Bank of NT Butterfield & Son Ltd (NTB) 2020 Q4 法說會逐字稿

Good morning. My name is Andrew and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter and Year-End 2020 Earnings Call for The Bank of N.T. Butterfield & Son Limited. (Operator Instructions)

Please note, this event is being recorded. I would now like to turn the call over to Noah Fields, Butterfield's Head of Investor Relations.

Thank you, operator. Good morning, everyone, and thank you for joining us. Today, we will be reviewing Butterfield's fourth quarter and year-end 2020 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 the call up for a question-and-answer session. Yesterday afternoon, we issued a press release announcing our fourth quarter and year-end results. The press release, along with a slide presentation that we will be referring 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 on 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. On Slide 26 of the presentation, we have also included a list of potential factors relevant to the implications of COVID-19 for the bank. 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 will begin our discussion with a look back at the full year and provide some observations on the bank experience in 2020 and then provide an update on COVID-19. I will then turn the call over to Michael Schrum, our CFO, to provide a detailed review of the fourth quarter financials.

Turning now to Slide 4, as a whole for 2020, I am very proud of Butterfield's performance and the resilience of the business model. In a near 0 interest rate environment, we produced net income of $147 million or $2.90 per share and core net income of $155 million or $3.04 per share, which equates to a core return on average tangible common equity of 17.3%. NIM finished the year at 2.42% with an average cost of deposits of 21 basis points for the year. We continued with a $0.44 per share quarterly cash dividend and completed a $3.5 million share repurchase program with the most activity during the second and third quarters. We also improved our capital profile with $100 million, 5.25% qualifying subordinated debt offering in June.

Butterfield's business model, which focuses on maximizing returns while closely managing credit and operational risk, proved successful during this period of uncertainty. The global pandemic tested us across all jurisdictions, and the bank continued to perform well. Our technology and collaborative culture allowed us to maintain safe and uninterrupted services for our clients by decisively moving between the office and remote working environments as conditions required.

Our conservative credit profile consists of 65% residential mortgages with relatively low LTVs, no out of market lending, a loan-to-deposit ratio of just 39% and an investment portfolio consisting of 97% U.S. government and federal agency securities. The historically low interest rates in 2020 also brought a renewed focus on improving efficiency. As a result, we implemented a bank-wide restructuring program to lower headcount as well as moving nonclient-facing positions to lower-cost service centers wherever possible.

We were very pleased to complete the integration of ABN AMRO Channel Islands acquisition this year. The Channel Islands continue to represent a growth opportunity for us, both organic and through potential acquisitions. In 2021, we are launching retail lending products to complement our U.K. mortgages business and to activate a portion of our sterling deposits over time. We expect this business to be similar in underwriting standards and character to our loan portfolios in Bermuda and Cayman. We plan to develop the book organically and anticipate it could grow to around $500 million over the next 4 to 5 years. Finally, I would like to recognize the additions to our executive management team during 2020, which now benefits from fresh perspectives and deep experience to the roles in trust, compliance and operations, risk, communications and human resources. I am proud and confident in our management team and believe we have the right people in place to grow Butterfield and reach its potential.

Turning now to Slide 5, here we have provided some context and an overview of our core markets and how the bank continues to manage through the pandemic. Bermuda, Cayman and the Channel Islands continue to have active domestic economic activity. However, much of the travel and tourism industry is operating well below historical norms. The vaccine rollout is progressing well and all jurisdictions have active government-sponsored vaccination programs. We expect that visitor numbers will continue to improve as we move through the summer and fall tourism seasons in 2021. As we discussed last quarter, following the mortgage assistance programs, we had implemented a calling program in Bermuda to better understand borrowers' status and ability to restore payments. I am pleased to say that the actual customer payment rates have exceeded the indications from the program. At this point, we are seeing short-term delinquency of less than 1% of the total residential loan book and continue to work closely with customers to determine the best way forward. While we are encouraged by these initial results, we recognize that the pandemic continues to impact customers and we'll maintain close monitoring of the mortgage books in Bermuda and Cayman.

Our commercial lending book remains solid and has not been significantly impacted by COVID-19 related issues. Direct hotel and restaurant lending continues to be limited, well underwritten and performing loans. I will now turn the call over to Michael Schrum to provide a detailed review of the fourth quarter.

Thank you, Michael. I'll begin on Slide 7, which provides some highlights from the fourth quarter. We ended 2020 with the most profitable quarter for the year, with net income of $42.1 million, core net income of $42.9 million or $0.86 per share and core return on average tangible common equity of 19%. The net interest margin was 2.25% for the quarter and the average cost of deposits improved to 12 basis points.

Turning to Slide 8, net interest income continued to be impacted by lower market rates, and particularly the reinvestment book yields of securities are lower than maturities. Prepayment speeds in our investment portfolio moderated slightly in the fourth quarter compared to the third quarter. However, they were still elevated with $329 million of paydowns compared to $339 million in the prior quarter. Investment yields were down 15 basis points in the fourth quarter compared to the prior quarter. New money yields averaged 1.46% in the fourth quarter or 4.7 basis points higher than the prior quarter. During the fourth quarter, the blended rate for loan originations was 3.66% for $201 million of new loans, down from 3.93% for $156 million of originations in the prior quarter.

On Slide 9, you can see that noninterest income was up 1.9% compared to the prior quarter due to improving economic activity across our jurisdictions and increases across asset management, banking, FX and trust business lines. The bank's contribution from fees continues to represent stable and capital-efficient earnings. For the fourth quarter, fees were 38% of total revenue.

Slide 10 provides a summary of core noninterest expense, which improved by 2.6% in the fourth quarter compared to the prior quarter. Expenses fell as we started to experience the benefits of the cost restructuring program in the third quarter, which achieved the expected reduced run rate. In addition, lower technology costs and indirect taxes improved, which was partially offset by higher marketing spend that increased along with improving economic activity. We continue to target a through cycle cost income ratio of 60%, and we expect to remain in the mid-60s during this ultra-low part of the rate cycle.

Slide 11 summarizes regulatory and leverage capital levels that continues to be in an excellent capital position with capital ratios well in excess of regulatory requirements. We have been pleased to note that our tangible book value per share has also increased 8.8% over the past calendar year. Capital management remains an important value driver for the bank. We continue to manage capital with an emphasis on protecting the sustainable quarterly cash dividend rate at $0.44 per common share. In addition, we maintain capital levels to support organic growth in our core markets as well as M&A opportunities. Share repurchases subject to market conditions, also continues to be part of the planned EPS growth, and the Board of Directors has authorized a new share repurchase program for up to 2 million shares for the coming 12-month period.

Turning now to Slide 12, Butterfield continues to manage a strong, conservative and highly liquid balance sheet. At the end of the fourth quarter, the loan portfolio represented only about 35% of total assets, whereas liquid assets were just at over 60% of total assets. Deposit balances ballooned to $13.3 billion at the end of the fourth quarter from $11.9 billion at the end of the previous quarter. We do expect some of the increase will be temporary and that the deposit balances will normalize over the next few quarters. The bank has maintained a low-risk density with risk-weighted assets to total assets of 34.4%, down from 36.7% last quarter.

On Slide 13 we show that Butterfield's asset quality remains exceptionally high with limited credit risk in its investment portfolio that is 99% comprised of AAA-rated U.S. government-guaranteed agency securities. Nonaccrual loans were down slightly versus the prior quarter at $72.5 million or 1.4% of gross loans. The net charge-off ratio ticked higher due to the secondary market sale of one commercial loan that crystallized the loss of provision previously recorded under the CECL model, and the overall NCL ratio remains very low. The implementation of the CECL accounting standard was well-managed for our bank and has resulted in improved credit quality overall. For Butterfield, the model has been responsive to portfolio performance and varying macroeconomic forecast as expected.

On Slide 14 we discuss the average cash and securities balance sheet with a summary interest rate sensitivity analysis. Butterfield's weighted average life of around 4.1 years continues to offer some income protection against the impact of near to medium-term low interest rates. The unrealized mark-to-market gain on invested securities was $183.2 million at December 31, 2020. Similar to the past few quarters, Butterfield continues to expect a potential increase in net interest income in future periods in both up and down parallel rate scenarios. I will now turn the call back to Michael Collins.

Thank you, Michael. I am proud of Butterfield's performance during 2020 as we were able to achieve a core return on average tangible common equity of 17.3% during a global pandemic in an ultra-low interest rate environment and at a time when our home markets were facing economic contraction. It was with confidence in the strength of our business that we were also well-positioned to contribute and support local communities at a time when many people faced great uncertainty. We were proud to offer the mortgage deferrals and offer our communities food security programs and other targeted charitable actions. I would like to express my thanks to our clients, staff and business partners for all of your support and contributions throughout the past year.

I believe Butterfield is well-positioned to benefit from the anticipated economic recovery in 2021. We continue to focus on building the world's leading offshore bank and trust business and aim to maintain top quartile risk-adjusted returns with meaningful noninterest income contribution, limited credit risk and emphasis on efficiency and shareholder conscious capital management.

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

(Operator Instructions) Your first question comes from Michael [Sivone] of KBW.

So with the TCE near the bottom of your target levels, but your regulatory capital very healthy, how should we think about the amount and the aggressiveness of your capital deployment strategy? And also on this point, can you just discuss your deployment priorities and if you're seeing any opportunity for M&A?

So I'll kick off just on the sort of BAU side of it, and Michael Collins can talk a bit about the M&A. So as you saw, we obviously measure both tangible as well as regulatory capital. So you're quite right that the regulatory capital benefited from a slight mix shift in terms of getting our subordinated debt issued midyear, which obviously made the efficacy at the existing capital stack a bit cheaper for us, but also allowed us to continue obviously with the buyback program that was fairly substantial last year, particularly executed in Q2 and Q3.

The priorities are I think, as we stated a little bit earlier, is to protect the dividend rate that we have at the moment, which is we view as very sustainable. Payout ratio has been around 60% this year. But probably due to procyclicality of reserve builds from CECL and obviously rates being much lower than at the beginning of last year. Secondly, we obviously need to help the organic growth profile in our home markets, so that's Bermuda and Cayman, where we see opportunities and also account for any risk migrations in risk-weighted assets on the regulatory side that might come from experiencing additional credit issues, which so far we haven't. And then thirdly, obviously we look at M&A where that's accretive and the criteria are fairly strict. We really look just for banking assets in other markets where we can get some synergies and also obviously private trust companies that provide a stable capital-efficient fee income at reasonable multiples. And then fourthly, we look at share repurchases, and we're pleased to see that the Board has approved another repurchase program for the next 12 months at 2 million shares or up to 2 million shares. And so that will be executed, obviously, subject to market conditions.

If you look at price-to-book at the moment, we're conscious, obviously, of potential book dilution relative to share repurchases, but we're still sitting at a fairly deep discount on P/E relative to peers. So I would say, look at the last couple of years of buybacks, and obviously, we'll execute that as and when. On the tangible, you saw it come down to sort of in the bottom to the middle of the range at 6.1. Obviously, ex-cash, it's a lot higher. And that was partly driven by OCI impact from post-retirement medical expenses having a material loss from the annual valuation cycle. So we're monitoring that as well as part of the overall capital strategy. So nothing has really changed, same priorities as last year. And obviously, we now have the firepower to exercise that as well. I'll let Michael just talk about M&A.

So we were happy to finish the integration of ABN AMRO last year. And if you remember, it provided us with 3 things. First, it provided us with a growth platform in a jurisdiction where we have very low market share. Obviously, Bermuda and Cayman, we've got sort of 35%, 40% market share, so it's harder to grow. Secondly, it reduced our concentration risk in Bermuda. And thirdly, it created relative balance sheet parity amongst our 3 banking jurisdictions. So strategically, that did a lot for us. Last year, obviously, conversations were pretty slow given the pandemic. We have a sense now that people are starting to get vaccines and starting of think about travel and starting to think about transactions more across our jurisdiction. So we are having some conversations, but we're always very cautious about thinking about whether they're going to come to fruition or the pricing is right or the AML is where we want it to be.

So we are having conversations. The strategy is the same. So it's stressed companies across our existing jurisdictions as sort of overlap acquisitions. With a particular focus on Singapore, we'd like to build scale there. And secondly, overlap acquisitions in our existing jurisdictions, whether it be Bermuda, Cayman or more likely the Channel Islands. So we continue to have conversations, and we think this could be a good year to bring something to conclusion, but we're always cautious because we are very focused on due diligence and AML given where we operate. So we'll just continue having those discretions.

Great. And then my second question relates to the margin. Should we expect the continuation of the slow creep downward as your books mature and continue to mature in this low rate environment? Or are there any further opportunities to offset or at least stabilize the compression within 2021?

Yes. Great question. So I'll just try and unpack that a little bit, starting with loan assets. Obviously, there's a front book backlog. As you know, we amortize all of our loans on balance sheet. So they're manually underwritten, full recourse loans. So you see that loan yield kind of stabilizing, even though I gave a little bit of detail around the most recent loan originations, which was 3.66% in the last quarter, so down a little bit on the front book side, but relatively stable overall as we look at the whole -- at the loan book as a whole. We do expect some modest mix shift as we launch the residential lending opportunity in the Channel Islands. Those are sterling loans, which would be at a slightly lower rate. But again, that will take some time organically to come through there, and it would be activated out of our cash balances effectively. So that should be helpful to NIM.

In terms of cash, pretty much floor there at 5 to 10 basis points. We're obviously watching the current discussions on sterling rates in terms of where they might go in the future. But that's probably reasonable there. That's been fully realized, if you will, at the short end of the curve. And then finally, on investments, prepayment speeds are obviously pretty elevated and have been pretty elevated throughout 2020. So we're seeing approximately 5% of the total investment book roll over a quarter, which is almost double what we saw in prior years, a combination there of a very flat forward yield curve.

And then obviously, on the opposite side of that, we're deploying excess cash from the ABN AMRO into the securities book. So you see volume, a positive volume impact from that. So overall, I'm expecting some stabilization as long as there's a reasonable sort of 10-year and are a normal sloping yield curve that we've seen more recently. But obviously, the short end of the curve seems to be floor for a longer period of time. So medium-term stabilization around where we are, I would expect.

The next question comes from Alex Twerdahl of Piper Sandler.

So first off, I was hoping you could give a little bit more color around the large deposit inflows that we saw in the fourth quarter. And I guess, what drove that and then why we expect those to move off-balance sheet and sort of the time frame for that to happen?

Yes. It's Michael Schrum. So I'll talk a little bit about it. You can see on the average balance that it was pretty much towards the end of the quarter. Really a combination of retail deposits, but I would say, slightly unusual flows in the retail deposit base in that it was driven probably by the deferrals that we put on mortgages here where people were obviously keeping their payments and putting it into bank accounts. So again, over time, I would expect some of that to flow out in Cayman, mostly driven by allowable pension withdrawals, which is kind of a one-off fiscal stimulus that was provided there. Again, over time, that could migrate into either real assets, property or it could migrate back out, I think, to some retirement portfolios. So again, a little uncertain here, but they are retail deposits, which is obviously very helpful.

And the other half roughly is related to sort of what I'd call hot money. So hedge funds flows in Cayman and capital insurance deposits in Bermuda, which typically follows sort of a premium claims cycle at the end of the quarter, and there's quite a lot of activity in the asset management space in -- towards the end of the fourth quarter. But again, I'm not -- we're not banking on those deposits. I think some of that will flow out over the next couple of quarters.

Yes, it's difficult at year-end, obviously, because we have our RMs talking to corporate clients, encouraging them not to put a lot of deposits on our balance sheet over year-end. But it's difficult in a sense these are good clients, and you can't necessarily turn away deposits, but we've been reasonably successful. We'll retain some of it. But as Michael said, we're not expecting to retain all of it.

Okay. And then just thinking about, I guess, the amount that potentially could flow out and then going back to the strategy of laddering cash into investments, has that changed at all in this rate environment? And is the goal there just to kind of consistently still put whatever it is $100 million, $150 million of cash into securities per quarter? Or is there a different target such as just aiming to keep NII flat over the next couple of quarters by deploying cash?

Yes. I mean nothing's really changed in terms of the core balances. So as we think about what's the behavioralized nature of the underlying deposits, we've been watching the ABN piece for over a year now and feel we have a good handle on those kind of relationships. Obviously, it was very key to integrate our systems and get them onto one platform there. So you'll see that that's continued throughout the fourth quarter. So over and above the maturities that we get from the investments, which obviously would keep rolling into lower rates, we're also deploying the extra at that sort of clip of $150 million, around that a quarter. So the strategy hasn't really changed. Obviously, as the deposit base has increased quite a lot, we'll just have to wait and see if that sticks around and what we can do with that. It's been pleasing, obviously, to see 10-year a little bit higher lately. So that helps to slow down prepayment rates and also helps the reinvestment rates.

Got it. And then in terms of the loan growth strategy in the Channel Islands, $500 million over 5 years, is it fair to assume that by the end of 2021, you'll be around $100 million? Is it a pretty straight-line ramp up? And just sort of how should we think about overall loan balances when we consider that potential growth versus other loan categories that I know may be a little inflated based on stimulus around the pandemic or other items that other loan balances that could actually potentially flow off the balance sheet?

Yes. Obviously, we've had a lot of discussion. We're really just in the launch phase right now, so we lost a month and a half or whatever, but it would be fair to probably think of that as a taper and annual increase. We haven't really -- we're not really a loan growth story, per se, but I think it's exciting that we're able to deploy some excess sterling, particularly as you look at the alternatives for sterling at the moment, whether it's secondary market or even gilts, which are pretty flat to 0. Some of it will just depend on the reaction we get in the market and reception. So far, obviously, conversations are positive. There seems to be some pent-up demand there. But there are other players, high street banks in the market there as well. And we're not sure exactly how it's going to actually filter in. But I think the -- so far, so good.

Yes. And Alex, the plan obviously is to turn the Channel Islands into a full-service bank on both sides of the balance sheet to look more like Bermuda and Cayman and also to dampen a little bit the percentage of U.K. Central London loans as a percentage of our portfolio, we want to -- it's been a great portfolio, but obviously, we don't want it to be 50% of our overall loan book. So growing in the Channel Islands will actually help quite a bit. But as Michael said, I think it will ramp up a little bit more slowly this year as we get into it.

Okay. That's helpful. Is that a broker-driven market, the way that the book in the U.K. is? Or is it more of an originated branch type of a product?

Yes. So there's a number of buildings. It's not a broker market. It's a direct underwriting market. But it's -- there are a number of buildings -- traditional building societies and property brokers that operate as well as underwriters in that market. So there's quite a breadth of product available. We're obviously looking mostly at the same types of character underwriting that we do for Bermuda and Cayman. So it will be sort of in the whole loan underwriting.

Yes. It's a lot more like jumbo mortgages, I guess. And it actually interacts really well with our corporate management company relationships. So if you have captive managers or fund management companies or trust companies, we know a lot of the executives in all these companies. And once you start launching mortgages, the corporate relationships all then turn into mortgage relationships personally as well.

The next question comes from Will Nance of Goldman Sachs.

Maybe just a follow-up on some of the growth initiatives and just how to think about how that impacts the margin over time. I mean can you just give us a sense for kind of like the -- what are you paying on sterling deposits now? I heard you that the -- or charging, I heard you that the reinvestment rate on gilts was something close to 0. It just seems like a decent amount of money to be able to kind of lever out at some kind of incremental margin. And so just any thoughts on how that can impact the margin? And is that -- do you think that can be a net positive? Or is that going in your minds to kind of just largely offset declines in the security portfolio and maybe run-off of some of the higher-yielding loans in the legacy jurisdictions?

Yes. Great question, Will. So it's a net positive, but it's almost -- it's too small to offset over a half year period. So once we get to sort of a more of a portfolio basis, obviously, that will be helpful in terms of stabilizing. I think the front book sort of types of rates are more similar to prime Central London. So you're talking in the 350 gross sterling. So it would be helpful to activate cash. Obviously, the current rates for secondary market assets and sterling is 0 to 50. I mean it's super flat. It's almost like -- and they're now talking about negative rates. So we're not paying up for sterling deposits, I would say. But obviously, there are overall client considerations following ABN.

There are some of funds that we service, both in Guernsey and Jersey that have both sterling and dollar deposits, so it's more of a relationship-based pricing. But clearly, it's a challenging -- and I think it's a challenging environment in the secondary market. I think the residential lending program will definitely be accretive on the margin side. But it's -- if you look at the volumes, given that we're doing this organically, obviously, we're also talking to other players in the market, but we're pretty particular about the underwriting standards, I would say. So it's almost -- it's going to be too small. It's going to be helpful, but not totally offset, if that makes sense.

Yes. No, that makes sense. And then maybe a follow-up on the question on the strategic discussions earlier. I think you just mentioned that you'd like to take the Channel Islands to look more like the Bermuda and Cayman jurisdictions in terms of being like a full-service bank. I mean can you maybe just expand on what the vision is for the footprint there? How are you thinking about like the pieces you have in place today? Do you need to acquire more in order to make that happen? Can you build it organically? Can it be kind of brick-and-mortar light? I'm just curious to kind of entering a new market, wanting to take market share, what your thoughts are on like how to build that infrastructure over time.

Yes. Sure. So I'd say we've been in the Channel Islands actually for years. So we've had a presence there for quite a long time. Jersey is a new market for us, but Guernsey, we've been there for decades. So we know the market very well. It is a market -- a corporate market very much like Bermuda and Cayman. So in so management companies, Bermuda is more captives and reinsurance companies; Caymans, obviously, hedge funds and captives and Guernsey and Jersey are both captives, but more funds and trust companies. But it's all the same sort of management company structure. So our systems and our RMs are geared to servicing that business. So we understand it well.

And what we've done with ABN, as I said, is to -- we've gotten to the point where we've actually balanced our balance sheet, so to speak, our risk exposures across the 3 jurisdictions relatively evenly. It's not the same from an earnings perspective. So Cayman in 2020, made about 56% of our core net income, Bermuda 31% and the Channel Islands, 14%. And even though the balance sheet are similar size, so that's simply because the Channel Islands are much more competitive from a pricing perspective. So that all makes sense.

So I think we're kind of where we need to be to allow the Channel Islands to grow organically. So our focus right now is much more on the fee businesses on the trust side to try to build scale across our jurisdictions, but particularly in Singapore. Now that's not to say there if was a decent-sized bank in Jersey that were to come up for sale, again, there are not a lot of natural buyers. So I think we would be interested. But I think we've kind of got the platform where the Channel Islands can grow organically now, and all 3 jurisdictions can grow together so that we actually have a balanced portfolio that we're not completely dependent on one island like Bermuda.

And Will, the only thing I would just add to that is it's exactly right. The reason why we're going in on a product-by-product basis here is we want to keep it bricks-and-mortar light, right? So it's a bit of proof of concept. We don't need lots of branches to do the residential lending platform. It could be a slick online form filling, processing. And we're aware, obviously, of the competition there in terms of the true retail and merchant acquiring is driven by HSBC, Barclays, NatWest, Lloyds, et cetera. So that's one of the reasons this isn't opening a whole bunch of branches at the moment. Let's start with the stuff that's most accretive for us.

Got it. Super helpful. And if I could just squeeze in a housekeeping note. Can you just kind of mark us to market on where we are on the fee income side? How depressed that is just from an environmental standpoint? And like is there -- if activity levels kind of normalize across the various jurisdictions, is there -- how much do we have to go and kind of what's like the right run rate going forward?

Yes. I mean it was great to see the fourth quarter increase, obviously, across the board, mostly from domestic activity. So domestic activity, I would say, is probably elevated in the fourth quarter. People aren't traveling. They're spending here. So you get a domestic Christmas shopping boost as opposed to an Amazon and shipping in kind of boost for Christmas. So that's been good. What's missing is obviously the tourism-related credit card fees that we normally get in the fourth quarter, particularly from Cayman. Airlift and capacity has been severely reduced during COVID. So that's been muted.

There's a few smaller positive items in the banking fees in the fourth quarter as well. But I would say you're probably going to see that run rate is a decent run rate. It was a bit smaller under trust fees in terms of activity-based fees, there was some recovery in that, but probably a bit smaller than we would see on the run rate side. And you'll probably see a substitution from domestic activity in the merchant acquiring side to credit card tourism related within the banking fees once the borders open and we get the vaccine passports.

The next question comes from Timur Braziler of Wells Fargo.

I wanted to follow-up on the M&A line of questioning. I guess in looking at the Channel Islands, if the presence there organically is good enough to launch kind of product by product I guess, what's the rationale for looking at some of these larger deals if they do come up? Is it an expense story? I guess what would be the rationale for doing a larger deal in the Channel Islands right now?

So first and foremost, I think, so we talk about our market shares and pricing power in Bermuda and Cayman came being market share of 35%, 40%. What's been attractive about both Guernsey and Jersey is we have a small market share, had, and still have a small market share in both jurisdictions. So we really can't grow organically or we can't as well as Bermuda and Cayman. So even after the ABN acquisition, we estimate our market share in Guernsey, and we're only on the corporate side and private banking and trust side, would be about 15%.

So there's a lot more banks, obviously, in the Channel Islands than in Bermuda and Guernsey. So even at 15%, that gives us a platform where we can grow organically, but if we were to find an attractive acquisition, it would be nice to be 30%, 30%, 40%. But what we're saying is that 15% in Guernsey is a platform where at last we can grow organically, and we'll be opportunistic about whether there's an acquisition. Jersey is even more interesting in the sense that I think our market share we're guessing is about 1%. So there's about GBP 120 billion in deposits.

So it's a huge banking market, and we only have a 1% market share. So I think Jersey would even be more interesting on the acquisition side. But I guess the point is across both Guernsey and Jersey, we have enough market share that we can grow product organically. But if there were a very attractively priced bank that were to come up for sale, we definitely would be interested. So our point is, we don't need to do it, but if it happened, we would look at it opportunistically.

Okay. That's good color. Maybe looking at the reserve this quarter, Michael Schrum, can you maybe just go through kind of what changed quarter-on-quarter? How much of that $7 million decline was driven by the commercial loan sale? And I guess, as we look ahead, is this kind of a good foundation for the allowance? Or is there incremental opportunity to further release reserves?

Yes. Great question. So yes, a couple of things there. Most of the -- so the CECL model now reflects the improved, obviously, macro GDP outlook, which is sort of forecasting a V-shaped recovery in Q2. I think we're being a bit cautious and we'd like to see the vaccine programs, obviously, taking root and seeing what actually happens. There's good news on the domestic side, obviously, almost all borrowers resume normal payments in Q4. So that was great to see. Still obviously continuing to monitor that. We're still not out of the pandemic yet.

So I think we should think about CECL as opposed to the backward-looking model more reflecting an improved sort of credit outlook and macro outlook. The actual release was, I would say, about half and half. So you see the tick up in NCO, which was the sale of the loan that crystallized a loss. It was a lower-rated corporate loan. And we also had a small sovereign legacy loan from when we used to have a Barbados operation. This is kind of cleanup exercise. So as you think about the reserve going forward, the objective of CECL is obviously to reflect the future GDP outlook, in particular, the U.S. GDP outlook as well as the experience on the portfolio that feeds back into the model. It's been quite a year in terms of macro GDP forecasts, which is causing more -- probably more volatility in the reserves, which was not the intent when CECL was implemented.

So it's sort of hard to predict, but I think we feel that the reserving level adequately reflects the underlying credit conditions and the current macroeconomic outlook. To the extent that that becomes better, that would result in obviously some release. But generally speaking, if you look at the coverage ratio, et cetera, we feel very comfortable that it reflects the underlying conditions of the loan book today. I know that wasn't a direct question, but it's -- I'm sure it's a difficult thing to predict the future, obviously.

Right. No, that's good color. I appreciate that. And one last one from me. Just looking at the expense base, you guys did a good job kind of modeling that out or calling that out for the fourth quarter. Is the expectation here that we should continue to expect expenses to migrate lower over the course of the year? Are some of these new initiatives going to weigh into that trajectory?

Yes. I mean I think we're sort of the [82 83] is probably appropriate run rate following the cost restructure program. There's a bit more of a staggered release benefit that's coming into Q1, but there's a bit of backfill coming into that as well. We do keep a sharp focus on expenses in this ultralow part of the cycle. And I think mid-60s efficiency during this part is -- of the rate cycle is probably where we're going to stay. But it is also worth remembering that as we're not subject to corporate income tax, we pay all of our taxes in the expense line, which has that kind of 4% to 5% dilutive effect on the cost-income ratio. But we keep a sharp focus on it. It was obviously difficult to execute a cost restructuring program, but I think it was the right thing following the health crisis.

Yes. And our full run rate in terms of our cost reductions will hit in Q2 this year. So as you know, we did substantial voluntary departures, early retirements, redundancies. In 2020, I wouldn't see us repeating that in this year because I think we obviously are very focused on operational risk and we don't want to cut into bone. But I would say we will continue to focus on Halifax as our service center and continuing to move operational non-client-facing positions to Halifax. And that's been going on for 4 or 5 years, we have 150 people up there now, and it's a really good model. We'll continue to support and move positions from higher cost jurisdictions to Halifax.

(Operator Instructions) The question comes from David Feaster of Raymond James.

I just wanted to start on your asset sensitivity. Clearly, you're very asset sensitive at this point. You guys have demonstrated that. I'm just curious how you plan to manage your rate sensitivity. It looks like you're staying pretty short on the securities book. But just given your leverage to rising rates, does that maybe give you a bit more confidence to take some duration in the securities book to get some yield and maybe drive some accelerating NII growth?

Yes. I mean it's been interesting to see as people start talking about negative rates and what potentially that impact could be in terms of us charging negative rates to customers and then now coming through. But I think, again, the strategy hasn't really changed. We keep laddering out what's maturing. The reason why the duration is pretty short and I think why we wanted to put weighted average life on there as well and the unrealized mark-to-market position, is that obviously we're fighting against the prepayment speeds, which are very materially elevated, I would say, partly fueled by refinancing rates and new originations in the U.S. market.

So MBS prepayment speeds have just been very elevated, in addition also to the buyout options that have been offered into those securities. So we keep just laddering out what's maturing. And then I think the pace of laddering out the ABN has not changed and really should match the behavioral duration of the underlying deposits as we grow the data set around the ABN deposits. As we get into -- and again, we're not a mark-to-market shop.

So we don't sort of speculate on the asset sensitivity. It just naturally it occurs because we have a very low loan asset to the deposit ratio and loan asset to total asset ratio, and that's just a function of the markets that we're in. But to the extent that we are starting to see some creeping up in a more normal yield curve, obviously, that does provide some opportunities for us to think a bit more tactically around the deployment. But for the time being and certainly over the last year, it's just been a case of moderating the impact on reinvestment rates and prepayment speeds through the re-laddering, and we'll continue to do that. But we obviously constantly review the book. We're also looking at tactical opportunities.

Okay. That's helpful. And then just -- it was great to see the increase in AUM in the quarter. Just curious how much of this growth was from market increases and increases in underlying assets versus new client additions, and maybe just kind of how that translates into asset management fees going forward.

Yes. So about half. So about half the book is on the AUM side, is the money fund that we run in Bermuda, and that's really to allow some additional optionality for hot money, in particular, or customers who want to balance their exposures from on balance sheet to a AAA-rated money fund. So that's just fees that we generate from our asset management subsidiary. The other half is really in the discretionary bucket and brokerage fees. So that's responsive, obviously, to changes in market valuations. So about 50%.

Okay. Okay. And then could you just give kind of a pulse for the market in Bermuda and I guess across your footprint, the health of your clients in the housing market and maybe where we are in the recovery?

Yes. Sure. So starting with Bermuda, from a COVID perspective, we've got 10 active cases. So there was a bit of spike up around December, but it's come right down. Again, the testing is really efficient and has worked really well. It's a small place and you're surrounded by miles of saltwater. So you tend to be able to control it. So COVID is in good shape. The public sector, the fiscal position in Bermuda is elevated, I would say, just in terms of national debt and deficit, some of it caused by COVID, but we came into the crisis with a reasonable amount of national debt. So there's less government flexibility in terms of spending.

I would say, as Michael mentioned, the local market has been pretty active because people aren't traveling. So it's just like everywhere else, people are ordering out, going to restaurants outside, that sort of thing. So that's kind of masks I think some of the underlying pain of not having tourists here. So I think when tourism comes that will pick things up. Surprisingly, or maybe not surprisingly, housing is -- the market has done quite well. So it's -- whether you're in Vermont or Bermuda and Cayman, people are looking for places that are safe and clean and have very few COVID cases, not just now but for future pandemics. And so we've seen a lot of interest, both locally and internationally in Bermuda Real Estate and Cayman real estate.

So I'd say we're holding our own in Bermuda, but the recovery is going to be pretty tough. Cayman is doing a bit better simply because they came into the crisis with no national debt and much lower deficits and their GDP has been growing more quickly than Bermuda. So I think they will come out of the crisis more easily. Same story in the housing market, housing in Cayman was doing really well even before the pandemic. So I think they continue to do well. They have about 35 active cases compared to Bermudas 10. Channel Islands has 400 active cases, so a bit more, obviously closer to the U.K., but they've also got 110,000 people in Jersey and 60,000 in Guernsey. So it's 3x the size of Bermuda and Cayman together. So a bit more cases, currency is a bit more shutdown right now.

Economically, again, both Guernsey and Jersey are extremely well managed, both politically and economically, so no national debt and so came into the crisis well from a fiscal position. GDP has done well before. The fund sector continues to do well. So I think they're in great shape. So across the board, I think our jurisdictions have actually handled it pretty well.

We do think it's a bit of a fake spring in the sense that because there's so much domestic activity that it's kind of masked some of the underlying issues that will come out as -- even as tourism sort of starts back up. But in some sense, we feel like we may have missed a bullet a bit. But each island is different in terms of where its fiscal situation is. So some can spend more than the others. Each island has borrowed money to handle the pandemic in terms of incentive spending and getting money out into the community, and we've been pretty much part of all those facilities, which has been great. So I would say looking back, I think in March last year, we thought -- I think we would have thought it would have been much worse than it's actually been.

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, Andrew, and thanks to everyone for joining us 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. You may now disconnect.