Bank of N.T. Butterfield & Son Limited (The)

Good morning. My name is Andrew, and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter and year-end 2020 earnings call for the Bank of N.T. Butterfield & Son Limited. All participants will be in listen-only mode. Should you need assistance, please signal a conference special by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then 1 on your telephone keypad. To withdraw your question, please press star then 2. Please note this event is being recorded. I would now like to turn the conference over to Noah Fields, Butterfield's Head of Investor Relations.

Thank you, Operator. Good morning, everyone, and thank you for joining us. Today, we will be reviewing Butterfield's fourth quarter and year-end 2020 financial results. On the call, I am joined by Butterfield's Chairman and Chief Executive Officer, Michael Collins, and Chief Financial Officer, Michael Scrum. 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 near end results. The press release, along with a slide presentation that we will be referring 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 reconciliation of these measures with 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. On slide 26 of the presentation, we have also included a list of potential factors relevant to the implications of COVID-19 for the bank. Additional information regarding these risks can be found in our SEC filings. I will now turn the call over to Michael Collins.

Thank you, Noah, and thanks to everyone joining the call today. I will begin our discussion with a look back at the full year and provide some observations on the bank's experience in 2020, and then provide an update on COVID-19. I will then turn the call over to Michael Scrum, our CFO, to provide a detailed review of the fourth quarter financials. Turning now to slide four. As a whole, for 2020, I am very proud of Barfield's performance and the resilience of the business model. In a near zero interest rate environment, we produced net income of $147 million, or $2.90 per share, and core net income of $155 million, or $3.04 per share, which equates to a core return on average tangible common equity of 17.3%. NIM finished the year at 2.42% with an average cost of deposit of 21 basis points for the year. We continued with a $0.44 per share quarterly cash dividend and completed a $3.5 million share repurchase program with the most activity during the second and third quarters. We also improved our capital profile with $100 million, 5.25% qualifying subordinated debt offering in June. Butterfield's business model, which focuses on maximizing returns while closely managing credit and operational risk, proved successful during this period of uncertainty. The global pandemic tested us across all jurisdictions, and the bank continued to perform well. Our technology and collaborative culture allowed us to maintain safe and uninterrupted services for our clients by decisively moving between the office and remote working environments as conditions required. Our conservative credit profile consists of 65% residential mortgages with relatively low LTVs, no out-of-market lending, a loan-to-deposit ratio of just 39%, and an investment portfolio consisting of 97% U.S. government and federal agency securities. The historically low interest rates in 2020 also brought a renewed focus on improving efficiency. As a result, we implemented a bank-wide restructuring program to lower headcount, as well as moving non-client-facing positions to lower-cost service centers wherever possible. We were very pleased to complete the integration of ABN AMRO Channel Island's acquisition this year. The Channel Islands continue to represent a growth opportunity for us, both organic and through potential acquisitions. In 2021, we are launching retail lending products to complement our UK mortgages business and to activate a portion of our sterling deposits over time. We expect this business to be similar in underwriting standards and character to our loan portfolios in Bermuda and Cayman. We plan to develop the book organically and anticipate it could grow to around $500 million over the next four to five years. Finally, I would like to recognize the additions to our executive management team during 2020, which now benefits from fresh perspectives and deep experience to their roles in trust, compliance and operations, risk communications, and human resources. I am proud and confident in our management team and believe we have the right people in place to grow Butterfield and reach its potential. Turning now to slide five. Here we have provided some context and an overview of our core markets and how the bank continues to manage through the pandemic. Bermuda Cayman and the Channel Islands continue to have active domestic economic activity. However, much of the travel and tourism industry is operating well below historical norms. The vaccine rollout is progressing well, and all jurisdictions have active government-sponsored vaccination programs. We expect that visitor numbers will continue to improve as we move through the summer and fall tourism seasons in 2021. As we discussed last quarter, following the mortgage assistance programs, we had implemented a calling program at Bermuda to better understand borrowers' status and the ability to restart payments. I am pleased to say that the actual customer payment rates have exceeded the indications from the program. At this point, we are seeing short-term delinquency of less than 1% of the total residential loan book and continue to work closely with customers to determine the best way forward. While we are encouraged by these initial results, we recognize that the pandemic continues to impact customers and will maintain close monitoring of the mortgage books in Bermuda and Cayman. Our commercial lending book remains solid and has not been significantly impacted by COVID-19-related issues. Direct hotel and restaurant lending continues to be limited, well underwritten, and performing loans. I will now turn the call over to Michael Scrum to provide a detailed review of the fourth quarter.

Thank you, Michael. I'll begin on slide seven, which provides some highlights from the fourth quarter. We ended 2020 with the most profitable quarter for the year, with net income of $42.1 million, core net income of $42.9 million, or 86 cents per share, and core return on average tangible common equity of 19 percent. The net interest margin was 2.25 percent for the quarter, and the average cost of deposits improved to 12 basis points. Turning to slide eight, net interest income continued to be impacted by lower market rates, and particularly the reinvestment book yields of securities are lower than maturities. Pre-payment speeds in our investment portfolio moderated slightly in the fourth quarter compared to the third quarter. However, they were still elevated with $329 million of paydowns compared to $339 million in the prior quarter. Investment yields were down 15 basis points in the fourth quarter compared to the prior quarter. New money yields averaged 1.46 percent in the fourth quarter, or 4.7 basis points higher than the prior quarter. During the fourth quarter, the blended rate for loan originations was 3.66 percent for 201 million dollars of new loans, down from 3.93 percent for 156 million of originations in the prior quarter. On slide nine, you can see that non-interest income was up 1.9 percent compared to the prior quarter due to improving economic activity across our jurisdictions. and increases across asset management, banking, FX, and trust business lines. The bank's contribution from fees continues to represent stable and capital-efficient earnings. For the fourth quarter, fees were 38% of total revenue. Slide 10 provides a summary of core non-interest expense, which improved by 2.6% in the fourth quarter compared to the prior quarter. Expenses fell as we start to experience the benefits of the cost restructuring program in the third quarter, which achieved the expected reduced run rate. In addition, lower technology costs and indirect taxes improved, which was partially offset by higher marketing spend that increased along with improving economic activity. We continue to target a through cycle cost income ratio of 60 percent, and we expect to remain in the mid-60s during this ultra-low part of the rate cycle. Slide 11 summarizes regulatory and leveraged capital levels. LIBIN continues to be in an excellent capital position, with capital ratios well in excess of regulatory requirements. We have been pleased to note that our tangible book value per share has also increased 8.8 percent over the past calendar year. Capital management remains an important value driver for the bank. We continue to manage capital with an emphasis on protecting the sustainable quarterly cash dividend rate at 44 cents per common share. In addition, we maintain capital levels to support organic growth in our core markets, as well as M&A opportunities. Share repurchases subject to market conditions also continues to be part of the planned EPS growth, and the Board of Directors has authorized a new share repurchase program for up to 2 million shares for the coming 12-month period. Turning now to slide 12, Butterfield continues to manage a strong conservative and highly liquid balance sheet. At the end of the fourth quarter, the loan portfolio represented only about 35 percent of total assets, whereas liquid assets were just over 60 percent of total assets. Deposit balances ballooned to $13.3 billion at the end of the fourth quarter from $11.9 billion at the end of the previous quarter. We do expect some of the increase will be temporary and that the deposit balances will normalize over the next few quarters. The bank has maintained a low risk density with risk-weighted assets to total assets of 34.4% down from 36.7% last quarter. On slide 13, we show that Butterfield's asset quality remains exceptionally high with limited credit risk in its investment portfolio that is 99% comprised of AAA-rated U.S. government-guaranteed agency securities. Non-accrual loans were down slightly versus the prior quarter at $72.5 million of 1.4% of gross loans. The net charge-off ratio ticked higher due to the secondary market sale of one commercial loan that crystallized the loss of provision previously recorded under the CECL model, and the overall NCO ratio remains very low. The implementation of the CECL accounting standard was well managed for our bank and has resulted in improved credit quality overall. For Butterfield, the model has been responsive to portfolio performance and varying macroeconomic forecasts as expected. On slide 14, we discussed the average cash and securities balance sheet with a summary interest rate sensitivity analysis. Butterfield's weighted average life of around 4.1 years continues to offer some income protection against the impact of near to medium-term low interest rates. The unrealized mark-to-market gain on invested securities was $183.2 million at 31 December 2020. Similar to the past few quarters, Butterfield continues to expect a potential increase in net interest income in future periods in both up and down parallel rate scenarios. I'll now turn the call back to Michael Collins.

Thank you, Michael. I am proud of Butterfield's performance during 2020. as we were able to achieve a core return on average tangible common equity of 17.3% during a global pandemic in an ultra-low interest rate environment and at a time when our home markets were facing economic contraction. It was with confidence in the strength of our business that we were also well-positioned to contribute and support local communities at a time when many people faced great uncertainties. We were proud to offer the mortgage deferrals and offer our communities food security programs and other targeted charitable actions. I would like to express my thanks to our clients, staff, and business partners for all of your support and contributions throughout the past year. I believe Butterfield is well positioned to benefit from the anticipated economic recovery in 2021. We continue to focus on building the world's leading offshore bank and trust business, and aim to maintain top quartile risk-adjusted returns with meaningful non-interest income contribution, limited credit risk, and emphasis on efficiency and shareholder-conscious capital management. Thank you, and with that, we'd be happy to take your questions. Operator?

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Michael Scavone of KBW. Please go ahead.

Hi, good morning, everyone.

Good morning, Michael.

So with the TC near the bottom of your target levels, but your regulatory capital very healthy, how should we think about the amount and aggressiveness of your capital deployment strategy? And also on this point, can you just discuss your deployment priorities and if you're seeing any opportunity for M&A?

Yeah, thanks, Michael. It's Michael Scrum. So I'll kick off just on the sort of BAU side of it, and Michael Collins can talk a bit about the M&A. So as you saw, we obviously measure both tangible as well as regulatory capital. So you're quite right, the regulatory capital benefited from a slight mixed shift in terms of getting our subordinated debt issued mid-year. which made the efficacy of the existing capital stack a bit cheaper for us, but also allowed us to continue, obviously, with the buyback program that was fairly substantial last year, particularly executing in Q2 and Q3. The priorities are, I think, as we stated a little bit earlier, is to protect the dividend rate that we have at the moment, which we view as very sustainable. Our payout ratio has been around 60% this year. but probably due to pro-cyclicality of reserve builds from CECL and obviously rates being much lower than in the beginning of last year. Secondly, obviously, to help the organic growth profile in our home markets, so that's Bermuda and Cayman where we see opportunities, and also account for any risk migrations and risk-weighted assets on the regulatory side that might come from CECL experiencing additional credit issues, which so far we haven't. And then thirdly, obviously, we look at M&A, where that's accretive, and the criteria are fairly strict. You know, we really look just for banking assets in our home markets where we can get some synergies, and also obviously private trust companies that provide stable, capital-efficient fee income at reasonable multiples. And then, fourthly, we look at share repurchases, and we're pleased to see that the board has approved another repurchase program for the next 12 months at 2 million shares or up to 2 million shares. And so that will be executed, obviously, subject to market conditions. You know, if you look at price to book at the moment, you know, we're conscious, obviously, of tangible book dilution. relative to share repurchases, but we're still, you know, sitting at a fairly deep discount on the PE relative to peers. So, you know, I would say, you know, look at the last couple of years of buybacks, and obviously we'll execute that as and when on the tangible. You saw it come down to sort of in the bottom to the middle of the range at 6.1. Obviously, ex-cash, it's a lot higher. And that was probably driven by an OCI impact from post-retirement medical expenses having natural loss on the annual valuation cycle. So we're monitoring that as well as part of the overall capital strategy. So nothing's really changed, same priorities as last year. And obviously we now have the firepower to exercise that as well. I'll let Michael just talk about M&A.

So we're happy to finish the integration of ABM Amro. Last year, and if you remember, it provided us with three things. First, it was provided for the growth platform in a jurisdiction where we have very low market share. Obviously, when Bermuda came in, we got sort of 35%, 40% market share, so it's harder to grow. Secondly, it reduced our concentration risk in Bermuda. And thirdly, it created efficiency. relative balance sheet parity amongst our three banking jurisdictions. So strategically, that did a lot for us. Last year, obviously, conversations were pretty slow given the pandemic. We have a sense now that people are starting to get vaccines and starting to think about travel and starting to think about transactions more across our jurisdiction. So we are having some conversations, but we're always very cautious about, you know, thinking about whether they're going to come to fruition or the pricing's right or the AML is where we want it to be. So we are having conversations. The strategy is the same. So it's trust companies across our existing jurisdictions that sort of overlap acquisitions. With a particular focus on Singapore, we'd like to build scale there. And secondly, overlap acquisitions in our existing jurisdictions, whether it be Bermuda Cayman or more likely the Channel Islands. So we continue to have conversations, and we think this could be a good year to bring something to conclusion. But we're always cautious because we are very focused on due diligence and AML, given where we operate. So we'll just continue having those discussions.

Great. Thank you for all that color. And then my second question relates to the margin. Should we expect the continuation of this low creep downward as your books continue to mature in this low rate environment? Or are there any further opportunities to offset or at least stabilize the compression within 2021?

Yeah, great question. So I'll just try and unpack that a little bit, starting with loan assets. Obviously, there's a front book backlog. As you know, we amortize all of our loans on balance sheets, so they're manually underwritten, you know, full recourse loans. So you see that loan yield kind of stabilizing, even though I gave a little bit of detail around the most recent loan originations, which was 3.66 in the last quarter. So down a little bit on the front book side. but relatively stable overall as you look at the loan book as a whole. We do expect some modest mix shift as we launch the residential lending opportunity in the Channel Islands. Those are sterling loans, which would be at a slightly lower rate. But again, that will take some time organically to come through there, and it would be activated out of our cash balances effectively. So that should be helpful. to them. In terms of cash, pretty much floor up there at 5 to 10 basis points. We're obviously watching the current discussions on sterling rates in terms of where they might go in the future. But that's probably reasonable there. That's been fully realized, if you will, at the short end of the curve. And then finally, on investments, prepayment speeds are obviously pretty elevated throughout We're at 2020, so we're seeing approximately 5% of the total investment book roll over a quarter, which is almost double what we saw in prior years. Combination there of a very flat forward yield curve, and then obviously on the opposite side of that, we're deploying excess cash from the ABN AMRO into the securities book, so you see a positive volume there. impact from that. So overall, I'm expecting some stabilization as long as there's a reasonable sort of 10-year and a sort of normal sloping yield curve that we've seen more recently. But obviously, the short end of the curve seems to be for a longer period of time. So medium-term, you know, stabilization, you know, around where we are, which I would expect.

Okay, very helpful.

Thanks for taking my questions.

The next question comes from Alex of Piper Sandler. Please go ahead. Hey, good morning, guys.

Good morning, Alex.

So first off, I was hoping you could give a little bit more color around the large deposit inflows that we saw in the fourth quarter and I guess what drove that and then why we expect those to move off balance sheet and sort of the timeframe for that to happen.

Yeah, it's like a scrum. So I'll talk a little bit about it. You can see on the average balance that it was pretty much towards the end of the quarter. Really a combination of retail deposits, but I would say slightly unusual flows in the retail deposit base in that it was driven probably by the deferrals that we put on mortgages here where people were obviously keeping their payments and putting it into bank accounts. So again, over time I would expect some of that to flow out in Cayman, mostly driven by allowable pension withdrawals, which is kind of a one off fiscal stimulus that was provided there. Again, over time, that could migrate into either real assets, property, or it could migrate back out, I think, to some retirement portfolios. So, again, a little uncertain there, but they are retail deposits, which is obviously very helpful. And the other half roughly is related to sort of what I call hot money. So, you know, hedge funds flows in Cayman and captive insurance deposits in Bermuda. which typically follows sort of a premium claims cycle at the end of the quarter, and there's quite a lot of activity in the asset management space towards the end of the fourth quarter. But again, we're not banking on those deposits. I think some of that will flow out over the next couple of quarters.

Yeah, it's difficult at year end, obviously, because we have our RMs talking to corporate clients, encouraging them not to put a lot of deposits on our balance sheet, you know, over year end. But it's difficult in the sense these are good clients and, you know, you can't necessarily turn away deposits. But we've been reasonably successful. We'll retain some of it. But as Michael said, we're not expecting to retain all of it.

Okay. And then, you know, just thinking about, I guess, the amount that potentially could flow out and then, you know, going back to the strategy of laddering cash into investments and Has that changed at all in this rate environment, and is the goal there just to kind of consistently still put whatever it is, $150 million of cash into securities per quarter, or is there a different target such as just aiming to keep NII flat over the next couple quarters by deploying cash?

Yeah, I mean, nothing's really changed in terms of the core balances. So, you know, as you think about what's the behavioralized nature of the underlying deposits, you know, we've been watching the ABN piece for over a year now and feel we have a good handle on those client relationships. Obviously, it's very key to integrate our systems and get them onto one platform there. So you'll see that that's continued throughout the fourth quarter. So over and above the maturities that we get from the investments, which obviously we keep rolling into lower rates, we're also deploying the extra at that sort of clip of 150 around that a quarter. So the strategy hasn't really changed. Obviously, as deposit base has increased quite a lot, we'll just have to wait and see if that sticks around and what we can do with that. You know, it's been pleasing, obviously, to see the 10-year a little bit higher lately. So that helps both slow down the prepayment rates and also you know, helps to reinvest in rates.

Got it. And then, you know, in terms of the loan growth strategy in the Channel Islands, $500 million over five years, is it fair to assume that by the end of 2021, you'll be around $100 million? Is it a pretty straight line ramp up? And just sort of how should we think about overall loan balances when we consider that potential growth versus other strategies loan categories that I know, you know, maybe a little inflated based on, uh, stimulus or around the pandemic or other items that, uh, other loan balances that could actually potentially flow off the balance sheet.

Yeah. We've got a lot of discussion. We're really just in the launch phase right now. So we lost, you know, month and a half or whatever, but you know, it'd be fair to probably think of that as, uh, you know, as a tapered, you know, annual increase. We're not really a loan growth story per se, but I think it's exciting that we're able to deploy some excess sterling, particularly as you look at the alternatives, you know, for sterling at the moment, whether it's secondary market or even gilts, which are pretty flat to zero. Some of it will just depend on the reaction we get in the market and the reception. So far, you know, obviously conversations are positive. There seems to be some pent-up demand there. But, you know, there are other players, high street banks, in the market there as well. And we're not sure exactly how it's going to actually filter in. But I think the, you know, so far so good.

Yeah, and Alex, the plan obviously is to turn the channel loans into a full-service bank on both sides of the balance sheet to look more like Bermuda and Cayman, and also to dampen a little bit the percentage of UK central London loans as a percentage of our portfolio we want to It's been a great portfolio, but obviously we don't want it to be 50% of our overall loan book, so growing into Channel Islands will actually help quite a bit. But as Michael said, I think it'll ramp up a little bit more slowly this year as we get into it.

Okay, that's helpful. Is that a broker-driven market the way that the book in the U.K. is, or is it more of an originating branch type of a product?

Yeah, so there's a number of buildings. It's not a broker market. It's a direct underwriting market. But there are a number of buildings, traditional building societies and property brokers that operate as well as underwriters in that market. So there's quite a breadth of product available. We're obviously looking mostly at the same types of character underwriting that we do for Bermuda and Cayman. So we sort of did in the whole loan underwriting

Yeah, it's a lot more like jumbo mortgages, I guess, and it actually interacts really well with our corporate management company relationships. So if you have captain managers or fund management companies or trust companies, we know a lot of the executives in all these companies, and once you start launching mortgages, the corporate relationships often turn into mortgage relationships personally as well.

Perfect. Thanks for taking my questions.

The next question comes from Will Nance of Goldman Sachs. Please go ahead.

Hey, guys. Good morning. Hi, Will. Good morning. Maybe just a follow-up on some of the growth initiatives and just how to think about how that impacts the margin over time. I mean, can you just give us a sense for kind of like the, you know, what are you paying on sterling deposits now? And I heard you that the, or charging, I heard that the reinvestment rates on gilts is something close to zero. It just seems like a decent amount of money to be able to kind of lever out at some kind of incremental margin. And so just any thoughts on how that can impact the margin and, Do you think that can be a net positive, or is that going, in your mind, to just largely offset declines in the security portfolio and maybe run off of some of the higher yielding loans in the legacy jurisdiction?

Yeah, great question. It's a net positive, but it's too small to offset over a five-year period. You know, once we get to sort of a more of a portfolio basis, obviously that will be helpful in terms of stabilizing. You know, I think the front sort of types of rates are more similar to Prime Central London. So you're talking, you know, in the 350 gross sterling. So it would be helpful to activate cash, obviously, the current, you know, rates for secondary market assets and sterling is, you know, zero to 50, I mean, super flat. It's almost like, you know, they're now talking about negative rates. So we're not paying up for sterling deposits, I would say, but obviously there are overall client considerations following ABN. There are some of funds that we service both in Guernsey and Jersey that have both sterling and dollar deposits. So it's more of a relationship-based pricing. But, you know, clearly it's a challenging, and I think it's a challenging environment in the secondary market. I think the residential lending program will definitely be accretive on the margin side, but if you look at the volumes, given that we're doing this organically, obviously we're also talking to other players in the market, but, you know, we're pretty particular about the underwriting standards, I would say. So it's going to be too small. It's going to be helpful, but not totally offset, if that makes sense.

Yeah, no, that makes sense. And then maybe a follow-up on the question on the strategic discussions earlier. I think you just mentioned that you'd like to take the Channel Islands to look more like the Bermuda and Cayman jurisdictions in terms of being like a full-service bank. I mean, can you maybe just expand on what the vision is for the footprint there, you know, How are you thinking about like the pieces you have in place today? Do you need to acquire more in order to make that happen? Can you build it organically? Can it be kind of brick and mortar light? I'm just curious to kind of, you know, entering a new market, wanting to take market share, what your thoughts are on like how to build that infrastructure over time.

Yeah, sure. So I'd say we've been in the Channel Islands actually for years. So we've had a presence there for quite a long time. Jersey is a new market for us, but Guernsey, we've been there for decades. So we know the market very well. It is a market, a corporate market, very much like Bermuda and Cayman. So management companies, Bermuda's more captive than reinsurance companies, Cayman's. Obviously, hedge funds and captives and Guernsey and Jersey are both captives, but more funds and trust companies. But it's all the same sort of management company structure. So our systems and our RNs are geared to servicing that business. So we understand it well. And what we've done with ABN, as I said, is we've gotten to the point where we've actually balanced our balance sheet, so to speak, our risk exposures across the three jurisdictions. relatively evenly. It's not the same from an earnings perspective. So Cayman in 2020 made about 56% of our core net income, Bermuda 31%, and the Channel Islands 14%. And even though the balance sheets are similar size, that's simply because Channel Islands are much more competitive from a pricing perspective. So that all makes sense. So I think we're kind of where we need to be to allow the Channel Islands to grow organically. So our focus right now is much more on the fee businesses on the trust side to try to build scale across our jurisdictions, but particularly in Singapore. Now, that's not to say if there was a decent-sized bank in Jersey that were to come up for sale. Again, there are not a lot of natural buyers, so I think we would be interested. But I think we've kind of got the platform where the Channel Islands can grow organically now and all three jurisdictions can grow together so that we actually have a balanced portfolio and we're not completely dependent on one island like Bermuda.

The only thing I'll just add to that is you're exactly right. The reason why we're going on a product-by-product basis here is we want to keep it bricks and mortar light. So it's a bit of proof of concept. We don't need lots of branches to do the residential lending platform. You know, it could be a slick online form filling, you know, processing. And we're aware, obviously, of the competition there in terms of the true retail and merchant acquiring is driven by HSBC, Barclays, NatWest, Lloyds, et cetera. So, you know, that's one of the reasons, you know, this isn't opening a whole bunch of branches at the moment. Let's start with the stuff that's most accretive for us.

Got it. Super helpful. And if I could just squeeze in a housekeeping note, can you just kind of mark us to market on where we are on the fee income side, you know, how depressed that is just from an environmental standpoint? And, you know, like, is there, you know, if activity levels kind of normalize across the various jurisdictions, is there, you know, how much do we have to go and kind of what's like the right run rate going forward?

Yeah, I mean, it was great to see the fourth quarter increase, obviously, across the board, mostly from domestic activity. So domestic activity, I would say, is probably elevated in the fourth quarter. People aren't traveling. They're spending here. So you get a domestic Christmas shopping boost as opposed to an Amazon and shipping in kind of boost for Christmas. So that's been great. been good. What's missing is obviously the tourism-related credit card fees that we normally get in the fourth quarter, particularly from Cayman. You know, airlift and capacity has been severely reduced during COVID. So that's been muted. There's a few smaller positive items in the banking fees in the fourth quarter as well. But I would say you're probably going to see, you know, that run rate is a decent run rate. It was a smaller on the trust fees in terms of activity-based fees. There was some recovery in that, but probably a bit smaller than we would see on the run rate side. And you would probably see a substitution from domestic activity in the merchant acquiring side to credit card, tourism-related, within the banking fees once the borders open and we get the vaccine passports.

Great. Super helpful. Thanks for taking all my questions.

The next question comes from Timur Brasilier of Wells Fargo. Please go ahead.

Hi, good morning. I wanted to follow up on the M&A line of questioning. I guess in looking at the Channel Islands, if the presence there organically is good enough to launch kind of product by product, I guess what's the rationale for looking at some of these larger deals if they do come up? Is it an expense story? I guess what would be the rationale for doing a larger deal in the Channel Islands right now?

So first and foremost, I think, so we talk about our market shares and pricing power in Bermuda and Cayman being market share of 35%, 40%. What's been attractive about both Guernsey and Jersey is we have a small market share hat and still have a small market share in both jurisdictions, so we really can't grow organically where we can't as well in Bermuda and Cayman. So even after the ABN acquisition, we estimate our market share in Guernsey, and we're only on the corporate side and private banking and trust side, would be about 15%. So there's a lot more banks, obviously, in the Channel Islands than in Burmese and Guernsey. So even at 15%, that gives us a platform where we can grow organically. But if we were to find an attractive acquisition, it would be nice to be 30%, 30%, 40%. But what we're saying is that 15% in Guernsey is a platform where, at last, we can grow organically and we'll be optimistic about whether there's an acquisition. Jersey is even more interesting in the sense that I think our market share, we're guessing, is about 1%. There's about 120 billion sterling in deposits, so it's a huge banking market, and we only have a 1% market share. So I think Jersey would even be more interesting on the acquisition side. But I guess the point is across both Guernsey and Jersey, we have enough market share that we can grow product by product organically. But if there were a very attractively priced bank that were to come up for sale, we definitely would be interested. So our point is, We don't need to do it, but if it happened, we would look at it opportunistically.

Okay, that's good, Collar. Thank you. Maybe looking at the reserve this quarter, Michael Scrum, can you just go through kind of what changed quarter on quarter? How much of that $7 million decline was driven by the commercial loan sale? And I guess as we look ahead, Is this kind of a good foundation for the allowance, or is there incremental opportunity to further release reserves?

Yeah, great question. So, yeah, a couple of things there. Most of the – so the seasonal model now reflects the improved, obviously, macro GDP outlook, which is sort of forecasting at, you know, V-shaped recovery in Q2. I think we're being a bit cautious and would like to see the vaccine programs obviously taking root and seeing what actually happens. It was good news on the domestic side. Obviously, almost all borrowers resumed normal payments in Q4, so that was great to see. Still, obviously, continuing to monitor that. We're still not out of the pandemic yet. So I think we should think about CECL as opposed to the backward-looking model, more reflecting an improved sort of credit outlook and macro outlook. The actual release was, I would say, about half and half. So you see the tick up in NCO, which was the sale of the loan that crystallized the loss. It was a lower-rated corporate loan. And we also had a small sovereign legacy loan from when we used to have a Barbados operation that was this kind of cleanup exercise. So as you think about the reserve going forward, the objective of CECL is obviously to reflect the future GDP outlook, in particular the US GDP outlook, as well as the experience on the portfolio that feeds back into the model. It's been quite a year in terms of macro GDP forecasts, which is causing probably more volatility in the reserves, which was not the intent when CESA was implemented. So it's sort of hard to predict, but I think we feel that the reserving level really adequately reflects the underlying credit conditions and the current macroeconomic outlook. To the extent that that becomes better, that would result in, obviously, some reliefs. But generally speaking, if you look at the coverage ratio, et cetera, we feel very comfortable that it reflects the underlying conditions of the loan book today. I know that wasn't... direct question, but I'm sure it's a difficult thing to predict the future, obviously.

Right. No, that's good color. I appreciate that. And one last one for me, just looking at the expense base, you guys did a good job kind of modeling that out or calling that out for the fourth quarter. Is the expectation here that we should continue to expect expenses to migrate lower over the course of the year, or are some of these new initiatives going to weigh into that trajectory?

Yeah, I mean, I think we're sort of the 82-83 is probably an appropriate run rate following the cost restructure program. There's a bit more staggered release benefit that's coming into Q1, but there's a bit of backfill coming into that as well. We do keep a sharp focus on expenses in this ultra-low part of the cycle. And I think, you know, mid-60s efficiency during this part of the rate cycle is probably where where we're going to stay. But it is also worth remembering that, you know, as we're not subject to corporate income tax, we pay all of our taxes in the expense line, which has that kind of 4% to 5% dilutive effect on the cost-income ratio. But we keep a sharp focus on it. It was obviously, you know, difficult to execute a cost-restructuring program, but I think it was the right thing following the health crisis.

Yeah, and our full run rate in terms of our cost reductions will hit in Q2 this year. So as you know, we did substantial voluntary departures, early retirements, redundancies in 2020. I wouldn't see us repeating that this year because I think we obviously are very focused on operational risk and we don't want to cut into bone. But I would say we will continue to focus on Halifax as our service center. and continuing to move operational non-client-facing positions to Halifax. And that's been going for four or five years. We have 150 people up there now, and it's a really good model. We'll continue to support and move positions from higher-cost jurisdictions to Halifax.

Great. Thank you for taking my questions.

Again, if you have any questions, please press star then 1. The next question comes from David Feaster of Raymond James. Please go ahead.

Good morning, everybody. I just wanted to start on your asset sensitivity. Clearly, you're very asset sensitive at this point. You guys have demonstrated that. Just curious how you plan to manage your rate sensitivity. It looks like you're staying pretty short on the securities book, but Just given your leverage to rising rates, does that maybe give you a bit more confidence to take some duration in the securities book to get some yield and maybe drive some accelerating NII growth?

Yeah, I mean, it's been interesting to see as people start talking about negative rates and what potentially that impact could be in terms of us charging negative rates to customers and then now coming through. But I think, again, the strategy hasn't really changed. We keep laddering out what's maturing. The reason why the duration is pretty short, and I think why we wanted to put weighted average life on there as well, and the unrealized market position, is that obviously we're fighting against the prepayment speeds, which are very materially elevated, I would say, probably fueled by refinancing rates and new originations in the U.S. market. So MBS prepayment speeds have just been very elevated in addition also to the buyout options that have been offered into the security. So we keep just laddering out what's maturing and then I think the pace of laddering out the ABN has not changed and really should match the behavioral duration of the underlying deposits as we grow the data set around the ABN deposits. As we get into – and again, we're not a mark-to-market shop, so we don't sort of speculate on the asset sensitivity. It just naturally occurs because we have a very low loan asset to deposit ratio and loan asset to total asset ratio, and that's just a function of the markets that we're in. But to the extent that we are starting to see some creeping up in a more normal yield curve, obviously that does provide some opportunities for us to think a bit more tactically around the deployment. But for the time being, and certainly over the last year, it's just been a case of moderating the impact on reinvestment rates and prepayment speeds. through the re-laddering, and we'll continue to do that. But we obviously constantly review the book for also looking at tactical opportunities.

Okay. That's helpful. And then just it was great to see the increase in AUM in the quarter. Just curious how much of this growth was from, you know, market increases and increases in underlying assets versus new client additions and maybe just kind of how that translates into asset management fees going forward.

About half the book on the AUM side is a money fund that we run in Bermuda, and that's really to allow some additional optionality for hot money in particular or customers who want to balance their exposures from one balance sheet to a AAA-rated money fund. So that's just fees that we generate from our asset management subsidiary. The other half is really in the discretionary bucket and brokerage fees. So that's responsive, obviously, to changes in market valuation. So about 50%.

Okay. Okay. And then could you just give kind of a pulse of the market in Bermuda and I guess across your footprint, the health of your clients in the housing market and maybe where we are in the recovery phase?

Yeah, sure. So starting with Bermuda, from a COVID perspective, we've got 10 active cases. So there was a bit of spike up around December, but it's come right down. Again, the testing is really efficient and it's worked really well. You know, it's a small place and you're surrounded by, you know, miles of salt water. So you tend to be able to control it. So COVID's in good shape. The public sector fiscal position in Bermuda is elevated, I would say, just in terms of national debt and deficit. Some of it caused by COVID, but we came into the crisis with a reasonable amount of national debt, so there's less government flexibility in terms of spending. I would say, as Michael mentioned, the local market has been pretty active because people aren't traveling, so You know, it's just like everywhere else. People are out going to restaurants outside, that sort of thing. So that's kind of masked some of the underlying pain of not having tourists here. So I think when tourism comes, that will pick things up. Surprisingly, or maybe not surprisingly, housing market has done quite well. So whether you're in Vermont or Bermuda and Cayman, people are looking for housing. places that are safe and clean and have very few COVID cases, not just now, but for future pandemics. And so we've seen a lot of interest, both locally and internationally in Bermuda real estate and Cayman real estate. So I'd say we're holding our own in Bermuda, but the recovery is going to be pretty tough. Cayman's doing a bit better simply because they came into the crisis with no national debt and much lower deficits. So their GDP has been growing significantly. more quickly than Bermuda, so I think they will come out of the crisis more easily. Same story on the housing market. Housing in Cayman was doing really well even before the pandemic, so I think they continue to do well. They've got about 35 active cases compared to Bermuda's 10. Channel Islands has 400 active cases, so a bit more obviously closer to the UK, but they've also got 110,000 people in Jersey and 60,000 in in Guernsey, so it's three times the size of Bermuda and Cayman together. So a bit more cases, Guernsey's a bit more shut down right now. Economically, again, both Guernsey and Jersey are extremely well managed, both politically and economically, so no national debt, and so came into the crisis well from a fiscal position. GDP has done well before. The fund sector continues to do well, so I think they're in great shape. So across the board, I think our jurisdictions have actually handled it pretty well. We do think it's a bit of a fake spring in the sense that because there's so much domestic activity that it's kind of masked some of the underlying issues that will come out as even as tourism sort of starts back up but uh you know in some sense we feel like we may have missed a bullet a bit but you know each island's different uh in terms of where the fiscal situation is so some can spend more than the others uh each island has borrowed money to handle the pandemic in terms of incentive uh spending and getting money out into the community and we've been uh pretty much part of all those facilities which which has been great so I would say looking back, I think in March last year, I think we would have thought it would have been much worse than it's actually been.

That's great. Thanks for the call. Thanks, everybody.

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

Thank you, Andrew, and thanks to everyone for joining us today. We look forward to speaking with you again next quarter. Have a great day.

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