandemic. We will continue to work with a small number of borrowing customers to help them find solutions to any challenges they may face. So far, our credit portfolios have shown a high degree of resilience during a difficult operating environment. The Board of Directors again declared the $0.44 per share dividend, which is consistent with our capital management philosophy of supporting a sustainable quarterly cash dividend with consideration for both organic and inorganic growth, as well as share repurchases. We continue to target a through cycle dividend payout ratio of approximately 50% with flexibility around share buybacks depending on market conditions and potential M and A opportunities. I will now turn the call over to Michael Schrum to provide more details on the Q1. Thank you, Michael. I'll start on slide 6 with a summary of net interest income and NIM. In the Q1, we reported NIM of 2.09 percent which was 16 basis points lower than the prior quarter due to 3 primary contributing factors. Firstly, continued low yields on the short end of the curve. Secondly, elevated prepayment speeds and reinvestment yields that are below running book yields in the investment portfolio and thirdly, the most important significant contributor was the level of customer deposits and cash balances, which remained at historic high levels throughout the Q1. Loan yields were down 5 basis points due to jurisdictional mix shift in the Q1. During the quarter, Bermuda had a modest increase in commercial loans, while Cayman saw some residential loan growth, although growth was mostly offset by an early repayment of a sizable commercial facility in the Channel Islands. During the quarter, the net average balance in the investment portfolio increased approximately 500,000,000 dollars or 10% as we put new money to work in the U. S. Agency MBS securities portfolio. New money yields averaged 1.62% in the Q1 of 2021 or 16 basis points higher than the 1.46% in the prior quarter. During the Q1, the blended rate for loan originations improved to 4.15 percent for $212,000,000 of new loans from 3 point 6 percent for $201,000,000 of originations in the Q4 of 2020. Turning to Slide 7, non interest income was stable at just over $47,500,000 Transaction volumes and foreign exchange increased, which lifted foreign exchange commissions by $1,900,000 in the quarter and asset management also benefited from increased valuation based fees. These offset the seasonal decline in debit and credit card fees due to the Q4 holiday shopping spending volumes. The bank continued to benefit from diverse and capital efficient fee business with a fee to income ratio of 38.4% in the Q1 of 2021. Slide 8 provides a summary of core non interest expense which improved by 1.8 percent to $80,900,000 in the first quarter of 2021 compared to the prior quarter. The phased restructuring during the second half of last year has continued to improve run rates with salaries and benefit costs reduced 4.3% over the prior quarter. This was moderated by an increase in high indirect taxes, but the overall restructuring program savings run rate has now been achieved. The cost to income ratio improved sequentially by 80 basis points to 64.8%, which is approximately where we expect to be at this point in the business and rate cycle. Slide 9 summarizes regulatory and leverage capital levels. Butterfield continues to maintain capital levels conservatively above regulatory requirements. During the quarter, higher U. S. Dollar long term interest rates lowered OCI gains on the AFS investment portfolio by $67,200,000 and this resulted in a TCE to TA ratio temporarily below our targeted range of 6% to 6.5%. We expect this to build back with normalized deposit levels supported by normal organic capital build over the coming quarters. Turning now to Slide 10. Butterfield's balance sheet continues to be strong and conservatively managed with very high degree of liquidity. As discussed, we continue to see historically high deposit balances due to government stimulus, one time pension withdrawals and varied commercial customer activity. We still expect that a portion of these deposits will be temporary On Slide 11, we show that Butterfield's asset quality remains exceptionally high with low credit risk in the investment portfolio, which continues to be 99% comprised of AAA rated U. S. Government guaranteed agency securities. We remain comfortable with our lending book profile with 2 thirds of loan comprised of manually underwritten full recourse mortgages in Bermuda, Cayman and the UK. In the Channel Islands, we are continuing the marketing of the residential mortgage products that will be similar in structure and underwriting to our Bermuda and Cayman loans and will allow us to activate our sterling deposits. The overall residential loan to value profile remains conservative at approximately 53% in Bermuda and Cayman. Our credit book continues to perform well with non accrual loans holding steady at 1.4% of gross loans. Following an increase in the Q4 of 2020 related to one commercial loan, the net charge off ratio has settled back down to negligible levels. We continue to actively monitor credit with outbound calling programs and are working with any customers who may be experiencing difficulty. On Slide 12, we discuss the average cash and securities balance sheet with a summary interest rate sensitivity analysis. Butterfield's weighted average life in the AFS investment portfolio increased to 6.1 years from 4.2 years last quarter due to the expectation of slower MBS repayment speeds as long term rates continue to rise. As mentioned, we also added approximately net 500,000,000 dollars of new money to lock in some of the benefit from higher rates during the quarter. Consistent with prior quarters, Butterfield's continues to expect a potential increase in net interest income in both the up and down rate scenarios. I will now turn the call back to Michael Collins. Thank you, Michael. I remain confident in Butterfield's strong operating position and the potential for continued organic growth as well as any possible acquisitions. We continue to examine potential acquisition targets and have seen an increase in the opportunity set that could be a good fit for Butterfield. Of particular interest are private trust companies within our geographic footprint. Pricing and due diligence will be key factors in progress on any possible deals, with particular emphasis on customer documentation and evidence of robust compliance risk management. Waterfield remains committed to the successful strategy that we initially listed with on the New York Stock Exchange in 2016. We continue to generate ROEs in the mid to high teens with recurring fee income, low cost deposits, a manually underwritten loan book with low LTVs, a capital efficient investment portfolio with limited credit risk, strong risk management and a disciplined expense and capital management approach. We believe these attributes will continue to generate value for the bank and all of our stakeholders as we emerge into a post pandemic 2021 and for the long term. Thank you. And with that, we'd be happy to take your questions. Operator? Thank you. We will now begin the question and answer session. Our first question comes from Alex Twerdahl with Piper Sandler. Please go ahead. Hey, good morning guys. Good morning Alex. First off, just wanted to ask a little bit about the management of the balance sheet. You guys put on a good chunk of securities this quarter. Where are you in the process of laddering cash into securities? I know you expect some deposit outflows, but are we going to expect should we expect some additional securities purchases over the next couple of quarters at a measured pace? Or are you pretty much done at this point? Yes. Good morning, Alex. It's Michael Schrum. So, I mean, you can see from a cash position that is still very elevated and it's obviously driven by probably by inflow in retail and inflow in commercial. So it's about half and half. Some of that is probably search deposits as we seen elsewhere in the financial system. And so we do expect some of that to be temporary in nature. We still do have some capacity from the ABN acquisition to ladder further out on a net new. So we're just continuing really with our as we discussed previously, about 150 net new quarter. But we did take the opportunity here as we saw rates kind of backing up in the quarter to lock in a bit of the asset sensitivity. Okay. So $150 per quarter is still a good rate to assume for the next few quarters? Yes. I mean, we want to monitor obviously deposit levels. As you can see, that's had an impact obviously with the OCI on the TCE ratio as well. So we continue to monitor. We're not quite at the point we can behavioralize those new deposits. So I think we've talked about before, we expect deposit growth in the GDP growth range across our home markets. And clearly, what we've seen is well in excess of that, which is positive, but we also want to make sure that they're sticking around. Perfect. And then as I look at the TTE level, which I know is a capital ratio that you guys manage to and just being below 6%, does that limit your appetite for share repurchases until the net TCE ratio goes above 6%? And does it also impact your ability to do M and A in the near term? Yes, good question as well. I mean, capital management really has remained the same. So we support dividend rate that we currently have and have announced again, plus organic growth in our markets, obviously. Then we look for accretive acquisitions. There's clearly been a bit more dialogue in that space. And then thirdly, obviously, buybacks subject to market conditions. But as we saw the long term rates starting to increase and deposit levels continuing in the Q1 at the sort of elevated level, we looked at the impact on leverage capital ratios and throttled back a bit on the repurchase activity. Share repurchases remain an important part of the overall capital return priorities, but it's just being a bit more conservative as the M and A dialogue is picking up as well. So I wouldn't put a hard limit on it. We're still active in the market. I think on a PE basis, we're still good value in the market. So and our price to book clearly has seen a bit of a pickup. But we're just being a bit more conservative given the TCE and given the M and A dialogue. So it's still part of the overall capital deployment. Great. And then just final question for me. We have some potential tax changes in the U. S. Coming down the pike, maybe changing from a regional to a global tax system, I guess going back to a global tax system. Can you just remind us, is that something that would have a meaningful impact on the economies of Bermuda or Cayman or the Channel Islands? Or Cayman or the Channel Islands? It's Michael Collins. I mean any U. S. Tax changes actually would have some impact on Bermuda and Cayman and even the channel loans. I'd say going back to when we had the Neal bill, which really changed the way reinsurers were able to transfer risk from the U. S. Entities to Bermuda, I think the fear was that would shut down the industry and it really didn't. I think U. S. Tax changes in terms of increasing the corporate tax, increasing once again the tax that U. S. Companies make on overseas earnings will have some impact, but nothing that Europe has talked about, Janet Yellen has talked about. We think logistically, it's very difficult to would be very difficult to get that sort of agreement across different countries, but it's something we need to keep an eye on. But I'd say, if you look at companies that did inversions like Ingersoll Rand, Google had a company in Bermuda, which looks like they may not have going forward. A lot of those big multinationals didn't really do a lot of business with the banks in Bermuda. I mean, they had intentionally incorporation and account, but not a huge impact. So there's been tax changes for the last 100 years and Bermuda and Cayman have been impacted by it. But so far we've been able to adapt. And companies are here for a lot more than tax. I mean, we've got a great regulatory environment. And we always talk about more than half of foreign capital in U. S. Hedge funds is based in Cayman funds and the Bermuda reinsurance industry reinsures about 60% of catastrophes in the U. S, and that's not going to go away. Perfect. Thanks for the commentary. Appreciate you taking my questions. Our next question comes from Tamer Berzillier with Wells Fargo. Please go ahead. Hi, good morning. Hi, Timur. Maybe first for Michael Schrum, how big was that loan that repaid or paid down in the Channel Islands that you mentioned? About £30,000,000 And then you're looking You can see that in the segment note. Some of that was made up by the new mortgage rollout in the Channel Islands as well, but it was sizable and profitable. Again, we're not a big loan growth story, so pretty stable asset quality and stable balances. Okay. Yes. And then that kind of dovetails to my second question. So the launching of retail products, I guess, when can we start seeing that make more of an impact on the balance sheet? And it looks like the deposit growth out in the Channel Islands has been quite strong over the past couple of quarters, especially this quarter. Is that a corollary to what's to come on the lending side? Any color on that would be great. Yes. I think we've made a good start on the mortgage lending in the Channel Islands. And as we've talked about in the past, what we're trying to do is make Channel Islands a full service bank on both sides of the balance sheet like Bermuda and Cayman. We started off with staff lending, which actually is a big part of the Bermuda and Cayman residential mortgage book, and that's gone quite well. So we're really keeping pace. I mean, I think we've talked about $500,000,000 worth of residential mortgages in the Channel Islands over 5 years, and we're on pace to achieve that. Okay. And then just the last question for me. Looking at the deposit book and how healthy those balances were in the Q1, Maybe if you can just quantify what your expectations are for deposit outflows? And is that a 2Q event? Or is your borrowing base still or your customer base still in liquidity buildup mode at this point? Yes, great question. Difficult to say really. I mean, as we sat here, I think after Q4, we definitely had some visibility around outflows coming into Q1, which actually did happen, but were replaced by other commercial activities such as premiums cycle on as you know, the insurance market is heartening quite significantly as the premiums are going up and we have more premium inflows for captive insurance companies at the beginning of the quarter and that's really kind of stuck around. So the half of the deposit increase that relates to retail is, as a reminder, just is sort of one time pension withdrawals, particularly in Cayman and Bermuda and general retail flows, some of which will stick around. On the commercial side, we're still expecting that to flow out over time, but it could be a couple of quarters. Honestly, I think we were probably not expecting those commercial deposits to be replaced by other temporary deposits in Q1, but that is what happened. Good problem to have, but obviously that means a little bit more conservative management and clearly an impact on NIM from average deposits in the quarter as well. Okay. Thank you for taking my questions. Thanks. Our next question comes from Will Nance with Goldman Sachs. Please go ahead. Hey guys, good morning. Hi Will. Maybe I could start on just some of the moving pieces of the net interest margin. I think so one, I think the consumer loan yields came down a decent amount in the quarter, if I'm seeing that right. I'm just wondering if you could kind of speak to some of the mix shift between jurisdictions that you're seeing and whether the decline in yields that we saw this quarter is a good run rate, if there's anything impacting that and just how to think about what mix shifts will do to the loan yields all else equal as we kind of look out? Thank you. Yes. Great question. There's quite a lot of there's some more detail on the balance sheet on the segment reporting as well. As you know, the Cayman mortgages new so the front book, both in Cayman and Bermuda, obviously, lower rates than the back book. And Cayman, in particular, is tied to U. S. Prime. So with more Cayman resi, obviously, that pressure is still on NIM or loan yields overall on the total book. And then obviously, as we talked about before, the Channel Islands sterling rates are in the gross rates at 3.50 ish. So it'll again below Bermuda and Cayman rates on mortgage origination. So over time, that will pressure the the yield a little bit on the loan book. But I mean, it was a handful of basis points. There's still a large back book. And so although amortization continues both in the Bermuda and Cayman book, it shouldn't it's not too much of an impact, if that makes sense. Got it. Appreciate that. And then just on the securities reinvestments that you're making, I heard you on the average securities yield in the quarter. Just wondering if maybe the exit run rate given the kind of backup in yields over the course of the quarter if the exit run rate was a little better than that. And the follow-up would be if that is the case, can we start to see the securities yield leveling off in the near term? Yes. Yes, it's the answer. The exit yield was probably in the 1.85%, 1.90%, so higher than the average for sure and a lot closer to the running book yield in the investment portfolio. So obviously that's helpful. We focus a lot more on NII obviously given the surge deposits and the impact that it has on the NIM overall. But we should see stabilization there. And certainly, we would expect prepayment speeds to stop slowing down as well. We haven't seen that yet, but we're expecting that with a higher rate environment as well. And obviously, the maturities really have been impacted quite significantly by the PPP program in terms of almost a third of our prepayments comes from lift outs, and that's really sort of accelerated the NIM decline in the MBS book, but we're getting a lot closer to the round book yield now. Got it. That's helpful. And then if I could squeeze in one more, just as you look at kind of capital management and obviously you're buying a lot of securities today, How do you think about OCI risk going forward? Any kind of sensitivity you provide? And are you thinking about any ways that you can maybe hedge that out in case we do see some further backup in yields over the next couple of quarters? Yes. So we've seen obviously almost an elimination of AFS OCI gains. We still have a gain in that book and obviously we're booking about fifty-fifty of new money between AFS and HTM, which is not necessarily a hedge, but certainly gets different accounting treatment. We still have significant gains in the overall unrealized mark to market on the HCM as well. And I would say it's not obviously, OCI is not a regulatory capital impact for us, but it is a leverage capital impact. So we're booking longer data maturities obviously in the HTM book as you would expect and more of the shorter date maturities in AFS. So that should provide some natural flow in the books and cushion the impact on AFS in a rising rate environment. The Board also looks at OCI paybacks and MCC paybacks from higher yields. And I'm certainly very comfortable about the payback period that we're sitting at the moment. Got it. Thank you for taking all my questions. Thanks. Our next question comes from Andrew DeFranco with KBW. Please go ahead. Hi, guys. This is Andrew DeFranco stepping in for Mike today. Thanks for taking my questions. Sure. Good morning, Andrew. Good morning. So I was just wondering, it was good to see expenses tick down after some of the actions you guys took last year. Any updated thoughts on where that trend near term? Or is there still some upward pressure potential as things have turned to normal regarding travel and maybe some other items? Yes. So just touching on last year, obviously, we reduced headcount by about 10% of the work force or about 130 positions. Clearly, that's not something we can do again this year. We're very focused on operational risk and making sure we've got enough people to have the controls that make us comfortable. So that was, I wouldn't say a one time shot, but we can't replicate it every year. What we are doing though is continuing to focus on our Halifax service center. So we're continuing to automate as much as we can in Bermuda and Cayman and then transfer those roles and functions to Halifax. We've got about 150 people up there now. So we finally have sort of a scale and critical mass where the teams are kind of supporting each other. So we continue to see that growing. And that will have a gradual impact on expenses over time. Basically, the cost is about 50 percent per SE compared to Bermuda and Cayman. But then you also have currency fluctuations as well. But it's a great quality workforce and will save us money over time. But I'll let Michael talk specifically about where we think this year will go. Yes. And just on the restructuring, there's a bit more to come in terms of benefit. As we talked about before, this was a phased approach where we wanted to make sure certainly during year end, we had folks in place in key control roles. And as we are transferring their responsibilities either to Halifax or to replacements, there's a bit more relief coming on the expense side. I do expect that to be broadly picked up by additional T and E expenses in the second half this year. I mean, post pandemic, there is a need for us to come out and see clients and go and see our colleagues in other jurisdictions. So I think the 8,801 level is probably what we previously said, we were thinking it's going to end up and that's still a good number. Okay. Has the pandemic noticeably changed the competitive landscape in the near markets? Have any banks pulled back any further or any new entrants looking to diversify away from the land? Not noticeably changed any competition. Just to give you a quick summary, Bermuda looks like is going to open up or the government announced on June 26, And it looks like the Channel Islands early July. And then although the gaming government, which just they just had election hasn't announced it probably September. So everyone's trying to kind of open up into their high tourist seasons. So Bermuda has the 4 banks. That's very high barriers to entry in this market and the banks are pretty HSBC and Butterfield have sort of equal market shares and we don't see that changing. Cayman is a bit more competitive with 6 banks and some Canadian banks, but I don't think the competitive landscape has changed dramatically. And then the Channel Islands is much more competitive with all the U. K. Banks and European banks. So no, I think everyone and particularly we feel proud that we're able to operate so efficiently from home and we're still doing that to some extent, but no noticeable changes. But we've been really pleased in terms of how much local activity as you can see in our fee income in the last year was a bit surprising in terms of how that held up, but no noticeable change in competition. This concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks. Thank you, Sarah, 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.