The Bank of N.T. Butterfield & Son Limited (NYSE:NTB) Q4 2022 Earnings Call Transcript

The Bank of N.T. Butterfield & Son Limited (NYSE:NTB) Q4 2022 Earnings Call Transcript February 14, 2023

Operator: Good morning. My name is Dave, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter and Full Year 2022 Earnings Call for The Bank of N.T. Butterfield & Son Limited. After today’s presentation, there will be an opportunity to ask questions. 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.

Noah Fields: Thank you. Good morning, everyone, and thank you for joining us. Today, we will be reviewing Butterfield’s fourth quarter and full year 2022 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 fourth quarter and full year 2022 results. The press release along with the 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.

Michael Collins: Thank you, Noah, and thanks to everyone joining the call today. Butterfield’s excellent results in the fourth quarter and full year 2022 benefited from strong positioning in our core banking and private trust markets in Bermuda, the Cayman Islands and the Channel Islands. In addition to these locations, we provide specialized financial and trust services in Singapore, The Bahamas and Switzerland as well as United Kingdom based mortgage lending and high-end Central London. The Bank’s geographic footprint is strategically based across best-in-class offshore banking and trust locations. Our revenue generating operating jurisdictions are efficiently supported in market and in addition by our service centers in Mauritius and Halifax, Canada.

I will now turn to the full year highlights on page 4. Butterfield had an excellent year with net income of $214 million and core net income of $215.7 million. Operating results have increased with rising market rates and resulted in a core return on average tangible common equity at 28.6% for 2022. In addition to higher net interest income, non-interest earnings were up 4% and expenses held steady, despite some inflationary cost pressures. I was also pleased to see tangible book value per common share recover by 15.7% in the fourth quarter. The net interest margin increased to 2.41% from 2.02% in 2021 with the cost of deposits rising to 34 basis points from 11 basis points in 2021. The current cycle deposit costs differ somewhat from previous cycles, as a result of our larger banking presence in the Channel Islands, which is more corporate than retail based and therefore more competitive.

We continue to pursue an active capital management strategy and have paid out around 40% of earnings in quarterly cash dividends. We are beginning to see our TCE to TA ratio improve towards our targeted range and expect to recommence share repurchases. The Board has approved a new share repurchase authorization for 2023 of up to 3 million common shares which will replace the expiring authorization at the end of February 2023. One of our growth vectors is in-market accretive acquisitions and we are making good progress towards the first closing in the Private Trust asset deal with Credit Suisse that we announced in September last year. Throughout 2023, we’ll be taking over the administration and servicing of selected Private Trust client structures in Singapore, Guernsey and The Bahamas.

We still expect the timing of the onboarding to occur progressively by jurisdiction with the first smaller tranche of Singapore clients coming across at the end of the first quarter, and Guernsey and The Bahamas in the second and third quarters. Our compliance team continues to conduct extensive due diligence at the client level and we are generally pleased with the quality of business so far. I will now turn the call over to Craig for more detail in the quarter.

Craig Bridgewater: Thank you, Michael, and good morning. I will begin with slide 6 where be provide the fourth quarter highlights. Butterfield reported net income for the fourth quarter of $63.1 million or $1.26 per diluted common share and core net income of $63.2 million or $1.27 per share. Our core return on average tangible common equity increased to 34.9% in the quarter from 31.6% in the prior quarter. Our net interest margin improved 20 basis points to 2.79% with the cost of deposits rising 44 basis points to 78 basis points. The Board of Directors again declared a quarterly cash dividend of $0.44 per share. We did not conduct share repurchases during the fourth quarter, although as Michael mentioned, we expect to resume share buybacks as we approach our targeted TCE/TA range of 6% to 6.5% due to deposit stabilization and sustained improvement in OCI marks.

Photo by Dmitry Demidko on Unsplash

I will now turn to slide 7, which provides a summary of net interest income and net interest margin. In the fourth quarter, we reported net interest income before provision for credit losses of $94.6 million, an increase of 3.7% versus the prior quarter. The increase was due mainly to continued improvement of yields on all interest earning assets, which was somewhat offset by higher deposit costs. Average cash and short-term investment balances were down $280.1 million during the quarter, driven by expected customer deposit outflows on the funding side. Average investment balances decreased by $152.5 million. We deployed the $108 million of portfolio maturities and short-dated instruments in the fourth quarter of 2022 compared to $90 million in the previous quarter.

The average loan balance was down $83.3 million, driven by net maturities in Bermuda and Cayman. Overall, loan yields were up 74 basis points during the fourth quarter, primarily due to the impact of previously announced rate increases on floating rate loans. We had new loan originations of $204 million at an average yield of 5.48% versus $239 million at 4.83% in the third quarter of 2022. Turning to slide 8. Non-interest income was up 10% quarter-over-quarter, primarily due to higher banking fees, which benefited from increased seasonal credit and debit card transaction activities and higher trust revenue from new business and increased activity based fees. Non-interest income continues to be a stable and capital efficient source of revenues with a fee income ratio of 37.1% up from 35.6% during the third quarter.

Slide 9 provides a summary of core non-interest expenses. Total core non-interest expenses were $84.5 million and 3.3% higher than $81.8 million in the prior quarter and slightly above our targeted run rate. The higher expenses are primarily the results of increased staff related costs, mostly from performance based incentive accruals and severance costs. The core efficiency ratio continued to improve to 55.6% and remains below our true cycle target of 60%. I will now turn the call over to Michael Schrum to review the balance sheet.

Michael Schrum: Thank you, Craig. Slide 10 summarizes regulatory and leverage capital levels. Butterfield’s capital levels continue to be significantly above regulatory minimum requirements. Our tangible leverage ratio of 5.6% has improved from 5.0% in the prior quarter due to improved OCI marks in our available-for-sale portfolio. As we see sustained improvements in the TCE to TA ratio towards our target range of 6% to 6.5%, we plan to recommence share repurchases subject to market conditions. It is important to note that the TCE to TA is not a regulatory ratio for Butterfield and the ex cash ratio also improved to 6.5% and excluding OCI on the securities book, the TCE to TA ratio remained at 8.2% Turning now to slide 11. Butterfield’s balance sheet remains conservatively managed with a high degree of liquidity.

Period-end deposit balances increased by approximately $530 million to $13 billion versus the prior quarter end. The stabilization and increase in deposits came from higher customer volumes as well as the impact of foreign exchange translation of non-U.S. dollar deposits, reversing some of the decline we saw in the third quarter of 2022. Butterfield’s low risk density of 33.9% continues to reflect the regulatory capital efficiency of the balance sheet with a low risk weighted residential mortgage loan portfolio, which now represents 70% of the total loan assets. Turning to slide 12, here we provide loan and deposit changes by volume and foreign exchange movement, as well as currency by segment. The chart shows the $530 million fourth quarter increase in deposits, which consists of $290 million of underlying deposit inflows, and $240 million due to currency translation changes from a weaker U.S. dollar.

New loan originations decreased as expected, but that decline was more than offset by foreign exchange movement. On slide 13, we show that Butterfield continues to have a strong asset quality with low credit risk in the investment portfolio, which is comprised of 96% AAA rated U.S. government guaranteed agency securities. Credit quality in the loan book also continues to remain robust with non-accrual loans holding at 1.2% of gross loans, and the loan net charge-off ratio, which is up 3 basis points from the prior quarter to 11 basis points. On slide 14, we present the average cash and securities balance sheet with a summary interest rate sensitivity analysis. The duration of the investment book held steady during the quarter at 5.4 years. We continue to expect asset sensitivity to result in improving NII with higher market rates.

Butterfield’s interest rate sensitivity has moderated somewhat due to a higher proportion of fixed rate loans and continued relatively higher sensitivity of U.S. dollar deposits to market rates in the Channel Islands. I will now turn a call back to Michael Collins.

Michael Collins: Thank you, Michael. I am pleased to note that Butterfield became a member of the UN Global Compact in 2022, which is a public confirmation of our commitment to responsible business practices in the areas of human rights, labor, the environment and anti-corruption. Our ESG program includes a specific focus on climate change and sustainable infrastructure, education and wellbeing, and workforce equity. Butterfield’s results continue to validate the strengths of our best-in-class operating jurisdictions, sustainable non-interest income, and disciplined expense management that helped drive the efficiency ratio below 60%. As we enter 2023, we believe that Butterfield’s return on common equity will continue to support overall growth objectives and investor returns.

Our longstanding strategy remains focused on limiting credit exposure in our conservative investment portfolio, growth through targeted acquisitions, and thoughtful capital management. Our core markets and market conditions remain constructive for Butterfield’s continuing success, given the proven relatively low risk and high return profile of our business model across recent interest rate and economic cycles. I look forward to working alongside our great teams of people in 2023, and beyond, to help clients achieve their financial goals and enhancing shareholder value. Thank you. And with that we’d be happy to take your questions. Operator?

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Q&A Session

Operator: Our first question comes from Alex Twerdahl with Piper Sandler. Please go ahead.

Alex Twerdahl: I wanted to ask about the deposit flows you had during the fourth quarter. Obviously, nice to see the reversal after a couple of quarters of outflows. As you look forward into €˜23, do you think that now that deposits are kind of back closer to where they were pre-pandemic that we should see some deposit stability or is there still some at-risk deposit or do you think that maybe there could — actually see some inflows over the next couple of months?

Michael Schrum: Good morning, Alex. It’s Michael Schrum. So maybe I’ll just kick off. Obviously, in the slide deck, you can see the FX movement, which is quite significant in terms of the underlying values that we put on the balance sheet. The underlying deposit flows, as you said, we’ve seen sort of a post-pandemic outflow, net outflow, still a bit elevated, I would say. So, I think we still believe when we look at the retail has held very steady, corporate, particularly in Bermuda and Cayman, is a bit more volatile in terms of business flows. So I still think we will land somewhere in the region of $12.5 billion. So, we’re still a little bit elevated right now. But obviously, we are trying to carefully balance the rate, the cost of deposits with the flows as well.

So, I think we’ve done a decent job of that, even though cost deposits are ticking up. But that’s the balance of this part of the cycle. So, I think we are still sort of looking at 12.5%, maybe a little bit higher, maybe a little bit lower, but thereabout.

Alex Twerdahl: Okay. And then in the same — I guess, correlated to that, as you think about cash flows from the investment portfolio. I think last year it was — most it is expecting the cash flows to kind of turn into cash. Have you changed the strategy? Are you are thinking about reinvesting some more, just given a little bit more stability expectations?

Michael Schrum: Yes. So, yes is the short answer. I mean, it’s geography to some extent, so we have a latter T-bill portfolio in our cash and short-term securities. Obviously, that’s helpful in terms of not having any more OCI coming into the FX book impacting TCE. So again, we’re just kind of sitting there until we kind of start the march back, and we were pleased to see a recovery obviously of the TCE this quarter, helped by some of the OCI marks coming back a little bit. So, as I — as well, we are pretty conservative. So, we are going to kind of — short-term rates are still pretty productive. But over time, obviously, we want the fixed rate assets in investment portfolio. So, maybe a couple of quarters more and see how rates develop and then we should be re-laddering out and going back to BAU.

Alex Twerdahl: Okay. That’s great. And then you talked a little bit about the deposit pressures starting to pick up a little bit, specifically in the Channel Islands. So, I was wondering if you could help us, just get a little bit better sense for how we are thinking about — or how you’re thinking about overall deposit betas in the various jurisdictions?