Bank of NT Butterfield & Son Ltd (NTB) 2022 Q3 法說會逐字稿

Good morning, everyone. My name Vashnavi, and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2022 Earnings Call for the Bank of Butterfield’s , articles and unlimited. (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 of Relations. Please go ahead, sir.

Thank you. Good morning, everyone, and thank you for joining us. Today, we will be reviewing Butterfield's third quarter 2012 financial results. On the call, I'm joined by Michael Collins, Butterfield's Chairman and Chief Executive Officer; Craig Bridgewater, Group Chief Financial Officer; and Michael Schrum, President and Group Chief Risk Officer. 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 third quarter results. The press release and financial statements, 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. Butterfield continued to deliver strong earnings across our offshore network of banking and wealth management platforms. We demonstrated consistent and solid fee income and remain well positioned for this period of rising market interest rates. We continue to see improving post-pandemic economic activity across our operating jurisdictions with the vast majority of border restrictions having been relaxed and tourism and business travel improving.

I will now turn to Slide 4, where we provide the third quarter highlights. Waterfield reported net income for the third quarter of $57.4 million or $1.15 per diluted common share and core net income of $57.6 million or $1.16 per diluted share. Our core return on average tangible common equity was 31.6% in the quarter compared to 27.8% in the prior quarter. Our net interest margin improved 33 basis points to 2.59% with the cost of deposits rising 18 basis points to 34 basis points. When compared to the last interest rate cycle, we are experiencing heightened U.S. dollar deposit costs in the Channel Islands, which has grown in recent years through acquisitions and is a more competitive market than Bermuda and Cayman. The Board of Directors again declared a quarterly cash dividend of $0.44 per share. Share repurchases remained on pause in the quarter due to the elevated OCI loss marks, which has held the TA ratio to around 5%. We continue to view share repurchases as an important part of capital management and plan to resume share buybacks as a path to our targeted TCE to TA rate of 6% to 6.5% emerges.

During the quarter, we announced the strategically important acquisition of Credit Suisse's trust business in Singapore, the Channel Islands and the Bahamas. This excludes business in Lichtenstein, which was sold to a separate and unrelated buyer. We're able to structure the acquisition as an asset deal, which will allow Butterfield to thoroughly due diligence each client before onboarding and therefore, reduce any reputational risk transfer. The deal meets all of our long-standing requirements for M&A. For example, it is significantly focused on private trust is within our existing geographic footprint with a forecasted IRR of more than 15% with a total consideration of less than $50 million and is well below 8x EBITDA. The deal is also forecast to increase trust fee income, which should help maintain our significant and stable fee income ratio and will position Butterfield as one of the largest private client trust companies in Singapore. We are excited to welcome new clients and colleagues and anticipate the onboarding period to complete in the first half of 2023. We I will now turn the call over to Craig Bridgewater to provide more details on the third quarter results.

Thank you, Michael. I will begin on Slide 6, which provides a summary of net interest income and net interest margin. In the third quarter, we reported net interest income of $91.2 million, an increase of 11.2% versus the prior quarter. The increase was due mainly to continued improvement of yields on all interest-earning assets, which was partially offset by higher deposit costs. Cash and short-term investment balances were down during the quarter, reflecting the lower deposit levels due to expected client withdrawals of pandemic rated deposits and a strengthening of the U.S. dollar, which impacted FX translation of non-U.S. dollar deposits. Average investment balances decreased by $136.6 million, primarily due to increased unrealized losses in the AFS portfolio as market interest rates climbed and declining paydowns and reinvestment rates. New money yields on investments decreased slightly to 3.75%, down from 3.85% in the previous quarter.

We made aggregate reinvestments of $19 million in the third quarter of 2022 versus $120 million in the previous quarter. The majority of securities practice consisted of U.S. treasuries and Freddie with lower durations. Paydowns continued to decelerate with $145 million of portfolio paydowns in the third quarter of 2022 versus $172 million in the previous quarter. The average loan balance was up $56.2 million, driven by an increase in commercial loans in the Cayman Islands, which was partially offset by a weaker pound sterling. Overall loan yields were up 57 basis points during the third quarter, primarily due to the impact of rate increases on floating rate loans. We had new loan originations of $239 million at an average yield of 4.38% versus $387 million of originations at 3.63% in the second quarter of 2022.

Turning to Slide 7. Noninterest income was down 3.6% quarter-over-quarter, primarily due to the other noninterest revenues, which did not benefit from the same scheduled recognition of unclaimed customer drafts and checks that occurred in the prior quarter. Banking income rose during the quarter due to switching fees assessed following a number of commercial claims moving from floating rate to fixed rate structures. Trust fees declined slightly due to heightened activity-based fees in the prior quarter, which should not recur at the same level in the current quarter. Noninterest income continues to be a stable and capital-efficient source of revenues with a fee income ratio of 35.6%, down from 38.9% during the second quarter as growth in net interest income outpaced noninterest income as expected. Slide 8 provides a summary of core noninterest expenses. Total core noninterest interest expenses were $81.8 million, in line with $81.9 million in the prior quarter and slightly below our current expected range of $82 million to $83 million. We continue to evaluate the impact of inflation on staffing costs and have enacted targeted salary increases to maintain our competitive positioning. The core efficiency ratio continued to improve to 57% and remains below our through-cycle target of 60%. I will now turn the call over to Michael Schrum to provide a review of the balance sheet.

Thank you, Craig. Slide line summarizes regulatory and leverage capital levels. Butterfield's capital levels continue to be above regulatory requirements. Our TCE to TA ratio of 5.0% is similar to that of the prior quarter and continues to be below our internal target range of 6% to 6.5% due to higher long-term U.S. dollar interest rates, resulting in lower marks on our available-for-sale portfolio. As previously mentioned, TCTA is not a regulatory ratio for Butterfield. And the ex-cash TCE to TA ratio remains 5.6% and ex OCI TCTA ratio improved to 8.2%. We continue to anticipate that rate-driven OCI marks will keep this ratio below our internal target range for a few more quarters as U.S. dollar interest rates rise, and this is expected to benefit net interest income.

Our dividend payout ratio was 43.4% in the third quarter of 2022 and is currently slightly below the bank's through cycle target of approximately 50%. Turning now to Slide 10. We outer field's balance sheet remains conservatively managed with a high degree of liquidity. Period-end deposit balances reduced by approximately $600 million to $12.5 billion versus the prior quarter end. The decrease in deposits has been anticipated. And as you'll see on the next slide, the fall in deposits is a combination of foreign exchange translation and customer withdrawals. Average deposit balances are also down approximately $600 million to $13.0 billion for the quarter. Butterfield's low risk density of 34.9% continues to reflect the regulatory efficiency and conservative nature of our balance sheet. Turning to Slide 11. Here, we provide loan and deposit changes by volume and foreign exchange movements as well as currency by segment. The chart on the upper left demonstrates the third quarter decrease in deposits consist of $350 million of actual deposit outflows and $260 million due to currency translation changes from the strong dollar. Loan volumes actually increased from a production standpoint, but that growth was negated by foreign exchange movement.

On Slide 12, we show that Butterfield's asset quality remains exceptionally high with low credit risk in the investment portfolio, which is comprised of 96% AAA-rated U.S. government-guaranteed agency securities. Credit quality continues to remain strong with nonaccrual loans holding at 1.2% of gross loans and a net charge-off ratio of 8 points. On Slide 13, we present the average cash and securities balance sheet with a summary interest rate sensitivity analysis. The duration of the investment portfolio has decreased marginally during the quarter to 5.4 years from 5.5 years due to portfolio runoff. We continue to expect asset sensitivity to result in improving NII as market rates increase. However, the sensitivity has reduced due to a higher level of 3- to 5-year fixed rate loans and lower sensitivity of Bermuda loan base rate and heightened U.S. dollar deposit costs in the Channel islands. The total value of fixed rate loans has increased by $866 million to $1.8 billion since year-end, which we expect will help mitigate rate-driven credit concerns over the medium term. Net unrealized losses in the AFS portfolio increased to $240.1 million from $152 million at the end of the last quarter as long-term U.S. market interest rates continue to rise. I'll now turn the call back to Michael Collins.

Thank you, Michael. The strong results in the third quarter are reason for optimism. However, we recognize the potential for some challenges ahead, and we will continue to closely monitor the credit book as interest rates rise and the global economy potentially cooled. We are very pleased to announce the acquisition of the Credit Suisse Trust business in Singapore, the Bahamas and Guernsey. We believe the deal structure provides us with flexibility and protection and should result in very high-quality business coming across. Our M&A strategy remains intact, and we continue to hold discussions with potential deal targets in the trust and banking sectors. I remain optimistic that we will continue to find deals and grow butter fuel through M&A and to a lesser extent, organically.

Our fee-generating business is capital efficient and helps us to consistently generate top quartile ROEs relative to U.S. regional banks. We also have a well-positioned balance sheet that combined with rising interest rates, has allowed us to achieve a quarterly core return on tangible common equity of 31.6% in the third quarter of 2022. We also reported a core cost efficiency ratio below our target of 60% and third quarter expenses within our targeted range of $82 million to $83 million. Our strong and liquid balance sheet continues to maintain a loan-to-deposit ratio below 40%, while our $5.8 billion investment portfolio is more than 95% AAA-rated U.S. treasuries and agency securities. Butterfield continues to be well positioned to prosper and grow. Thank you. And with that, we'd be happy to take your questions. Operator.

Thank you. We will now open the question-and-answer session. (Operator Instructions). Our first question comes from Timur Braziler with Wells Fargo.

Maybe starting on the deposit side. Very much appreciate Slide 11. I think that's very helpful. But as you're looking at the deposit base and kind of what you still see in there as excess or surge deposits, can you just give us an update on what your expectation is of kind of balance sheet size and trajectory over the next couple of quarters there?

Yes. Thanks, Tim. It's Michael Schrum. Yes, so we outlined the FX movement separately on that slide, both on the loans and deposit side. As we've talked about before, there are a number of -- we had about $1.4 billion command in the form of search deposits, and we haven't really seen any movement in our core deposits, but we've certainly seen these chunky depositors withdrawal over the past couple of quarters. And I would expect that we should see some stabilization going forward on the balance sheet. So at the moment, we're expecting somewhere between $12 billion and $12.5 billion of deposits where we end up. As you know, we can have normal variations in that, which kind of leaves you with a total balance sheet size of around 14-ish.

So we've had about $1.4 billion of deposits exit the franchise over the last 2 quarters, a component of that has been FX. But do you think going forward, the pace of those surge deposits, I mean, if they haven't left yet is a likelihood that they're going to stay on the balance sheet for longer? Or are we still expecting them to exit maybe just not at the pace you're originally expecting?

Yes. I think the pace has been a little quicker, but I mean, we were very conservative on the liquidity side. So that suddenly has been beneficial to us. It's hard to predict exactly where we can end up. There is normal variations in the deposit levels. So I would estimate that we probably have a couple of hundred more of sort of search deposits, but they could come and go a couple of hundred million more. So it's just a little bit difficult to exactly predict if that, in fact, is going to leave or if that is actually going to hang around for a while. It is worth noting though in the Channel Islands, we've had some success in converting some of the search deposits into some of our fund products off balance sheet. So that's been helpful as well. Got it.

Okay. And then looking at the increase in the cost of deposits from 20 to 44 basis points in the quarter, was that all driven by Channel Islands? Do you guys have the breakout of deposit costs kind of by geography, what the Channel Islands or Cayman and Bermuda?

Yes, we do. So this is Craig. In regards to deposits, you're right, the cost of deposit is largely driven by the Channel Islands. Obviously, we've kind of stated before that channels a lot more competitive market than Bermuda and Cayman. So we came and we move in really adjusting our fixed deposit rates. So not haven't paid anything on demand deposits or the core deposit book in Bermuda and Cayman. But obviously, in Channel Islands is a lot more competitive. So out of the change about 13 basis points is actually attributable to Channel Islands of the change in the course of deposits from the prior quarter.

And then just last for me, kind of a bigger picture question. After the last FOMC hike, how should we think about your asset sensitivity profile? Do you expect deposits to lag the last hike? Or should we think of deposit costs stopping with the last FOMC hike, and then the asset side kind of continues to reprice and fixed rates rolling off, new production coming on. How should we think about margin and deposit costs following the last hike?

So I think for deposit costs, I think we were -- because we were able to keep the cost of deposits down during the -- I guess, this first phase of the rate hike. So we're going to be pretty successful in kind of managing those calls really tightly. Obviously, other than the Channel Islands, where we have to react to the more competitive environment. We continue to adjust our fixed deposit rates in Cayman and Bermuda and we think we'll continue to react to our guess, market forces in those jurisdictions. I think at this point, we can continue to, I guess, suppress the cost increases on the core demand deposits. Going into Q1, depending on, again, where the Fed goes, we're going to have to look very carefully as to whether we need to pay on demand deposits.

We're finally starting to see the base rate changes that we did 3 months ago coming through as at the end of October. So we're going to start to see, obviously, loans repricing. I would say though that about 40% of the total loan book now has rolled into fixed. So I think in terms of your original question around asset sensitivity, we actually view that as marginally helpful at this point in the rate cycle in that, that is starting to add some protection from a downgrade scenario. So while we're continuing to see a sensitivity, the NIM trajectory is going to be still upward sloping, but slower. And on the downside, we're starting to build some of that protection there from customer fixed loans.

Our next question comes from Will Nance with Goldman Sachs.

I wanted to ask on just the Credit Suisse deal, realizing that you guys may not have final numbers yet because you need to kind of go client by client and underwrite. But I guess, are there any stats you can kind of share on just the scale of the business that you are going to be evaluating? And kind of, I guess, what the TAM is for this deal if we think about some percentage of that business coming over, over the course of the year?

Yes, I think it's -- so it's Michael Schrum. Good question. I think the reason why -- so we're actually getting through the consent process right now. So the initial phase of the integration, if you will, getting customer consent so that we can actually review files and DD to files and then make a decision about how come of that DD process and then move on to an onboarding process. We obviously -- we do understand what the addressable universe of clients are, which is sort of approximately 1,500 structures. Having said which, we're not quite -- I mean there is an element of client decisioning in here as well in terms of is this a time to look at the overall relationship? Or are we happy to just kind of move along with Butterfield. So certainly, as we get through to the onboarding process through our DD, we'll share more information around the -- what our expectation is in terms of the population and some of the numbers around that. But if we end up with 50% or 60% of the population. That is vastly different than maybe 80%. And so it's a little bit tough to say right now, but the deal was structured in a way that we only pay for what we get. So ultimately, it will be marginally accretive to the bank overall. It will be helpful for the Singapore business and for our trust business in general. But it's just a little bit early to kind of see how -- see which way both the bank and the clients are going to jump in terms of DD process.

We can say, Will, that the consent process is going well. So all the letters are out. We're getting responses. We've had a number of client meetings, and so far, the quality of the client base is as we would expect or even better. So some really good structure, really good names. So we're really pleased where we are working with the employee base to bring them over. But as Michael said, it's -- the best part about the structure is that we can pick and choose and pick the right clients and not take the ones that we're not quite comfortable with at this point. So it's very difficult to estimate because we can't really tell until we get through DD through the first half of next year.

Got it. That's great to hear. And then maybe on a different topic, you mentioned the increasing percentage of the loan portfolio that's shifted over to fixed rate. Just wondering if you could provide a bit more details on how that process has evolved. I mean is this something you guys are kind of proactively doing? Is it the function of some of the lending opportunities that you've come across that have just tended to skew more fixed rate. Any color for kind of where the loan volume has come from and then what it's been sort of replacing on the balance sheet?

Yes. Good question. I would say we've been actively encouraging it. We've been offering 3- and 5-year fixed rate loans in pet currencies, so Bermuda and Cayman for quite a while, but customer preference has always been floating rate in these markets traditionally. I think as we saw rates starting to go up quite rapidly, one of the ways that we saw an opportunity in the market is to talk to customers about protecting their cash flow and trying to understand what that meant in terms of repayment terms, et cetera. So round way of saying 90% of it is from existing floating rate and 10% is net new. But we've sort of been encouraging the 3 to 5 year to kind of get customers through what potentially could be a difficult credit cycle or difficult period for them and actually being helpful to the bank at the same time. So while it's reducing our sensitivity somewhat, I think in the broader scheme, it's probably at this point in the rate cycle pretty helpful overall to the bank.

And, this is Craig. So really the fixed rate loans have been a tool used by both -- sorry, both customers as well as Asebank. So as Michael said, we had some outreach in regards to clients and just helping them to manage through this process. But we have also had several inbound calls as well in all our jurisdictions just looking to go from variable to fixed.

Got it. That make sense. Just a clarification. Is this mostly on the ready mortgage side? Or is it both commercial and consumer?

It's both.

Our next question comes from Michael Perito with KBWS.

A couple -- just really a couple of follow-ups. Just one on the asset sensitivity NIM conversation. As we look to just near term here, I mean, the margin was up about, I think, 30 years, 34 basis points quarter-over-quarter in the third quarter. So I mean am I just conceptually kind of understand you guys correctly, like in the fourth quarter here, if we assume the curve kind of plays out as expected right now that you would expect that benefit to be lower but still kind of materially higher? I mean, like I don't want to ask too specifically, but are we talking more like 15 to 20 basis points, just if the consensus curve kind of plays out? Just trying to understand how much kind of is coming off from an asset sensitivity standpoint as you guys add some of those fixed rate loans and the deposit costs pick up on the Channel Islands?

Yes. I think -- I guess kind of maybe just kind of look through how we think about it. so it's kind of more about what the drivers are of NIM. And I guess, how we would expect that to expand over the next few quarters. So you are right. So we have less assets sensitivity. So we have more fixed rate loans. I think we're approaching kind of 40% probably portfolio will be in fixed rate. So obviously, as we do have rate increases, then it's going to be a bit muted in regards to how we benefit from those increases. We still have 75 basis points of announced increases in the metadata base rate. So that's about kind of $1.8 million -- or sorry, about $1 billion that will benefit from that additional 75 basis points. And then obviously, we'll see what the effect does going forward. But then that will also be tempered by also pressures on the cost of deposits as well. So we do expect that to continue to go up. So I think we'll still continue to see NIM expansion but at a slower rate.

Yes. Mike -- sorry, it's Michael Schrum. I'll just add to that. I think your thinking is the right way to think about it, but the as sensitivity is mostly realized at the long end of the curve right now because that unless that starts to move higher. That 1/3 of the as sensitivity is kind of sitting where it is. And that's just going to come through rollovers and paydowns in the securities book. the short end, obviously, is still going to react, meaning that we still have EUR 3 billion of cash sitting around. And that's still going to react to whatever the Fed funds does essentially. So most of the asset sensitivity is going to sit at the short end of the curve, and that's going to obviously cause some NIM expansion but not as pronounced as we've seen probably in the last quarter. So I think that's right.

That was very helpful. And then just kind of a big picture question here. I mean, in your opening remarks, I think you guys even mentioned it. I mean -- and I know you've talked about it for years, kind of the 15% to 25% ROE through the cycle and 60% on average efficiency through the cycle. But obviously, in the third quarter here, very much kind of better than the top end of those ranges. And I guess kind of a 2-part question. One, I mean, I guess, is -- it seems like that will probably be sustainable near term here. Would you agree? Or are there any other areas, particularly with the $82 million to $83 million expense run rate, it seems like that will remain the case. But just curious if there's anything else we're not maybe thinking about that could impact those ranges? And then secondly, just as you think about how the business mix has changed over the last 3 to 5 years from a geography standpoint and some of the different dynamics on the balance sheet. I mean does the lower end of that through the cycle ROE range, does that move higher with less of the asset sensitivity? I mean do you think you're kind of reaching a higher forward outlook for kind of the profitability of the company with maybe a little less volatility? Or just curious how you guys are thinking about those dynamics?

Sure. Sure. I'll start off and then pass it over. So yes, we think it's sustainable. I mean we've said 15% to 25%. I mean we're up over 31% today, but some of that obviously is OCI and the unrealized losses. So you sort of normalize that, I think it does get us sort of into the upper mid- to upper 20s. So I think that guidance is still true. And we look at this going back through multiple interest rate cycles over the years in different environments and the 60% efficiency ratio, which is driven by more people intensive 70% efficiency ratio for trust. And maybe in the top of the cycle, like 50% for banking does get us to about 60% sort of through cycles. So obviously, we're in the mid-50s and probably going to outperform that. But we don't like to sort of talk about it at the extreme upper end or extreme lower end. So I think 15 to 25 is still about right based on our business. And it has changed since we have a bigger Channel Islands business, as we talked about, that's much more competitive. The environment looks a lot like Bermudan Cayman, but it's much more competitive. So NIM expansion is much more limited there. But I'll let Michael...

I was just going to mention, Joe, the end point, obviously, helpful to the ROE overall, but as that comes back over the next -- well, over the duration red of the AFS book, which is 3.7 years, that's going to start to dilute the ROE a little bit. So probably adjusted, we would view that as kind of a mid to up 20 ROE. In terms of the longer-term question, that's kind of what we've been trying to do, I guess, while still investing in the business in terms of generating more fee income from the Trust acquisition, so stabilizing and growing noncorrelated income to our whole jurisdictions being banking jurisdictions, Bermuda and Cayman and Channel Islands, whereas the trust fee revenue is annuity revenue capital efficient. And the underlying economic activity in that business doesn't correlate particularly to the domestic economic picture of where we are. And so doing these small add-on trust acquisitions ultimately will help stabilize the fee income and give us a better platform for capital return overall, whilst making all of our jurisdictions profitable. So hopefully, I think the as sensitivity is maybe a cyclical component here. We will still remain very sensitive, just the structure of our balance sheet being 40% lent, mostly floating rate is just a structural sensitive balance sheet. So I think that will continue, but the stabilization of the stable component of the income statement should grow over time, and that's kind of where we've been aiming.

If I'm going to speak on the question around expenses. I think obviously, we've seen some really good expense management throughout 2022. We expect that to continue going into Q4. We're going through our budgeting or planning process at the moment. So we kind of see what 2023 looks like, but we expect a bit of probably salary inflation being able to address that going into 2023. And then as has been scripted in prior calls, we also will see our core banking system coming online in Q1 of next year. So we've been—beginning mortization of that. And then also we're doing some capital improvement to our branches in Bermuda and Cayman as well. So I think for Q4, I think we'll still be able to kind of stick to the guidance that we put out there. And the last thing I mentioned is that, obviously, we've been able to benefit from the volatility in the Ton-sterling exchange rate as well. So about, say, 30% to 35% of our expenses are denominated in pound sterling. So we've been able to benefit from that. But be able to just keep on that at that exchange rate and tag that affects the income statement.

The next question comes from David Feaster with Raymond James.

Just kind of following you touched on the currency side. I mean it's having some benefits on the expense front. It obviously weighed on the balance sheet this quarter. I know you guys do some hedging on sterling. But just curious, given the volatility that we've had, has your thoughts on more fully hedging currency risk change at all? I'm just curious your thoughts on that front.

Yes. Maybe I'll start off. It's Michael Schrum. So we view our direct investment in our sterling-denominated subsidiaries as a structural investment in foreign currency earnings effectively. And so we do use a fair market value hedge for that. So we use deposits that are naturally occurring in Bermuda in sterling to hedge that. We don't run a proprietary book at all. And I think our view on the earnings derived from the Channel Islands in the U.K. is that over a full cycle, those earnings will vary with the sterling in terms of the dollar value of those, but ultimately, the average earnings are going to come back. So we really measure those subsidiaries in the traditional sense in native currency on their ROE profile, cost income ratio and we wouldn't want to be on the wrong side of a hedge, right? So that's a risk-taking position. So we view that very much as an economic investment in those countries -- so I don't know if I answered your question, that, David?

Yes. No, that was helpful. And maybe just curious how you think about -- you talked about having -- we're still sitting on $3 billion in cash. Just curious how you think about liquidity deployment more broadly and maybe some of the timing of it? I know you've been very disciplined and you're still benefiting from rising rates, but just curious how you think about liquidity deployment and maybe kind of what a normalized level of cash you might be?

Yes. Great question. It's Michael Schrum again. I'll start and maybe Craig can pitch in as well. So we -- as you know, we're a deposit-funded balance sheet, retail, mid-market corporate. So when we look at cash and short-term securities because we operate across 4 different banking jurisdictions in a subsidiarized structure. All of those subsidiaries need to retain sufficient resources, whether it be capital funding or liquidity to satisfy their loan pipelines and in and out flows, respectively. And that leaves a significant component of our assets in cash just to try and manage that because we don't have a Fed window or lend-result really. And so we really are our own treasury. So we manage those intercompany flows with bema having a backstop as well. So the way we think about it is really about 20% of the balance sheet, probably, I would say, on the back testing basis between 15% and 20% of all of our deposits -- sorry, all of the total balance sheet is always going to be in cash and short-term securities. So at the moment, we're a little heavy. We've seen a lot of volatility. Obviously, we've seen deposits come off. As we said, the 210 isn't particularly constructive at the moment. And so we're just really rolling into short -- with the OCI hit.

We're just rolling everything into short term at the moment for the next quarter really. And then over the long term, our investment philosophy hasn't changed in that we need to buy some protection from the asset sensitivity in the securities book, and that's why we buy fixed-rate securities through the cycle. But from -- for the next couple of quarters, we'll just roll into short-term securities. And then as we start to see things stabilize, OCI coming back, et cetera, then we'll have some more options, whether it's some further restructuring in the AFS book that we're always going to look out for that or whether it's just further deployment of cash into fixed rate securities longer term.

But I think it's useful. It was in the formal comments, we kind of talked about our reinvestment rates. And I guess the paydowns that we are seeing coming through. So pad-to-pad downs are slowing down, but also slowing down our reinvestment rates as well for some of the reasons that Michael just talked about in regards to stability of deposits and just making sure we have adequate liquidity on hand. And then even just the investment environment being constructive as well would have decided to just slow down our reinvestment rates for now until things get a bit more stable.

That makes sense. And then just lastly, touching on asset quality. Nonaccruals did tick down a bit, but obviously, higher mortgage rates are probably weighing on cash flows from some of your clients. And I know you guys are very proactive in reaching out to those that may have some cash flow issues. Just curious overall asset quality trends and what you're hearing from your mortgage clients given the higher rates? And then just if you could touch on the overall health of the housing market across your footprint as well.

I'll kick off, and then I'll satisfy as well. So again, with regards to asset quality, we're not seeing any indications at this point of any weakening asset quality. We are having active conversations with all our customers. We've actually kind of looked at the book looked at kind of the potential for payments to increase some indicators of capacity of customers to be able to absorb those pay increases as well. But we haven't seen any indication that asset quality is going to be impaired in any way. Obviously, with the lag in adopting the Billing dollar base rate increases, our estimate is that if anything is going to come though, we're going to start to see it kind of middle of Q1 going into Q2. So we're obviously going to keep a really good eye on it and also consider that as we look at our provisioning as well, whether we need any qualitative overlays, et cetera. But right now, it's pretty good and happy about that. Are, want to be joining the queue.

(Operator Instructions) The next question is a follow-up from Timur Braziler with Wells Fargo.

Actually, just keeping that conversation going from the last question. Looking at your London mortgage book, I mean, it seems like London housing market has been a bit of a mess. Maybe what are you seeing there for a potential credit issues with just some of the reductions in value? And then maybe longer term, how are you thinking about that portfolio going forward? And is that going to be a headwind to kind of balance sheet growth as some of that production over the last couple of years rolls off? Or is there an expectation that, that book of business remains more or less flat going forward?

So we're not seeing really any pressure so far in the London book. The market we're in, as you know, is Central London. So if there are any price decreases, it's nothing substantial. We've underwritten it very conservatively. So 60% loan-to-value, 5-year interest only. It's been about 5 years. So a lot of those are rolling over, and we're re-underwriting them. So we get another look at the credit quality. So the timing is quite good actually, but not seeing a lot of stress. And our plan is really not necessarily to grow that portfolio. It's really try to keep it steady because as we said in the past, we don't want London to be more than 1/4 of our total loan book, where we start looking like a very different bank. Where we are growing is rolling out our retail business in the Channel Islands. So that's going quite well. So we've got over 700 retail clients now sort of approaching a couple of hundred million in mortgages, which is well ahead of our plan. I think we've talked about $500 million over 5 years, and we're well on the way to that. We're rolling out our credit card products early next year.

And we do think as we become more of a retail bank, particularly on the mortgage side, there's some really good retail deposit funding on both islands. So we think over time, we can start to convert from getting deposits from some of the financial intermediaries, which as you know are very competitive on a pricing perspective. to more retail funding that actually will provide us with spreads and margins that will never look like Bermuda and Cayman, but it will start to look a little bit more like those 2 places. So London, we don't see stress at this point. We think it's really well underwritten, try to keep it flat, but the growth is going to come from rolling out retail mortgages in Gent Jersey.

This concludes our question-and-answer session. I would like to turn the conference back over to you for any closing remarks.

Thank you very much, and thanks to everyone for dialing in today. We look forward to speaking with you in the future. Thanks again. Have a great day.

The conference has now concluded. Thank you for attending today's presentation, you may now disconnect.