Bank of NT Butterfield & Son Ltd (NTB) 2017 Q3 法說會逐字稿

Good morning.

My name is Kerri, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Third Quarter 2017 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 conference over to Bryon Stevens, Butterfield's Head of Investor Relations.

Please go ahead.

Thank you, operator.

Good morning, everyone, and thank you for joining us today as review -- as we review Butterfield's third quarter 2017 financial results.

On the call, I am joined by Butterfield 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 the call up for a question-and-answer session.

This morning, we issued a news release announcing our third quarter 2017 results.

The release, along with a slide presentation that we will refer to during our remarks in 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 a 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 description of the company's risk factors.

I will now turn the call over to Michael Collins.

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

We're pleased to announce another strong quarter at Butterfield, as rate increases led to margin improvements and expenses began to return to a more normal level.

It was a little more than a year ago that we completed our initial public offering, and I'd like to thank our customers, employees and shareholders who have contributed to our success as a public company.

Without your support, we could not have achieved the record results that are highlighted on Slide 4, with core net income increasing to $0.73 per share, net interest margin increasing to 2.81% and core return on equity increasing to 22.2%.

During the quarter, hurricanes caused significant damage to communities in the Caribbean and Southern United States.

We were fortunate and were not affected, but as residents of violent communities ourselves, our thoughts and prayers go out to everyone who was impacted.

Today, we're also excited to announce an agreement to acquire Deutsche Bank's Global Trust Solutions Business, which will add scale and talent to our existing operations and add a profitable and strategically important private trust platform in Singapore.

This transaction represents our fourth such acquisition in 3 years and is consistent with our strategy to expand our capital efficient, fee-based trust business in select markets.

It also validates Butterfield's reputation as a leader in international wealth management and trust services, with a proven ability to integrate businesses from global financial leaders like Deutsche Bank.

In addition to the acquisition, we're pleased to have entered into a partnership with Deutsche Bank's Wealth Management team, whereby Butterfield will provide trust solutions to Deutsche Bank's clients on an ongoing basis.

We believe that working closely with Deutsche Bank will provide us with additional opportunities to expand our businesses, especially in Asia.

Taken together, we believe our strong financial results, combined with our success in growing our trust business, demonstrates that our strategy to create shareholder value is working.

I'll now turn over the call to Michael Schrum.

Thank you, Michael, and good morning, everyone.

On Slide 6, we show a healthy third quarter increase in net interest income to $74.3 million and a corresponding 15 basis point increase in net interest margin to 2.81%.

This continued margin expansion was due to higher short-term rates that boosted the returns on our liquidity and investment portfolios as well as repricing that increased the yields on our loan book.

In aggregate, loan margins expanded by 5 basis points, as commercial loan yields increased by 19 basis points and consumer loan yields decreased by 1 basis point.

The decline in consumer yields was due to lower-yielding U.K. residential mortgage originations, replacing higher-yielding amortization from the Bermuda and Cayman mortgage book.

Slide 7 details the performance of our various fee businesses, which generated $38.2 million of capital-efficient noninterest income in the third quarter.

Banking, trust and FX revenues were broadly flat, while we did see some growth in Asset Management.

At 34%, Butterfield's fee income ratio is well above our peer average and helps produce industry-leading returns on equity.

We expect the acquisition of Global Trust Solutions business from Deutsche Bank will add new trust revenue and will be accretive once integrated in the first half of 2018.

We're also pleased to be acquiring a high-quality and profitable trust platform in Singapore that will accelerate our plans to expand in that region.

As you may have guessed by now, we are limited in what financial information we can disclose, but we can confirm that the transaction is within previously disclosed parameters in terms of size expected return and earnings multiple.

Upon completion of the transaction, which is subject to regulatory approvals, Butterfield will take over the ongoing management and administration of Global Trust Solutions business, comprising approximately 1,000 trust structures for some 900 private clients.

Butterfield is also offering positions to all personnel who are fully dedicated to the Global Trust Solutions business based in the Cayman Islands, Guernsey, Singapore, Switzerland and Mauritius, thereby ensuring continuity of service for clients.

Slide 8 highlights the progress we continue to make in bringing expenses down to a more normal level.

We remain on track to deliver our core cost-to-income ratio of approximately 60% over the coming quarters.

As anticipated, third quarter marketing expenses decreased, as costs related to the America's Cup events in Bermuda ended.

Expenses related to our Sarbanes Oxley program and investments in compliance systems continued as expected but are anticipated to level off by the end of 2017.

Expenses related to the Halifax service center build-out will likely continue through the end of the year, and thereafter, we'll start to create operational efficiencies and additional capacity.

Professional fees were also elevated this quarter as we deployed resources to assist with the acquisition.

We have included some of these specific third party costs in noncore expenses, consistent with previous acquisitions.

And we have also included a line-by-line reconciliation to our U.S. GAAP financials in the Appendix to the presentation.

Slide 9 highlights capital levels, showing both Basel III regulatory capital and leverage capital.

We recorded an increase in our Basel III capital ratio of 80 basis points to 19.9%, a level well above the Bermuda regulatory requirements.

Our tangible common equity to total asset ratio also increased by 30 basis points to 7% and remains at the high end of our target range.

Pro forma for the acquisition, which we expect to close in the first half of 2018, capital levels are expected to remain at the high end of our target range.

For the third 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.

We will be reviewing the dividend and other capital allocation strategies, consistent with last year, once we complete the 2018 planning cycle that is currently underway.

I will now hand it over to Dan to discuss the balance sheet.

Thank you, Michael.

Good morning, everyone.

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 third quarter, which at $10.6 billion, was essentially flat from the second quarter of 2017.

We continued to maintain a highly liquid position, with 62% of our total assets comprised of cash and equivalents, short-term investments and investment assets.

Loan balances remained flat from the prior quarter, due primarily to commercial and residential loan amortizations, offset by continued growth in the new residential mortgages, particularly in our U.K. mortgage business.

As we've discussed before, average deposit balances tend to fluctuate inter-quarter as our largest trust customers manage their commercial interests.

A summary of our loan and investment portfolios on Slide 11 shows the composition and size of the loan portfolio remaining broadly flat at $3.6 billion and made up of essentially the same mix of assets.

Nonperforming loans, which include gross nonaccrual loans and accruing loans past due 90 days or more, totaled $61.8 million as of September 30, 2017, which is in line with last quarter's balance.

The net charge-off ratio remained low at 2 basis points 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 will have opportunities to prudently deploy additional excess deposits into this market in the near term at better rates.

At quarter-end, approximately 92% of the investment portfolio consisted of AAA-rated securities.

Slide 12 summarizes the average balance sheet for the rest -- of the left side of our balance sheet and highlights the client-driven quarter-to-quarter changes we tend to see.

Slide 12 also illustrates our interest rate sensitivity relative to our U.S. peers and shows that a 200 basis point increase in rates would generate an uptick in net interest income of 12.7% versus our peers at 6%.

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

Thank you, Dan.

The third quarter, again, demonstrated the strength of the Butterfield franchise, with expanding net interest margin, stable fee revenue, continued low-cost deposits and core return on equity that remained above 20% for the third consecutive quarter.

Our acquisition of Deutsche Bank's Global Trust Solutions business demonstrates our ability to transact with industry leaders and is expected to create additional opportunities for us as we continue to add scale to our international trust business.

We also believe that Butterfield's partnership with Deutsche Bank Wealth Management will benefit both companies by deepening existing client relationships and helping, also, to create new ones.

With that, we'd like to take your questions.

Operator?

(Operator Instructions) The first question will come from Timur Braziler of Wells Fargo.

Looking, maybe, first at the period on the loan growth, the strong result out of the residential line item, how much of that came from the U.K. business versus the traditional line of businesses?

So it's Dan, Tim.

Listen, the majority of it came from the U.K. business.

The U.K. business has turned out to be a good generator of new assets for us.

There was a -- while Bermuda and Cayman showed a bit of growth, the reality is that they're -- they still have an amortizing book that runs off.

So the U.K. book, overall, was probably up $70 million or $80 million of that difference.

So it's the lion's share of the piece.

Okay.

And I guess, as that book continues to grow and until the amortization schedule catches up, is it a fair assumption that -- to think that loan growth might actually exceed prior quarters as that book gets up to speed?

Or is there still the assumption that it should be relatively flat?

Yes.

No, that's fair.

No, I think that's fair.

I think -- I mean, I don't think it's going to grow meaningfully.

We've never sort of given guidance it's growing meaningfully, but flat to slightly up is the -- it's still the right model.

Okay.

And was there any positive benefit from a strengthening pound over the quarter?

As far as I see -- it's Michael Schrum.

So as -- we retranslate, obviously, through the balance sheet.

And then, well, you kind of get the average on the NII, if you will.

So there was a benefit in terms of the translation into dollars but it wasn't really very material actually.

Okay, that’s helpful.

And then last one for me.

Just looking at the expense base, is there a way that we can get some color around the remaining expenses associated with the SOX and the investment in the compliance piece and the transition out to Halifax?

I guess, what's a good remaining balance that should be kind of out of the run rate as we head into 2018?

Yes.

It's Michael Schrum again.

Thanks, Timur.

It's -- as you saw, we did make some -- I think, we previously talked about America's Cup and, obviously, that ended.

It was good to see that coming down.

I think in -- on the Q1 call, I said sort of 69% to 70% is kind of a good run rate a quarter, obviously, ex acquisitions, where we'll be joined by some new colleagues once that completes.

So on a core basis, that's kind of where I'm aiming at, it kind us gets us to that guidance number around the 60% in Q4, Q1 next year.

So we ended this quarter, I think, at 71.8% on a core basis.

There's a little bit of noise in the noncore.

But -- so, say, a couple or 3 out of that base.

And then going into next year, obviously, as we start to get some capacity out of the Halifax center, that will be a tailwind, if you will, to offset some -- maybe some of the headwinds that we're seeing elsewhere.

The next question comes from Alex Twerdahl of Sandler O'Neill.

My first question, I understand you're limited, probably, in what you can say in terms of the terms of the acquisition this quarter.

But I'm just wondering, did this acquisition come with deposits the way that the Bermuda Trust Company did 2 years ago?

Thanks, Alex.

It's Michael Collins.

The difference with this acquisition is it's a trust-only acquisition, so we're partnering with Deutsche Bank's Wealth Management business to provide trustee services for those clients.

So initially, it won't come with a lot of deposits.

So it's different from the HSBC acquisition, which was both a trust company acquisition that came with other parts of Wealth Management.

So that's really the difference.

But we do expect to pick up deposits over time.

But I would make that distinction that this is a trust-only acquisition.

Okay.

And then maybe you can provide just a little bit more color on what we saw for deposit trends this quarter.

I know last quarter, you alluded to several large flows.

I think there was 2 specific customers that had outflows in the second quarter.

Did we see -- was there any large inflows or outflows from Trust clients during the third quarter that just kind of wouldn't be necessarily seen from the headline numbers?

Not really.

No.

And we're not really seeing any pressure from interest rates again.

So we've gone back through and done an analysis name by name for every movement above a pretty small size to make sure that as we come off the bottom and that we've not passed along rates that there's no real rate pressure yet in the market.

So no, not really.

I think just normal course of business.

There's been some transactions done by some families, but nothing of trend, Alex.

Okay.

And then that brings me to my next question, which is sort of how much -- it's been maybe somewhat of a moving target, maybe not, in terms of how much liquidity you could actually take from the cash and short-term securities and divest -- or not divest, invest over a longer time period to get to some incremental spread.

And now that the 10-year treasury is getting within striking distance of kind of that 250 mark where you have deployed cash in the past, how much do you think, realistically, if the yield curve continues to move in the right direction, that we could see deployed in the fourth quarter in terms of the excess liquidity?

Alex, it's Michael Schrum.

Maybe I can -- I'll start on the liquidity book, and then Dan can kind of pitch in on the investment side.

So I think we've consistently said, look, we're operating 3 banks across 3 different jurisdictions in multicurrency with no lendable results.

So our target levels around the liquidity book was -- is somewhere between $1.5 to $2 billion.

That gets us ample liquidity with additional repo lines behind to ensure that we -- that we're always on the conservative side of that spectrum where we should be.

So we're just under the $2 billion in ending this quarter on cash and short-term investments.

So if you thought, somewhat, another 200, 300 maybe, depending on loan demand and commitments and cash flow, there is some opportunity there.

And we clearly also hold short-dated -- short-durated assets in the investment book as well.

So I'll let Dan speak about that.

Yes, so I think, Alex, you're right.

I think the last couple of weeks and, certainly, last couple of days have been good in terms of steepening and deals finally moving.

And we were very patient through this process to try to understand where the markets were headed because we just couldn't understand where they went for the last 6 months.

So they're -- we're probably reaching an entry point.

And Michael's right, there's 2 areas.

One is a bit of cash, a bit.

And then we have bought a bunch of [jinny] floaters.

So the jinny floaters have been a good interim step for us to create a little bit of earnings momentum, but we could move out of the jinny floaters and probably add in a bit of duration into the investment portfolio if rates continues to move and steepen the way we've seen over the last couple of days.

The next question comes from Will Nance of Goldman Sachs.

Congratulations on the acquisition; and also, Dan, congrats on the new role.

So I guess, first on the acquisition.

Singapore has been a target market for you guys for a while, can you give a sense of what pro forma market share might look like there?

And I guess second is, does having a physical presence there open up opportunities for further M&A in that market?

Yes.

Thanks, Will.

It's Michael Collins.

So obviously, what we talked about, we can't disclose the financial terms of the transaction.

But what we can say, going back to the acquisition criteria that we've laid out in the past, it really meets all the buckets.

So in terms of size, under $50 million purchase price.

We talked about price of 8x EBITDA or less, so it meets that in terms of trailing EBITDA.

The profile of the business has to be at least 2/3 private trust.

So as we've talked about in the past, we're less interested or not interested, really, in fund administration and company secretarial work and that sort of stuff.

It really is private trust we're after.

This is obviously 100% private trust.

And if you remember the locations have to be our existing jurisdictions, Switzerland, Guernsey, Bermuda, Cayman, where we have scale, and, as you pointed out, with the exception of Singapore.

So Singapore, obviously, is a market we've wanted to get into for a long time, and it goes back historically to our trust business from a lot of the Hong Kong family.

So having a presence there is really important.

It's not possible, really, to talk about market share in terms of trust in Singapore, really, any jurisdictions.

Its information that's private and confidential, it's really hard to get that sort of data.

But I can tell you that Singapore is basically about -- the acquisition comes with about 90 people in those jurisdictions.

Singapore is about 15% of that, and it would represent about 20% of the revenue of that business.

And overall, roughly, it's about 20%, this acquisition is about 20%, 25% of the size of our existing Trust business.

So I think that gives you a little bit of a sense of the scale.

So having a platform in Singapore will allow us to grow, but it's tough to actually talk about what sort of market share we would have there.

Sure.

And then, maybe, switching over to the margin.

So you talked about consumer yields being down.

I guess, I'm assuming that did include some pickup in the loan yields in Bermuda.

I guess, looking forward to next quarter and maybe even beyond, can you give us a sense for how you would expect the margin to trend, given some of the repricing dynamics in the consumer book?

And I guess, maybe ex rate hike, just to level-set everyone?

Yeah.

No great.

Thanks for the question, Will.

It's Michael Schrum.

As you correctly pointed out, the U.K. mortgage origination, they're accretive from a net interest income prospective, but they tend to, obviously, cause a downward pressure on the overall consumer margin, which, in this quarter, offset the margin expansion from the Bermuda book, which is an amortizing book.

So as we continue to see growth opportunities in the U.K., that will tend to, in the absence of any rate -- further rate hikes, tend to have a flattish to slightly downward pressure on the overall consumer yields.

In terms of the commercial, it's really -- this quarter, we had some significant margin expansion, really a product mix issue.

So we had a higher utilization of commercial overdrafts at higher yields during the entire quarter, while term balances remained fairly stable.

So it's really a product mix there on the commercial, which caused a significant uptick in the yields on that book.

I think going forward, on the commercial side, it's a relatively small book, but I think we should expect that to sort of be flattish, again, absent any further funding cost increases.

Great.

And if I could squeeze one more in.

You guys have been talking about instating a buyback for some time.

I guess, with an acquisition now on the table, does this at all change your thoughts about potential capital distribution going forward?

Yes, I think -- I mean, look, there was a very good discussion at the board, I think, this quarter around capital commitments, et cetera.

And I think we -- where we landed was, look, we want to see the plan for next year.

We are currently going through that process.

We have an acquisition similar to last year where we really came out of the gates in Q1, that would be the point at which we would want to look at all the capital allocation, including a buyback.

I don't think our thoughts have changed in that area.

I think tactically deploying some of the excess capital into sort of a tactical buyback still seems to be broadly acceptable and certainly would be accretive.

The next question comes from Michael Perito of KBW.

Maybe wanted to start on the deal, I appreciate the color, Mike, about some of the size -- the relative size and whatnot.

I know you guys are limited as you've said.

But I'm just curious, maybe you could comment about how the overall, kind of, profitability of the trust business you're acquiring maybe compares to your legacy trust business?

Thanks.

It's Michael Collins.

It's similar.

I mean, I think that these sorts of businesses that we know very well, they're not necessarily scale businesses.

We talked about if banking has efficiency ratios in the low 50s, trust would be sort of around 70%.

So it somewhere in that sense.

It is -- I think, we can say it's accretive, so that's important.

But it's a very similar business, and I think we're excited.

And I think we've talked about a little bit in the past that our focus is going from founder-owned trust company acquisitions, potentially, to more bank-owned trust company acquisitions, simply because we're probably a little bit more comfortable in terms of their having done their work to scrub the book and make sure what we're acquiring is as clean as it can possibly be.

So -- but the profitability would be relatively similar.

We'll have some costs in the near term because we're setting up 2 new -- we're in 2 new locations.

So obviously, we haven't been in Singapore, we haven't been in Mauritius, so we can't combine those with the existing operations, Switzerland and Guernsey and Cayman, that makes that so much easier because we've got existing staff and systems in everything.

So there'll be a little bit more cost in the near term, but nothing substantial.

And just to clarify, when -- I mean, in near term, that means kind of allegates once the transaction is closed or kind of in anticipation of closing the transaction?

Yes, so -- sorry, it's Michael Schrum.

So, I mean, we obviously modeled this forward.

But just bear in mind, we got to sign new leases in Singapore, we got a stand-up IT systems, we got to -- the normal stuff, really.

So once it completes, and obviously, that's the hard work that's going on now, that will come through in the near term and, obviously, that tapers off and becomes a BAU.

So when you ask about the metrics relative to the existing trust business, I would say, yes, that's absolutely the case once it's integrated.

Okay.

And then just one last one for me, just on the -- the asset management business, had a really nice quarter, I was just curious if you could maybe dig into that a little deeper.

What kind of drove the up revenues and what the outlook is from here after putting up the strong results?

Yes, it's -- it was actually nice to see.

They've been out chasing prospects for a while and they landed a couple of new significant clients this quarter.

And so very pleased to see that growth in that area.

And this concludes our question-and-answer session.

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

Thanks, everyone, for joining, and we'll look forward to talking to you again next quarter.

The conference has now concluded.

Thank you for attending today's presentation.

You may now disconnect your lines.

Have a great day.