Bank of NT Butterfield & Son Ltd (NTB) 2019 Q4 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Fourth Quarter and Year-end 2019 Earnings Call for The Bank of NT Butterfield & Son Limited.

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

I would now like to turn the conference over to Noah Fields, Butterfield's Head of Investor Relations.

Please go ahead.

Thank you.

Good morning, everyone, and thank you for joining us.

Today, we will be reviewing Butterfield's fourth quarter and full year 2019 financial results.

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

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

Yesterday afternoon, we issued a press release announcing our fourth quarter and full year 2019 results.

Press release, along with a slide presentation that we will refer to during our remarks on this call, are available on the Investor Relations section of our website at www.butterfieldgroup.com.

Before I turn the call over to Michael Collins, I would like to remind everyone that today's discussions 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 and slide presentation.

Today's call and associated materials may also contain certain forward-looking statements, which are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements.

Additional information regarding these risks can be found in our SEC filings.

I will now turn the call over to Michael Collins.

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

I am very pleased with the bank's achievements in 2019 and the strides we have taken towards being the leading independent offshore bank and trust company.

During the past year, we successfully pursued our acquisition and growth strategy that is focused on our established footprint in key jurisdictions, which include Bermuda, the Cayman Islands and the Channel Islands.

In addition, we have a well-established, high net worth lending business in the U.K., primarily focused on Central London.

We support these businesses with lower-cost service centers in Canada and Mauritius, which provide us with ongoing expense leverage and expanded talent pool as we continue to move forward the client service proposition.

I wanted to acknowledge the resilience of our Cayman team and infrastructure.

2 weeks ago, there was a magnitude 7.7 earthquake very close to Cayman.

While serious, I am thankful to say that there were no serious injuries and minimal damage.

Within 24 hours, we were back to business as usual, due to our strong business resilience framework.

Turning now to Slide 4. Butterfield reported strong annual net income of $177.1 million and record core operating income of $197.9 million.

These earnings translate to annual core return on average tangible common equity of 23.4%.

NIM of 2.86% for the year was down, primarily due to the acquisition of the Channel Islands, which was accretive to net interest income despite being NIM dilutive.

Our focus on lowering costs and improving efficiency resulted in a core efficiency ratio of 62.2%.

These efforts to moderate expense growth are particularly important in a lower interest rate environment and at a time when we are integrating a large acquisition.

I'm also encouraged by the growth in our loan book this year, which increased 27% due to our newly acquired business in the Channel Islands, new Bermuda and Cayman sovereign loans and our continued growth in the Central London mortgage book.

Our interest rate sensitivity has also moderated to a level that is more in line with U.S. regional bank peers due to increased fixed-rate exposure in Ginnie Maes and customer loans.

We consider capital management an important value driver with the majority of the bank's earnings supporting quarterly cash dividends and share repurchases.

We continue to return excess capital to shareholders, while also considering an accretive acquisition target, although we are not likely to consider any significant acquisitions until the latter part of 2020 or into next year where we fully integrate our recent Channel Islands deal.

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

Thank you, Michael.

During the fourth quarter, we reported net income of $43.9 million or $0.82 per share and $46.2 million or $0.87 per share on a core basis.

Butterfield's core return on tangible equity was 21.1%.

The fourth quarter results benefited from our larger balance sheet, growth in noninterest income and a higher net interest margin.

Deposit costs fell by 4 basis points compared to the prior quarter to 50 basis points, contributing to a NIM of 2.59%.

The Board of Directors continue to express confidence in our earnings profile with the approval of a $0.44 per common share quarterly dividend, which is around a 5% annual yield at the current share price.

In addition to the dividend, Butterfield currently has an approved share repurchase program of up to 3.5 million common shares.

On Slide 7, we provide a summary of net interest income and NIM.

Net interest income was flat in the quarter, while NIM increased 7 basis points compared to the last quarter due to an improved asset mix, with increased volumes from loans.

The average balance sheet of loans in the quarter increased by $351 million or 8%, while lower-yielding cash and short-term investments fell by $643 million or 14%.

We have continued the process of monitoring the customer flows from the ABN deal in the Channel Islands and expect to gradually improve productivity through deployment from cash into additional investment securities.

Looking now at Slide 8. On Slide 8, we provide an overview of average customer deposit balances by location, currency and contractual nature.

As of December 31, 2019, total deposits were $12.4 billion, down approximately $221 million compared to the prior quarter.

U.S. dollars represent 70% of deposits, with sterling at 20% and other, which is primarily made up of euros, at 10%.

We have been successfully repricing euro deposits, which is in line with our integration model, resulting in a modest attrition in euro balances in the Channel Islands.

Overall, the cost of deposits has dropped 4 basis points to 50 basis points, with term deposit costs falling 10 basis points to 1.38% and demand deposit costs down 3 basis points to 25 basis points, each compared to the prior quarter.

Turning now to Slide 9. Fee income was up 6.6% in the fourth quarter due to the full quarter of contribution from the Channel Islands acquisition and increased seasonal merchant-acquiring volumes, which tends to occur in the fourth quarter each year.

Cloud services contributed $6.4 million to the $14 million of banking noninterest income in the fourth quarter.

The fee income ratio increased during the quarter to 37% from 35% in the prior quarter.

The significant contribution from fee income as a percentage of Battlefield's total revenues contribute stable and capital-efficient earnings, and we believe this is a positive differentiator relative to U.S. retail banking peers.

On Slide 10, we provide an overview of core noninterest expenses, which have increased during the quarter to $91.6 million from $84 million in the prior quarter.

Expense control remains a priority for management, while the fourth quarter included some specific client-focused investments and programs, which will reduce or disappear once full operational integration of ABN is achieved.

This is still expected late in the second quarter of 2020.

The fourth quarter includes cost associated with the expansion of group service centers in preparation for our call center migration planned for the second quarter of 2020, acquisition-related integration and compliance review expenses in professional services as well as investment in our exciting new Camana Bay branch in the Cayman Islands and the launch of Butterfield's global rebranding initiative.

We continue to expect expenses to return to around the $88 million per quarter level, following the full operational integration in the Channel Islands in the second quarter of 2020.

Looking now at Slide 11, we provide a summary of capital levels.

Balance capital management remains a key focus and we continue to manage to our target levels.

Our TCE-to-TA ratio of 6.3% is within our target range of 6% to 6.5%.

We believe that the current dividend payout ratio of 52.8% is sustainable and contemplates continued share repurchases and the potential to make further accretive acquisitions.

Turning now to Slide 12 and a discussion of the balance sheet.

As we had anticipated, Butterfield's total assets reduced to $13.9 billion from $14.2 billion at the end of the prior quarter as we continue to reduce euro balances in the Channel Islands.

While the balance sheet is smaller, our earning assets have grown due to increased lending to the governments of Bermuda and the Cayman Islands as well as growth in our Central London mortgage books.

We continue to maintain a consistent and conservative underwriting profile.

Additionally, balance sheet values that are reported in U.S. dollars benefited from a favorable sterling exchange rate at the year-end.

On Slide 13, we demonstrate the low credit risk in our investment portfolio, with 99% of investments in AAA-rated U.S. government-guaranteed mortgage-backed securities.

Our loan book is comprised of 62% of residential mortgages, with 3 quarters of residential loans below 70% LTV as of December 31, 2019.

Nonaccrual loans have continued to trend lower, with a net charge-off ratio at 2 basis points.

We've completed our CECL adoption models and have determined the transitional adjustment to the total allowance for credit losses to be $7.8 million as at January 1, 2020.

As discussed last quarter, this is within the expected range and consistent with the expected ranges of outcomes being communicated by other U.S. banks.

On Slide 14, we discuss the average cash and securities balance sheet with a summary interest rate sensitivity analysis.

During the fourth quarter, Butterfield's asset sensitivity reduced significantly as we increased fixed-rate assets with a large new fixed-rate sovereign loan in the Cayman Islands and added London fixed-rate mortgages.

Additionally, with a more stable long-term U.S. rates outlook this quarter, the duration of the existing mortgage-backed securities portfolio extended by 3 months to 4 years.

We believe the current levels of interest rate sensitivity should provide improved earnings stability and protect value for the franchise and shareholders in future years.

I will now turn the call back to Michael Collins.

Thank you, Michael.

The fourth quarter was a solid finish to the year.

The integration of the Channel Islands acquisition is proceeding well, and I continue to be impressed with the high-quality of clients and new colleagues we gained with the deal.

We anticipate the new business to be fully integrated by the end of the second quarter of 2020.

In the interim, we're exploring potential acquisition targets.

And we'll continue to pursue M&A opportunities, which exceed our financial, geographic and business mix acquisition requirements.

Expense levels were higher than our targeted run rate this quarter, but we anticipate cost to normalize, and the investment we made towards the business this quarter will benefit the bank in the fullness of time.

We expect to buy back shares, subject to market conditions and believe the current quarterly cash dividend rate is an appropriate way to continue rewarding shareholders.

After more than a month into 2020, I am confident that we are well positioned for continued profitable growth.

We have footholds in the markets where we can most effectively help clients create wealth and build relationships.

There are markets in which we have a long history and an established right to compete for lending, banking, trust, high net worth clients and long-term affiliations with financial intermediaries.

Over the past year, our balance sheet has become more evenly distributed across Bermuda, Cayman and the Channel Islands.

We see opportunities in all of our locations with the Channel Islands likely to have the greatest opportunity for growth, either organically or by further acquisitions.

Thank you.

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

Operator?

(Operator Instructions) Our first question comes from Arren Cyganovich with Citi.

I was just wondering if you could talk a little bit about where the deposit attrition is today and the pace that you expect going forward for maybe an acquisition.

Yes, Arren.

Thanks.

It's Michael Schrum.

So we're broadly in line with the announced acquisition model in terms of the attrition.

Obviously, the balance sheet also benefited from a very strong sterling rate at the end of the year, so that boosted the balance sheet values in dollar terms by about $150 million.

I would say we're sort of halfway through that process.

We probably have $300 million to $400 million still sort of what we would call at-risk deposits, primarily euros, again, in ABN.

As I mentioned just a moment ago, about 10% of deposits are now in other currencies, and it's primarily euros.

Those customer relationships tend to be linked with other currency deposits.

And so we're looking quite carefully at those but broadly in line with where we announced the model.

Okay.

And then you kind of -- you gave us an idea of run rate expenses.

Did you say what you expect for run rate fee income now that you've had the combined entity, how that should look on a kind of quarter-to-quarter basis?

I know the fourth quarter tends to be higher from seasonal card issues, but just kind of an idea of what the fees should be looking like?

Yes.

So I think the fourth quarter was fairly representative, except for the merchant-acquiring volumes and some seasonality in card usage, primarily associated with Christmas shopping as well as -- it's the high season for tourism in Cayman.

So it's probably about $1.4 billion out of that $1.9 million delta in the quarter that's coming from that.

But other than that, that quarter is fairly representative in terms of the first full quarter impact of ABN.

Obviously, we're hoping to -- that, that creates a base for growth as well.

Our next question comes from David Feaster with Raymond James.

Just wanted to follow-up on the expenses.

So I guess for the first quarter, would the fourth quarter, I guess, ex one-time items of like $90 million be a good starting point for the first quarter?

And then, well, you said, $88 million in the second quarter going on?

Yes.

No.

I'm happy -- thanks, David.

I'm happy to give a bit more color around expenses.

Obviously, we had some noncore expenses this quarter, which primarily relates to staff exit cost as part of the program to align staffing levels of the ABN to the go forward.

So that was pretty much done last quarter.

But in terms of the core expense run rate, as we look at some of the programs that we've been running out, the brand rollout, which primarily is around the new trademarks, new logo, new customer forums, credit cards, branded materials, et cetera, primarily booked in marketing in the quarter is probably high by about $1 million.

There will be some elements of that program that will continue for the full year as we're adopting a phased approach.

So we're telling -- we're not replacing current credit cards that are still valid.

But on renewal, they will be replaced to kind of try and protect some of the burn rate on that.

Property, new signage, we had some expanded space in the Halifax service center in anticipation of onboarding the call centers, which we had a partial impact this quarter of running multiple call centers, but that transition will flip over some of it this quarter and some of it next quarter.

And then we had some moves in Bermuda as well, again, property-related for the new branch that we're refreshing here in Bermuda.

Again, that will be a fully rebranded branch as part of that.

We were just opening a new branch in Camana Bay this week.

It looks fantastic.

It should attract a lot of the mid-market corporate and private client footfall traffic in Cayman Islands.

And finally, we have some office moves in Guernsey as well to co-locate some of the RM teams in one building following ABN.

So again, that property is probably elevated this quarter.

And these won't sort of recur fully, certainly, in the next quarters.

Elements of that will come through, but there was probably almost 1 million there in terms of elevated expense levels.

The accelerated customer reviews of the ABN book, so we've taken a view that within a year, we'll look at all high and medium risk.

Again, these are core expenses, but we expect completion again of that into 2Q 2020.

It's growing pretty well.

That's about $0.5 million in professional services there.

And then finally, we also worked on the integration for the ABN and IT upgrade.

So we're upgrading the system for our current customers in anticipation to -- of having one banking system across the Channel Islands.

So about $0.5 million there in salaries in IT.

Again, that completes into Q2.

And then, obviously, we had some consulting fees in the fourth quarter as well.

We had some purchase price allocation fees, professional services fees, the review of the loan book, quite detailed to look for any impairments there.

And that was probably $0.5 million.

So that work is completed was in Q4.

And that's kind of it for the quarter in terms of what I would call out there.

I think over time, we're targeting flat year-on-year ex ABN in core expenses.

So we expect to revert to the approximate $88 million run rate over the next couple of quarters, but probably not fully seen until Q3 this year.

So we'll kind of gradually phase down as some of these programs phase out, essentially.

So David, it's Michael Collins.

I think I would just give you an example.

So the call center in Halifax.

So we have 140 people, all in, in Halifax today.

So it's ramped up very quickly.

We've got a full call center sort of working ready to go there.

And we still have our Bermudan Cayman call centers.

So we really have 3 call centers where we're going to have 1.

And then the other part of the expenses is really investments in brand and client functionality.

So we're launching our new online banking for corporates in Bermuda and Cayman.

So they're all good investments, but it was a bit toppy this quarter.

Yes.

That makes sense.

And I guess, looking out to 2021, I know it's a bit fuzzy.

But just as I think about it, given inflationary pressures combined with the decreasing amortization expense that we talked about last quarter from the Butterfield platform.

Should -- you think we can get back to the $86 million to $87 million run rate that you discussed last quarter?

Yes.

Absolutely.

I think if you consider the amortization, just on its own, the full year impact of that is almost $10 million being phased in starting at the end of this year.

I mean it's always a bit tricky, but we don't know what the government is going to do in terms of taxes.

The annual budget is coming up.

But certainly, that's what we would foresee as we sit here today.

Okay.

Terrific.

And then -- that was great color.

Could you just talk about your thoughts on capital deployment?

What are your priorities here?

You mentioned the buyback and additional M&A, but how do you think about each of those independently?

And how are M&A conversations?

And, I guess, would you be willing to go towards the low end of your TCE target towards that 6% level?

Yes.

It's a great, great question.

And certainly, a very good dialogue at the Board and we continue to have that every quarter with the Board.

Again, the Board keeps reiterating we have a balanced capital allocation.

So it was, first and foremost, supporting a healthy and sustainable dividend rate, which approximates 50% payout ratio through the cycle.

So we've been a bit low on that ratio coming up the rate curve.

We're now a little bit more mature.

So we've had a number of years where we've increased the dividend quite rapidly.

And we're now at that 50%.

We're integrating a large new bank.

So the sort of stable earnings profile of that and the organic growth profile of that is a bit up in the air as we're repricing some of those.

Secondly, we favor certainly buybacks at the moment, and we have a big authorization out there, which look attractive at a sort of 20% ROE in a single-digit forward PE valuation point.

Thirdly, selective M&A and organic growth support.

We're going to continue to support core markets that we operate in.

So the 3 primary banking markets, as well as look at M&A opportunities.

We're sort of currently at the middle of the target TCE range.

We were just at around the 6% following the ABN deal and we have been certainly above the target range prior to the acquisition of M&A.

So it's kind of a target range that we're sitting in the middle of right now.

The dividend rate, as I said, is discussed every -- and approved every quarter, especially given the ABN integration at the moment.

And so overall, this supports the strategy, which remains really focused on growth in tangible book value over the long term.

Yes.

In terms of M&A, I would just add that we're still going to focus on finishing our integration of ABN in Q2, really, with the system conversions.

So that's still the focus.

We'll continue to focus on bank and trust company acquisitions, but really only in our existing jurisdictions, probably with an enhanced focus on, obviously, the Channel Islands, where we're growing well and also Singapore, where we've got a great new trust company, but we need to get some scale there.

We actually have passed on a couple of smaller trust opportunities recently.

So we're continuing to have discussions and look, but its got to be -- its got to really fit all of our criteria.

And so we'll keep focusing on it, but it's ABN at this point.

Our next question comes from Alex Twerdahl with Piper Sandler.

First, I wanted to drill in a little bit more to the loan growth that we saw in the fourth quarter.

It was a bit of a surprise.

It seems to me like -- I mean, I guess, first, maybe you can break out how much of it was U.K. mortgage and how much of it was the loans to the governments of Bermuda and Cayman.

Okay.

So it's Michael Collins.

I would say that the 2, Bermuda and Cayman sovereign loans are really specific transactions that are unlikely to be repeated.

So as we said, we increased from Q3 to Q4 about 10%, 27% year-on-year, so to about $5.1 billion.

Bermuda was about $100 million of that.

So there was a $200 million Bermuda government facility that was really bridge financing to a new bond issue.

We took $100 million of that.

HSBC Bermuda took $100 million.

It's only a 1-year term floating rate at about 4.25%.

Cayman was a great opportunity, $180 million loan, 15 years fixed at 3.25%.

Obviously, both 0-risk weighted.

So from a risk-adjusted perspective, really, really great opportunities for us.

But the Bermuda one will come off pretty quickly.

They may come back to us in the future, but it's really sort of one-off stuff.

The Cayman is 15 years, so that will stay with us.

Butterfield mortgages had a really good quarter as Brexit -- the Brexit outcome became more clear.

So that was about -- basically, about the same sort of quantum as the other 2. So we would never really sort of characterize ourselves as a loan growth story.

Our strategy is still a lot to do and the out-of-market lending even as rates rate decline.

So that's still the focus, but we did get a little bit lucky this year, but part of it will come off.

So really helpful, but I would say that it's going to be relatively flat this year, maybe a little bit up.

And then the U.K. mortgage that I think you mentioned in the prepared remarks that you were mostly putting on a fixed rate today.

Is that correct?

And doesn't that compare to floating or variable rate U.K. mortgages, which is kind of the traditional product for you guys?

Yes.

So the U.K. market -- sorry, it's Michael Schrum.

So the U.K. market sort of flips between floating and fixed, as you know, the 3 to 5 year IO typically structures.

And they've been leaning more towards the fixed-rate product now.

So in terms of overall -- on a portfolio basis, we now have, approximating 10% fixed-rate loans on the books.

Bermuda and Cayman have also been somewhat successful in getting more fixed-rate product on the balance sheet.

And obviously, the Cayman facility was -- is a real helper in terms of our sensitivity as well.

Okay.

And then in terms of when you look at the balance sheet and the complexion of the sterling-denominated deposits relative to sort of capacity to add additional mortgages in the U.K., is there still capacity on the balance sheet for them?

Yes.

Absolutely.

So we're at about $1 billion today between the -- between the ABN mortgages and the BML mortgages booked through BML.

About 20% of our balance sheet is in sterling today of customer deposits.

So depending a little bit on the attrition there, if some of them go from the ABN book repricing.

But there's certainly ample cash, short-term investments sitting in sterling today.

And that would obviously be very helpful to get some good loans on the books.

Okay.

Yes.

So I mean, certainly, loan growth is going to be NIM accretive, especially relative to cash and securities, but just kind of thinking about the other pieces of the margin here.

Deposits saw some nice repricing down of CDs during the quarter.

Kind of as you weigh sort of what's going on in the books with euro-denominated deposits continue to run off and potential additional opportunities to reprice lower CDs, how are you thinking about your cost of deposits for the first couple of quarters the next year?

And then maybe you can kind of wrap it all together and kind of give us some suggestions on how we should think about the trajectory of the NIM, assuming the yield curve kind of stays relatively similar to what it looks like today?

Yes.

No, great question, Alex.

Thanks.

I mean I would just -- I'm just going to focus on the sort of bigger levers here.

So obviously, there's a lot going on with the multi-currency and the repricing of the euro deposits.

But essentially, we have that 25 basis points in the Bermuda mortgages coming through.

Obviously, that's a downdraft on NIM in Q1 this year, so we priced with a 90-day lag.

The term deposits rates will continue to reset at lower rates as they roll over.

Approximately 90% of term deposits or CDs roll over automatically.

And with the rate reductions that we've already done following the market adjustments, we would expect for those to partly offset that downdraft in NIM.

Demand deposits is -- that's going to improve slightly, but it will depend a little bit on the attrition levels in the ABN book.

There's not much more that we can do in terms of the cost of deposits for -- in Bermuda and Cayman market.

So generally, I mean, overall, even with the securities side, I would say flattish, I mean, plus/minus a handful of basis points in the next couple of quarters.

And then as we start to season the deposits in during the second half, we would expect a more meaningful improvement in overall NIM subject to, obviously, what the market is doing at that time.

But that seasoning could translate on a full year basis into sort of a 70 basis points on $500 million to $700 million, depending on where we land on total deposits level for full year effect at the current market rates.

So hopefully, that gives you a sense sort of how we're thinking about it.

Our next question comes from Timur Braziler with Wells Fargo Securities.

Just circling back on Alex's question on the loan book.

This year, it was low double-digit kind of organic loan growth.

Last year, I think loan growth surprised to the upside relative to expectations.

It seems like there's still room in the U.K. resi book.

I guess what gives you pause to future loan growth?

And what drives the expectation for balances to be flat here, given some of these tailwinds that we've seen?

Yes.

So I would say that #1 gating factor is, as I said, we're not going to do out-of-market lending, which is Bermuda, Cayman, potentially the Channel Islands if we get it down that route.

And certainly, Central London, which was the portion of our old bank that we kept.

So we understand that market and fund it out of the Channel Islands with sterling.

So that's the #1 gating factor.

I would say, Bermuda, economically, is relatively flat right now.

So not a huge amount of loan demand, either on the residential or corporate side.

Cayman actually is growing quite well.

The economy is really growing at a 3% clip year-on-year.

So we'll grow with GDP and with the economy.

So I think there is some organic growth opportunities in Cayman over time.

Butterfield Mortgages Limited has done a great job.

And I think with Brexit clearing up and having a better sense of where that's going, that will continue.

So I think there's opportunities to grow in London and a little bit in Cayman with GDP.

But again, I would just stress that the 2 sovereign transactions were very specific.

I think Butterfield mortgages had a big bump because Brexit was kind of clearing up and Corbyn didn't get elected, probably more importantly.

So I think that's pretty clear.

But it's -- we keep saying it's not a loan growth story because I think if we said it were a loan growth story, that would actually imply that we'd be lending out of market, which is not something we're willing to do from a risk perspective.

And we're in very small jurisdictions.

So we do get lucky occasionally when you get big sovereign facilities.

But we will generally grow with GDP in Bermuda, which is flat, Cayman maybe 3%.

And I would think that London will do well.

But we might have had a bump in Q4 because of the Brexit clarity.

So that's how I'd describe it.

Okay.

That's helpful.

And then as you look at the Channel Islands, do you foresee a lending opportunity there as you kind of fill in that business?

And if so, where do you think Butterfield could fit into the lending picture there?

Well, I mean, I think we're looking at it.

Obviously, both our bank in Guernsey has been a corporate financial intermediary bank as is our new bank in Jersey.

So that's our expertise in the Channel Islands.

I would say, over time, as we get more and more comfortable with the environment there, there is an opportunity over time that we could end up maybe looking a little bit more like Bermuda and Cayman, where we would focus on residential lending and maybe some more fund lending, financial intermediaries, which we're doing a bit now.

But on the retail side, we are potentially having a look at it.

The one most important factor is we're still 62% of our loan book across the group is residential mortgages and the other 38%, 40% actually is still kind of commercial lending, but it's all secured by property.

And -- so it's very much like a residential mortgage.

So that wouldn't change.

So if we're able to replicate that, what we've done in Bermuda and Cayman, with reasonable deposit rates, financial intermediary deposits, funding higher mortgage -- higher-margin residential mortgages, it's something we will look at.

But I would stress that, that will take time as we get more comfortable with the market.

Okay.

That's helpful.

And then just one last one for me.

Looking at the pound sterling portion of the acquired deposits, I guess, what's the plan for those?

It seems like much of the focus thus far has been on the euro-based deposits.

And that's what we've seen much of the attrition in.

But as we look at the pound sterling deposits, is the plan still to reduce those balances as you go through those accounts?

Or is the strong demand for U.K. mortgages likely to result in those staying on the balance sheet?

No.

Great question.

So I think the first thing is we're focused on the euro balances.

We like the sterling deposits.

We have U.K. GILTS.

There are sovereign exposures that are highly rated similar to the Ginnie portfolio that we have in dollars.

As long as we can make a nice turn and create some -- create ROE on a regulatory capital basis, effectively, that remains a priority for us.

Obviously, loan growth is being supported by the funding in the sterling.

And I think we certainly have more runway there, so we're not -- the attrition in the sterling was really as a result, potentially, of having multicurrency depositors where we're repricing the euro deposits.

And that's the exercise that we're going through at the moment, Timur.

So not exactly clear where it's going to ultimately land, but I think we're certainly very fond of sterling deposits.

Okay.

And then as you look at the original deposit attrition guidance of the 35% to 40% of the acquired book, is that seeming conservative at this point?

Or do you think that it will still get there as we go through the course of '20?

Yes.

I mean, that's -- so remember, the book is also moving all the time.

So we have normal commercial movements, and we've actually won some pretty good business in Guernsey, so we're seeing good opportunities for deposit growth, both in the -- what was the existing Butterfield bank and the combined entity now that we're a bigger market share in the Guernsey market.

But we're still on target for this -- for the deposit attrition.

The early parts were easier to some extent in that they were primarily only euro depositors.

And the multicurrency depositors, obviously, we want to handle with care and make sure that we're understanding their requirements and needs for banking with us.

A lot of them have custody relationship, FX relationships as well.

So that's the exercise we're going through at the moment.

But I think the best -- our estimate is still the guidance that was put out.

Our next question comes from Will Nance with Goldman Sachs.

Maybe I can follow-up on the earlier question on the margin.

Thanks for all the moving pieces.

Just on the securities yield, the yields held up quite nicely this quarter.

And I guess, just given what's happened with the yield curve over the past several weeks, can you just give us a sense for where the kind of new money yield is on securities and how to think about the pace of deployment of liquidity into the securities portfolio over the next 12 months?

Yes.

So the last quarter, actually, we didn't really invest.

We just rolled over existing maturities.

I don't have the -- I don't have them right here with me.

But essentially, we also got some extension, obviously, in the book due to some slower prepayment speeds in the book.

So that helped.

And the reason why we didn't deploy this quarter was we had these lending opportunities, which, obviously, was a better use of funds.

I would say the primary focus, obviously, on reinvesting in existing maturities, and that's what's driving slightly improved market rate outlook this quarter that's helping our sensitivity in that regard.

And as we look into the second half of this year, we should see the AFS and HTM books starting to expand or getting that cash put to work.

Essentially, that's underpinning the customer deposits in the ABN book.

You should expect a pace of that similar to when we did the 2016 acquisition of HSBC here in Bermuda, where we got about EUR 1.6 billion of deposits.

And we sort of typically target sort of -- we end up targeting between 40% and 65% of deposits, so we get the cash balances back to just really a treasury management function.

And then that gets flattered out over a period of sort of 9 to 12 quarters.

And we continue to monitor flows to ensure that, obviously, we maintained -- conserve liquidity buffers for ourselves during that time.

So that could result in a deployment in the second half of this year at about $200 million a quarter over the subsequent sort of 8 quarters.

Got it.

That's very helpful.

And then just maybe a high-level one on business in the Channel Islands.

Can you just talk about the reception to Butterfield in the market versus some of the other competitors there?

And I guess how are you thinking about the ability to win new business?

Do you feel like you need to do more acquisitions in the market?

Or have early kind of conversations with clients been encouraging?

And just like how are you thinking about the growth opportunities there, both organically and inorganically?

Well, we're the first new bank in Jersey in a number of decades.

So I think the initial reception was quite good.

I think both Guernsey and Jersey are experiencing a situation where there's a lot of indigenous banks and subserves high street U.K. banks that are actually kind of getting out of the market.

So having a bank in Guernsey with a 10% or 15% market share and a new bank in Jersey with a small market share but the first in decades, the reception has been great. .

I think what always interests us is that when we take on a new bank or take on new clients that are institutional, they actually get pretty comfortable with our credit quality.

Occasionally, if a client has $200 million or $300 million with us, they'll move some of it just from a size perspective.

But I think when they kind of dig into our public information and being listed in New York, actually, for a small bank like us helps a lot.

If there's tons of information out there, they get very comfortable.

So we lost very few clients, ABN clients, just based on the fact we're not ABN.

We're a much smaller bank.

So that's a lot of the work.

But the reception has been great.

I think the premise still holds.

There's a dislocation in the market.

A lot of sellers, very few buyers.

So I think if we just continue to focus on making sure ABN is a success, our relationships with both the Guernsey Financial Services Commission, Jersey Financial Services Commission are both very good.

That's hugely important.

So we want to make sure ABN is a success and continue to wait for more dislocation in the market.

And we've really balanced our exposures across the 3 jurisdictions, which was one of the strategic goals of ours.

And now really, it's about organic growth and maybe sort of layering on another acquisition when people get out.

So we're the only bank or one of the few banks that visibly is really, really committed to that market.

And I think it shows because clients don't want to move around.

I mean, as everyone knows, trying to set up an account at any bank today is like pulling teeth.

So it's important to have stability.

And I think we show that because we want to be in the market, and clients understand that.

(Operator Instructions)

And our next question will be from Michael Perito with KBW.

Yes.

A lot of my questions have been kind of asked and answered already.

I did just want to clarify a couple of items, just on expense and margins just to make sure I kind of heard all the comments right because I got on the call a little bit late.

So I apologize for that.

But just, I guess, first on expenses.

So I mean, is it correct to think that the -- so the $91.6 million core in the fourth quarter, that will step down modestly in the first half of the year, but the $88 million really will take hold in the third quarter.

Is that correct?

Yes.

That's how we are thinking about it.

Some of the programs, like the property movements and some of the marketing expenses associated with the brand rollout will continue at a modest pace throughout the year.

But some of the other programs roll off during the first and second quarter of this year.

Okay.

And then on the margin, the -- I think the outlook was from this 2.59% level for somewhat stability near-term before some of the leveraging of the balance sheet that you guys have spoken to takes it hopefully higher.

But what does that kind of assume around the $100 million bridge financing with the Bermuda sovereign?

I mean, does that assume that, that stays for the next 12 months and then rolls out?

So I imagine there will be some modest step down just given the potential mix shift when that loan rolls off.

Yes.

And it's a good question.

But again, it's $100 million at 4.25%.

So it's 1 or 2 -- it's max 1 or 2 basis points in the $5 billion portfolio.

Well, I mean, it's -- yes.

So we're -- the way we sort of look at it is it's more up to what's happening in the market really at this point as opposed to what we are doing in terms of the forward NIM.

It's going to be kind of plus/minus 5 basis points in the first couple of quarters.

And then, obviously, the leverage will start to happen in the second half.

Okay.

Great.

And then just 2 last ones.

One, Mike, would you say you guys have greater appetite for longer duration assets maybe relative to 6, 12 months ago, just given kind of the state of the U.S. yield curve as we think about you guys deploying the cash?

I mean, are you comfortable maybe seeing a little bit longer duration on the securities that you guys buy, given there's really not much global outlook for increasing rates at this point?

Or how are you guys thinking about that dynamic?

Yes.

I mean, I think, again, we've been sort of fairly consistent in terms of -- we're always targeting a duration at around -- we behaviorized deposits out to 6 years at the moment.

Based on our history, that could be longer.

So if I think about the investment book being part of that, and that will, to some extent, depend on the loan growth as well.

So $15 million -- 15-year fixed-rate loan is obviously a big draw on funding our liquidity for the bank as well to the Cayman Islands government.

But I would say we target around a 5 year.

It's been shorter because we've been seasoning in deposits from prior acquisitions.

So the DB acquisition is done, got seasoned in.

Prior to that, we had the HSBC acquisition.

So we've always been a little bit shy of our target, really, on the investment book.

But I would say we're continuing -- we favor Ginnie's explicitly guaranteed issuances complexity instruments that give us that kind of a bell curve on the balance sheet.

And then we have to be conservative at the short end, obviously, because we manage our own treasury positions between the different banking balance sheet.

So I would say it hasn't really changed given the rate outlook, it's just that we are continuing to do what we said we were going to do.

Okay.

And then just lastly, I was wondering if you could expand a little bit more on the new banking center in Cayman.

Is that in -- I mean because it's -- that has been a market where you guys have been optimistic about the growth for some time.

Do you think this branch will help you reach kind of a new geographic portion of that market?

Or can you talk, I guess, just a little bit more broadly about kind of the decision to make this expansion and what you expect some of the benefits will be in the market?

I know you guys have already seen some nice growth there.

Yes.

It's -- so we just got back from Cayman on Tuesday night.

We had a Cayman bank subsidiary Board meeting and we opened Camana Bay branch.

And I think the most important part is Camana Bay, for people that know Cayman, is a pretty new development that's residential.

It's corporate.

It's hospitality, restaurant sort of built from scratch.

So it's got scale.

It sort of reached a critical mass in terms of development over the last 10 years.

So I think our timing is pretty perfect.

The other Canadian banks, Scotia, RBC are both there.

And it was sort of the one area that we haven't sort of developed.

I'd say we're the largest bank in Cayman.

We've been there 50 years.

We're really considered the local bank, I think, for most Caymanians.

And I think having -- not having a branch at Camana Bay kind of stood out.

It also gives an opportunity to really visibly launch our new brands.

So it's a very different look and we're getting a lot of great comment about it.

I think it's good for the Cayman employees as the bank continues to grow there, but most importantly, Cayman is doing well.

So whether it's tourism or funding corporations or building, it actually is growing quite rapidly, relative to some of our other jurisdictions.

And we really want to invest our capital in places that appear to have GDP that's going north.

Population has increased from about 60,000 to about 68,000, so it's pretty much an open economy.

And just spending a couple of days down there, it feels like it really is booming.

So we're just investing our capital in places where we think we have opportunities to grow.

Yes.

And Mike, in terms of the facility, it's primarily a retail branch.

But one of the access points that we were missing in Cayman is a lot of the nexus of the mid-market corporate business, so the fund admin companies, the captive insurance companies, have moved their offices to Camana Bay.

And so this facility really allows us to have meeting rooms for meeting with clients like Aon and Marsh.

So the corporate banking folks can get out and have a meeting room with them.

And I think we'll continue to certainly keep that market share as well as increase our retail market share over time.

This concludes our question-and-answer session.

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

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

We look forward to speaking with you again next quarter.

Have a great day.

The conference has now concluded.

Thank you for attending today's presentation.

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