The Bank of N.T. Butterfield & Son Limited (NYSE:NTB) Q3 2023 Earnings Call Transcript

The Bank of N.T. Butterfield & Son Limited (NYSE:NTB) Q3 2023 Earnings Call Transcript October 25, 2023

Operator: Good morning. My name is Andrea, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2023 Earnings Call for The Bank of N.T. Butterfield & Son Limited. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [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. Please go ahead.

Noah Fields: Thank you. Good morning, everyone, and thank you for joining us. Today we will be reviewing Butterfield’s third quarter 2023 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 2023 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.

A smiling customer, holding a debit card issued by the bank. Editorial photo for a financial news article. 8k. –ar 16:9

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 US 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.

Michael Collins: Thank you, Noah, and thanks to everyone joining the call today. I am pleased with Butterfield’s performance during the third quarter and believe that these results demonstrate our continued focus on a stable low-risk density balance sheet, while delivering consistent and growing noninterest income and balanced capital management. As a reminder, Butterfield has market-leading bank franchises in Bermuda and the Cayman Islands and a growing retail banking presence in the Channel Islands, with wealth management provided in all three jurisdictions. Banking services consist of deposit taking, cash management, and lending solutions for individual, business, and institutional clients. Wealth management services include trust, private banking, asset management, and custody.

The bank also provides specialized financial services offerings in the Bahamas, Switzerland, Singapore, and the UK, where we offer mortgages to high-net-worth clients with properties in prime Central London. I will now turn to the third quarter of 2023 highlights on Page 4. Butterfield reported positive results with net income of $48.7 million and core net income of $57 million. The non-core expenses of $8.2 million were associated with a groupwide restructuring program implemented in the quarter. We reported a core return on average tangible common equity of 26.1% for the third quarter of 2023 with core earnings per share of $1.16. The net interest margin was 2.76% in the third quarter, a decrease of 7 basis points, with the cost of deposits rising to 152 basis points from 127 basis points in the prior quarter.

Deposit pricing increased across all of our banking jurisdictions as there was a mix shift from demand deposits to term deposits and fixed-term deposits rolled into higher rates due to the rising market interest rates. Our TCE/TA ratio of 6.5% has held steady and continues to be at the conservative end of our targeted range of between 6% and 6.5%. As a result, we increased activity in our share buyback program with repurchases of just over 1 million common shares in the third quarter. The rolling integration of the Credit Suisse trust asset acquisition progressed as planned during the third quarter. Our third closing saw us acquiring assets in the Bahamas and the fourth closing incorporated a total of 50 trust structures, primarily in Guernsey, with an additional five in Singapore.

We are very pleased with the progress so far and the quality of clients onboarded in the deal and continue to expect a final closing of the transaction this quarter, and we are tracking towards the $8 million to $10 million in added trust revenues from the deal in 2024, along with an estimated $6 million of expenses. I will now turn the call over to Craig for more detail on the quarter.

Craig Bridgewater: Thank you, Michael, and good morning, everyone. Looking now at slide 6. Here we provide a summary of net interest income and net interest margin. In the third quarter, we reported net interest income before provision for credit losses of $19.2 million, a decrease of 2.5% versus the prior quarter. The decrease was mainly due to higher deposit costs and a decrease in average balance sheet volumes. During the quarter, the net interest margin decreased 7 basis points due to increased deposit costs which outpaced higher earned yields and Treasury margins. Average interest-earning assets decreased marginally by 1% to $12.95 billion due to deposit outflows as customers activated funds and sought higher-yielding asset classes.

The yield on interest-earning assets increased 12 basis points to 4.22% from 4.1% as investment portfolio runoff continued to be invested at the shorter end of the yield curve. The yield on Treasury assets during the quarter of 4.47% versus 4.06% in the prior quarter and the investment portfolio yield at 2.06%, which was consistent with the second quarter. In addition, the yield on loan balances increased by 9 basis points to 6.51%. Average investment balances decreased by $119.8 million, or 2.1% compared to the prior quarter, mainly due to the scheduled maturity of some US Treasury securities. We remain conservatively positioned in the near-term by placing portfolio runoff into cash and cash equivalents, which continue to offer an attractive return profile without the OCI risk.

Turning to Slide 7. Noninterest income was up 3.6% versus the prior quarter, with higher banking fees due to improved card volumes in Bermuda and Cayman, as well as some fees from loan prepayments. Trust fees also increased compared to the prior quarter as a result of new clients acquired in the Credit Suisse deal, as well as organic growth and higher activity-based fees. Noninterest income continues to be a stable and capital efficient source of revenue with a fee income ratio of 36.7%. Slide 8 provides a summary of core noninterest expenses. Total core noninterest expenses were $84.3 million, a small and expected increase compared to $83.6 million in the prior quarter. The higher expenses are primarily attributable to increased staff-related expenses and higher technology and communication costs related to the investment in IT infrastructure and the banking application upgrade in Bermuda.

Prior to consideration of expenses associated with the servicing of the newly onboarded trust clients, we continue to expect a quarterly expense run rate of between $85 million to $86 million over the next few quarters, given that changes from the restructuring will not be fully implemented until the end of Q2 2024, and we have the full impact of the new cloud hosting fees and the amortization of the upgraded banking application and banking branches to be incurred. We are in the midst of developing our annual operating plan for 2024 and will provide updated expense guidance when we report fourth quarter results. I will now turn the call over to Michael Schrum to review the balance sheet.

Michael Schrum: Thank you, Craig. Slide 9 shows that Butterfield’s balance sheet remains liquid and conservatively managed. Period-end deposit balances decreased to $11.9 billion from the prior quarter end. Deposits ended the quarter down approximately 2.7% and is reflective of typical client activity with some added seasonality. We currently anticipate total deposits stabilizing in the range of between $11.5 billion to $12 billion as competition for deposits has increased, and we see more evidence of a higher-for-longer interest rate environment in the near term. Butterfield’s low-risk density of 34.3% continues to reflect the regulatory capital efficiency of the balance sheet with the lower risk-weighted residential mortgage loan portfolio, which now represents 70% of the total loan assets.

Turning now to Slide 10. Here we provide additional detail on our deposit composition by segment. Butterfield’s deposits remain well diversified across its banking jurisdictions, with an uptick in term deposits for the group, primarily driven by Cayman where competition has increased and some clients have moved funds out to term. While this increased the cost of deposits, it is encouraging to see some additional term funding on the balance sheet from regular client activity. Core noninterest-bearing deposits remained at approximately 22% of deposits and $2.6 billion at quarter-end. To date, client deposit activity has been broadly as expected, with the bank seeking to balance deposit volumes against the cost of funds for each market. Turning to Slide 11.

We provide details of loans by type, business segment, and rate type. The chart on the bottom left shows the loan volume movements across our lending jurisdictions, with Bermuda and the London loan portfolio showing net reductions as those portfolios amortized in addition to some increase in prepayments. On the bottom right, fixed rate loans now represent 50% of total loans as clients elected to fix their payments in a rising interest rate environment. Loans are typically fixed for three to five years and should help moderate any potential debt servicing issues. The higher proportion of fixed term loans has also lowered our asset sensitivity over the past six quarters. Turning to Slide 12, we display two charts that demonstrate the conservative nature of Butterfield’s balance sheet versus peers.

Butterfield remains — maintains a high degree of liquidity due to the nature of our markets and as a result of not having access to a central bank or a Fed window. We continue to have significant holdings of cash and cash equivalents, interbank deposits, and short-dated sovereign securities, in addition to liquidity lines with correspondent banks. Butterfield’s loan-to-deposit ratio remains low at 40% with conservative lending standards, and we only offer credit products in our home markets. On Slide 13, we show that Butterfield continues to have strong asset quality with low credit risk in the investment portfolio, which is comprised of 99% AA rated US Government guaranteed agency securities. The rerating of the portfolio follows Fitch’s August downgrade of the Long-Term Issuer Default Rating of the United States of America.

Credit quality in the loan book also continues to be strong, with non-accrual loans standing at 1.2% of gross loans and a small charge-off rate at 4 basis points. On Slide 14, we present the average cash and securities balance sheet with a summary interest rate sensitivity analysis. Asset sensitivity has continued to decrease during the past couple of years and now suggest a more moderate NII response to changes in market rates. Unrealized losses in the AFS portfolio included in OCI was $238 million at the end of the third quarter, up from $207.3 million at June 30. At the current implied forward curve, we expect the OCI burn-down to be $65 million, or 27% of the total in the next 12 months, and a total decrease of $103 million, or 43% over the next 2 years.

Slide 15 summarizes regulatory capital and leverage capital levels. Butterfield’s capital levels continue to be significantly above regulatory requirements. I will now turn the call back to Michael Collins.

Michael Collins: Thank you, Michael. As mentioned earlier, during the third quarter, we made a difficult decision to implement a groupwide restructuring program that will result in a 9% reduction of our global workforce. This is intended to mitigate inflationary and other expense pressures. The projected $13 million annualized cost savings, once the program is fully implemented, should partially offset earnings at risk from lower interest rates in the future and inflationary pressure on expenses. The restructuring plans considered operational risk mitigation and new business processes and incorporates the placement of some additional non-client-facing functions in our service centers. We expect to continue to operate in all of our jurisdictions without significant changes in products and service offerings.

I’m pleased to say that here in Bermuda, we are concluding a solid 2023 tourism season. In Cayman, which is just entering its high season, we are seeing strong bookings and enhanced airlift and expect significant [Technical Difficulty] coming months. While not directly a driver of our business, healthy visitor numbers increase credit and debit card activity, which is beneficial to the bank and our clients. Our strategy to augment growth through M&A remains important, and we continue to evaluate potential targets in both the banking and private trust sectors. We do not have any specific deals to comment on currently, and Butterfield remains well positioned to continue growing organically while generating top quartile risk-adjusted returns. Thank you, and with that, we’d be happy to take your questions.

Operator?

See also ChatGPT Stock Advice: 15 Recent Stock Recommendations and 13 Best Defense Stocks To Buy Now.

Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from David Feaster of Raymond James.

David Feaster: Hi, good morning, everybody.

Michael Collins: Good morning, David.

Craig Bridgewater: Good morning, David.

David Feaster: I was hoping to maybe — you talked about the impacts of a higher-for-longer environment. I’m curious, have your thoughts changed — assuming that we are in the higher-for-longer environment, have your thoughts changed on how you manage the balance sheet and rate sensitivity and just kind of that balance sheet optimization? And as you think about the margin trajectory in a higher-for-longer environment, ultimately it seems like this is a huge positive for you, especially once things start to stabilize. But curious how you think about the margin trajectory assuming the rate environment stays here.

Michael Schrum: Yeah. Good morning, David. It’s Michael Schrum. So maybe just — I’ll just comment a bit on the balance sheet balancing act and Craig can comment a little bit on the NIM trajectory. As we look at loans, obviously, the first thing to mention there is just around a third of that quarter-over-quarter movement was due to FX as we saw dollar strengthening against the pound, some unscheduled prepayments, particularly in the UK book, which generated some additional fees. But the bottom line is probably in this environment, originations are not really going to keep up with the amortization across the markets, and it’s consistent sort of with a general slowdown I think, on new originations across the markets. And I would just mention, we’re keeping consistent underwriting standards through this part of the interest rate cycle.

On the deposit side, we saw some movement again, and as you said, higher-for-longer means some customers activated their funds through either term deposits with us to generate more of a portfolio return on their cash, and we’ve seen — we had some conversations obviously with customers about money funds, returns, et cetera. But overall these are normal commercial movements during this part of the cycle, and I would just say, our depositor concentration remains consistent with prior quarters where the top 20 groups roughly represent 20% of deposits and the rest is pretty diversified down the balance levels. So the normal commercial flows really as I think customers are adjusting to a higher-for-longer period of high interest rates. And obviously, it’s good for us in the sense that we get to wait for some repricing of assets.

We do have some lag repricing coming through the investment portfolio and the loan portfolio. And I’ll just let Craig talk about NIM generally.

Craig Bridgewater: Yeah. Good morning, David, and just to carry on from Michael’s comments, and what we are seeing is customers kind of having a look and kind of use of their deposit levels. And as you mentioned in the formal comments, there’s increased competition for deposit levels. As we stay higher-for-longer, we’re actually going to see — and we saw a mix shift. We saw a mix shift of deposits from demand deposits into term deposits. So customers are seeking that higher yield. And I guess from a relationship perspective, we’re really looking to service our key customer relationships, where necessary, provide a competitive yield to them as they look at other asset classes as well and other uses of their cash. So we’re being very selective and kind of working with customers to kind of build out a ladder and just do what makes sense in regards to the liquidity requirements in the upcoming quarters.

Having said that, and as Michael said, we’re going to see some asset repricing, but we also are going to see increased pressure on pricing of deposits as well. So we do expect to see some compression, at least in the next quarter or two. And then as the asset repricing comes through in kind of towards the end of Q1, we’re going to see the benefits of that. On the loan side, again, yields are increasing, volumes are coming down. Part of that is currency and part of that is volume. But we also, in Bermuda anyway, we do have one more 25 basis point increase coming in at the end of October. So we see the full impact of that in Q4.

David Feaster: Okay, that’s helpful. And then maybe just digging into some of those deposit trends, it sounds like the deposit flows are primarily driven by client activation and utilization of deposits rather than folks leaving the bank. How much of the deposits are you able to retain through the trust and wealth management business? And then I guess, what gives you confidence that balances are going to kind of stabilize here in the range that you gave? Is it just increasingly competitive on rate or just the idea that, again, rates stabilize here and most of the rate-sensitive excess deposits have really been deployed at this point?

Michael Schrum: Yeah. No great questions, David. It’s Michael Schrum. So the first thing on deposits, roughly a third of that, if you look there’s the Slide 17, I think, in the deck, a third of that quarterly movement was due to FX translation. Again, we saw a strengthening dollar against both the pound and euro this quarter. And I think when we look at our core deposit franchises, we see that these are normal commercial movements and deposit concentrations staying where it is. So I think it’s just clients adjusting their expectations and us adjusting accordingly on the pricing. And we obviously want to defend our key strategic relationships. But at the same time, we also know it’s a normal commercial reality that people want to ladder out a little bit and generate some return.

So, I think — again, I think everyone’s going through this adjustment period at the moment, but we feel confident in the current environment, given that we’ve looked at core deposits, we’ve looked at depositor concentration, and the FX movement that we saw last quarter as well.

Craig Bridgewater: I’ll just add that, again, the core deposits remain intact. So about $2.6 billion of core deposits and that’s there. And if we look at trends going back to pre-COVID, that our core deposits and our legacy franchise — deposit franchise is actually up kind of in the 10% to 15% range. So we are maintaining that. And as we have messaged in earlier quarters, some of the corporate deposits in Channel Islands, et cetera, we have seen those. And that’s the nature of the business of those clients that are looking for higher yields. But we feel that a lot of that has happened, and we are now seeing normal movements and we’re seeing again that mix shift into time deposits and we’ll work to maintain those term deposits as they roll over in the coming quarter. So those on average have an average duration of about three months, just above three months. And so they will reprice, and we will be conscious to work with those customers.