The Bank of N.T. Butterfield & Son Limited
Q2 2017 Earnings Call Transcript
Published:
- Operator:
- Good morning. My name is Austin and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2017 Earnings Conference Call for the Bank of N.T Butterfield and Son Limited. All participants will be in 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 conference over to Brian Stevens, Butterfield Head of Investor Relations.
- Brian Stevens:
- Thank you, Austin. Good morning, everyone, and thank you for joining us today as we review Butterfield’s second quarter 2017 financial results. On the call, I’m joined by Butterfield’s Chief Executive Officer, Michael Collins; Chief Financial Officer, Michael Schrum; and Chief Risk Officer, Dan Frumkin. Following their prepared remarks, we will open up the call up for question-and-answer session. Yesterday, we issued a news release announcing our second quarter 2017 results. The release along with the slide presentation that we will refer to during our remarks on the call is available on the Investor Relations section of our website. Before I turn the call over to Michael Collins, I would like to remind everyone that today’s discussion will refer to certain non-GAAP measures, which we believe are important in evaluating the company’s performance. For reconciliation of these measures to U.S. GAAP, please refer to the earnings press release. Today’s call may also contain certain forward-looking statements, which are subject to risks and uncertainties. Please refer to the forward-looking statement disclosure contained in our SEC filings for a full discussion of the company’s risks factors. I will now turn the call over to Michael Collins.
- Michael Collins:
- Thank you, Brian, and thanks to everyone joining the call today. Butterfield is the full-service bank and wealth manager headquarter in Bermuda and operations here to Cayman Islands, Guernsey, Bahamas Switzerland and the UK. And Bermuda and Cayman Island, we offer retail, private corporate banking and trust and asset management services. In Guernsey, we offer trust, private banking and asset management services. Our Bahamas and Switzerland office provide personnel trust services while in the UK we offer residential property lending. Our long history and leading market shares in Bermuda and Cayman, allow us to secure low-cost deposits and originate high quality residential mortgages and commercial loans. Our core banking business when combined with our growing capital efficiency fee based businesses, help Butterfield generate industry leading returns on equity. We are aware of the unique environment which we operate and maintain a conservative liquid balance sheet to maximize safety and stability. Slide four highlights the second quarter results and shows how all these attributes combined to help produce solid core results and momentum as we execute our strategic plan. Net interest margin expanded 8 basis points from the first quarter due to the reprising of the mortgage portfolio and increase yield on the liquid portfolio. The bank's diversified fee generating businesses produced stable, non-interest income and the UK mortgage business have another strong quarter originating attracted risk adjusted assets and a continuing favourable credit environment. The second quarter also saw the successful staging of the 35th America's Capital Bermuda where despite the failure of team USA to deliver another come from behind victory the island demonstrated its ability to host a world class selling event and Butterfield welcomed more than 800 clients and guest at corporate related events, providing tremendous business retention and development opportunities for the bank. Turning to financial results, second quarter core earnings were $37.5 million which was a $1 million decrease from the last quarter, but a $5.4 million increase from the second quarter of 2016. Earnings were impacted by temporarily and elevated expenses that Michael Schrum will address in more detail. Despite higher than normal expenses, core return on equity of 21.6% demonstrates that our model and strategy are working. I’ll now turn the call over to Michael Schrum.
- Michael Schrum:
- Thank you, Michael and good morning to everyone. Starting with net interest income on slide 6. Second quarter increased $3.6 million over the prior quarter to $71.5 million, the increase was due mainly to improving yields on the Bermuda and Cayman mortgage books, as adjustable rates began to reset following the recent fed rate moves. We also benefited on our cash and short-term liquidity portfolios as a result of higher short-term rates. Subdued pricing in US dollar term rates kept the yield on our investment portfolio stable, but we are cautiously optimistic that we should see a more constructive term rate structure and better deployment opportunities in the second half of 2017. Slide 7 lays out the performance of our various fee businesses during the quarter which generated stable capital efficient, non-interest income despite some variability in these individual product lines. Banking fees primarily driven by cost transactions during the America's Cup period increased almost 9% in the quarter and offset a decline in FX revenue. At 35% Butterfield's fee income ratio is ahead of our peer average and helps produce industry leading returns on equity. As we've discussed, we continue to pursue accretive acquisitions in our core wealth management businesses in high quality jurisdictions that will help us build additional scale. I'd like to spend some time on slide eight as I believe our elevated expenses warrant some comment and an outline of our plans to return to a more normal level. The first thing I would like to reiterate is that we remain confident in our previous guidance of a core cost income ratio of around 60% without further rate moves or acquisitions by the end of this year. There are four items that have been driving expenses higher in 2017, marketing for the America's Cup, Sarbanes Oxley, investment in compliant systems and capabilities and the build out of our Halifax, Nova Scotia support centre. Second quarter marketing cost increased due to expenses related to the America's Cup which will not be recurring in the first quarter. Expenses related to Sarbanes Oxley and investment in compliance systems picked up in the second quarter but should start to level off by the end of 2017. Expenses related to the Halifax build out will likely continue through the end of the year before abating in early 2018 and thereafter we'll start to create operational efficiencies for the group. We continue to be very focused on expenses and expect to show significant progress by the end of the year as projects conclude and we achieve the anticipated savings. Slide 9 highlights capital levels, showing both Basel III regulatory capital as well as leverage capital. As a result of our strong capital generation and high ROE, Butterfield increased its Basel III capital ratio by a 120 basis points to 19.1%, a level well above both Bermuda regulatory requirements and the US average. Our common equity to total asset ratio also increased by 50 basis points to 6.7% and is now at the high end of our target range. For the second quarter of 2017 the Board declared a dividend of $0.32 per common share which reflects our ongoing balanced approach to capital management and commitment to providing shareholders with stable returns. Our capital management strategy is unchanged. We are investing in our existing businesses and we look for trust and wealth acquisition opportunities and quality jurisdictions that will allow us to grow our fee income. In the absence of any compelling acquisitions we anticipate reviewing the dividend and other capital allocation strategies in line with previous guidance and commitments. I will now hand over the call to Dan Frumkin to discuss the balance sheet.
- Dan Frumkin:
- Thank you, Michael, as Michael Collins mentioned we are aware of the unique environment in which we operate and seek to maximize safety and stability by managing risk while maintaining sufficient gap of all and then efficient and liquid balance sheet. Slide 10, summarizes the bank’s balance sheet at the end of the second quarter and shows a slight decrease in total assets of $10.7 billion compared to $10.9 billion in the first quarter of 2017. During the quarter, we continue to maintain a highly liquid position with 63% of our total assets comprised of cash and equivalence, short-term investments and investment assets. Loan balances remain flat from the prior quarter due primarily to commercial and residential loan amortization, offset by growth in new residential mortgages particularly in our UK mortgage business where we had another solid quarter of originations. Expecting cash outflows relating to two customers, one we made substantial private equity investments, and one, we funded a corporate restructuring resulted in the majority of the decrease in interest bearing deposits from the first quarter. Non-interest-bearing deposits increased by $66 million during the quarter. The cost of deposits was flat from the prior quarter at 11 basis points. Slide 11, provides a summary of our loan investment portfolios, the size and composition of our $3.6 billion loan portfolio is essentially unchanged from the first quarter and is comprised primarily of residential mortgages. Non-performing loans which include gross non-accrual loans and accruing loans past due by 90 days or more totalled $61.8 million as of June 30, 2017, which represents an increase of circa $4 million from the first quarter. This is due to one $5 million relationship that is now in litigation. No provision has been made on this new nonaccrual as at this juncture the bank believes it is protected by sufficient collateral. The net charge-off ratio remains at a low one basis point for the quarter. Our investment portfolio remains stable at $4.6 billion as a lack of attractive pricing in the US dollar term rate market deterred any significant rebalancing. We are cautiously optimistic that we will have opportunities to prudently deploy more capital into this market in the third quarter. At quarter end, approximately 92% of the investment portfolio was comprised of AAA rated securities. Overall, we continue to be pleased with our asset quality and the strength of our balance sheet. On slide 12, you will see our interest rate sensitivity. Butterfield remains significantly more sensitive to interest rate increases versus our US peers as you can see on slide 12. Looking at the graph, on the upper right, a 200-basis point increase in rates would generate an uptick in net interest income of 12.7% versus our US peers at 5.7%. Now, I will turn the call back to Michael Collins for closing remarks.
- Michael Collins:
- Thank you, Dan. The second quarter demonstrated the strength of the Butterfield franchise with expanding net interest margins, stable fee revenue, continued low cost deposits and poor return on equity above 20%. Looking forward, we will continue to execute our strategy with the focus on growth and shareholder returns, we will also continue to focus on expenses which should further boost our return and benefit our shareholders. Finally, as announced in yesterday’s earnings release, it is my privilege to assume the role of Chairman of the Butterfield Board in addition to my current duties as Chief Executive Officer. As we continue to successfully execute against our strategy, I look forward to working with my fellow board members including newly named lead Independent Director David Zwiener and engaging the wide range of expertise they all possess. On behalf of the entire board, I also want to extend my gratitude to Berkeley Siemens for his service to the bank as a Director and Chairman through our IPO and secondary offering and to Wolf Schoellkopf for his services as a Director since 2010. With that, we’d be happy to take your questions. Operator?
- Operator:
- Thank you. We will now begin the question-and-answer session [Operator Instructions] Our first question comes from Will Nance with Goldman Sachs. Please go ahead.
- Will Nance:
- Hi, guys. And maybe just start on the margins, so I guess on commercial loan yields in particular did you guys have talked about I guess 10 basis points to 15 basis points expansion and I think they were up something like 40 basis points. So, is there anything to call out there in terms of no noise purchase accounting, recovering, something on those lines. And then maybe looking forward, is there any kind of colour you can help us with on trajectory of those factoring in kind of the last two rate hikes that we've seen?
- Dan Frumkin:
- Hi, Will. Dan, how are you. Listen, thanks for the question. Yeah, you’ll see the commercial loans have increasing from 4.9 to 492, so it’s about 43 basis points quarter-on-quarter. There is some one-off noise in there however, so I think the guidance of sort of 15 basis points to 20 basis points was the right guidance at the time. There was a bit of restructuring fees that came through as a one off, that was probably worth 5 basis points or 6 basis points of the increase. There is a day jam issue between the first quarter and second quarter, there was worth another 4 basis points or 5 basis points. And then we had a bit of transit or issues we were restructuring couple of low yielding credits. So, actually they come out of the average balance as you will see they drop, but they’re back in as you get to the tail end of June. So, there’ll be in the run-rate as we go forward. So, sort of all of that taken together is probably half of the 43 basis points maybe a little more than half of the 43-basis point increase. So, I think your thought process was about, right. And again, we adjust commercial loans immediately after the base rate rises other than the step [indiscernible] LIBOR, which is 90-day notice stuff. But the reality is, is the rate was already embedded in there, unlike our residential lending portfolio in Bermuda where you know it has a 90-day lag as we have to provide notice. So, the second, the last rate move won’t bleed through into our Bermuda residential mortgages until September, so that’s where we sit here today.
- Will Nance:
- Got you. Thank you. And then maybe on the second -- just a follow up on the expenses. So, I appreciate you guys reiterating the 60% of efficiency ratio target for the end of the year. Given that you have, I guess you called out four different points that are kind of elevating the expenses right now and some of those aren’t expected to abate until the end of the year and maybe looking into next year. Could you maybe help us think about the efficiency trending maybe into next year and where you guys ultimately think you can run that?
- Michael Collins:
- Yeah. I’ll start and thanks for the question, it’s Michael. So, we still think we’re going to get to 60% efficiency as we said in Q1. So, I think we telegraphed that we have a bit of bump in expenses this quarter but we're still very confident given our run rate where we're going to be sort of early next year but I'll let Michael Schrum give you some detail.
- Michael Schrum:
- Yes thanks, good morning Will. You know so as you saw we're just starting at the sort of 74 core net income. Obviously, America's Cup was a bump in Q2 that won't repeat so between marketing and a bit of property related expenses it’s approaching the sort of $2 million mark in the quarter so that's immediately out and normalizing in Q3. You know between socks and compliance programs we're running to pace to complete those his programs, obviously as you know we're getting self-compliant this year. All the documentation's done etc and the testing is about to begin. So, this quarter was kind of a big quarter to get that over the line. Between socks and compliance you're probably looking at sort of five on the quarter and then that will probably stabilize at around the 2 mark in Q1, the timing around that is a little bit uncertain in terms of some of that will be stabilized in Q3 and some of it will be stabilizing in Q4, and then finally the build out of Telefax which will start to generate operational efficiencies into 2018 but build out and duplicate head count as we onboard people there, you know will start to abate and start to generate actual net savings into 2018. So that, that's kind of the guidance is still the same, the timing between the two quarters probably a little bit uncertain but certainly America's Cup is a big one in Q2.
- Operator:
- Our next question is from Alex Twerdahl with Sandler O’Neill, please go ahead.
- Alex Twerdahl:
- First off, I was wondering if you can just give a little bit of commentary on the assets under trust ticked up or maybe rebounded from the fourth quarter fairly substantially, is that due to just the valuation of some of these assets or did you actually pick up or potentially pick up some additional customers mid quarter.
- Dan Frumkin:
- Alex thanks, it's Dan. No, it's really just a revaluation as we work through the HSBC portfolios that we acquired about a year ago, we're going through sort of our annual cycle of risk and operational reviews and as part of that valuations get done and we start looking at making sure that all of the AUA is on our core system. It's more that and as you know as well as anybody we're not sort of bank in New York or one of those models, AUA isn't really a driver of revenue for us, it's just sort of a natural outcome of the underlying trust assets the way we bill for trust services isn't directly connected to AUA.
- Michael Collins:
- And if you remember Alex while some of its financial assets but a lot of its privately held businesses that are mortgage [indiscernible] to value but we keep looking at it.
- Alex Twerdahl:
- And then, you know obviously there's a lot of uncertainty about the outlook for interest rates going forward, but if the ten-year treasury kind of stays within the range it's been for I don’t know the last couple of months stays below 240 which is below kind of where I know you guys would ideally like to put excess cash to work for the remainder of the year. At what point does the strategy change to actually start to pull in cash as potentially lower yields versus what you know kind of ideally would be the case.
- Michael Collins:
- Yes, no, thanks for the question, it's a great one. As you know we've been sort of patient this quarter really, but if you look at the financials you see that there is actually a category there where we executed some trades that were pending settlements into this quarter. We’re cautiously optimistic that we’ll see a constructive environment in the second half, we’ll up see the fact decision on timing around tapering et cetera. But, as you know the investment portfolio is really there to manage the interest rate risk in the banking book, so, we will continue to look forward as banks mature. We’ve been a little bit patient, this quarter, but I would say if we don’t any constructive change in term rates, we’ll continue to manage the risk profile of the investment both to offset the interest rate risk that really comes from the floating rate loan book and the favourable deposits in the second half. So, we will look for entry points, but we will not start to change the interest rate risk profile maturity of the bank. We’re still very asset sensitive and as you can see we picked up quite a bit on the short end of the curve. So, that’s obviously helping as well.
- Alex Twerdahl:
- Okay. And then just one final question for me. I was wondering if you can just give some commentary on when you raise the Butterfield Bank rate or loans reprised higher particularly residential loans in Cayman, how does the payment for the borrower change when that happens? And really what I’m trying to get at is clearly you’ve been kind of running against this headwind of a lot of amortization in your different portfolios, and since there is not a lot of organic loan growth that tends to be pretty meaningful for you. So, as rates go higher does the amortization schedule for these loans actually change in such a way that maybe we can actually see a little bit more loan growth than previously expected as the rate continues to move higher?
- Michael Collins:
- So, Alex it’s a good question. And one we’ve talked about internally. So, for one of the base rate moves in Bermuda, we didn’t change the payment in Bermuda. So, in essence we extended the amortization on those assets. In both jurisdictions, we’ve gone out with the mail to all customers that gives them the opportunity to hold payments flat and again that would extend the amortization. The take up on that offer has been less than we would have hoped. We think we would have difficulty unilaterally not changing the payments to hold the amortization based on conversations we’ve had with the regulator. So, at this juncture, we adjust the payment to sort of hold the amortization. We don’t adjust the amortization to hold the payment if that makes sense. But we do have the ability for customers come in and we have written and contacted all customers to ask whether they would like to hold their payments swap. And we'll revisit it as we move forward and again as we come further off the bottom, we clearly have a lot of capacity based on our average loan to value profile in both portfolios to really help customers through this rate move by extending amortization. And as you said as rightly say as long as it’s the right thing to do for the customer, it clearly is beneficial for all parties.
- Operator:
- [Operator Instructions] Our next question comes from Fred Cannon with KBW. Please go ahead.
- Frederick Cannon:
- Great. Thanks for taking my question. Most of the issues have been addressed, a couple of clarifications. One, in terms of the mortgage book fee, I get the fee June rate rises is going to flow through until the following quarter. The March rate rise though, we won’t get a benefit out of the mortgage book, because it’s only every other rate rise that goes in. Can you just remind me of how that plays itself out?
- Dan Frumkim:
- So, well that’s how we model for interest rate rest, we have passed the loan book for March rate rise and the June rate rise to our Bermuda mortgage customers. So, the March rate rise kicked in at June 19 for memory. And so, you really didn’t have much effect in the second quarter you get the full effect out in the third quarter and the June rate rise I think kicks in September 19 or 23, and again you’ll see part of that in the third quarter. While we model our interest rate risk that way, I think it’s a conservative assumption and we don’t have any forward-looking view what we’ll do on the next rate rise assuming she holds her nerve and we actually get one.
- Frederick Cannon:
- Okay. Got it. So, in the last quarter we saw what I say the December rate rise, this coming quarter we will see the March rate rise in the following quarter?
- Michael Collins:
- Right. Exactly, exactly. And then the delay is really only for the Bermuda residential mortgage portfolio which is about $1 billion to $1.2 billion, Fred.
- Frederick Cannon:
- Right. Got it. And given the previous discussion on both, I mean given the growth rate we’ve seen in the capital ratios and the concern about investing the excess cash that you guys have in more securities, any update on your in terms of capital deployment vis-à-vis share repurchases or the dividend?
- Michael Schrum:
- Yes. Thanks, Fred. It’s Michael Schrum, so as you correctly said we’re at the upper end of capital target range now and we’ve certainly just in the conclusion of the board meetings started to have those conversations and they will continue into as we’ve guided to before once we see the plan for next year. We’re still guiding towards that 50% pay-out ratio on the cash side. And then, I think there was quite a lot of receptiveness towards looking at share repurchase program as well. So, we’ll have more conversations and dialogue around that in the fourth quarter.
- Operator:
- This concludes our question-and-answer session. I’d like to turn the conference back over to Brian Steven for any closing remarks.
- Brian Stevens:
- Thank you, Austin and thanks to everyone for dialling in today. Look forward to speaking with you again next quarter.
- Operator:
- The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.
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