Bank of NT Butterfield & Son Ltd (NTB) 2018 Q1 法說會逐字稿

Good day.

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

At this time, I would like to welcome everyone to the First Quarter 2018 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 call over to Mr. Noah Fields, Butterfield's Head of Investor Relations.

Mr. Fields, the floor is yours, sir.

Thank you.

Good morning, everyone, and thank you for joining us today as we review Butterfield's First Quarter 2018 Financial Results.

On the call, I'm joined by Butterfield Chairman and Chief Executive Officer, Michael Collins; Chief Financial Officer, Michael Schrum; and Chief Operating Officer, Daniel Frumkin.

Following their prepared remarks, we will open the call up for a question-and-answer session.

Yesterday afternoon, we issued a news release announcing our first quarter 2018 results.

The press 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 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 statements 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.

Thanks, Noah.

It's good to be here today.

The first quarter of 2018 was an excellent start to Butterfield's fiscal year.

We continued to develop our financial services offerings in important offshore jurisdictions, including Bermuda and Cayman, where we offer a market-leading, retail banking trust and asset management services; the Bahamas, Switzerland and Guernsey, where we focus on wealth management and trust; and the U.K., where we offer lending services, exclusively to high net worth clients.

Following the closing of Deutsche Bank's Global Trust Solutions acquisition, we now have a strategically important trust office in Singapore as well as a cost-effective back office operation in Mauritius.

Following the expected completion of Deutsche Bank's banking business in Cayman and the Channel Islands later this year, we will also have a new bank location in Jersey.

Turning now to Slide 4. Butterfield continues to deliver a highly profitable financial result as we benefit from a well-positioned asset-sensitive balance sheet and capital-efficient diversified fee revenues.

Core return on average tangible common equity improved to 24.3% versus 22.3% in the fourth quarter of 2017.

Our net interest margin increased to 3.05% from 2.87% as the Fed continue its planned interest rate increases.

As expected, we closed the acquisition of the Global Trust Solutions business from Deutsche Bank at the end of the first quarter.

The onboarding of clients and staff has gone very well as has the integration of trust operations in Cayman, Guernsey and Switzerland.

The new office in Singapore is now operational, and we are actively marketing to potential trust clients in Southeast Asia from this new location.

We're also pleased with the progress being made towards closing the previously announced acquisition of Deutsche Bank's banking operations in Cayman and the Channel Islands.

In addition to growing market share in the established markets of Cayman and Guernsey, we look forward to servicing the Jersey market with the newly established bank.

We anticipate that when this deal closes by the end of the year, we will increase total bank deposits by as much as 20%.

We believe there is currently a dislocation in the offshore banking sector resulting in more sellers of banking and wealth management businesses than buyers.

We are very well positioned to benefit from this phenomenon.

Following our successful deals with Deutsche Bank, we believe Butterfield will be viewed as an acquirer of choice for businesses that are consistent with our strategy in key jurisdictions.

I'll now turn the call over to Michael Schrum to provide commentary on the first quarter financial results.

Thank you.

Thank you, Michael, and good morning, everyone.

I'll now cover the first quarter performance in further detail.

Starting on Slide 6, we present a summary of net interest income.

In the first quarter, net interest income increased $3.8 million to $79.9 million compared to the fourth quarter of 2017.

The net interest margin of 3.05%, increased 18 basis points from 2.87% last quarter.

NIM grew due to loan repricing as well as increased volume in customer loan portfolios.

Interest-earning assets averaged $10.6 billion with a yield of 3.22%, as yields rose across all asset classes, and we continued to plan to allocate the commercial surplus to higher-yielding securities.

As you can see on Slide 7, noninterest income was down 6.1% sequentially from a strong fourth quarter, which included seasonal promotions for card users as well as some seasonal foreign exchange volumes and card usage during the holiday season in December.

Butterfield's fee income continues to be large, stable, capital-efficient and important component of the overall revenue base compared to U.S. peers.

Slide 8 provides details regarding Butterfield's core noninterest expense of $76 million.

Expenses were modestly down in the first quarter of 2018 compared to the prior quarter due to lower performance-related bonus accruals in the quarter.

Butterfield's noninterest expense of $77.8 million included $1.6 million of noncore professional services fees related to recent acquisition activity.

First year Sarbanes Oxley costs started to normalize late in the first quarter as our first year compliance program has now completed.

Our core efficiency ratio for the quarter was 62.3% and continuing to trend towards our target 60% core efficiency ratio run rate.

Slide 9 provides a summary of regulatory capital and leverage capital ratio levels.

In the first quarter, Butterfield's Basel III total capital ratio decreased 7 basis points to 19.2% compared to the fourth quarter, mainly due to the GTS acquisition consideration payments.

This remains well above our Bermuda regulatory capital levels and our U.S. peer average.

Our common equity to total asset ratio decreased 4 basis points to 6.7%, which is approaching target levels as it was previously above 7%.

As mentioned last quarter, the new Deutsche Bank client deposit and regulatory capital requirements in Jersey will be managed within the existing capital base.

This will, in turn, activate excess capital, and we anticipate to move our leverage capital ratios towards the target range of 6% to 6.5%.

Last week, we filed an F-3 shelf registration that provides Butterfield with the flexibility to efficiently issue securities.

The shelf filing allows us to preregister information with the SEC that will be required for a securities offering, including any potential subordinated debt.

I'm also pleased to say that the board has authorized a quarterly dividend of $0.38 per common share that was increased 18% last quarter.

The common share repurchase program authorization already announced in the first quarter became effective on April 1, and we did not purchase any shares in the first quarter.

Turning now to Slide 10.

We continue to focus on strong risk management with an emphasis on efficiency and profitability.

Here we provide a summary of the bank's balance sheet at the end of the first quarter.

We ended the quarter with total assets of approximately $11 billion, an increase of 1.9% from the end of last year.

We continue to be positioned for rising interest rates with 46% of our total assets in cash and equivalents, short-term investments and investment assets.

As interest rates increase, a significant portion of our assets can reprice or be invested into higher-yielding securities.

Average deposit balances of $9.8 billion increased from $9.6 billion last quarter.

Our deposit balances can fluctuate quarter-over-quarter, as larger trust clients manage their commercial interests.

Looking now at asset quality on Slide 11.

Our loan portfolio was $4.0 billion at the end of the first quarter, comprised primarily of residential mortgages and, to a less extent, commercial loans.

Loan balances increased by approximately $180 million from the prior quarter, due primarily to additional drawing on a new sovereign loan as well as continued growth in our U.K. residential mortgage portfolio.

Group nonaccrual loans totaled $42.4 million as at the end of the first quarter, down from $43.9 million as at the end of the year.

Credit conditions continue to be benign, and our net charge-off ratio was 2 basis points for the quarter.

The investment portfolio was $4.5 billion at the end of the first quarter, 4% lower than the fourth quarter of 2017 as the timing of some maturities and pay downs came late in the first quarter.

We have set some of the late quarter volume decrease with reinvestment into the held-to-maturity portfolio and expect investments will continue into the second quarter depending on market rates.

In terms of credit quality, AAA-rated securities continue to make up the majority of the investment portfolio with 94.6% of investments at that rating at the end of the first quarter.

On Slide 12, you can see the -- that in line with previous quarters, Butterfield remains significantly more interest rate-sensitive than U.S. peers.

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

Thanks, Michael.

The first quarter of 2018 was a solid start to the year and highlighted the benefits of Butterfield's stable fee income, expanding net interest margins and low-cost deposits.

This was our fifth consecutive quarter with core return on average tangible common equity above 20% and the first quarter at or above 24%.

We continue to focus on expense management and work towards maintaining a 60% efficiency ratio.

Overall, we feel positive about the bank's current earnings momentum and strategic position.

We are actively searching for strategic acquisitions, and we are pleased to have closed the first of our 2 deals with Deutsche Bank.

We look forward to updating you on our progress as we work towards concluding the Deutsche Banking acquisition in Cayman and the Channel Islands.

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

Operator?

This is actually Noah Fields here.

Before we begin the Q&A, I had 1 administrative point to cover.

In the earnings press release and 6-K issued last night, there was a typographical error in the heading of the average balance sheet, which affected comparative information for prior periods only, not the current quarter, and this did not affect the earnings deck, which we referred to during the call.

An amended 6-K was filed this morning to correct the dates for the prior periods in the average balance sheet.

We would now like to proceed with the Q&A.

Please go ahead, operator.

(Operator Instructions) Our first question will come from Michael Perito of KBW.

I want to maybe start on, on the capital side.

Obviously, you guys didn't repurchase any shares in the quarter and it seems like the M&A pipeline saw some opportunities, I guess.

Is it fair to interpret those items as related?

I mean, at this point is the buyback kind of on secondary hold until you guys explore other options in the M&A pipeline?

Is that a fair way to think about near-term capital deployment?

Yes, Mike.

Yes, I mean, I think, the -- it's a great question.

The guidance is kind of similar to what we said in the prior quarters.

We're very, obviously, conscious of returning excess capital back to shareholders.

We can't deploy it effectively in the marketplace.

The buyback was really just instituted as a kind of tactical buyback scheme in periods where there's a lack of support in the market.

It became effective on the 1st of April.

And again, the healthy dividend coupled with the acquisitions and then thirdly, when there is an opportunity and again, conscious of the price book dynamics here as well, we would go out in the open market.

But it's definitely a pretty small size, and we still remain very optimistic about the other opportunities to deploy capital.

Okay.

Helpful, Michael.

Maybe jumping over to the net interest margin.

It looks like, it's -- I think, it's your sixth consecutive quarter of kind of seeing expanding NIM.

I know in past conference calls, you guys have discussed possibly not acting on raises whether it be on the mortgage side or passing some down on the deposit side.

And then, obviously, with the banking and custody, Deutsche Banking deal here progressing, you guys will be bringing some more liquidity on the balance sheet as 2018 unfolds.

So I'm curious what the kind of updated thoughts are near term, if we kind of get the consensus U.S. interest rate environment out there, another raise or 2 this year and a modest pickup in the 10-year, what you kind of think the NIM can do from this 3.05% level going forward?

I'll just start.

It's Michael Collins.

So I think what you're seeing in our NIM is what we've talked about for quite some time, obviously, our asset sensitivity and our pricing power in both Bermuda and Cayman.

As time goes on, we've moved every time the Fed funds have moved on the asset side here in Bermuda.

Everywhere else, automatically adjusts.

So we're going to continue to look at it.

I think, we understand our pricing power, but we also recognize as the cycle matures, we need to be as balanced as we can.

But I'll let Michael Schrum talk.

Yes.

I think, I mean when I look at the loans first, the commercial -- we're very pleased, obviously, to see what we expected, the expansion in NIM on the commercial side.

Consumer, obviously, a little bit flattish in the quarter, primarily because the new volume came through the U.K. origination, which we're very pleased with the volume increases there.

If you go on to the securities side, and just looking at the -- at Slide 12 again, you'll see sequentially we've taken some of the asset sensitivity off and continued deploying.

We found pretty constructive rates with the 10-year bouncing around 2.90%, and that's, obviously, translated to a good NIM expansion on the investment asset side.

And I think we'll just continue with that.

We are expecting, obviously, to get a number of different currencies coming in with the next acquisition, which will have a series of closings into the second half of this year, and we're looking pretty closely at how we can, obviously, behavioralize those into -- those deposits into the existing book of business and continue to expand margin as well on the investment asset side.

And Michael, I would add, it's Dan.

There's a couple of things.

I think we saw reasonably good loan growth in the quarter.

There was a couple of pieces you will see in the loan footnote, you will notice that the commercial lending outside of Bermuda increased by circa $50 million.

That was a transaction for a PE-backed insurance entity for a couple of acquisitions where we're really quite pleased to win that piece of business.

It got -- it was underwritten here in Bermuda, but got booked into Guernsey for tax reasons and other considerations, because, again, there is a tax treaty between Guernsey and the U.K.

You will notice we grew residential lending by about $20 million or $30 million outside of Bermuda again.

And so I think there's a couple of things.

As the London loan portfolio continues to grow, it will have some drag on NIM expansion because it's a lower rate product in absolute terms, still great returns, but it's a lower rate product in absolute terms than our Bermuda mortgages.

And I think the second thing, which you raised is, which is right.

By the end of the year, we'll start to see a significant additional liquidity added to the balance sheet.

As that liquidity gets added to the balance sheet, it will be -- it will at least be held short term for a period of time.

And so we're comfortable that we know it well enough to be able to begin to ladder it out.

So again our cash in short-term number will increase.

And as that mix shifts, and we have more cash in short-term, it will be a bit of drag on NIM.

But the reality is as long as rates move as anticipated, the repricing of the loan book, the continuing laddering out of the investment portfolio will give us some pretty strong momentum on the NIM side as we continue.

Great.

It's -- this is very helpful color, guys.

Just one last one for me.

Michael, can you help us think about the core expense trajectory from here a little bit?

There is a few moving pieces, it would seem still kind of impacting the number.

I think, you had mentioned the core rate was a little under $76 million from here.

Does seem like though there is probably some more expenses that are going to come in from both the full quarter impact of the GTS deal, but also the banking and custody deal that's ongoing.

So just any help you can give us kind of on your expectations.

I know the efficiency ratio target is the same, but just in terms of the dollar expense quarterly run rate.

Any help you can give would be great.

Yes.

Sure, Mike.

Yes, so as I said, I think, core expenses improved sequentially, and we are trending towards the 60%.

And we have a continued focus on expenses, obviously.

This quarter, we finished the first year SOX implementation.

We probably had incremental first year cost in the first quarter of $2.5 million to $3 million above our kind of normalized run rate for the first year.

Some of the other smaller items in core expenses each in the sort of few hundreds of thousands included some legal fees in connection with the shelf registration that we filed.

I think that was good and well received.

Some initiation costs for the some of the cyber risk programs that we're running.

So a little bit of upfront there.

Some recruitment costs.

You've seen that we've recruited a number of really high-profile board members, obviously, comes at a bit of recruitment costs and some professional fees in connection with some of the mitigation of our U.K. pension scheme.

But again, in a few hundreds.

Professional fees for review of some of the -- a gap analysis on some of the data privacy and protection rules that are coming into Europe, GDPR as well as Bermuda added a few hundred in that quarter.

So all taken together, total core expense probably in the $4.5 million to $5 million heavy for the quarter.

It's -- I think it's worth noting as well that, obviously, we closed the GTS acquisition.

So all of our new colleagues have come onboard on March 29, and that will add sort of to the core expense absolute number approximately a couple of million give or take of core expenses each quarter going forward.

Obviously, that comes with revenue as well.

And I think we're overall still very confident that we're tracking in the right direction.

They were a bit heavy again this quarter, but 60% remains our target, and we're heading in the right direction.

We have a good understanding of what's going on underneath the covers, so to speak.

Okay.

So I mean, it sounds like -- is this range plus or minus a decent place that -- for expectations next quarter?

With -- but there is some new coming on, but it sounds like there is some stuff coming off as well that could offset each other?

Yes, I mean, I think we've -- absent any kind of unforeseen headwinds, I mean, I think we kind of know what the tailwinds are here, what are sort of the first year costs of SOX and some of the compliance programs that we sort of landed in the last couple of quarters.

I think we always said, our long-term run rate would be at the 60%, and we are definitely heading in the right direction.

So I think with that sort of -- it's fair to say there's always some new things coming on, but we also have some tailwinds in the form of what we're doing in Halifax that continues to provide structural expense savings.

So I think that's probably -- I'm still confident in that sort of range, but just with, obviously, on the existing business because the GTS or the acquired business will add, obviously, to core expenses going forward.

Next we have Timur Braziler of Wells Fargo.

Maybe just starting, looking at the loan growth, another impressive quarter there.

I guess, first, what was the extension of credit on the sovereign loan?

A bit above this quarter...

So that's -- as we've said before, we lend money to the Bermuda government.

It's basically a bridge facility between bond offerings to let them be able to sort of manage when they go to market.

So we made available facility, and they continue to draw down under that facility.

Unfortunately, there will come a moment where they will go to the bond markets over the next 12 to 15 months.

And when they do, that full facility will be repaid.

So we do it really to help the governments move out their entry point and go from there.

Yes, Timur, it's Michael.

As you know, in the last quarter, we talked about there is a 50 drawn on the 150 sort of facility.

If you look at the current account deficit of the government, they're running at about 120 a year and then sort of think about that's their expenses.

That would be a good sort of way of thinking about that.

Okay.

And then as you look out of the production in the U.K., that certainly continues to ramp up.

Just would love to hear an update out of that business.

Where is it relative to where you guys want it to be?

And what that pipeline looks like going forward?

So Timur, it's Dan again.

Listen, I think it's going very well.

I think, we're very happy with the production we're seeing.

Again, that business continues to grow for us pretty substantially, but not significantly to the point where it's going to move the needle too much.

I think we had hoped that it would fill the hole as Bermuda mortgages continue to amortize down slightly.

We had some further mortgage production in Cayman, which made up for some of the amortization there.

So again, it fills a hole for us.

We don't think it fundamentally alters the loan book significantly in terms of growing to be an overly significant part, but it should add a couple, $300 million a year of loan outstandings net new, which will help offset and create maybe marginal growth.

And then also, Timur, it also soaks up, obviously, our sterling deposits out of Guernsey and with the Deutsche Banking acquisition, that's going to continue to grow.

So it's a great outlet for sterling deposits, which, as you know, are hard to invest in the market.

And again, Timur, in term from a credit quality perspective, we've not had a single delinquency.

We're still doing sub-65% loan-to-value mortgages to genuinely affluent people in affluent neighborhoods in London.

So again, we're really happy with the way that's performed.

That's worked out to be a really good piece of the overall business.

Okay.

That's good color.

And then just looking at the linked quarter change in the securities balance, I know you had said that some of that was driven due to late quarter maturities, but the yield was meaningfully higher.

Was there still a good amount of repositioning going on?

And with the loan growth coming in maybe a little bit stronger, it took some pressure off in really growing that balance?

I guess, how should we look at the securities book in relation to the little bit over $2 billion in cash and loan growth likely flowing?

Should we see a meaningful ramp in securities starting in the second quarter here?

Yes.

I think, I mean, we feel very good about where the 10 year is sort of bouncing around right now.

I think, again, we're not doing anything different than what we had already said.

We're just kind of trying to make sure that the timing is right, and it's adding to the bottom line.

But cash and short-term investments will continue to be at least up until the onboarding of the new deposits for operating purposes between $1.5 billion to $2 billion, that's laddered out in a 6-month T-bill ladder.

What you saw really in the quarter is we took some AFS securities, and we put them into longer-dated maturities, took some of the asset sensitivity down a little bit and added meaningfully to the running book yield and the NIM expansion that you saw in the quarter.

We have just in the fourth quarter sort of done a combination of the traditional 30-year and some 3-year paper because of the inflection point in the yield curve, and we were able to kind of twist that back out to the long end to produce the NIM expansion.

And we have some additional powder in the AFS portfolio in the form of floaters and traditionals.

So we'll continue to look at where we can add value doing that as well.

Right now, the 2.10% is pretty flat.

But we feel overall pretty good about where the curve is at the moment.

So we'll just continue to really ladder out, but we'll continue to have -- maintain quite a significant and conservative liquidity position, obviously, given that we operate in multicurrency across 3 and soon to be 4 different banking jurisdictions.

So really just continuing what we're doing.

Okay.

Great.

And then just one last one for me.

Just looking at the deposit base, so obviously, excellent results there with funding costs pretty impressive.

But just looking at the mix shift, it looks like there is some mix away from noninterest-bearing into interest-bearing this quarter.

Maybe just talk a little bit about that dynamic.

And is there anything that you guys are worried about from a funding cost perspective that might result in deposit betas doing anything different kind of back end of the year relative to what we've experienced so far?

So what I would say from a business perspective, again, Timur, we're going through every inflow, outflow, trying to make sure that we're comfortable that it is not rate-driven.

We're not seeing any additional pressure to date.

We continue to have 1 or 2 clients who come in and talk to us about rate.

Maybe that's fine.

We can make one-off exceptions.

We're small enough to be able to do that.

But we're not seeing any systemic pressure on the rate book.

And to date, we've not really seen much shift.

I know there is a bit in the way it's described in here, but it wasn't costly that shift.

So the reality is we're not seeing a lot of people take up our term deposit offers that we've done in the market.

And actually, we now are offering customers choice.

So if they want a bit more yield, they're welcome to tie up their money for a little bit longer, a bit like the CDs in the U.S. But we're not seeing much takeup on that.

So again, every rate rise gets a little bit harder, every rate rise gets a little bit more tempting to pass some of that along.

But at the moment, we're not really seeing much client pressure.

But we're always aware of trying to do the right thing by our clients to make sure that we're giving them options.

If they choose to take them, it's really up to them.

But we're not really seeing any systemic pressure as we sit here today.

I think, as Dan said, options are the most important in small markets, like -- finite markets like Bermuda and Cayman, where, as you know, there's not a huge amount of competition.

So as long as we're able to offer longer-term fixed rates to clients, I think, we're comfortable.

But there really hasn't been a lot of pressure on the pricing side.

But I think in the medium term, offering fixed-term deposits is a solution longer term.

Obviously, we'll eventually have to start doing on savings, but it isn't yet.

Next we have Alex Twerdahl, Sandler O'Neill.

I wanted to spend a little bit more time talking about the loan book and the potential outlook for growth there.

I mean, I think I was a little surprised this morning to see such strong growth, particularly from C&I.

And Dan, I appreciate that you mentioned that $50 million PE-backed insurance entity opportunity that you were able to execute on during the quarter.

One, is that an emerging area for potential growth or opportunity in the future?

And second, the other C&I growth that we saw -- the other, call it $30 million that was in Bermuda, is that something that is core and sustainable?

Or is that more short-term type C&I growth?

And maybe just a little bit more color from that perspective.

Okay.

So I can give you a couple of things.

One is, yes, we think there is some opportunity in private equity backed.

We have pretty good relationships in that space.

So we see a little bit of transaction flow.

We also see some reinsurance companies trying to invest in private equity vehicles, and there is a way that we can help them with that, which we've done a bit of which starts to bleed through.

Some of the increase in Bermuda is the government increase, which you will have seen which, as I said, is transitory.

But there is a bit of activity in the C&I side that hopefully will create some stability and maybe some growth.

Again, we -- our commercial real estate book does amortize down.

So over time, the commercial real estate mortgages drop slightly.

You'll see that both inside and outside of Bermuda, they are down $3 million or $4 million in the quarter, not exciting, but we do need to lend to be able to do that.

So I don't think the opportunity we had in Europe, in the U.K., it will be repeatable.

So that large $50 million increase quarter-over-quarter in commercial lending outside of Bermuda, I don't think you should assume that we have a pipeline of more of those deals.

It was sort of a one-off to somebody we knew very well and were very comfortable with.

And I think some of the Bermuda commercial growth you're seeing, I think it will continue to exist, but it will moderate.

So the C&I loan that I've seen, going from $197 million to $226 million in the loans footnote, I'm not sure we can sustain that every quarter.

It was a good quarter.

We had a bit of extra activity.

And I think on the residential side, outside of Bermuda, you'll continue to see some growth.

Alex, we've always been pretty consistent that we're not a big loan-growth story as an institution.

I think we've done better than that.

We're at about $4 billion now.

It's not going to be become $4.5 billion.

It's going to -- can we get up it to $4.1 billion, $4.2 billion?

Maybe.

But it's a relatively slow-growth story.

Okay.

Understood.

But other than the typical amortization in the residential and the CRE books, some of the things you did and the government loan that you mentioned earlier, the balances that you have in the quarter are fairly sustainable going into the second quarter, is that correct?

Yes, I don't think they're transitory.

And again, we're not aware the government going to -- we've not had any conversations about them beginning to test the bond market.

So I think that's sustainable for the quarter as well.

Okay, great.

And then a little bit more color on expenses.

So I think in the fourth quarter, Michael, you said something like $6.5 million, $7 million of inflation in the expense number just due to some of the onetime items.

And then earlier in this call, you gave some color.

You said maybe $4.5 million to $5 million of additional expenses that maybe will kind of not be repeatable.

In the second quarter, does that number go from $4.5 million to $5 million down to 0?

Or does it go to $3.5 million to $4 million?

Or kind of just how do we think about some of these things and some of the -- the pipeline for some of these initiatives over the next few quarters on the way to that 60% efficiency ratio?

I think -- yes, it's a great question, Alex.

I think the SOX first year, as I mentioned, $2.5 million to $3 million goes away and becomes kind of a normal program for this year.

We -- that was -- we're quite a complex small organization across many different jurisdictions with currencies and systems, et cetera.

So probably drew a bit more expense into the year, but it's kind of ticked the game up, we wanted a good execution of this SOX program.

And it's actually highlighted some really constructive things that we can improve within the organization as well.

So -- but that $2.5 million to $3 million definitely goes away, then there's a few of those initiation costs, for example, from cyber, some of that goes away.

But again you're into kind of a couple of hundred -- $300,000 ranges.

And then there is a little bit of sort of inflation, I think, coming through.

We normally do an annual review of salaries, et cetera on April 1. So you'd expect a little bit of headwind in that respect, but then there is some tailwind on a few of the other lines.

So I would say for sure on the SOX side.

I think I'd like to think that some of these get to a lower level.

Certainly, we're not recruiting for multiple additional board members at the moment.

So that will -- part of that will go away, but again you're talking sort of hundreds of thousands of dollars and then against that, you have the new setup cost for the Singapore entity, which probably run at a little bit higher core expenses than you would have otherwise done just because it's new to us.

So I hate to be into these numbers, but I think we've kind of have a good walk back to what I think was kind of a little bit more unusual this quarter.

I think the 60% is definitely continues to be a target.

I think, we're pretty happy we can get there in the near term.

The absolute number because it's onboarding 54 new staff, et cetera, is -- we're certainly focused on it.

We're looking at it.

But the exact number in absolute terms is probably a little bit fuzzier just because of some of the moving parts, if you understand what I mean.

But I think we have good line of sight to it, and we're focused on it.

So I don't understand the question.

Okay, great.

And then final question from me just with respect to M&A.

Last 2 quarters, we had some nice announcements to see along with earnings.

I think you mentioned earlier in this call that the Deutsche banking operations should close by the end of the year.

Should we -- in terms of the pipeline for further M&A, is it most realistic to expect that deal to close before moving onto the next one?

Or is there some possibility that you could continue to kind of even before closing it, layer on some more of these types of smaller acquisitions?

So Alex, it's Dan.

So there's a couple of things.

I don't think the DB banking acquisition would prohibit us from looking at something else if it were to come up in the near term.

In particular, if there was a trust fee business, again, the folks working on integrating the banking side are meaningfully different even from an IT perspective than the folks doing the banking side.

So that would be a possibility.

And again, I think if even the right banking transaction came up in the near term, we might try to feather it in, layer it in ahead of time.

That being said, we're having lots of conversations across the globe really.

The reality is is that there's nothing that's overly pressing.

We continue to work with various institutions around the globe and hopefully, something clicks.

We have no regulatory pressure to wait.

We have no -- there is nobody forcing us to wait.

So if something were to come up, we would move forward with it.

It's just -- they come when they come.

There's -- the universe of them isn't overly substantial.

So we need to stay very close to all of the various institutions doing business in the Channel Islands and in markets where we already operate, obviously.

Next we have Arren Cyganovich of Citi.

Just kind of following up on the last question.

When we think about the pipeline of potential acquisitions that are out there, what's the rough approximation of how many of those are more fee businesses versus banking?

And is there anything of the size of this Deutsche Banking you're doing because that was pretty meaningfully large relative to your balance sheet?

So I think -- listen, I think there is a few things.

So I think it's unlikely in Bermuda, there would be anything we could do given the small number of competitors and our large market share, although I know most people have seen in the press that our largest competitor here did mention that they may be exiting.

But I think that would be difficult for us to figure out a way to structure around.

I think people will, obviously, be very familiar with FirstCaribbean pulling its listing.

So clearly that's an organization, in terms of CIBC, we know well.

Victor Dodig used to sit on our board so Michael and he have a relationship as do he and I. So there is a Cayman operation of that, that you could consider, which would be quite substantial, bigger than the Deutsche Bank transaction.

Then you start looking at the Channel Islands, and you have all the U.K. high streets operating there, HSBC, NatWest/RBS, Lloyds, some of those transactions would have larger deposit bases than what we had with the Deutsche Bank transaction.

So they would be somewhat substantial.

There is also smaller players in the Channel Islands in banking.

And then on the fee side, I think we've been through it before.

There is the bank-owned trust companies that hopefully they would look to exit, like HSBC or RBC.

But in addition, there are medium-sized firms that got created by lawyers and accountants and then there's handfuls of those as well.

So again, the hard part for us will be keeping the fee income as a percentage of overall income because NII continues to grow, NIM continues to expand, we are picking up deposits.

But there is opportunities both on the fee side as well as on the banking balance sheet side that we continue to have conversations.

I'm not sure where they'll lead, if anywhere, but we're pretty disciplined about making sure we're reaching out.

And, I would say, we've done sort of, I guess, 6 acquisitions in the last few years.

And there's been periods like we're in now where we've got 2 concurrent Deutsche acquisitions and then there has been periods where we haven't done anything for 18 months.

So as Dan said, we are out there talking to everybody, but it is opportunistic, and we won't stretch for it.

And the most important thing is, number one, to make sure the AML is in perfect shape or we wouldn't be interested, and number two, to make sure we can integrate it.

And I think we have gotten very good in terms of integrating both island banks and offshore trust companies because we know the people, we know the business, we understand that they own their clients.

So I think we're very good at it, but we're not going to push if it's not natural.

Okay.

That's very helpful.

And then the -- thinking about the noninterest fee income, is there any kind of natural organic growth associated with what you have in the business already?

Or is the growth on the fee side really contingent on making additional acquisitions?

Yes.

It's Michael, Arren.

Thanks for the question.

I think, if you look at Page 17 of the deck, we've kind of said that fees are probably more or less flat ex acquisitions and the major growth areas for fees have really been from the acquisitions that we've done in trust and asset management.

So while sequentially we were down a little bit mainly due to seasonality in Q4, which is a very good quarter, if you go back 7 quarters and kind of average that out, you will see sort of high 30s average quarterly run rate, and that's a very stable component of our income and a very capital-efficient way for us to have revenue, and it's really diversified across the trust business lines and asset management as well as banking FX.

So I think there isn't really much opportunity.

I mean, we continue to review fees every year on the banking side, particularly where we have standing order fees and all transactional fees.

So that's a combination of sort of transaction fees as well as account fees, if you will.

FX is a little bit more dependent on, obviously, volatility in the market, but it's quite a healthy part of our overall fee income.

Asset management a little bit tied to how the markets are doing and most of that really comes from a combination of discretionary portfolio management, but also running a money fund that we run here and trust fees we really look at more as annuity fee income.

These are very long -- longevity types of fee income that just kind of keeps trucking.

So a majority of the fee income really comes from the acquisition side.

And none of these fee lines really vary very much with market conditions, but obviously, roughly in the trust side, 2% of our trusts are closing or closed at any one point in time, and we sort of roughly onboard 2% of new fees every year.

So -- but it's a stable component.

And just my last question is on the asset sensitivity after the Deutsche Banking transaction closes.

Do you anticipate that to change your asset sensitivity of the balance sheet much whenever you incorporate that into the balance sheet?

Yes.

So inevitably, it will, because the reality is that as we're picking up -- I think we've guided circa around $2 billion of deposits.

It will take us a while to ladder that out and take out some of the inherent interest rate risk because of the stickiness of those deposits.

So yes, our asset sensitivity will increase, and then we'll have to work to ladder out the deposits when we're more comfortable how sticky they are and offset that inherent interest rate risk by putting on some longer-durated investments.

Again, it comes with minimal to no loan book.

So it will have to be the investment portfolio that mitigates the behavioral nature of those deposits from an interest-rate risk perspective.

And next we have Don Worthington of Raymond James.

Really just had one more question and that was on the provisions you were able to release reserves again this quarter.

Just curious about the outlook as to whether there might be more opportunity for that or whether you might start provisioning again next quarter?

Yes.

Thanks, Don.

It's Michael Schrum.

So I think what we've said in the past is we continue to see benign credit conditions, but there is low velocity in the 2 markets, Cayman and Bermuda.

And so amortization kind of runs faster than originations.

But there is no inherent credit stress in those mortgages, 65% of our loans are individually underwritten home loans and mortgages in Bermuda and Cayman and the U.K. In terms of the provision number and also on the commercial side, probably because the number in absolute terms is kind of low, we might see a little bit of lumpiness if we see something trip in.

But there is no current stress in that book either.

What's happening on the provision side really is the lookback period for the hospitality is a 5-year lookback period, and that will start to normalize into next year.

So as some of the 2009, '10, '11 loans that were cured or, in restructure, start to run out of that historic lookback period, that provision number will start to normalize, and we'll see less or no releases coming through.

But that will be some time into at the end of this year or some time into next year.

Offsetting that, obviously, if we start to see stresses it will come through net charge-off rate or new provisions created.

I'm showing no further questions.

We'll go ahead and conclude our question-and-answer session.

I would now like to turn the conference call back over to Mr. Noah Fields for any closing remarks.

Sir?

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

We look forward to speaking with you again next quarter.

Have a great day.

And we thank you, sir, also for your time and to the rest of the management team.

Again, the conference call is now concluded.

And again, we thank you all for attending today's presentation.

At this time, you may disconnect your lines.

Thank you, take care, and have a great day, everyone.