Bank of N.T. Butterfield & Son Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2023

There are 10 speakers on the call.

Operator

Good morning. My name is Nikki, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2023 Earnings Call for the Bank of NT Butterfield and Sun Limited. At this time, all participants are in a listen only mode. Later, you will have the opportunity to ask questions during the question and answer session.

Operator

Please note this call is being recorded and I will be standing by should you need any assistance. I would now like to turn the call over to Noah Fields, Butterfield's Head of Investor Relations.

Speaker 1

Thank you. Good morning, everyone, and thank you for joining us. Today, we will be reviewing Butterfield's Q2 2023 financial results. On the call, I am joined by Michael Collins, Butterfield's Chairman and Chief Executive Officer Craig Bridgewater, Group Chief Financial Officer and Michael Scrum, President and Group Chief Risk Officer. Following their prepared remarks, we will open the call up for a question and answer session.

Speaker 1

Yesterday afternoon, we issued a press release announcing our Q2 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. 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.

Speaker 1

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.

Speaker 2

Thank you, Noah, and thanks to everyone joining the call today. The Q2 results continued to demonstrate the strength of Butterfield's leading bank franchise and market position as well as our conservative and well managed balance sheet. We delivered consistent quarter over quarter non interest income and expense discipline, which helped offset lower net interest income. As a reminder, Butterfield is comprised of well established bank and private trust businesses located in premier offshore jurisdictions. We maintain leading bank market shares in Bermuda and the Cayman Islands with targeted growth in the Channel Islands.

Speaker 2

In the Bahamas, Switzerland and Singapore, we provide private trust services in addition to our Prime Central London mortgage offerings available to high net worth borrowers. I will now turn to the Q2 of 2023 highlights on Page 4. Butterfield reported solid results with net income of $61,000,000 and coordinate income of $57,000,000 We reported a core return on average tangible common equity of 26.3% for the Q2 of 2023 with core earnings per share of 1 $0.14 The net interest margin was 2.83 percent in the 2nd quarter, a decrease of 5 basis points with the cost of deposits rising to 127 basis points from 110 basis points in

Speaker 1

the prior quarter.

Speaker 2

Deposit pricing increased across jurisdictions as fixed term deposits rolled into higher rates due to rising market interest rates. Our business in the Channel Islands, which has a higher proportion of corporate banking customers, continues to be the most competitive market and the most significant contributor to the increase in the cost of deposits. Our TCE to TA ratio of 6.5% has improved the conservative end of our targeted range of between 6% and 6.5%. As a result, we've been able to continue with the execution of our balanced capital return strategy, accelerating our share buyback program in the 2nd quarter with a repurchase of 723,000 shares in the quarter. We expect to continue repurchasing shares throughout 2023 subject to market conditions.

Speaker 2

Our liquidity position and strong capital profile also allowed us to redeem our 2018 issuance of $75,000,000 5.25 percent supported a debt in June, which will lower our interest expense going forward. The redemption had a onetime $900,000 interest cost impact in the quarter due to the accelerated amortization of issuance costs. I am also pleased that we completed the 2nd closing of our planned acquisition of Trust Assets from Credit Suisse. To date, 374 relationships representing $21,100,000,000 of assets under administration have now transferred to Butterfield, significantly expanding our footprint in Asia. Workers continue in a client due diligence for subsequent tranches, which will include additional relationships in Singapore as well as Guernsey in the Bahamas.

Speaker 2

We continue to expect to between $8,000,000 to $10,000,000 in annual trust fees from the deal in 2024 with anticipated associated running costs of around $6,000,000 per annum. I will now turn the call over to Craig for more detail on the quarter.

Speaker 3

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 Q2, we reported net interest income before provision for credit losses of $92,500,000 a decrease of 5% versus the prior quarter. The decrease was mainly due to lower average balance sheet volumes, higher deposit costs and the accelerated amortization of issuance costs from the 2018 subordinated debt issue. During the quarter, the net interest margin decreased 5 basis points due to increased deposit costs and the early redemption of the sub debt, which had a 3 basis point negative impact on NIM in the quarter.

Speaker 3

Average interest earning assets fell 4.5 percent to $13,100,000,000 due to customer deposit outflows. The yield on interest earning assets increased 12 basis points to 4.1 percent from 3.98% as investment portfolio runoff was invested in cash and short term securities at the shorter end of the yield curve. The yield on treasury assets during the quarter was 4.06 percent versus an investment portfolio yield of 2.07%. Average investment balances were down 105,500,000 dollars or 1.8% compared to the prior quarter, as pay downs and maturities were deployed into cash and short term investments. We continue to evaluate the market interest rate environment and expect to resume investment into longer dated securities over time subject to market conditions.

Speaker 3

Turning to Slide 7. Non interest income was unchanged sequentially quarter over quarter as increased asset management, trust and foreign exchange revenues offset lower banking and other income earnings. Non interest income continues to be stable and a capital efficient source of revenues with a fee income ratio of 35.5%. During the quarter, we saw the impact of the fresh tranche of clients on boarded Credit Suisse and increased ad hoc services on cost revenue. Slide 8 provides a summary of core non interest expenses.

Speaker 3

Total core non interest expenses were $83,600,000 and improved compared to the $84,100,000 in the prior quarter. The lower expenses are primarily attributable to lower staff related costs, partially offset by higher technology and communications expenses related to the implementation of the new core banking system upgrade in Bermuda. Expenses were somewhat better than expected this quarter. However, we anticipate a quarterly run rate of between $85,000,000 to $86,000,000 over the next few quarters due to the investment in planned bank branch upgrades in Bermuda and Cayman, as well as the costs associated with the go live of the cloud based core banking system in Bermuda and the expected completion of a similar upgrade in Cayman during the second half of twenty twenty three. I will now turn the call over to Michael Schrum to review the balance sheet.

Speaker 4

Thank you, Craig. Slide 9 shows that Butterfield's balance sheet remains conservatively managed with a high degree of liquidity. Period end deposit balances decreased to $12,200,000,000 from the prior quarter end. The decline in deposits of approximately $150,000,000 is the result of typical client activity and some seasonality. As the year has progressed, we now expect to see post pandemic stabilization of total deposit levels at around $12,000,000,000 This is broadly in line with the longer term deposit trends prior to the pandemic and adjusted for the 2019 acquisition of ABN AMRO Channel Islands.

Speaker 4

Butterfield's low risk density of 34.3 percent continues to reflect the regulatory capital efficiency of the balance sheet with the low risk weighted residential mortgage loan portfolio, which now represents 71% of total loan assets. Turning now to Slide 10, we provide additional detail on our deposit composition by segment. Butterfield's deposits remained well diversified across jurisdictions with Bermuda holding the largest deposit share followed by Cayman and then the Channel Islands. We continue to offer term deposit product alternatives for clients seeking additional yield and we are seeing consistency in the mix with core non interest bearing deposits remaining at approximately 23% of deposits and at $2,800,000,000 at quarter end. As we have discussed in the past, deposit balances can fluctuate quarter to quarter as our larger corporate and trust clients manage their commercial interests.

Speaker 4

Turning to Slide 11, we provide details on loans by type, business segment and rate type. The chart on the bottom left shows the growth of loans in Cayman and the Channel Islands compared to Bermuda, which has seen a net reduction as the portfolio amortizes. On the bottom right, we have seen a significant increase in the proportion of fixed rate loans in 2022 and the first half of twenty twenty three. The larger proportion of fixed rate loans is expected to help stabilize yield and mitigate any potential credit issues. Change in mix has also significantly decreased the overall asset sensitivity over the past 5 quarters.

Speaker 4

Turning to Slide 12, we display 2 charts that demonstrate the conservative nature of Butterfield's balance sheet versus peers. A high degree of liquidity is a structural feature for Butterfield as our banking entities do not have access to a central bank or a Fed window. Butterfield has significant holdings of cash and cash equivalents, interbank deposits and short dated sovereign securities as well as liquidity facilities with Corusformant Banks. Butterfield's loan to deposit ratio remains low at 41% as we have conservative lending standards and 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 95% AAA rated U.

Speaker 4

S. Government guaranteed agency securities. Credit quality in the loan book also continues to be strong with non accrual loans standing at 1.2% of gross loans and a very small charge off rate of 2 basis points. On Slide 14, we present the average cash and securities balance sheet with a summary interest rate sensitivity analysis. We continue to model modest asset sensitivity to result in improved NII with higher market rates.

Speaker 4

Unrealized losses in the AFS portfolio included in OCI stood at $207,300,000 at June 30, 2023. At the current implied forward curve, we expect the OCI burn down to be $68,000,000 or 33% of the total in the next 12 months and an expected decrease in OCI of $105,000,000 or 51% in 24 months. Slide 15 summarizes regulatory and leverage capital levels. Butterfield's capital levels continue to be significantly above regulatory requirements. Our tangible leverage capital ratio has further improved to 6.5% from 6.3% at the end of the prior quarter.

Speaker 4

This has allowed us to gradually increase share repurchase activity this quarter in addition to our regular dividend. I will now turn the call back to Michael Collins.

Speaker 2

Thank you, Michael. As a management team, we regularly evaluate our operations, capital levels and efficiency. Our current outlook anticipates the Fed holding rates at an elevated level for a period and then begin to ease economic conditions to encourage growth. As a result, we will sharpen our focus on efficiency, credit risk mitigation and expense management with a continued emphasis on conservative liquidity and capital management. We have successfully navigated interest rate cycles in the past and remain well positioned for a more moderate rate environment when that emerges.

Speaker 2

Over the past year, we have upgraded our core banking system in Bermuda and onboarded the first two tranches of the Credit Suisse Trust clients, while navigating the challenges of the recent liquidity crisis. Following the official end of the global pandemic, we now look forward to continued recovery in tourism activity, and we will continue to focus on delivering exceptional services and products to our customers to help them reach their financial objectives. Thank you. And with that, we'd be happy to take your questions. Operator?

Operator

Thank you. We'll take our first question from Eric Spector with Raymond James. Please go ahead.

Speaker 5

Hey, good morning everybody. This is Eric on the line for David Feaster. Appreciate you guys taking the questions. Just wanted to touch on the funding side to start off. Just looking at the period end balances versus the averages, it looked like there might have been some migration towards the end of the quarter.

Speaker 5

Just curious if you could provide some color on flows throughout the quarter, whether you're seeing non interest bearing balances stabilize and then how they're trending here early in 3Q and how deposit costs are trending as well? Appreciate any color on that. And thank you.

Speaker 4

Yes. Good morning, Eric. It's Michael Schrum. I'll start off just on the balance side and then Craig can talk a little bit more about the cost of deposits and how that's trending. I think we sort of when we look at average balances, you're absolutely right, there's been some movement throughout the quarter, Mostly sort of normal commercial movement really, we're not seeing a lot of pressure, so we're kind of thinking stabilization is mostly what we've seen towards the end of the quarter.

Speaker 4

So, at this point, I think the period end balance is probably a good reflection of where we see things kind of shaking out. Obviously, there's ongoing conversations with customers around on our balance sheet strategies as well as laddering strategies. But I think what we've seen market rates kind of stabilizing a little bit. So we kind of we've also seen our deposit base kind of stabilize. And I think coming out of the pandemic and then the central banks kind of shrinking their balance sheets, We've certainly seen the impact of that in a higher rate environment as well.

Speaker 4

And we continue to balance the cost of deposits versus the flows. But so far, what we've seen is really normal commercial flows. I'll let Craig just talk about cost of deposits.

Speaker 3

Yes. And I guess, Eric, just to kind of add to that, in regards to just the mix, if you kind of look on Slide 10 of our presentation, the mix of deposits between non interest bearing, interest bearing demand deposits as well as time to term deposits is relatively stable. As on a a group basis, you can see it's stable. We did see a little bit of mix shift in Bermuda and Cayman and that's just a result of duration on those deposits. We're seeing average duration is about 3 months, so 3.5 months is the average duration.

Speaker 3

And as a result, we will expect to see a little bit ticking up in the cost of deposits as those rollover as they mature. But overall, as Michael said, kind of we're seeing some stability. Kind of the beta cycle to date is 24%, and we're modeling somewhere around 27%. So we're going to see some more creeping up in the cost of deposits we think over the next couple of quarters as well.

Speaker 5

Great. I appreciate all the color. Just wanted to touch going off that on to the loan growth side. You saw some continued declines this quarter. Just curious your thoughts on the lending environment and growth and how pipelines are trending and your appetite for growth going forward?

Speaker 4

Yes, sure. Thanks, Eric. So, I mean, the first thing is we've never really been a loan growth story. We've always sort of said low single digits growth sort of in line with the economies that we lend into. We only lend in our home markets because we know the markets quite well and we tend to favor lower risk density assets, loan assets such as residential mortgages that have a better diversification and a more efficient regulatory capital treatment as well.

Speaker 4

Mostly resi and we warehouse all the loans on our balance sheet, so we get amortization coming through, obviously, the repayment cycle, but that conversely results in a pretty good LTV profile of the loan book overall, because the different vintages obviously have amortized significantly, some of them contractually up to 20, 25 years. So the loan book is one that we've consciously changed from being primarily commercial about 6, 7 years ago to primarily resi at this point. We don't lend outside of our home market, so we only really lend into Diamond, Prime Central, into Bermuda and Cayman, and obviously the Channel Islands. More recently, we've started a resi program there as well. So, we continue to see good opportunities, I would say, particularly where we see higher growth and that for us is at the moment in the Cayman Islands.

Speaker 4

Bermuda, as you can tell, quarter over quarter is kind of going a little bit backwards and London's kind of been mostly stable, But we do have some good opportunities in the pipeline in the Cayman Islands, both on the resi side, but also on the commercial side. So, again, I think low single digits is probably where we normally see ourselves. It's obviously a little bit slower at the moment because of where rates are, but I think we're sort of through cycle consistent lender into the market. And at this point, I think we'll just continue to see sort of a slightly slower than average growth. But as rates sort of get normalized a little bit more, people have more certainty about their cash flows and then we'll probably start to see that pick up a little bit.

Speaker 4

We don't really stretch for credit in that way.

Speaker 2

Yes. I think we will always be about 40% loans to deposits.

Speaker 6

That's about what's right for us.

Speaker 5

Got it. That's helpful. And then just wanted to touch on just liquidity deployment strategy plans, like 13% of your balance sheet is now in cash. And I know you obviously want to be prudent with that, but just curious your plans for deploying excess liquidity with a normalized level of cash balance. I mean, it was good to see that the debt repayment during the quarter, is there any appetite for further debt pay downs?

Speaker 5

Just curious, any color on that?

Speaker 4

Yes. So it's Michael Sklarma again. So we're running the AFS and HCM down a little bit. You can see that the balances are coming in through the maturities there. It will take a little bit of time, but as a result of that, we're also getting the OCI burn down and improvement in tangible portfolio as a result of that.

Speaker 4

I think for the last 9 months, we've really just put all the maturities into cash and short term securities because there was a significant amount of uncertainty around where central banks are ultimately going to end up doing, and we didn't want to increase or exacerbate the OCI risk any more than what was already in the book. So that's worked out quite well for us in terms of the short end. We are conscious though that we do need fixed rate assets. At the moment, we have also swapped quite a lot of our customers have actually originated quite a lot of fixed rate loans, so that's providing some duration on the balance sheet that is non investment assets related. And so ultimately, we do need to start laddering back out.

Speaker 4

And I think we're probably at that point pretty close here in the next couple of quarters where we have now recovered a significant amount of TCE. We're back in the range where we need to be. And I think we're kind of reaching the slowly reaching the crest of the rate cycle. We do have a couple of pretty chunky maturities coming up here in the next couple of quarters. So I think we ultimately would want a systematic way of laddering out the balance sheet.

Speaker 4

We do have a lot of cash on the balance sheet. Approximately 20% of the balance sheet is always going to be held in cash because we don't have a central bank or lender of last resort and we deal in multiple currencies across all the 4 different balance sheets. And so that results in a hold back position that's significant because we have to fund our own deposit flows. But as we see deposit flows stabilizing and TCE recovering, we want to kind of put that back on a systemic track over the next couple of quarters.

Speaker 5

Great. Thank you for taking the questions and I'll step back.

Speaker 7

Thanks.

Operator

And we'll take our next question from Timur Braziler with Wells Fargo. Please go ahead.

Speaker 8

Hi, good morning.

Speaker 9

Good morning, Dan.

Speaker 8

Maybe sticking on the bond book, can you just talk through the dynamic again as to what drove yields in the bond book lower this quarter? And then I guess bigger picture question, as we look out at margin and NII going forward, just some of the headwinds this quarter, is the expectation that we're going to get top line growth and NIM expansion from here given the forward rate curve?

Speaker 3

Yes. Hi, Jim. It's Craig. I think the I guess, when regards to the investment portfolio and there's the slight decrease in the yield on that, it's really driven by, I guess, the increase in pay downs. So, we're getting pay downs of just above $30,000,000 a month on that about $100,000,000 a quarter.

Speaker 3

So, there's an increase in pay downs over the quarter as well as this amortization premiums or discounts, I'm sorry, on those securities. So that's what drove it down well. So coupons actually remained flat. It was really the amortization that drove it down slightly by about 2 basis points on that. In regards to the outlook, we're thinking that is that NIM will remain flat as to where we are now.

Speaker 3

We do have some headwinds in regards to cost of deposits, but we also have some tailwinds as well. So again, we paid off the sub debt. So that's going to result in increased savings. And then obviously, we're not going to have that accelerated amortization coming through every quarter as well. And then we also have we've seen some rate increases.

Speaker 3

We saw a Fed increase last week. In Bermuda, we passed that on to the personal base rate, 25 basis points that we have that one that will come through in October, obviously 90 days notice and we have another one coming through or becoming effective next week. That would be a rate that we announced back in May. So I think you have some tailwinds, but they'll be offset by cost of deposits and as kind of term deposits rollover into higher rates would offset that. So we're thinking level to where we are now.

Speaker 8

Okay. And then looking at Slide 14, the asset sensitivity profile, I guess I'm a little surprised to the still the magnitude of decline on negative 100 basis point move, especially given your comments about laddering out kind of longer term in the bond book again. In reality, is that I guess included in that negative 5% expectation? And what should we expect from the deposit base on the way down? Are you going to be able to move as quickly?

Speaker 8

Or does the addition of Channel Islands and kind of that competitive dynamic limit your ability to move rates on deposits down in tandem with falling rates?

Speaker 4

Yes. Thanks, Timo. It's Michael Schrum. So the negative 100 is obviously a parallel shock that we model. Most of that from where we are today really relates to the fact that there will be a lag in cost of deposits coming down on term deposits, but we obviously flawed our non interest bearing deposits right away because we're paying 0 on that obviously.

Speaker 4

And a lot of the even the interest bearing demand deposits, Bermuda and Cayman is also paying 0. So that's going to have a pretty pronounced effect. And we're not at the floors on the fixed rate loans on the first 100. And so that's really why you're seeing that minus 5%. I think we continue to model obviously modest asset sensitivity in the current environment.

Speaker 4

And some of the things that we're looking at the moment is obviously how can we moderate that down scenario as we get towards the top of the cycle through additional fixed rate assets in the investment program.

Speaker 8

Okay, that's helpful. And then just last for me, I appreciate you reiterating the $10,000,000 in revenues, dollars 6,000,000 in expenses for CS. I guess what's included in the existing numbers? How much of that $106,000,000 is captured in the 2nd quarter balances?

Speaker 3

Hi, Tim, it's Craig. So, I guess, we had as you know, we had the fresh tranche that closed just at the end of Q1. So we have a full quarter of the impact of that. So then what we did have, we had revenue of about 600,000 dollars on those newly acquired relationships over the quarter. And then we had expenses of around $400,000 in the quarter.

Speaker 3

So that would include salaries, expense, as well as onboarding those employees and kind of getting them operational as well. So $600,000,000 in revenue and $400,000,000 in expenses, that's from that first tranche. And then I guess when we come back in Q3, we kind of have an update in regards to what we are continuing to earn on those relationships year to date.

Speaker 8

Got it. Okay. So the vast majority of both revenue and expenses are still to come?

Speaker 3

Yes. Great. Yes. So we have obviously had the 1st close at the end of the Q1. We just had another close.

Speaker 3

Then we have a close of Bahamas, which is relatively small at end of July. So just kind of just yesterday, I guess. And then we have another close at the end of September, which will be Guernsey, and then a late close at the end of November. So that's the expected sequencing of that transaction. So by year end, we should be complete, but we have Singapore will be pretty much on board and then Guernsey at the end of September.

Speaker 8

Great. Thank you for the questions.

Operator

We'll take our next question from Michael Perito with KBW. Please go ahead.

Speaker 9

Hey, guys. How are you doing?

Speaker 6

Good morning, Mike.

Speaker 9

Good morning. Thanks Just a couple of follow ups. So just on Tmall's last line of questioning, the tenant 6. So Craig, the 85 to 86 near term expense run rate though, that will capture the 6 that needs to come in, correct? Or would that be theoretically on top of it, particularly in the Q4 of all the closings, Kaul, as you just laid out?

Speaker 3

Yes. So that will be on top of that. So what we did the guidance that we did give is the full annual run rate that we would expect. So again, to 2024, that will be the full annual run Obviously, as we bring on the various tranches this year, it will come on proportionately, but that's the full annual run rate. And the guidance, the $85,000,000 to $86,000,000 is operating expenses also take into account the expenses related to the new core banking upgrades, the amortization of that as well as kind of cloud based fees.

Speaker 3

Now also, I'll spring it online branches, a new branch in Bermuda and then some branch upgrades in Cayman as well. So we expect to see some increases in cost related to those. And those are coming online now. So the Bermuda branch has opened this quarter, and they came in kind of refits are happening as we speak.

Speaker 6

Yes. And we do have obviously

Speaker 2

a sharp focus

Speaker 6

on expenses right now, obviously, where we are in the interest rate cycle. So we're working on a program that we'll talk about in the coming quarters, but we're very focused on total compensation expenses given where we are in terms of NIM. So we'll make some progress in expenses for sure a little bit down the road.

Speaker 9

Got it. So the 85% to 86% near term, maybe a little upward pressure on that if the deal closes as expected and then opportunities in 2024 to hopefully reduce net expense growth that you'll communicate in the coming quarters?

Speaker 3

Yes.

Speaker 9

Fair? Okay, perfect. Then on the NIM, also following up on Timor's question. So I mean, stable in the mid-280s from here. But is it fair I mean, obviously, the NIM bottomed, I think, just below 2 in the prior zero cycle.

Speaker 9

I mean, is it just structurally with the fixed assets you've put on, the idea would be that the rate of attrition if rate cuts did indeed occur, which obviously the forward curve is not pulling in now, but you would expect something more optimistic than that as long as kind of the current duration of the asset side of the balance sheet holds stable. Is that generally fair? I mean, it seems it, but I just wanted to make sure that that's how you guys were thinking about it.

Speaker 4

Yes. I mean, I think sorry, Mike, it's Michael Schrum. So, I mean, if you look at the asset sensitivity disclosures, obviously, with the implied forwards, we are thinking there is a possibility of getting some modest NIM expansion as we get through, but for the near term, it's probably in the mid-280s. Obviously, the sub debt not being there will help NII effectively in future quarters. But over the medium term, if we have a longer elongated elevated rate cycle, then that would be a net positive for

Speaker 9

us. Right, got it. Okay. And then just last for me on the non interest income side. You guys mentioned it's been fairly stable on a core basis the last two quarters.

Speaker 9

Between some seasonality pickup and the fees coming on, is it fair for us to be thinking that, that quarterly run rate could see a healthy step higher in the back half of the year? Is that in line with what you're budgeting or how you guys how would you have us think about where that run rate could go in the next 6 months based on what you know today?

Speaker 3

I think based on what we know today, it is I mean, that's a reasonable run rate subject to seasonality. As you know, when we get to Q4 as an example, kind of with the Christmas and the shopping season, we usually see an increase in banking fees. So we would expect that, but absent seasonality and then as we bring on the kind of Credit Suisse assets as well, we would expect the run rate that we're seeing now to be a reasonable proxy for the way forward.

Speaker 9

Got it. Great. Thanks. And then just one last kind of bigger picture question for me. You guys mentioned the cloud based core on the Bermuda platform now.

Speaker 9

Can you just maybe give us a little bit more flavor on what that means exactly? So like how much of your core base system is in the cloud today? And what do you guys view as kind of the biggest benefits of that moving forward as you think about managing the tech costs, particularly the technical debt and then being more nimble to move forward if opportunities arise to plug in upgrades, which just would love a little bit deeper in terms of what that looks like and what the benefits could be longer term as you guys see it?

Speaker 4

Yes. Sorry, Mike, you broke up a little bit. I think you were asking about what are the sort of longer term benefits of having the IT migration? Is that

Speaker 9

Yes, sorry, can you guys hear me okay?

Speaker 6

It's breaking up a bit, sorry.

Speaker 9

No, sorry. It was just about the cloud core based system and what some of the benefits of that would be longer term, why it's worth the investment today as you guys see it?

Speaker 4

Okay, great. Obviously, it's a transit sorry, I got that perfectly, Mike. Thanks. So obviously, we're going through a transition where we've had a 10 year amortization period to broadly a 5 year amortization period, and so with the sort of broadly the same run rate. So, I think that certainly is helpful from a financial perspective.

Speaker 4

In terms of the functionality, going to cloud means that we don't need to have as big an IT team internally effectively because where we previously had a big contract with DXC, We actually owned all the racks. And so now we've kind of go into a software as a service kind of model where effectively Oracle, who is the owner of the banking system, is also responsible for the maintenance. So, on the risk side, there's a single point of failure. On the positive side, obviously, we just push it to Oracle right away if there's service issues. And they're pretty significant vendor in the space and so we have a pretty good relationship with them.

Speaker 4

It will allow us to move to more frequent updates in the future and therefore quicker timing to market for new functionality that's rolling out. The upgrade that we just did was quite a major migration update. So, even though it was a version upgrade, it was fairly significant in terms of the new functionality that was added to the platform in addition to going to the cloud. So effectively, it becomes a sort of more independent model where we are not in the IT business, we're in the banking business and ultimately will allow us faster timing to market for new products and functionality coming through the platform.

Speaker 9

Great. Thanks guys. And sorry for the technical difficulties, but appreciate you taking my questions.

Speaker 3

Thanks Mike. Thanks Mike.

Operator

We'll take our next question from Alex Twerdahl with Piper Sandler. Please go ahead.

Speaker 4

Hey, good morning. Good morning, Alex.

Speaker 7

Hey, first question for me. Just can you talk us through a little bit with the loan fixing, the moving to fixed rate, the 51% you've done, sort of what those new loans look like? I think you alluded to there being some floors on some of them, but just so we fully understand exactly what the product is in terms of the new timeframe on them and new duration and what could impact them in the future? And then also just maybe the geographic breakdown or the breakdown by product on what's been fixed so far?

Speaker 3

Sure. I'll start out, Alex, in regards to just the movement to fixed loans. And I guess as you kind of you'll be familiar that we've seen a significant increase in that sort of from about 21% at the beginning of last year to 51% now. So we kind of turned it around in because we got to be split between fixed and variable. And I think we've kind of seen a lot of that come on.

Speaker 3

There's there were some historically in Channel Islands, but in Bermuda and Cayman, as you work with our larger commercial customers, that's largely where it's coming from in Bermuda. And then in regards to some residential, we're working with customers just to help them to understand and just to solidify their cash flow requirements going forward, so they're comfortable with that. But largely, most of our commercial customers are now on fixed, so we expect, I guess, the rate of increase in that to slow down a bit, but it has been able to just kind of help them to secure and understand their cash flows. And also, as you know, kind of on the way down in the interest rate cycle, it will give us some protection. But just as a recap, that is just a between 2 or 3 year fixed within a longer loan duration.

Speaker 3

And then so when we get to that at the end of that 3 year period, we all need to renegotiate where it goes from there, whether stays on fixed or it goes back to variable.

Speaker 7

Okay. So, yes, perfect. That's incredibly helpful. And so in the residential, like you alluded to the residential rate increases in Bermuda, The way that's going to impact the residential portfolios, you said some of that maybe is moved to fixed, but it's certainly not 51% that's on the residential book.

Speaker 6

Yes. I mean, I think at this point, we're not seeing any credit stress, if that was the question, I think on the residential book. It does help that we have a higher proportion of fixed rate loans that at this point in the cycle than we've ever seen in the past. So that happened pretty quickly. So I think 2 things that will help us on the way down obviously, but it's clearly helped us on delinquencies and 30 day delinquencies in Bermuda and Cayman

Speaker 2

But I think the both islands are pretty

Speaker 6

flush with cash right now. But I think the both islands are pretty flush with cash right now. So I think we're seeing a little bit a better experience in this part of the cycle than we have seen in the past. And I just also point out, obviously, we don't have any commercial real estate exposure. So it's 2 thirds residential, a third commercial and the commercial is really pretty straightforward stuff.

Speaker 6

So we're pretty pleased where we are with the credit portfolio right now.

Speaker 3

And I guess if we look kind of in detail around delinquency rates, again, we haven't seen a significant uptick in delinquency rates, just a little bit kind of 30 day, but as we kind of look past that and get to 60 90 day, it gets back to expectations. So it just shows that those are kind of one offs, if you will, and then they are being corrected kind of before they to 90 day pass due and non accrual. The increase that we did see in non accrual that you might have noted in the presentations is really specific facilities. They are around there are some interest some late interest rate payments that have been remediated after quarter end. And what we do is just kind of hold them in that non accrual status for 1 or 2 months to make sure they're back on track and then we move them back into pass and be comfortable with those.

Speaker 3

So, working really closely with those customers, trying to understand those, but they are unique circumstances that some have been remediated, some are waiting for sales of properties to happen. And then in the Q1, and I think it's kind of worked through now, we had a divorce proceeding that was going on. So selling other assets in order to satisfy the loan proceeds, but it's just kind of a long legal process for that specific facility.

Speaker 7

Got it. And then I think the press release alluded to a higher ACL associated with credit cards as well as worsening economic conditions. Is there anything specific that you're seeing in credit cards or is it just is it more tied to the change in the economic conditions and how that impacts the modeling?

Speaker 3

Yeah, it's more tied to economic conditions and kind of just looking at the forward looking rates or GDP rates or macroeconomic rates. We actually are seeing kind of good performance in credit cards. That's good. We're keeping a very close eye on that. We kind of think that potentially credit cards could be a leading indicator to other issues when it comes to customers and being able to satisfy their commitments and then potentially have some issues around other credits in the residential, but we're actually seeing good performance on credit cards, which is a good thing to see at this point in the rate cycle.

Speaker 4

Yes, we're not really seeing utilization moving up either. People are paying off their credit card and using it as normal really.

Speaker 7

Great. And then just a final question just with respect to capital, M and A, etcetera. I mean, it seems like given all the AOCI that you mentioned will be coming back in over the next 20 4 months combined with earnings that you're going to that TCE ratio target of 6.5%, you're going to be well above that before you know it. As you think through capital return and sort of utilizing the capital, does that push you to look more towards some M and A or additional M and A, I guess, or increasing the buyback or just how you're kind of thinking about, I guess, 1, the updates the long term TCE targets? And 2, remind us how you're thinking about achieving those targets?

Speaker 4

Yes, thanks Alex. It's Michael Schrum. So I think we've set a target of 6% to 6.5% on TCE. Obviously, we do hold a lot of cash on the balance sheet. So that draws some we have to capitalize that.

Speaker 4

And you're absolutely correct in terms of the USCI burn down. We could expect to see that TCE drift higher if forward rates are holding the way they are at the moment. We're not really too concerned about being a little bit on the high side from a 2C perspective. We feel that the credit content or the credit profile of our book should allow us to run a slightly below peer leverage. But at this point in the cycle, when we're just coming off at the sort of whole regional bank crisis in the U.

Speaker 4

S, having a little bit of extra resources, maybe just slight detriment of ROE for this part of the cycle is actually not a bad thing. In terms of capital return, absolutely focused. We view the current situation as sort of cyclical, if you will. And so we would tend to favor share repurchases, which has the flexibility for us to dial up or dial down during this period. Obviously, the Board continues to be committed to the stable dividend rate of $0.44 per quarter per share.

Speaker 4

And then we obviously looked then at acquisition pipeline. And there's still ongoing discussions. We absolutely are focused on betting in the tranches and getting that, credit sweep still over the line at the end of this year, but there's still ongoing conversations around other potential books of business that we could buy. So that factors into how much capital we want to utilize for the share repurchases. But we have dialed it up this quarter as we saw sort of TCE coming back and I think we'll continue obviously do that subject to market conditions of course.

Speaker 7

Perfect. Thank you for taking my questions.

Speaker 4

Thanks, Alex.

Operator

And it appears that we have no further questions at this time. I would now like to turn the program over to management for closing remarks.

Speaker 9

Thank you, Nikki, and thanks

Speaker 1

to everyone for dialing in today. We look forward to speaking with you again next quarter. Have a great day.

Operator

And this does conclude today's program. Thank you for your participation. You may disconnect at any time.

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Earnings Conference Call
Bank of N.T. Butterfield & Son Q2 2023
00:00 / 00:00
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