Bank of NT Butterfield & Son Ltd (NTB) 2016 Q4 法說會逐字稿

Good morning. My name is Anita, and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth-quarter and full-year 2016 earnings call for The Bank of N.T. Butterfield & Son Limited.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the call over to Mr. Mark Johnson, Vice President, Group Head of Communications for The Bank of N.T. Butterfield & Son Limited.

Thank you. Good morning, everyone, and thank you for joining us today as we review Butterfield's fourth-quarter and full-year 2016 financial results. On the call, I am joined by Butterfield's Chief Executive Officer, Michael Collins; Chief Financial Officer, Michael Schrum; and Chief Risk Officer, Daniel Frumkin. Following their prepared remarks, we will open the call up for a question-and-answer session.

Earlier today, we issued a news release announcing our fourth-quarter and full-year 2016 results. The release along with the slide presentation that we will refer to during our remarks on the call today is available on the investor relations section of our website. Today, we also filed the Form F-1 with the United States Securities and Exchange Commission for a secondary offering of our shares. Due to quiet period restrictions, we will not be able to comment on the secondary offering on today's call.

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 a reconciliation of these measures to US 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 risk factors. I will now turn the call over to Michael Collins.

Thank you, Mark, and thanks to everyone joining the call today, which is our second since Butterfield's initial public offering on the New York Stock Exchange just in September 2016. I will give a brief overview of our strategy, execution, accomplishments, and financial results in 2016. Michael Schrum and Dan Frumkin will then go into further detail on our fourth-quarter and full-year financial results.

Starting with slide 3, while many of you are familiar with Butterfield, I'd like to provide an overview of the Bank and reiterate what we believe to be our core attributes and competitive strengths. Butterfield is a full service bank and trust company with a leading market share and pricing power in our banking jurisdictions, Bermuda and Cayman. We offer community banking services composed of retail and corporate banking to individuals, local businesses, captive insurers, reinsurance companies, trust companies, and hedge funds.

Our banking products include personal and business deposits, residential and commercial mortgages, small business loans, credit and debit cards, merchant acquiring, mobile and online banking, and cash management. Butterfield's award-winning wealth management business, located in Bermuda, Cayman, Guernsey, Switzerland, and the Bahamas provides trust, private banking, asset management, and custody services to ultra-high net worth individuals and family offices based in Asia, Europe, and Latin America.

As an additional service, Butterfield Mortgages Limited provides residential mortgages on properties in central London for our international clients with an interest in establishing a presence in the UK. Butterfield's strong capital generation and high returns are driven by a number of factors, including recurring fee income, low cost deposits, high yielding floating rate loans, a conservative capital efficient investment portfolio, and our presence in income tax mutual jurisdictions.

In 2016 we achieved a core return on average common tangible equity of 20% and attractive return considering that two-thirds of our assets are held in cash and securities, which are invested primarily in lower risk, US government, and federal agencies. Our strategy is simple. We expect to continue to produce high risk adjusted returns relative to our US regional bank peers due to our unique business model.

A leading market share, high barriers to entry, and pricing power in each of our banking jurisdictions will generate excess capital that will be used to pay dividends and build our wealth management business through trust acquisitions. With a long and recognized history of structuring trusts for mobile, ultra-high net worth families, we are well positioned to service the global private wealth business emanating from Asia, Europe, and Latin America.

Turning to slide 4, our community banking and wealth management businesses performed well in 2016, leading to a 22% increase in core net income. During the year, we successfully repositioned the Bank by acquiring HSBC Bermuda's wealth management business and completing the wind down of our UK private bank. The integration of HSBC wealth and the conversion of our deposit-taking UK bank into a mortgage company for ultra-high net worth clients were both executed on time and within budget.

In September 2016, the Bank completed a successful initial public offering on the New York Stock Exchange, which enhanced trading liquidity for shareholders and provided the Bank with access to international capital. Following the IPO, we deployed $212 million of capital to repurchase preference shares, saving $15 million of annual preferred dividends and government guarantee fees, funds that will be used for the benefit of our common shareholders. The Board has declared a common dividend of $0.32 per share for Q4 2016, which is triple the $0.10 quarterly dividend paid to common shareholders for the fourth quarter of 2015.

This morning, we reported strong results for the full year with 2016 net income of $115.9 million, up 49% over 2015. Excluding non-core items, core net income rose from $113.9 million in 2015 to $138.6 million in 2016, an increase of 22%. 2016 core earnings per share was $2.48.

2016 was an important year for Butterfield. We made good progress in executing our strategy, producing healthy returns while acquiring HSBC Bermuda's wealth business, winding down our UK bank, listing on the New York Stock Exchange, redeeming the preference shares, and increasing the Q4 dividend to $0.32 per share.

I'll now turn the call over to Michael Schrum, our Chief Financial Officer, to talk more about our financial results.

Thank you, Michael, and good morning to everyone on the call. I'll now take you through some details of our 2016 financial results with emphasis on the fourth quarter. For further reference, we've also attached an expanded quarterly appendix at the end of this presentation as well as a full quarterly reconciliation of any non-GAAP financial measures used.

On slide 6, we show a summary income statement and a quarterly trend. Butterfield posted net income for the fourth quarter of $35.4 million and core net income of $37.1 million. This represent growth in both net interest income and fee income, as well as a net reduction in credit costs and expenses in the quarter. We saw continued growth in deposits and a marked increase in liquidity returns. The coefficiency ratio for the quarter was 65.5% and 63.8% for the full year.

Turning to slide 7, the growth in net interest income in the current quarter is in line with recent trends. As we continue to deploy excess liquidity into longer-dated US agency securities, primarily in the health to maturity category, we saw attractive entry points in rates shortly after the US election. New and high-yielding securities have already stabilized investment yields in the quarter and positively contributed to our running book yield.

We also took the opportunity to reprice the entire dollar loan book following the Fed rate hike in mid December. Residential mortgages impacts follows a 90-day notice period from the 15th of December 2016. On the customer deposit side, we've held rates while continuing to win market share. Our cost of deposits in the quarter was 13 basis points, which continues to remain significantly below US regional peers at around 27 basis points. The overall net interest margin improved by 6 basis points to 2.45% in the quarter, consistent with the improved liquidity returns and returns on the new held to maturity investment additions.

Highlighted on slide 8 is the steady upward trend in non-interest income over the past four years, driven by both core market share growth, as well as the impact of the addition and retention of our acquired fee businesses. The fourth quarter is normally a busy period for [Troezen]-related foreign exchange and banking fees in our Cayman business, as well as seasonal holiday activity in the cash business in Bermuda and Cayman as the management fees increased in the quarter as underlying portfolio evaluations improved.

We also saw an uptick in brokerage and asset management fees due to new assets under management. This was achieved by targeted marketing to recapture redemption proceeds from the Bank's own preference share capital retirement. Throughout the past three years, our core fee income ratios remained above 35% and reached 36.7% in the fourth quarter of 2016. This compares favorably to similar sized US banks with a median fee income ratio at around 25%. These annuity-like fees continue to represent a capital efficient and important revenue flow for the Bank.

Turning to slide 9, we continued to make good progress with expenses. Expenses decreased from prior quarter due to the vesting cost of legacy option expenses in the third quarter. This was offset in the fourth quarter by tail core expenses from the UK restructure, as well as higher than usual costs for customer compliance file reviews. In addition, we've now started to make premium payments to the Bermuda deposit insurance scheme, and finally, we now have some new costs associated with being a US public company. For the full year, the core cost efficiency ratio improved by 230 basis points to 63.8%.

On the capital management slide on slide 10, you will note that we continued to manage capital resources in a conservative and prudent manner. During the quarter, we retired the expensive 8% preferred share capital issue, which will make an additional $16 million available to common shareholders annually.

At 31 December, total regulatory capital stood at 17.6% with a common equity tier 1 ratio at 15.3%. These ratios remain well above regulatory minimum under the standardized Basel III regime operating in our core operating segments. Our leveraged capital ratio at 5.9% is now in line with our target range. We continue to operate below the median of comparable US banks due to the relatively lower credit risk density of our balance sheet. The ex-cash leverage ratio was more comparable at 7.3% at the end of the year.

Finally, on the capital side, we declared our first quarterly dividend after the IPO and preference share capital redemption of $0.32 per share. This represents a more than threefold increase from the prior quarters and equates to $1.28 per share on an annualized basis.

Now, I'll turn the call over to our Chief Risk Officer, Dan Frumkin, to talk about the balance sheet.

Thank you, Michael. As both Michael Collins and Michael Schrum highlighted, Butterfield continues to generate strong profits and deliver on our promises to shareholders. As part of our overall strategy, we continue to focus on maintaining our efficient and liquid balance sheet while strategically managing the Bank's risk profile.

Turning now to slide 11, as of December 31, 2016, our total assets were $11.1 billion, a slight increase over the $11 billion in quarter three. For the year, assets were up $0.8 billion, attributed largely to the acquired deposits that were invested in securities offset by the exiting the UK deposit-taking operation and changes in the USD/Great British pound exchange rates throughout the year.

Growth was supplemented by normal business as usual activities, as can be seen from the deposit growth in quarter four. Loans declined by $260 million in quarter four, driven mainly by a $200 million repayment of a government overdraft, as the government successfully issued a bond in early quarter four. In addition, the annual reduction in loans of $430 million was driven by the above repayment, the changes in USD/GBP exchange rates reducing loan balances by $101 million during the year, and a lack of opportunities to lend in our core markets.

A factor in lower new loan volume was the UK restructure that distracted the team originating new UK mortgages. We continue to maintain a highly liquid position with 65%, or $7.2 billion of our total assets comprising cash, short-term securities, reverse repurchase agreements, and investments. The bank continues to benefit from an attractive core deposit base with a combination of interest bearing and non-interest bearing accounts.

As of the end of 2016, our total deposits were $10 billion, which is $357 million increase from Quarter Three and an increase of $850 million from year-end 2015. The growth in deposits was driven primarily by the HSBC acquisition, though this was reduced by the effects of the wind-down of the UK deposit taking and asset management businesses, and the FX effect on sterling denominated deposits in Guernsey and Bermuda. The quarter-four growth was driven organically as the HSBC acquisition occurred earlier in 2016.

Turning to slide 12, the Bank continues to maintain a conservative balance sheet. Our loan portfolio remains largely residential mortgages, which are individually manually underwritten. The Bank has benefited from a stabilizing macroeconomic environment with a reduction of both non-performing and non-accrual loans. Net charge-off rates remain low when compared to our US peers. This is driven by the fact that almost all lending at the bank is secured and that the loan to value profile and the residential mortgage book is conservative.

New residential mortgage originations in Bermuda are limited per policy to a maximum 80% loan to value, while in the UK, we limit new residential mortgages to a maximum 65% loan to value. The investment portfolio is 87% AAA-rated securities and 100% investment grade. The Bank continues to maintain a highly liquid and conservative balance sheet.

Turning to slide 13, you can see the Bank remains more asset sensitive than US peers. This asset sensitivity is after increasing the size of the HTM investment portfolio and increasing duration on the overall investment portfolio during quarter four. You can see the spot HTM balances at year end is above the average balance for the quarter as investments were made late in the quarter.

Now, I will turn the call back over to Michael Collins for closing remarks.

Thank you, Dan. Before we open up for questions, I would just like to reiterate our key highlights of the year and how they are evidence of our ongoing ability to execute our strategy for the benefit of our shareholders.

We continue to make excellent headway in support of our strategic plan with the acquisition and seamless integration of HSBC Bermuda's private banking, investment management, and trust business in furtherance of our goal to scale our trust and management business in core markets. In line with our focus, we restructured our UK operations to focus on our competitive strength in the residential property lending business there.

And of course, we successfully completed our initial public offering of common shares on the New York Stock Exchange on September 16, which in turn funded the redemption of our 2008 preference share issue in the fourth quarter. Our results in the fourth quarter and for the full year were strong with sustainable earnings performances evidenced by the 49% increase in net income and 22% increase in core earnings. And Butterfield continues to be recognized in honor for our leadership in core markets and key business units.

Everything we've accomplished in 2016 has established an exceptionally solid foundation for our future growth as an independent bank and trust company. We look forward to continuing to service our customers and provide strong and stable returns to our shareholders by focusing on our core markets, maintaining our leading position in Bermuda and the Cayman Islands, and scaling our trust and asset management business.

Thank you, Michael. We'll now open the call up for questions.

(Operator Instructions)

The first question comes from Alex Twerdahl with Sandler O'Neill.

Good morning, guys.

Good morning.

I wanted to start with a follow-up on slide 13 about the interest rate risk. First off, the percentages here in the parallel shift, is the base case for that, is that year end of 2016?

And then just as a follow-up to that, can you just remind us which percentages of loans repriced immediately with the rate hike in December? And how much there is that has yet to reprice based on a 90-day lag between the rate hike and the increase to the Butterfield base rate?

Sure, Alex. This is Dan Frumkin. The sensitivities you see in the upper right on slide 13 are based off of the balance sheet at December 31, 2016. It would incorporate the HTM investments made late in the quarter. It would also incorporate the reduction in loan balances.

In terms of what repriced automatically, our commercial loan portfolio in Bermuda repriced at the time of the announcement and our Cayman loan book repriced. What's still to reprice is the Bermuda residential mortgages where we had to provide 90-day notice. That notice runs off and prices increase on March 13 or 14, I believe.

March 14.

That's about $1 billion. The parts that have already repriced are about $1.2 billion, $1.3 billion. We pass along the full 25-basis-point move.

Okay. Great. Thanks for that. With respect to that $200 million government loan that I think we knew about that was going to come due, or I guess come off the balance sheet in the fourth quarter, are there other opportunities as the government comes up with this budgeting and whatnot to finance short-term budgetary shortfalls or whatnot that could just add to loan balances as the year progresses?

Yes. Thanks, Alex. There are more opportunities. We continue to talk to the government about their cash needs. And over the last few years, we act as a bridge financer basically between their cash needs and then there going to the markets. Obviously, they don't want to go to the markets consistently.

So that $200 million came off. We'll continue to talk to them about whether they need short-term loans. But I think it's fair to say that, given the fact that it will usually end up with a capital markets transaction, those balances will go up and down.

I think the $3.6 billion you see today, absent the government loan and absent the sterling move, which was $300 million out of the $400 million in decline in the quarter, I think that's kind of the core loan book that will consistently stay flat. But we'll continue to work with the government. And I think, to your point, there are more opportunities to do bridge financing.

Okay. Great. Then a just final question for me: As I look at the fee income lines, some of these items seem like they've jumped up pretty good in the fourth quarter: asset management, banking, FX. I know you've addressed those to some extent in your prepared remarks, and we talked about seasonality and FX in the last quarter's call. Is there some stuff in here that might well be in core might not be recurring into 2017, stuff that maybe was just one time for the fourth quarter?

No, that's all recurring. Obviously, what you're seeing, particularly in asset management, is the full integration of HSBC wealth. So that's increased those lines.

Then on the banking side, we've consistently increased our banking fees and transaction fees usually on an annual basis during January 1, but we've continued to move up. As our compliance costs go up, we're able to pass that on to clients because it's more and more expensive to take on clients. So we're continuing to pass on our costs. So I think what you're seeing at about 36% fee income ratio is recurring and very sticky.

Great. Thanks for taking my questions.

Our next question comes from Will Nance of Goldman Sachs.

Hello, guys. Good morning. The first question was just on tax policy -- a bigger picture question. If we do see some sort of border tax adjustment, obviously acknowledging that policy details are still a little bit hard to come by, what should we be thinking about in terms of potential impacts to some of the international businesses in your jurisdiction?

Okay. Thanks, Will. It's a very good question. It's obviously something near and dear to our hearts that we're keeping an eye on. I think it's a little early for anyone outside the US, and particularly Bermuda and Cayman and Guernsey, to fully see what's going to happen in terms of the Trump tax policies and what the impact is going to be.

I'd say, broader picture, although it is early, obviously a border adjustment tax would be a net negative for Bermuda. There is some sense that services like reinsurance potentially could be carved out. But we'll have to wait and see what happens there.

I would also say that reinsurance and captive insurance companies are in Bermuda for a lot of different reasons. These are global companies, and won't necessarily be completely dictated in terms of moving or deciding to have a different strategy just based on tax. They're here because of the market and the infrastructure.

And then secondly, I think the overall tax policy, if that were to decrease down to 15% or 20%, there would be compression I think between what you'd see in terms of tax cost in the US and outside Bermuda. But again, these are global companies that do two-thirds of their premiums outside the US. I wouldn't necessarily see all of them or a lot of them setting up in the US for a third of their earnings.

I think overall from a regulatory perspective, we're obviously not in the US so we look at what's happening in the US, we look at what's happening with Brexit. I think the most impactful part of all this is if there is infrastructure spending, if there is a reduction in tax, and there is inflationary aspects to that, then obviously our interest rate sensitivity would be really important to the story.

So I think -- in some way, I think it's wait and see. I don't think there's any reason to be overly concerned at this point. There's a lot of moving parts. But we sense that all of it is moving towards a different interest rate cycle which will help us.

Great. Thank you for taking my questions.

(Operator Instructions)

Our next question comes from Jefferson Harralson with KBW.

Hi, thanks. Can you guys talk about your capital strategy? I know you guys, because of the shape of your balance sheet, you have lower leverage and very high regulatory ratios. Is there room to optimize this? Are you where you want to be on your capital structure?

Thanks, Jefferson. I'll start off just by saying that I don't think our -- our guidance is the same as it's been. So in terms of the TCE ratio, we're still thinking 6% to 6.5%, and we're very, very comfortable with that. But I'll pass it off to Michael.

Thanks, Jefferson. As you know, we have a very efficient balance sheet, very low risk density. If you look in the press release as well, you see risk weighted assets remain flat at around $4.3 billion, risk density around 40%. We feel very comfortable on the 6% to 6.5% leverage capital basis.

Regulatory capital is what it is, if you will. We don't per se get a tax benefit out of issuing debt, but it is an expensive capital structure to run. I think we're pretty much where we are in the 6% to 6.5%.

Obviously, as rates go up, some of that leverage, some of the AFS securities may impact the [TC to TA] as well. We would like to run with a little bit of a buffer over the 6%. And then as we go through a couple more quarters, we've agreed with the Board we'll come back and talk about dividend policy, et cetera, and it's the fourth quarter this year, so let's get through a couple quarters with the new dividend.

All right. And one last one: I think you guys touched on it a little bit. Can you talk about the drivers to loan growth this year? Can it be flat? Can it be a little up this year? And what are the milestones we should be looking at to see if that can happen?

Thanks again, Jefferson. I think our view is that our loan portfolio, which is just about $3.6 billion today, will continue to stay flat. As I said, the reduction recently in last quarter from $4 billion to $3.6 billion was $200 million of that was this government loan that repaid that possibly could come back a bit, and about $100 million in FX impacts from our sterling loans, so most of that was really explained by those two items. So it really is, has been relatively flat.

We don't see it increasing. I think we've said consistently that we have a very different business model than most US regional banks, and that with basically with capital flows, deposits 3 times GDP in Bermuda and Cayman, we're always going to have a lot of deposits that we're going to have to invest elsewhere.

We're not interested in going outside our home markets to find loans. I think that doesn't usually end well. I think we're going to stick to our knitting, be consistent, and I think it's going to stay around $3.6 billion.

(Multiple speakers) the only thing I'd add, Jefferson, is that I've gone through, as you would expect, in anticipation of this call, pretty detailed forecasts from all the business for the next couple of quarters, and I think we'll see some more activity out of our UK residential lending operation. They were clearly distracted with the wind-down last year. That pipeline looks pretty good.

I think in Bermuda and Cayman, as we flagged all along, the opportunities for us to grow that book are somewhat muted. And again, from a risk perspective, the majority of our loans amortize, so we sort of have to run fast to stand still.

So I think Michael's guidance is right. I think it will be flat to slightly up as we make our way throughout the year, with the biggest swing factor being what Alex highlighted, which is the government of Bermuda potentially borrowing in between bond issues.

All right. Outstanding. Can you talk about the level of -- or I guess how to ask this -- about the potential to acquire trust companies over the next 12 to 24 months? Do you feel like that's increasing in potential now that you're public? Or is it the same or maybe is it a little bit muted for some reason?

I would say it's the same. We've hired an advisor based out of London who specializes in trusts, and our trust team is methodically -- we've methodically gone through the potential companies that we can acquire.

I would say that we're staying disciplined. If you remember what our investment criteria were, one, it has to be 8 times EBITDA or below, which is basically trying to prove that there's this dislocation in the market. It's got to be in the jurisdictions that we already have scaled, so Bermuda, Cayman, Guernsey. It's got to be two-thirds private trust. We don't want a lot of company administration or mutual fund administration.

And we've stayed disciplined. We've seen quite a few opportunities since we spoke last, and looked at a couple of them pretty seriously. But at the end of the day, unless it really meets our needs, I think there is plenty of opportunities out there.

So we're being methodical. It takes time. I would say the opportunities are definitely still there. And as I said in our opening, we're throwing off, generating a lot of capital, a lot of banking, and our strategy still is to invest in trust companies, but we will do it methodically and cautiously and take our time. Nothing's changed in that guidance.

All right. Thanks, guys.

(Operator Instructions)

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

Thank you, Anita, and thanks to everyone for dialing in today. We look forward to speaking with you again soon.

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.