Bank of NT Butterfield & Son Ltd (NTB) 2017 Q2 法說會逐字稿

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 & Son Limited.

(Operator Instructions) Please note, this event is being recorded.

I would now like to turn the call over to Bryon Stevens, Butterfield's Head of Investor Relations.

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 am 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 the call up for question-and-answer session.

Yesterday, we issued a news release announcing our second quarter 2017 results.

The release, along with a 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 risk factors.

I will now turn the call over to Michael Collins.

Thank you, Bryon, and thanks to everyone joining the call today.

Butterfield is a full-service bank and wealth manager, headquartered in Bermuda with operations here, the Cayman Islands, Guernsey, The Bahamas, Switzerland and the U.K.

In Bermuda and the Cayman Islands we offer retail, private and corporate banking and trust and asset management services.

In Guernsey, we offer trust, private banking and asset management services.

Our Bahamas and Switzerland offices provide personal trust services, while in the U.K. we offer residential property lending.

Our long history in 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 efficient fee-based businesses, helped Butterfield generate industry-leading returns on equity.

We are aware of the unique environment in which we operate and maintain a conservative, liquid balance sheet to maximize safety and stability.

Slide 4 highlights the second quarter results, and shows how all of these attributes combine to help produce solid core result and momentum, as we execute our strategic plan.

Net interest margin expanded 8 basis points from the first quarter due to the repricing of the mortgage portfolio, and increased yield on the liquid portfolio.

The bank's diversified fee-generating businesses produced stable, noninterest income and the U.K. mortgage business had another strong quarter.

Originating attractive, risk-adjusted assets in a continuing favorable credit environment.

The second quarter also saw the successful staging of the 35th America’s Cup in 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 sailing event, and Butterfield welcomed more than 800 clients and guests at cup-related events, providing tremendous business retention and development opportunities for the Bank.

Turning to financial result, second quarter core earnings were $37.5 million, which was $1 million decrease from the last quarter, but a $5.4 million increase from the second quarter of 2016.

Earnings were impacted by temporarily 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.

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 U.S. 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, noninterest income despite some variability in the individual product lines.

Banking fees, primarily driven by card 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 8, 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 iterate -- 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 this year.

There are 4 items that have been driving expenses higher in 2017.

Marketing for the America’s Cup, Sarbanes Oxley, investment in compliance systems and capabilities and the build out of our Halifax, Nova Scotia Support Center.

Second quarter marketing cost increased due to expenses related to the America’s Cup, which will not be recurring in the third 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 fading in early 2018, and thereafter, will 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 120 basis points, to 19.1%.

A level well above both Bermuda regulatory requirements and the U.S. 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 in 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.

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 capital in an 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 equivalents, 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 U.K. mortgage business, where we had another solid quarter of originations.

Expected cash outflows related to 2 customers.

One, who made substantial private equity investments, and one who funded a corporate restructuring, resulted in a majority of the decrease in interest-bearing deposits from the first quarter.

Noninterest-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 and 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.

Nonperforming loans, which include gross nonaccrual loans and accruing loans past due by 90 days or more, totaled $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 remained at a low 1 basis point for the quarter.

Our investment portfolio remains stable at $4.6 billion, as a lack of attractive pricing in the U.S. dollar term rate market deterred any significant rebalancing.

We are cautiously optimistic that we'll have out 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 U.S. 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 U.S. peers at 5.7%.

Now I'll turn the call back over to Michael Collins for closing remarks.

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 core return on equity above 20%.

Looking forward, we will continue to execute our strategy with a focus on growth and shareholder returns.

We will also continue to focus on expenses, which should further boost our returns 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 Barclay Simmons 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 Director since 2010.

With that, we'd be happy to take your questions.

Operator?

(Operator Instructions) Our first question comes from Will Nance with Goldman Sachs.

Maybe I could just start on the margin.

So I guess, on commercial loan yields, in particular, I think you guys had talked about like a 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 noise, purchase accounting, recoveries, something along those lines?

And then maybe looking forward, is there any kind of color you can help us with on thinking about the trajectory of those factoring in kind of the last 2 rate hikes that we've seen?

Hey, Will, Dan.

Listen, thanks for the question.

Yes, you'll see the commercial loans, I think reached from 4.49% to 4.92%.

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 to us as a one-off.

That was probably worth 5 basis points or 6 basis points of the increase.

There was a day count issue between the first and second quarter.

That was worth another 4 basis points, 5 basis points.

And then we had a bit of transitory issues.

We were restructuring a couple of low-yielding credits.

So actually, they come out at the average balances, as you'll see, they drop.

But they're back in, as you get to the tail end of June.

So they'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 bit more than half of the 43 basis points 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 stuff tied to LIBOR, with some stuff -- 90-day notice stuff.

But the reality is the rate was already embedded in there.

Unlike our residential lending portfolio in Bermuda, where you know it has a 90-day lag because 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 as we sit here today.

Got you.

And then maybe on the second, I'll just follow up on the expenses.

So I appreciate you guys reiterating the 60% efficiency ratio target for the end of the year.

Given that you have, I guess, you called out 4 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 at?

I'll start.

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 telegraph 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.

Yes.

So as you saw, we just starting at just 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.

Between SOX and compliance programs, we're running at pace to complete those programs.

Obviously, as you know we're getting SOX-compliant this year.

All the documentation is done, et cetera, and the testing is about to begin.

So this quarter was kind of a big quarter to get that over the line.

Between SOX and compliance, you're probably looking at sort of $5 million on the quarter.

And then, that will probably stabilize at around the $2 million mark in Q1.

The timing around that is a little bit uncertain in terms of whether that -- some of that will be stabilizing in Q3 and some of that will be stabilizing in Q4.

And then finally, the build out of Halifax, which will start to generate operational efficiencies into 2018.

But build out and duplicate headcount, as we on-board people there, we'll start to abate and start to generate actual net savings into 2018.

So that's kind of -- the guidance is still the same.

The timing between the 2 quarters is probably a little bit uncertain, but certainly America’s Cup is a big one in Q2.

The next question is from Alex Twerdahl with Sandler O'Neill.

First off, I was wondering if you can just give a little 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?

Alex, it's Dan.

No, it's really just the revaluations.

So as we start to work through the HSBC portfolio 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.

So it's more that.

And as you know as well as anybody, we're not sort of Bank of 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.

And if you remember, Alex, like some of it's financial assets, but a lot of it's privately held businesses that are more difficult to value.

But we keep looking at it.

And then, obviously, there's a lot of uncertainty about the outlook for interest rates going forward.

But if the 10-year treasury kind of stays within the range that it has been for the, I don't know the last couple of months, say it stays below 2.40%, 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.

Does -- at what point does the strategy change to actually start deploying cash at potentially lower yields versus what kind of ideally would be the case?

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'll see that there is actually a category there where we executed some trades that were pending settlement into this quarter.

We're cautiously optimistic that we'll see a constructive environment in the second half.

We'll obviously await the Fed's decision on timing around tapering, et cetera.

But we -- and as you know, the investment portfolio is really, it's really there to manage the interest rate risk in a banking book.

So we will continue to deploy as things mature.

We've been a little bit patient I would say, this quarter.

But I would say, if we don't see any constructive change in term rates, we'll continue to manage the risk profile of the investment book to offset the interest rates raise that really comes from the floating rate loan book and the (inaudible) deposits in the second half.

So we will look for entry points but we will not start to change the interest rate risk profile materially of the Bank.

We're still very asset sensitive, and as you can see, we've picked up quite a bit on the short end of the curve, so that's obviously helping as well.

Okay.

And then just one final question for me.

I was wondering if you can just give some commentary on, when you raised the Butterfield bank rate or when loans repriced 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's not a lot of organic loan growth that tends to be pretty meaningful for you.

So as rate goes higher, does the amortization schedule for these loans actually change in such a way that maybe we could actually see a little bit more loan growth than previously expected, as rates continue to move higher?

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 amortization on those assets.

In both jurisdictions, we've gone out with the mailer to all our customers that give them the opportunity to hold payments flat.

But -- 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 regulators.

So at this juncture, we adjust the payments 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 to come in, and we have written and contacted all customers to ask whether they would like to hold their payments flat.

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 rightly say, as long as it is the right thing to do for the customer, it clearly is beneficial for all parties.

(Operator Instructions) Our next question comes from Fred Cannon with KBW.

Great.

Most of the issues have been addressed.

A couple of clarifications.

One, in terms of the mortgage book fee, I get that the June rate rise isn't going to flow through until the following quarter.

The March rate rise though, we won't get a benefit of that in 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?

So Fred, it's Dan.

So while that's how we model for interest rate risk, we have passed along both the March rate rise and the June rate rise to our Bermuda mortgage customers.

So the March rate rise kicked in, I think June 19, from 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 of what we'll do on the next rate rise, assuming she holds her nerve, and we actually get one.

Okay.

Got it.

So the last quarter, we saw the December rate rise, this coming quarter we will see the March rate rise and the following quarter we will see [the June rate rise].

Exactly, exactly.

And the delay's really only for the Bermuda residential mortgage portfolio, which is about $1 billion, $1.2 billion, Fred.

Right.

Got it.

And given the previous discussion on both -- I mean given the growth that we've seen in the capital ratios, and the concern about investing the excess cash you guys have in more securities, any update on your thinking in terms of capital deployment, vis-à-vis, share repurchases or the dividend?

Yes.

It's Michael Schrum.

So as you correctly said, the -- we're at the upper end of the capital target range now and we've certainly just in the conclusion of the current Board meetings, started to have those conversations, and they will continue into -- as we guided to before, once we see the plan for next year, we're still guiding towards that 50% payout ratio on the cash side.

And then -- I think there was quite a lot of receptiveness towards looking at the share repurchases program as well.

So we'll have more conversations and dialogue around that in the fourth quarter.

This concludes our question-and-answer session.

I would like to turn the conference back over to Bryon Stevens for any closing remarks.

Thank you, Austin, and thanks to everyone for dialing in today.

We look forward to speaking with you again next quarter.

The conference has now concluded.

Thank you, for attending today's presentation.

You may now disconnect.