Earnings Call Transcript - NTB Q2 2025

Operator, Operator

Good morning. My name is Drew, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2025 Earnings Call for The Bank of N.T. Butterfield & Son Limited. 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, Head of Investor Relations

Thank you. Good morning, everyone, and thank you for joining us. Today, we will be reviewing Butterfield's second quarter 2025 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 second quarter 2025 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.

Michael Weld Collins, Chairman and CEO

Thank you, Noah, and thanks to everyone joining the call today. I am encouraged by our strong second quarter results, which continue to demonstrate our focus on sustainable profitability and creating shareholder value. Performance was driven by solid net interest income, diversified fee revenue, prudent expense management, and a strong stable balance sheet. The Butterfield franchise continues to generate long-term value in a dynamic external environment. Butterfield stands as a market leader in offshore banking and wealth management, with universal banking models in Bermuda and the Cayman Islands complemented by an expanding retail presence in the Channel Islands. Our comprehensive suite of wealth management solutions spans trust services, private banking, asset management, and custody tailored to meet the sophisticated needs of clients in these island jurisdictions. Our tailored wealth management services are also available to customers in the Bahamas, Switzerland, and Singapore while we provide high-net-worth mortgage lending for properties located in prime Central London. I will now turn to the second quarter highlights on Page 4. Butterfield reported high-quality financial results in the quarter with net income of $53.3 million and core net income of $53.7 million. We reported core earnings per share of $1.26, with a core return on average tangible common equity of 22.3% in the second quarter. The net interest margin of 2.64% in the second quarter was a modest decline of 6 basis points from the prior quarter, with the cost of deposits falling 4 basis points to 156 basis points from the prior quarter. During the second quarter, the bank completed the early redemption of its $100 million subordinated debt, which resulted in the immediate recognition of $1.2 million of unamortized issuance costs and a 2 basis point one-time negative impact on NIM. With the redemption of the subordinated debt, we also took the opportunity to review the bank's overall capital levels and capital return strategy. Over the past five years, we have increased stable fee revenue through M&A and significantly reduced the number of shares outstanding following our share repurchase programs. As a result, we are now rebalancing our capital return strategy with a 14% increase to the quarterly cash dividend rate to $0.50 per share. The Board has approved this increase in the dividend rate as well as a new share repurchase authorization of 1.5 million shares to commence following completion of the current program. During the second quarter, we continued to repurchase shares with a total of 1.1 million shares in the second quarter at an average price of $40.69 per share. Finally, we had a few Board composition changes during this quarter. We would like to take a moment to thank Sonia Baxendale for her commitment and guidance during her five-year tenure on Butterfield's Board of Directors. Due to other time commitments and opportunities, Sonia has chosen not to stand for reelection at the bank's AGM this past May, and we wish her all the best in her future endeavors. Yesterday, we also announced the appointment of Andrew Henton to the Board of Directors. Andrew has been serving as a Director for Butterfield's subsidiary banking business in the Channel Islands, and I’m very pleased to welcome him to the group Board. Andrew brings extensive knowledge of governance, private banking, private equity, and investment banking to Butterfield, and I look forward to his continuing contributions. I will now turn the call over to Craig for details in the second quarter.

Craig Bridgewater, Group CFO

Thank you, Michael, and good morning. On Slide 6, we will provide a summary of net interest income and net interest margin. In the second quarter, we reported increased net interest income before provision for credit losses of $89.4 million. The increase was primarily due to an increase in average interest-earning assets, partially offset by lower yields on treasury assets. The net interest margin decreased modestly, settling at 2.64% compared to 2.7% in the prior quarter. This decline is largely attributed to lower treasury yields, which declined by 27 basis points directly in line with decreased short-term market interest rates, as well as the accelerated amortization of unamortized sub debt issuance costs, contributing to a one-time 2 basis point contraction in NIM. Average loan balances were slightly higher compared to the prior quarter, predominantly driven by the impact of foreign exchange translation from the strengthening of the pound sterling against the U.S. dollar. Absent the FX translation impact, loan volume decreased by $55 million as we recovered the full outstanding loan balances from a large legacy hospitality facility that was under receivership in Bermuda. Average interest-earning assets in the second quarter increased by $166.7 million to $13.6 billion. Treasury yields were 27 basis points lower at 3.71%. Loan yields were comparable at 6.31%. Whilst average investment yields were 1 basis point lower at 2.67% due to day count effect. During the quarter, the bank maintained its conservative strategy of reinvesting the proceeds of investment maturities and paydowns into a mix of U.S. agency MBS Securities and medium-term U.S. treasuries. Slide 7 provides a summary of noninterest income, which totaled $57 million, a decline of $1.4 million linked quarter, resulting from a number of underlying movements. First, banking fees were lower due to the seasonal reduction in merchant and international money transfer volumes, partially offset by an increase in card volumes. Similarly, a seasonal reduction in volumes led to a decrease in foreign exchange revenue. Custody and other administration fees saw a decline as transaction volumes and assets under custody trended lower. We are pleased to report offsetting positive contributions from an increase in trust revenue attributable to annual fee increases, the repricing of acquired business relationships, new client onboarding, and an increase in special and time-based fees. The capital-efficient fee ratio was consistent with the prior quarter at 39%, continuing to compare favorably to historical peer averages. On Slide 8, we present core noninterest expenses. Total noninterest expenses were $91.4 million, higher than the $98.3 million in the prior quarter, but continuing to be within our expectations. This increase was due to several factors, including the FX impact of a strengthened pound sterling relative to the U.S. dollar and increased performance-based incentive accruals, in addition to lower staff healthcare costs recorded in the prior quarter. Offsetting these increases was a decrease in payroll taxes, which are classified as indirect taxes. In terms of our expense expectations, we continue to think that a quarterly core expense rate of between $90 million and $92 million for the remainder of the year is appropriate, but we continue to monitor inflation and FX fluctuations across the franchise. I will now turn the call over to Michael Schrum to review the balance sheet.

Michael L. Schrum, President and Group Chief Risk Officer

Thank you, Craig. Slide 9 shows that Butterfield's balance sheet remains liquid and conservatively positioned. Period-end deposit balances increased to $12.8 billion from $12.6 billion at the prior quarter end. This movement was due to a $260 million effect from the strengthening British pound, which was partially offset by a decrease in actual customer deposits of $30 million. Butterfield's low risk density of 28.6% continues to reflect the regulatory capital efficiency of the balance sheet. On Slide 10, we show that Butterfield continues to have strong overall asset quality with low credit risk in the investment portfolio, which is 100% AA or higher rated U.S. treasuries and government-guaranteed agency securities. Overall, credit quality of the loan and mortgage portfolio improved during the quarter as the net charge-off rate was negligible. Nonaccrual loans as a percentage of gross loans decreased 30 basis points to 2% as we fully recovered a couple of commercial loans at Bermuda, and the allowance for credit losses coverage ratio of 0.6% remained consistent with prior quarters. As mentioned previously, Butterfield's loan portfolio continues to be 70% full recourse residential mortgages, of which 81% have loan to values below 70%. We remain focused on our conservative credit posture with a preference for residential mortgage lending in Bermuda, the Cayman Islands, and the Channel Islands. On Slide 11, we present the average cash and securities balances with a summary of interest rate sensitivity. Duration decreased slightly for the AFS book. Net unrealized losses in the AFS portfolio included in OCI were $120 million at the end of the second quarter, an improvement of $11.4 million or 8.7% over the prior quarter. We continue to expect improvement with additional burn down of OCI over the next 12 to 24 months of 33% and 42%, respectively. Slide 12 summarizes regulatory and leverage capital levels. As Michael Collins mentioned earlier, the Board of Directors has approved an increase in the quarterly dividend rate to $0.50 per share. In addition to the increased quarterly cash dividend rate and new share repurchase program, the bank continues to evaluate potential acquisitions as part of our continued growth priorities. Finally, our tangible book value per share continued to improve this quarter by 3.6% to $23.77 as unrealized losses on investments improved. I will now turn the call back to Michael Collins.

Michael Weld Collins, Chairman and CEO

Thank you, Michael. During the second quarter and now into the third quarter, we've seen encouraging signs of economic growth in our island jurisdictions. Bermuda is currently in its high tourism season, and by all accounts, it is shaping up to be a good year. Bermuda continues to be a premier tourist destination with headline events such as the Butterfield Bermuda Championship, a PGA event, the Bermuda Triple Crown Billfish International Fishing Tournament, the SLGP 2026 series, and the biennial Newport to Bermuda Sailing Race. The reinsurance industry continues to perform well with added growth and interest in the life reinsurance sector. In Cayman, we continue to see sustained growth across the board, including strong business performance in tourism, real estate, and international business sectors. Jersey and Guernsey are both doing well and continue to be recognized as choice locations for international business. Butterfield has benefited from this environment through the provision of banking, private trust custody, and fiduciary services. We're also seeing growth in the retail business as we focus on our competitive local credit card offering as well as local banking services. Butterfield continues to be a responsible steward of capital by consistently returning excess funding to shareholders through a quarterly cash dividend and share repurchases when appropriate. In addition, I would like to emphasize that we continue to pursue M&A fee growth, particularly in private trust. The increased dividend and new share repurchase authorization reflects the strength of our business over the past few years and our efforts to increase long-term value for our shareholders. Thank you. And with that, we would be happy to take your questions.

Operator, Operator

The first question comes from David Feaster with Raymond James.

David Pipkin Feaster, Analyst

Maybe I want to start out. You touched on the impact of the treasury market in the press releases on the margin this quarter. I know you're really disciplined about laddering the book. I was hoping maybe you could touch on your bond investment strategy just given the shape of the curve and whether that's changed at all and whether your approach has adjusted just given the prospect of declining short-term rates perhaps later this year.

Michael L. Schrum, President and Group Chief Risk Officer

David, it's Michael Schrum. Great question to kick off. I think at the moment, we're just reinvesting maturities from the bond portfolio. So we obviously get both HTM and AFS maturities coming back at around $30 million to $35 million a month, and it's going into a blend of sort of primarily 15-year mortgage-backed securities and sort of 50% of that and then 50% into a T-bill ladder or U.S. Treasury medium-term ladder, so 2, 3, 5 years. We're obviously looking for kinks in the curve. There is quite a lot of movement in the market. As you know, we've seen kind of a gradual steepener, and there's definitely downward pressure on short rates. So it's definitely an active conversation in terms of all the excess liquidity that's sitting on the balance sheet. And then you have the whole Fed decisions coming up next year. So we're definitely looking at it at the moment, and we feel very comfortable with where the strategy is. It's gradually shortening the overall duration of the investment portfolio, and we're obviously able to reinvest at higher rates. But it is a slow process, and there's a lot of movement in the market. So it's definitely top of mind at the moment.

David Pipkin Feaster, Analyst

Okay. That's helpful.

Craig Bridgewater, Group CFO

Just add, David. Yes, I mean, as Michael said, we're continuing to invest at higher rates. So investment somewhere around kind of 380 basis points and around a 3-year duration, so 3 or 3.1 year duration, so bringing duration in. But and as I said, we're very focused on it, looking at any excess liquidity that we have and kind of seeing if it makes sense to kind of invest some of that or pre-invest some of that, given that we're looking at a potentially downward interest rate.

David Pipkin Feaster, Analyst

Okay. That's helpful. And then the last couple of quarters, we talked about some transitory, maybe temporary deposits that might be rolling out. In the prepared remarks, I didn't hear anything. I may have missed it, but just kind of curious, an update there whether anything has changed with those? Have they flown out? Just kind of curious how you think about that as we think about the size of the balance sheet.

Craig Bridgewater, Group CFO

Yes, we still believe that some deposits could leave the bank or may be considered as hard money. The fund we've been discussing for several quarters that's in liquidation is still with us, but we expect that to change at some point due to the ongoing legal process. Some of the larger deposits in wealth management have already flowed out and have been put to use. However, we have also seen some new deposits coming in to offset those. We don’t analyze this behavior extensively. The fund in receivership is around 200, while the funds above that are approximately 700 to 800. Therefore, we can’t consider them to be stable at this point, and they could leave the bank. We need to monitor how these deposits behave over time, which brings us back to our expectation that deposits may stabilize in the medium term.

Michael L. Schrum, President and Group Chief Risk Officer

Yes. I think it's challenging to understand the impact when the sterling is moving quickly or the dollar is weakening, which is largely due to the differences in interest rates among markets as central banks take divergent paths. We highlight that actual customer outflows resulting from normalization and customer behavior are somewhat obscured by a weakening dollar or a strengthening pound. This effect is particularly noticeable this quarter, both in terms of loan asset balances at the end of the period and in deposits.

David Pipkin Feaster, Analyst

Yes, that’s a good point. I’d like to discuss the capital aspect. Michael, you mentioned it briefly in your opening comments. You already have a solid balance sheet, along with the dividend increase and the boosted share repurchase authorization. However, you spoke about reconsidering your capital return strategy, and I was hoping you could provide more details on that. Has there been any change in your focus? The press release suggested that mergers and acquisitions could be a higher priority now. I’m interested in hearing more about your current capital priorities.

Michael Weld Collins, Chairman and CEO

Yes, it's Michael Collins. First and foremost, the dividend is a priority, followed by mergers and acquisitions, and then share buybacks. We have been in discussions regarding M&A, but we remain disciplined on pricing. There's still competition from private equity, which is looking to consolidate trust companies and fund administration firms offshore before potentially going public or selling them. We are not willing to pay the same prices that private equity funds pay for these franchises because we likely understand them better. We are still focused on being disciplined, and while we are in discussions, we will take our time. Regarding the dividend, we have increased it over the last six years, maintaining a payout ratio of 34%. We're working towards a 36% payout ratio. We have repurchased a significant number of shares, which has positively impacted our earnings per share and share price, but we feel it’s important to adjust our approach to dividend payments instead of allocating 70% to share buybacks. This is not something we assess every quarter; it's more of an occasional review, and as you can see, after six years, we have a very healthy dividend payout ratio and yield. We are satisfied with that, and I’ll pass it to Michael Schrum, but we aim to maintain a payout ratio slightly above 100% over time.

Michael L. Schrum, President and Group Chief Risk Officer

Yes, it's Michael Schrum. The Board is very supportive of our buyback strategy in terms of overall capital deployment. The share buyback authorization may be slightly smaller than in the past, as we're looking at a combined payout ratio that includes cash dividends and the authorized buyback amount. We want to ensure we still have room for growth and potential M&A, so the authorization is likely scaled down a bit. However, the Board is open to revisiting this, keeping in mind that share buybacks depend on market conditions. Essentially, we're increasing cash dividends while reducing share buyback authorization, with the understanding that we can request more if necessary.

Operator, Operator

The next question comes from Timur Braziler with Wells Fargo.

Timur Felixovich Braziler, Analyst

Back on the capital question, CET1 is now closer to 26%, was down somewhere between kind of 17% and 20% pre-pandemic. I get the lender of last resort and the need to hold additional capital. But even that statement seems a little excessive for you guys. I guess how are you thinking about your level of capital here? And what is ultimately the right level that we should think about that getting to over time?

Michael L. Schrum, President and Group Chief Risk Officer

Yes, it's Michael Schrum. That's another great question. Currently, we are using more capital than we are earning, so it will take a few years to reach the mid-20s range. The Basel IV implementation provided us with a boost, and some of that benefit has been reinvested to improve the quality of our capital by redeeming subordinated debt, which has allowed us to increase our interest earnings by eliminating that expense. This was due for a five-year reset to floating rates, and tapering capital relief as well. We thought it made sense to utilize some of that benefit and our ability to return value to common shareholders. We still hope to conclude a fair value M&A transaction that would enhance shareholder value, as that could help stabilize our earnings through reliable fee income and reduce our reliance on net interest earnings. We are maintaining excess capital, which could allow for a significant deal without needing to solicit more from current shareholders. Additionally, we have the option to reenter the subordinated debt market; however, current rates make it impractical to issue new debt at this time. We're in ongoing discussions, and most transactions have been under $30 million in terms of consideration, leaving room for a couple of deals within our excess capital. Ultimately, with a 25% rate cap, it's uncertain whether raising additional capital would address any issues.

Michael Weld Collins, Chairman and CEO

Yes. I think I figured, like Michael hit it on M&A. So we don't want to reduce capital substantially and then need capital for something that comes up. But I also think we're looking at the long term, and we've got a 22% ROE or mid-20% ROEs throughout the cycle with 35% loans-to-deposits. So it's a pretty good model. And right now, with everything going on geopolitically and tariffs, and with the U.S. and where is inflation going and what's the Fed doing? I think it's probably a decent time to just hold a little capital and see where it plays out. And as Michael said, it's not a war chest, but we probably will find something at some point in the future. So we're pretty comfortable where it is. But obviously, we want a payout ratio that's sort of 108%, 110% so that we start to get down to the low 20s in terms of total capital as opposed to where we are today.

Timur Felixovich Braziler, Analyst

Yes, it's a high-class problem for sure.

Michael Weld Collins, Chairman and CEO

It's exhausting, Timur.

Timur Felixovich Braziler, Analyst

On the deposit side, again, I think, surprising on the ability to bring costs down given the really low starting point. I think when we spoke last quarter, it didn't seem like there was all that much room to go, and then here we are with another pretty good result. Where are we at this point and the ability to drive deposit costs lower ex any future rate cuts?

Craig Bridgewater, Group CFO

Yes. We have benefited from a reduction in the duration of deposits. This allows us to lower the rates we offer on deposits, particularly for fixed terms, while also seeing a shift towards more demand deposits. At the end of December, about 65% of our deposits were in demand accounts, and that has now increased to around 70%. This change has helped reduce our cost of deposits. In response to your question, given the shift in duration and our success in lowering deposit costs over time, I believe we can still achieve some reductions, but the pace will likely slow as we move forward, particularly in the current interest rate environment.

Michael L. Schrum, President and Group Chief Risk Officer

Yes, Tim, it's Michael. In the asset sensitivity slide, we are still modestly asset sensitive, but we are exposed to a decrease of 100 basis points. This indicates we are approaching a flattening net interest margin where we cannot reduce deposit costs below zero. We may be slightly more vulnerable in this area compared to our peers, largely due to our starting point. Mike Collins and I have both been in Island Banking for over 25 years, and historically, net interest margins of around 2.75% to 3% are where we generally peak through different interest rate cycles. Each cycle is unique, and there are several dynamics at play.

Operator, Operator

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

Noah Fields, Head of Investor Relations

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

Operator, Operator

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