The Bank of N.T. Butterfield & Son Limited
Q4 2018 Earnings Call Transcript

Published: 20 Feb 2019

[Operator:]

Good morning. My name is Chad, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter and Year-End 2018 Earnings Call for The Bank of N.T. Butterfield & Son Limited. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] 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.

[Noah Fields:]

Thank you. Good morning, everyone, and thank you for joining us today as we review Butterfield’s fourth quarter and year-end 2018 financial results. On the call, I’m joined by Butterfield’s Chairman and Chief Executive Officer, Michael Collins; Chief Financial Officer, Michael Schrum; and Chief Operating Officer, Dan Frumkin. Following their prepared remarks, we will open up the call for a question-and-answer session. Yesterday afternoon, we issued a press release announcing our fourth quarter 2018 results. The press release, along with a slide presentation that we will refer to during our remarks on the 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 U.S. GAAP, please refer to the earnings press release and slide presentation. Today’s call 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.

[Michael Collins:]

Thank you, Noah, and thanks to everyone joining the call today. I’m pleased to report that our business performed well in 2018 and is a good reminder of the strength of our operating model. For those of you who may be new to the Butterfield story, we’re a Bermuda headquartered bank, with shares traded on the New York Stock Exchange and here in Bermuda on the Bermuda Stock Exchange. Our service offerings include

[Michael Schrum:]

Thank you, Michael, and good morning, everyone. On Slide 6, you can see the fourth quarter was a very strong finish to the year for Butterfield. We reported net income of $50.9 million, or $0.92 per diluted share and core net income of $51.1 million, or $0.92 per share. Core net income was up 4% compared to the prior quarter and up 21% compared to the fourth quarter of 2017. Core return on average tangible common equity rose to 25.8% from 24.9% in the prior quarter. This is the eighth consecutive quarter with core returns in excess of 20%, as we continue to generate a sustainable and strong return profile. The net interest margin increased 1 basis point compared to the prior quarter, as term deposit interest cost increases were outpaced by higher yields from investment and loans. As expected, we saw deposit levels stabilize during the quarter, with additional client deposits added towards the end of the quarter in Jersey from the Deutsche Bank acquisition. On Slide 7, we provide a summary of NIM and net interest income. Over the past few quarters, we benefited from upward U.S. interest rate movements, which have favored asset yields, while our cost of deposits have held fairly steady and remained really inexpensive. In the fourth quarter, the overall cost of deposits increased 7 basis points to 27 basis points due to higher rates paid on term deposit– to term deposit holders. Yields on investments in the quarter increased 9 basis points sequentially and rose 60 basis points compared to the fourth quarter of 2017. The new deposits from the Deutsche Bank acquisition were onboarded late in the fourth quarter and are expected to contribute more meaningfully in 2019. On Slide 8, we provided some further detail on average deposit balances in terms of geography, currency and contractual nature. The currency mix has held fairly steady over the past year on average, but we do expect the pound sterling to increase as a percentage of the total, as deposits continue to grow in the Channel Islands. Demand deposit costs have increased 2 basis points, while term deposits have increased in line with U.S. short-term rates in the quarter. As we have discussed previously, there can be significant deposit movements from quarter-to-quarter due to large trust and fund clients managing their normal commercial flows. Historically, these types of more dynamic deposit relationships can contribute as much as $1.5 billion and could be as low as $500 million. At the end of the quarter, we remain towards the low-end of that range for those large deposit relationships. Turning now to Slide 9. Our capital efficient non-interest income increased 10.8% to $45.7 million in the fourth quarter of 2018, compared to the prior quarter and was up 7.9% versus the year-ago quarter. We normally see an increase in fee revenue during the fourth quarter, due to increased banking FX and credit card usage around the holiday season, as well as towards some spending in Cayman. On Slide 10, we provide an overview of core non-interest expense, which totaled $83.1 million for the fourth quarter of 2018 and was flat versus prior quarter. This was in line with expectations. The cost income ratio has improved sequentially and through a focus on cost savings continues to trend towards the 60% target. Looking now at Slide 11, we provide a summary of capital levels, specifically Basel III regulatory capital and leverage capital. Capital level – levels remain on the high-end of our targeted range, and we are pleased that the Board this quarter authorized a significant increase in the common dividend rate to $0.44 a quarter. We are confident that the combination of the cash dividend and active share repurchases provide the required flexibility, while we continue to pursue accretive acquisitions of Banking and Trust businesses in existing jurisdictions. Turning to Slide 12. We ended the quarter with total assets of $10.7 billion, approximately the same as at the end of 2017. Loans increased in the high net worth Central London lending book, as well as Bermuda commercial loans. At the end of the fourth quarter, we had an inflow of client deposits in Jersey from Deutsche Bank, which is expected to begin contributing more fully to earnings in 2019. Looking now at asset quality on Slide 13. Our loan book was $4 billion at the end of the fourth quarter, with residential mortgages representing 65.3%. Non-accrual loans increased slightly to $48.7 million, but we remain comfortable with the composition and quality of the loan book and are not currently seeing any specific problem areas. Our $4.3 billion investment portfolio remains highly rated, with 96.3% of securities rated AAA, primarily inexplicitly guaranteed U.S. Government Ginnie Mae securities. On Slide 14, we discuss the average cash and securities balance sheet with a summary interest rate sensitivity analysis. The balance sheet profile remains structurally moderately asset sensitive, although, we continue to reduce that aggregate exposure and we have gradually been extending duration and booking asset sensitivity into higher book yields. The interest rate sensitivity gap between Butterfield and U.S peers continues to decrease as we roll over maturities. I will now turn the call back to Michael Collins for concluding remarks.

[Michael Collins:]

Thank you, Michael. 2018 was a year of record profitability in Butterfield’s history, with core returns on equity in the mid-20s. As we enter 161st-year of continuous operations, I believe Butterfield is really well-positioned for continued profitability and growth. As a bank that specializes in offshore financial services, I believe we are operating from the right locations, with strong regulatory oversight and great people. We have franchise-level market shares in Bermuda and Cayman, strong fee-generating businesses with the opportunity to grow in the Channel Islands organically and through acquisitions. We continue to seek out potential strategic acquisitions that are financially accretive. Before we open up for Q&A, I would just like to thank the Butterfield staff, management team and Board of Directors for your hard work and dedication in 2018, and look forward to making 2019 another successful year. Thank you. And with that, we’d be happy to take your question. Operator?

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question today will be from Timur Braziler with Wells Fargo. Please go ahead.

[Timur Braziler:]

Hi, good morning, gentlemen.

[Michael Collins:]

Good morning, Timur.

[Timur Braziler:]

First question is on the deposits. If you can provide any kind of puts and takes on what occurred this quarter? What was the actual balance that was brought in from the Channel Islands and the Cayman deposits? And I guess, what happened within the larger trust relationships, any additional pressure from that portfolio?

[Michael Schrum:]

Yes. Thanks, Timur. It’s Michael Schrum, maybe kickoff and then Dan can give a bit of an update on the integration activities on the DB book. But fundamentally, the deposit levels stabilized in the quarter and our core franchise deposits are holding up really well. I think, as we mentioned last quarter, a reasonable way to think about deposit levels would be to stop at the end of Q3 period-end balance of just over $9 billion, I think, it was $9.1 billion, given that we had some outflow last quarter. And in terms of the DB book, that’s been coming online in rolling closes. So as we discussed last quarter, Cayman completed late in Q3, with approximately a quarter of the total, so about $250 million, so that was sort of in the ending number there. The Channel Islands and Jersey rolling close in late Q4 added another half of the total books or another $0.5 billion getting us to the $9.5 billion level at the end of the quarter. But obviously, the averages are a bit lower than that just because of the timing of that. And then finally, we expect another quarter of client deposits to be onboarded in 1Q. And it would, therefore, be our expectations that we should see an uplift at the end of Q1 by another $1.25 billion, which would then complete the rolling closes for the Deutsche Bank acquisition. As we’ve discussed previously as well, the expected currency mix and somewhat lower productivity levels of the deposits will kind of create some NIM dynamics in Q1, as well as the fact that we obviously didn’t pay anything for the business. It was essentially free and we didn’t pay any consideration to the seller. So it should be still at the accretion levels that we talked about. And I’ll just hand it over to Dan to maybe give a little bit more of an update summary of the integration activities.

[Daniel Frumkin:]

Thanks, Michael. So the integration is going well. Client response remains positive. The take on activity is on plan with rolling closes. And again, I would just caution that in quarter one, the rolling closes are staged towards the back-end of the quarter just like quarter four. So when you’re thinking about average balance sheet for the first quarter, I would not build in the increase in deposits. It’ll come at the very tail end of the quarter again, just because of the way we structured them. And that deposit book is a deposit book we’ve been quite pleased with although it is – it’s fund families mostly, so it’s a bit of volatility. There’s monies in and out. So, spots always been tricky and it does have meaningful fund flows. And as Michael says, it’s a mix of pounds, euros and dollars. The staff has come onboard. Again, the onboarding process for staff is great. We’re doing some cultural events in the first quarter to get everybody integrated. We currently have about 70 of the 75 staff we are going to have in place. The majority of the staff, however, joined us in January. So there will be some uptick in expenses associated with the higher staffing levels as we’ve highlighted previously. So, again, I think it’s going really well. We’re really happy. As we said last quarter, Cayman has been fully integrated for a quarter. Those clients continue to operate well with good transaction levels and Cayman and – I mean, Guernsey and Jersey are making really good progress.

[Timur Braziler:]

Okay. And I understand just from a liquidity standpoint the pressure or the perceived pressure on margin. But as far as the rates on those deposits coming in, are they much different from what’s currently on the balance sheet?

[Michael Collins:]

No, not really. I said not at all actually

[Timur Braziler:]

Okay. And then just looking at the existing balance sheet, what portion of the term deposits have already been repriced at higher levels? And what are still kind of – what’s still kind of in the pipeline to be repriced at these higher levels?

[Michael Collins:]

Yes. It’s a great question. So the majority of the term deposits have relatively short tenure, so three to six months. So the majority of that will have been moved through the cycle already, obviously, without any further Fed rate moves, we’d expect for those deposit rate levels to stay flat as well. We’re not looking here to get ahead of the market obviously, but we’re looking to just stay sort of competitive within the jurisdictions.

[Michael Schrum:]

And the only thing I’d add to that Timur is, we’re not seeing a big shift from non-interest bearing to term. So, again, you’re not seeing term balances grow meaningfully, it’s just the repricing in the existing bankbook.

[Timur Braziler:]

Understood. And then just one last one for me, to the extent that you could provide any additional information on some of the disclosure from the December Financial Times article, any new information would be great there?

[Michael Collins:]

Yes. So basically, we haven’t been contacted by the jury, prosecutor or anybody. So we’re working through the client base and thus far haven’t done anything that would give us any concern. But really our sense was, we were sort of the byproduct to the story, and at this point don’t expect any real outcome from it. So no contact whatsoever at this stage.

[Timur Braziler:]

Okay, great. Thank you.

[Operator:]

The next question will be from Michael Perito with KBW. Please go ahead.

[Michael Perito:]

Hey, good morning, guys.

[Michael Collins:]

Hey, good morning, Mike.

[Michael Schrum:]

Good morning.

[Michael Perito:]

A couple of questions I wanted to address. I guess, one, on the margins. So, Michael Schrum, you just mentioned that you assume no more Fed fund hikes. Your expectation would be that the deposit pricing pressure would kind of slow. But I was curious how should we think about your internal kind of base rate and the movement of that relative to what we could see from U.S. Fed funds here? If Fed funds stabilize, does that stabilize as well right away, or is there kind of a lag behind it if fed fund decrease? I mean, what’s – how do you guys see this? Walk us through a little bit about how you’re think about that? The relationship between your internal base rate and the U.S. Fed funds as we see maybe the mix here changing a little with the slowdown in the hikes – future hikes rather?

[Michael Schrum:]

Yes. I mean, it kind of directly ties into why we didn’t see further margin expansion – NIM expansion this quarter because, obviously, as you recall, there’s a 90-day lag on any repricing that we do under Bermuda dollar loan book, and we didn’t reprice in September. We sort of passed – that didn’t pass that on to customers with the Fed funds there, but we did in December and we would always expect that to come through in 2Q more fully in terms of margin. So, I think, as I think about the NIM, there are a couple of things happening. We should see some stabilization in deposit costs. Obviously, there shouldn’t be a lot of more pressure in there. There’ll be a bit on the loan book NIM expansion. There’s a little bit from the investment book rolling over a couple of basis points as we roll into higher rates on maturities. But given the complexity of those instruments and the investment book, we will continue to ladder out and season in that the new monies started coming in, as you can see, our cash balances and short-term securities were quite elevated at the end of the quarter. So that held at the short end and then we’ll start to sort of season those in – into the book overall, which should have a modest NIM expansion effect as well. And then, obviously, the challenges or the headwinds there are going to be how do we deploy the sterling deposits at the moment. We’re running a short sterling position, because we anticipate more sterling to come on and they’re productively engaged in loan assets in the UK. But over time, that would be some form of guilt and obviously lower productivity levels there. So that will – all things being equal, have a downward – downdraft on the NIM. So as I think through the whole year, there will be – there should be some modest expansion coming throughout the year from the different asset classes. But I think the loans are kind of without any further Fed funds increases, we wouldn’t expect to reprice loans again. At this point, we tend to move in line with the Fed funds up and down with some lag.

[Michael Collins:]

And Mike, I would also say that, I think, our general outlook is obviously kind of reach the top of the cycle and we’re not expecting any real expansion from NIM going forward, which has really focused our conversation to what we need to do and is becoming much more of an intense – expense focus and using our Halifax and Mauritius offices to reduce our expenses in the higher-cost jurisdictions. So it’s a management team that has actually been through both sides in interest rate cycle in Bermuda and Cayman. So I think we have a pretty good sense when NIM flattens out, what our next moves are. So we’re really intensely focused on expenses over the next six months.

[Michael Perito:]

Yes. I do want to spend a minute there. But I guess, just one quick follow-up. So I mean – and Michael, I guess, you kind of just addressed this. But – so I mean, it would seem like then that while there could be maybe a drift down in the first-half of this year because of all its liquidity that’s coming on this $335 million to $340 million margin is kind of a stabilization number that you guys would be comfortable from an outlook perspective maintaining?

[Michael Collins:]

Yes, I think, so I don’t see any reason why that would be further eroded. It should all – it should definitely expand our NII, obviously. But it would be at the short-end of the curve and then it will be if – the only way that we might see a meaningful uptick and investment book if the long-end stops moving a bit. So, at the moment, most of that asset sensitivity is kind of baked in to running book yields now. There’s obviously some prepayment risk associated with those in terms of duration. But we’ve been extending duration and there’s no real reason why we should see a meaningful downdraft in the NIM.

[Michael Perito:]

Okay. And then on the expense side, it sounds like there could be a tick up coming in the first quarter. But you guys – I think, I saw a comment in the slides that there were some redundancy expenses, which I’m curious. So I guess, two-part question. I guess, what is kind of the run rate on expenses once this deal is fully integrated in those redundancy expenses are presumably moderated? And then second, what are some of the actions being looked at to make the overall franchise more efficient now that some of the benefits of the higher shorter-term interest rates has kind of played itself out?

[Michael Collins:]

To start off, I think, overall, the focus is clearly becoming more efficient in our operational processing, automating everything and then moving what we can to Halifax and Mauritius and getting costs down that way. But I think that’s one of the ways we can do it. There are other programs we’re working on that. We’ll talk about next quarter that I think will give you sense of how you reduce expenses in an Island population, where you reduce headcount, it has effect on the community, has effect on your clients, and we have pretty good sense of how to do that without hurting our franchise. So we’ll talk a bit more about that in Q2. But I’ll let Michael get to the specifics.

[Michael Schrum:]

Yes. So I think, in terms of expenses and you’re right, those are a bit of redundancy in this quarter. I think, if you go back to Q1 and Q2, we always said we’re going to probably end with the DB integration in $84 million, $85 million run rate a quarter. And I think at $83 million, there’s still some stuff to come on in Jersey. And so I think that still holds $84 million, $85 million, that still gets us to kind of the $60 million number, pretty close if you backed out the redundancy cost there. That was really just a bit of a late one from the previous redundancies that we have in Q2. So I think that run rate kind of holds once we get to the Channel Islands DB staff fully transferred in. Remember, I think, it’s in line with expectations. I’m not seeing anything there. I would say, obviously, we’re fighting any kind of headwinds with, as Michael said, becoming more efficient, setting up new operations, onboarding new stuff and then betting that and getting to be a BAU is going to be sort of focus for the next couple of years, right, in Jersey, and that’s going to definitely generate some efficiencies and we’re pushing pretty hard on that.

[Michael Perito:]

Helpful. And then just last one for me on the – on the capital side and I apologize, I jumped on the call a bit late, I’m sorry if I missed some commentary you guys made about this. But if I think about interrupting the numbers way you guys did 1 million, the old – completed the old 1 million share purchase authorization at the end of last year. It looks like you did maybe another $300,000 of the new 2.5 million share authorization you guys put out before year-end. So you’ve got about $2.2 million left. Just curious about how we should be thinking about your appetite for that and utilizing that over the course of 2019?

[Michael Schrum:]

Yes. So, again, I think, again, we haven’t really changed our thinking about this. I am hopeful that, we’re still looking obviously at the M&A opportunities there. But we also conscious that we’re at the very high-end of our target range. And the previous four, give acquisitions we’ve made have been reasonably small in terms of the size and consideration and capital draw even from a balance sheet side – point of view in terms of tangible. So I think we’re conscious, we want to commit to continuing to have a healthy dividend first and sustainable dividend first and foremost. And then, obviously, looking at accretive acquisitions and Dan can talk a bit about that. And then thirdly, share repurchases is a good way for us. I think, we’re certainly feeling about eight, nine times earnings is a very good price point for us to be in there. So I don’t think we’re looking at sort of a massive acceleration of that. We want to be mindful of market dynamics and opportunities for others as well. But I think it could be a meaningful EPS accretion over time. And then fourthly, obviously, if we run our capacity there, we would also consider specials, but that would probably be our last priority in that mix. So, again, it’s kind of consistent what we’ve said before. We’re obviously mindful of price book dynamics as well, but we do feel that it’s low risk and quite accretive way to deploy capital.

[Michael Perito:]

Helpful. Thank you, guys, for taking my questions. I appreciate it.

[Michael Collins:]

Thanks, Mike.

[Michael Schrum:]

Thanks, Mike.

[Operator:]

The next question comes from Alex Twerdahl with Sandler O’Neill. Please go ahead.

[Alexander Twerdahl:]

Hey, good morning, guys.

[Michael Collins:]

Hey, Alex.

[Michael Schrum:]

Hey, Alex.

[Alexander Twerdahl:]

Just want to make sure I fully understand your comments early on the deposit flows. So it sounds to me like the $1 billion or so that you guided to that was going to come on board with the Deutsche deal. It’s still very much on track to be a $1 billion with $250 million being already in the numbers last – at the end of last quarter, $500 million coming on this quarter and then another $250 million coming on at the end of the first quarter, is that correct?

[Michael Schrum:]

Yes, that’s how we’re thinking about it, Alex. I would say that deposit gathering is not sort of a linear or exact science. Clients do take money in, but that’s kind of – that’s exactly how we think about it.

[Alexander Twerdahl:]

Okay. And so that would just imply that organic or legacy deposits were down a little bit over $100 million in the fourth quarter, is that correct?

[Michael Schrum:]

Yes, I think deposits come and go, right? And we – as we said before, we have some trust in clients. We’re still at the lower-end of that sort of deposit range or significant depositors, right? So, there we would expect some positive – more positive momentum on those, but again, they come and go, so.

[Daniel Frumkin:]

And there’s nothing systemic we’re seeing, Alex. It’s just typical flows. So – and there’s nothing. We’re not, again, we go through every deposit above or very small level. We go through to make sure, it’s not rate-driven and everything else and we’re just not – we’re not seeing anything actually and we’ve actually – so just typical flows.

[Alexander Twerdahl:]

Okay. So I mean, at the end of – I guess, maybe the second quarter or so, you guys kind of had heads up or you sort of newer and some inclination that there would be some outflows in the third quarter related to larger deposits that were parts of the bank part of that sort of volatile piece. And at this time, there’s nothing to suggest that, I know that volatile piece you’re saying is kind of towards cyclical lows. But there’s nothing to suggest any outflows in the first quarter from that, or any meaningful outflows in the first quarter from that, right?

[Michael Collins:]

Not there we’re aware of, but again, you don’t know what you don’t know, but not that we’re aware of.

[Michael Schrum:]

Okay. And going back to the big deposit outflows, as we talked about last time, those were really two clients and majority of it was one client, which we knew would eventually going to be put to work. And so that’s the nature of our balance sheet and that’s kind of the way it works. I mean, it can come in and go out, but the big client that went out that those funds aren’t coming back as they put into work in the market, so.

[Alexander Twerdahl:]

Okay. And then, Dan, in the past with regard to the – in regard to the deal you kind of gave out some sort of deal metrics, sort of what the expectations were for the – for fee income expenses and NII, et cetera? It seems to me like the NII probably doesn’t change a whole heck of a lot given the size of the balances, haven’t really changed. With the fee income piece or the expenses associated with those Deutsch deposits, is there a little more clarity now on kind of what that might shake out to in 2019?

[Michael Schrum:]

So I think we guided that it would be 4% to 5% accretive and when stabilized. So we think that’s right, Alex, with everything.

[Alexander Twerdahl:]

Okay. And then for like the fee income this quarter was relatively elevated relative to last quarter and the year-ago quarter. Is any of that already coming from the new deposits are coming online? Is that – it was getting a little taste of what we can expect in 2019, or you think is really just more seasonality in the fourth quarter that drove higher fee income this quarter?

[Michael Collins:]

So I think it’s a combination of a few things. One is, you’ll notice the trust fees, I think, where the largest component of our non-interest income fee line for the second quarter in a row, I think. But for the first time in history, that’s really is a reflection of the GTS acquisition as we’ve seen those fees come through and be sticky and stay and been able to grow some of those fees marginally, but some growth. I think that’s first thing. There is a bit of seasonality, so if you look at fourth quarter of 2017 versus the fourth quarter of 2018 in banking fees, there’s a little bit of Christmas spending that occurs on the cars. There’s a little bit of more of funds flow that comes through a little bit more of FX. People travel a bit through that period. So there’s a bit of seasonality. And then, yes, we are seeing some custody in FX fees in the Cayman business, as well as a bit in the Channel Islands associated with the Deutsche Bank acquisition. So it’s a bit of a mix. Now those custodian FX fees aren’t huge, but they’re not insignificant either. So it’s a combination of all those events.

[Michael Schrum:]

Yes. The way I would think about it, so if I look at the delta of three between banking and FX, probably half of that might be sort of what you consider seasonality, which is sort of card usage, I mentioned acquiring, as well as credit card usage.

[Michael Collins:]

Part of the biggest part of seasonality is just, as you know, Cayman is a big winter Christmas destination for tourists and that always bumps up, so every fourth quarter is a bit high.

[Alexander Twerdahl:]

Okay. And then, did you see the breakout for the UK mortgages handy at the end of the quarter?

[Michael Collins:]

I don’t, sorry.

[Alexander Twerdahl:]

Okay.

[Michael Collins:]

When you say breakout the balance…

[Alexander Twerdahl:]

Yes, the balance.

[Michael Collins:]

…because we didn’t disclose the financials.

[Alexander Twerdahl:]

I guess, we’ll get with the 20-F next week, but…

[Michael Collins:]

You’ll get with the 20-F.

[Michael Schrum:]

Yes. And one of the reasons why – I mean, this is our first year of sort of being accelerated fall out, if you will, for the 20-F with the full integrated reporting. And so that’s one of the reason why we want to kind of give a bit more time to kind of close off the books or a bit later reporting this year than some of the peers. But obviously, it’s – going forward that should be more in line.

[Michael Collins:]

But you’ll see in the 20-F, I think, it’s fair to say that you will see further growth in residential loan book out of the UK. And while overall loans have remained sort of flattish with the exception of the Bermuda government now moving up, that’s really been a mix shift for us, which bleeds through into the loan margin a bit. So I mean, – but again, you’ll see that in the 20-F. I just – I can’t remember the exact numbers of them, and I don’t want to guess. So – but the trend is right. You will see more UK mortgages and the mix of our loan book has continued to show slightly, which does have a slight negative impact on loan margins, completely accretive to NII, but a bit on loan margin. Yes.

[Alexander Twerdahl:]

I agree and understood. I just want to ask though, there’s an article in The Wall Street Journal about a week and a half ago about higher-end UK real estate. And I think it’s something that’s been kind of under pressure for quite sometime, but maybe just getting a little bit more publicity with the whole Brexit thing going on. Is there anything that you’re looking at? I know your LTVs are extremely conservative and the market you’re applying in is a little bit unique. But from your standpoint with respect to the supply for these types of mortgages, for the credit quality, for everything, I mean, is there anything that’s kind of changing or that has sort of changed your methodology and your standards with respect to Brexit and kind of some things are going out to real estate market over there?

[Michael Collins:]

Sorry. No, I definitely not. I think we structure our underwriting guidelines to 60% LTVs, any of these are sort of three to five-year rolling mortgages. So they’re pretty short-term. We’ve really been disciplined about location, so we really stayed in Central London. We haven’t sort of drifted out outside of that area. And I’d say, a number of things happening in the UK in terms of stamp duty and concerns about Brexit. But there’s a store wealth in those three or four neighborhoods in Central London that is never going to drop sort of 40% or 50%. So we’re really confident about the book. It’s growing part of the loan portfolio. It’s obviously the biggest growth area. And while everything in the UK will be affected somewhat by Brexit depending on which way it goes, I think, this is the most insulated part of the market. And each loan is individually underwritten. We know the properties inside and out. We know the clients inside and out. So it’s a very carefully underwritten book.

[Alexander Twerdahl:]

Thank you for taking all my questions.

[Michael Collins:]

Thanks, Alex.

[Michael Schrum:]

Thanks, Alex.

[Operator:]

[Operator Instructions] The next question will be from Will Nance with Goldman Sachs. Please go ahead.

[Will Nance:]

Hey, guys, thanks for taking my questions. Most of the questions been asked. I guess, the one I had, I guess, would interest rates being less of a driver of earnings growth going forward, how are you feeling about the potential and I guess the bandwidth for further M&A once we get past the Deutsche acquisition?

[Michael Collins:]

Yes. So I’ll pass it over to Dan. But I think, overall, our strategy really hasn’t changed. We’ve got incredible franchises and Bermuda came in with dominant market shares in higher barriers to entry. But our growth area other than overlap acquisitions in Bermuda came is to continue to be the Channel Islands. So we continue to see opportunities and we’re very focused on it.

[Daniel Frumkin:]

So I would say, again, well, there’s lots of conversations going on, and again, it’s a sort of natural cycle, people are getting through their year-end results. I think I have made some strategic decisions as they’ve gone to their strategy reviews and anticipation at year-end. They’re now at a place where they can breathe again and those conversations have different levels of traction. And again, we’re very focused on banking in the Channel Islands. For those who might want to exit that market, including custody operations and we’re very focused in the trust space in markets we currently operate. And again there’s a fair amount of activity, I don’t know if any, but it will bear fruit, but we’re having a fair number of conversations.

[Will Nance:]

Got it. And just – I know some of the tax compliance costs this quarter, any thoughts on when we might see some resolution on that?

[Michael Schrum:]

Yes, the DOJ. Yes, I mean, there hasn’t really been a lot of traction, but there are – there is some activity in terms of reviews in supplying data, which is driving a bit of cost. But it’s really just kind of a watching brief to some extent. But it is kind of working its way through. It’s just not quite clear to us, what would trigger resolution still.

[Michael Collins:]

But there is still…

[Michael Schrum:]

…but there’s no bad news.

[Michael Collins:]

So contract in open communication in a very good relationship, I think, between the parties. So whereas Michael said, we’re working through it.

[Will Nance:]

Understood. Okay. Thanks, guys, for taking my questions.

[Michael Collins:]

Thanks, Will.

[Michael Schrum:]

Thanks, Will.

[Operator:]

The next question is from Don Worthington of Raymond James. Please go ahead.

[Donald Worthington:]

Thank you. Good morning, everyone.

[Michael Collins:]

Good morning, Don.

[Michael Schrum:]

Good morning, Don.

[Donald Worthington:]

Just a question on the provisions, what’s the outlook might be there, you’ve had reserve releases each quarter in 2018? What’s your thoughts are in terms of provisioning going forward?

[Michael Schrum:]

That’s a great question. And the releases really have been about sort of the backward looking, so pre-seasonal, if you will, provisioning models. And the fact that some of the larger losses have dropped out of our five-year look back. And therefore, some of those qualitative overlays around hospitality and C&I loans have kind of dropped out of the history, if you will. And so that’s created those Channel provision releases. I think, we’re at a level now, where the coverage is looking as it should. There’s no sort of qualitative overlays left there. We’re still not seeing any problem spots in terms of the loans. But I would probably expect for – I would probably not expect for those release to continue. I would expect for us to be sort of at the level we are now. We’re preparing for seasonal implementation, obviously, at the end of this year. Again, not expecting a whole lot of movement there, but clearly, that’s a work in progress as well. So we’re kind of thinking. It’s going to be event-driven, if we get any specifics and the general is kind of where it needs to be.

[Michael Collins:]

And all I would add to that is that, the mix of the loan portfolio being mostly residential, it’s sort of choose our – it’s resi at the moment. It’s very different than you’d see in a U.S. regional bank. And for those you know resi portfolio, it should have less volatility than commercial real estate or C&I lending or asset-based lending to retailers or any of the other types of stuff that might be embedded in U.S. regional bank.

[Donald Worthington:]

Okay, great. Thank you.

[Operator:]

Our next question will be from Arren Cyganovich with Citi. Please go ahead.

[Arren Cyganovich:]

Thanks. The longer-term target for the efficiency ratio is around 60%. What’s the timeframe do you think it will take you to achieve that?

[Michael Collins:]

Yes. So I think, we’ve been close a couple of quarters. We had obviously a redundancy cost that’s kind of not going to recur. But I don’t see, at the levels we’re forecasting expenses right now, absent any other headwinds, it’s a matter of quarters really. We’re pretty close this quarter. We are continuing to see elevated prefunding, if you will, of Jersey until we get the business fully embedded in. We’re taking the staff. We have a full space there. We have a computer set up and all that kind of stuff. So there’s a bit of – just a bit of timing gap, but it’s a matter of quarters really and then that will sort of back down effectively. And then obviously, if we get further rate rises, that could drift down further. But I think we’re pretty much there.

[Arren Cyganovich:]

Okay. And then on the net interest margin, I think, you talked about it being expected to be kind of flattish going forward. I think, I originally had expected the NIM to compress a little bit after you layered on a portion of the lower-yielding investment securities? I know – I think that maybe it’s the great British pound or the small segment of the euro that was going to have a negative impact? Is that going to drag down the NIM going once this is fully integrated to the Deutsche Bank deposit base?

[Michael Schrum:]

Yes. I mean, we tend to have a downdraft impact on the NIM. But then as you know, longer-term rates stay where they are. We’re still rolling over into higher rates on the investment portfolio in dollars. So that’s tending to have a couple of basis points. The other way then the mortgage repricing tends to be sort of a 6 basis point, 90-day lag type of thing. So upwards and then flat from there. So there’s a couple of things over the next three to four quarters. And I think we’ll certainly keep updating that are dragging NIM in either direction. I think, the lower deposit levels, particularly the lower euro deposits in the Channel Islands is going to have a beneficial effect relative to our previous expectation. So we actually – that would have been otherwise a drag on NIM in Q1. So it’s good. That’s why I kind of sort of saying flattish. We’re updating obviously, but that’s – our expectation is flat to a little bit up.

[Arren Cyganovich:]

Okay. Thank you.

[Operator:]

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

[Michael Collins:]

Thank you, and thanks to, everyone, for joining us today. We look forward to seeing with you soon. Have a great day.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.