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Edited Transcript of NTB earnings conference call or presentation 20-Feb-19 3:00pm GMT

Q4 2018 Bank of N.T. Butterfield & Son Ltd Earnings Call

Hamilton Feb 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Bank of N.T. Butterfield & Son Ltd earnings conference call or presentation Wednesday, February 20, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel Frumkin

The Bank of N.T. Butterfield & Son Limited - Group COO

* Michael L. Schrum

The Bank of N.T. Butterfield & Son Limited - Group CFO

* Michael W. Collins

The Bank of N.T. Butterfield & Son Limited - Chairman & CEO

* Noah Fields

The Bank of N.T. Butterfield & Son Limited - VP of IR

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Conference Call Participants

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* Alexander Roberts Huxley Twerdahl

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

* Arren Saul Cyganovich

Citigroup Inc, Research Division - VP & Senior Analyst

* Donald Allen Worthington

Raymond James & Associates, Inc., Research Division - Research Analyst

* Michael Perito

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* Timur Felixovich Braziler

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* William Alfred Nance

Goldman Sachs Group Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Chad, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter and Year-end 2018 Earnings Call for The Bank of N.T. Butterfield & Son Limited. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the call over to Noah Fields, Butterfield's Head of Investor Relations. Please go ahead.

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Noah Fields, The Bank of N.T. Butterfield & Son Limited - VP of IR [2]

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Thank you. Good morning, everyone, and thank you for joining us today as we review Butterfield's fourth quarter and year-end 2018 financial results. On the call, I'm joined by Butterfield's Chairman and Chief Executive Officer, Michael Collins; Chief Financial Officer, Michael Schrum; and Chief Operating Officer, Dan Frumkin. Following their prepared remarks, we will open up the call for a question-and-answer session. Yesterday afternoon, we issued a press release announcing our fourth quarter 2018 results. The press release along with a slide presentation that we will refer to during our remarks on the 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 discussion 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 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.

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [3]

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Thank you, Noah, and thanks to everyone joining the call today. I am pleased to report that our business performed well in 2018 and is a good reminder of the strength of our operating model.

For those of you who may be new to the Butterfield story, we are a Bermuda-headquartered bank with shares traded on the New York Stock Exchange and here in Bermuda on the Bermuda Stock Exchange. Our serviced offerings include leading retail banking, trust and asset management services in Bermuda, Cayman and the Channel Islands; wealth management and trust business in the Bahamas, Singapore and Switzerland. And finally, we offer lending services to high net worth clients in the U.K. To best support our revenue generating operations, we maintain cost-effective support centers in Canada and Mauritius.

Turning now to Slide 4. Butterfield reported its second consecutive year of record profitability with net income of $195 million, up 27.4% over 2017 and a core return on average tangible common equity at 25.6%, an increase of 320 basis points compared to the 22.4% in 2017. Our strong results were driven by a well-positioned investment portfolio, conservatively underwritten loan book with growth in Central London to high net worth clients, diversified fee businesses, disciplined expense and capital management.

We are pleased to have completed the acquisition of Deutsche Bank's Global Trust Solutions business and integrated the majority of Deutsche Bank's banking business in Cayman and the Channel Islands. The onboarding of the Global Trust Solutions business has gone well, and we continue to see the benefits that this trust business brings, particularly potentially new trust opportunities in Asia as well as the future cost benefits of the Mauritius service center. The Deutsche Bank banking business in Cayman and the Channel Islands has been mostly onboarded late in the fourth quarter, and we still expect 4% to 5% accretion in 2019. Our newly licensed bank in Jersey has received a positive reception in the market, while we continue to focus on the final stages of onboarding of former DB clients and staff. We remain excited about the long-term prospects for growth and profitability in Jersey.

In the U.K., we've had a good year developing our high net worth residential mortgages. This is a very conservatively underwritten book exclusively in Central London with loan-to-value averages just below 60%. With client deposits coming on in the Channel Islands, lending in Central London residential properties remains an appealing deployment option.

We view capital management as an important lever to create shareholder value. As we announced yesterday, the board has increased the quarterly common share dividend by 16% to $0.44 per share, which represents approximately a 5% yield at recent share prices. This is in addition to the 2.5 million share repurchase program authorized by the board in December. We believe this balanced capital discipline will create flexibility and attractive shareholder yield, combined with EPS growth over time, while ensuring that the qualified cash dividend remains sustainable.

I will now turn the call over to Michael Schrum to provide detailed commentary on the fourth quarter results.

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [4]

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Thank you, Michael, and good morning, everyone. On Slide 6, you can see that fourth quarter was a very strong finish to the year for Butterfield. We reported net income of $50.9 million or $0.92 per diluted share and core net income of $51.1 million or $0.92 per share. Core net income was up 4% compared to the prior quarter and up 21% compared to the fourth quarter of 2017.

Core return on average tangible common equity rose to 25.8% from 24.9% in the prior quarter. This is the eighth consecutive quarter with core returns in excess of 20%, as we continue to generate a sustainable and strong return profile.

The net interest margin increased 1 basis point compared to the prior quarter as term deposit interest cost increases were outpaced by higher yields from investment and loans. As expected, we saw deposit levels stabilize during the quarter with additional client deposits added towards the end of the quarter in Jersey from the Deutsche Bank acquisition.

On Slide 7, we provide a summary of NIM and net interest income. Over the past few quarters, we benefited from upward U.S. interest rate movements which have favored asset yields, while our cost of deposits have held fairly steady and remained really inexpensive. In the fourth quarter, the overall cost of deposits increased 7 basis points to 27 basis points due to higher rates paid on term deposit -- to term deposit holders. Yields on investments in the quarter increased 9 basis points sequentially and rose 60 basis points compared to the fourth quarter of 2017. The new deposits from the Deutsche Bank acquisition were onboarded late in the fourth quarter and are expected to contribute more meaningfully in 2019.

On Slide 8, we provided some further detail on average deposit balances in terms of geography, currency and contractual nature. The currency mix has held fairly steady over the past year on average, but we do expect the pound sterling to increase as a percentage of the total as deposits continue to grow in the Channel Islands. Demand deposit costs have increased 2 basis points, while term deposits have increased in line with U.S. short-term rates in the quarter. As we have discussed previously, there can be significant deposit movements from quarter to quarter due to large trust and fund clients managing their normal commercial flows. Historically, these types of more dynamic deposit relationships can contribute as much as $1.5 billion and could be as low as $500 million. At the end of the quarter, we remain towards the low end of that range for those large deposit relationships.

Turning now to Slide 9. Our capital-efficient noninterest income increased 10.8% to $45.7 million in the fourth quarter of 2018 compared to the prior quarter and was up 7.9% versus the year ago quarter. We normally see an increase in fee revenue during the fourth quarter due to increased banking, FX and credit card usage around the holiday season as well as towards some spending in Cayman.

On Slide 10, we provide an overview of core noninterest expense, which totaled $83.1 million for the fourth quarter of 2018 and was flat versus prior quarter. This was in line with expectations. The cost-income ratio has improved sequentially and through a focus on cost savings continues to trend towards the 60% target.

Looking now at Slide 11. We provide a summary of capital levels, specifically Basel III regulatory capital and leverage capital. Capital level -- levels remain on the high end of our targeted range, and we're pleased that the board this quarter authorized a significant increase in the common dividend rate to $0.44 per quarter. We are confident that the combination of the cash dividend and active share repurchases provide the required flexibility, while we continue to pursue accretive acquisitions of banking and trust businesses in existing jurisdictions.

Turning to Slide 12. We ended the quarter with total assets of $10.7 billion, approximately the same as at the end of 2017. Loans increased in the high net worth Central London lending book as well as Bermuda commercial loans. At the end of the fourth quarter, we had an inflow of client deposits in Jersey from Deutsche Bank, which is expected to begin contributing more fully to earnings in 2019.

Looking now at asset quality on Slide 13. Our loan book was $4 billion at the end of the fourth quarter with residential mortgages representing 65.3%. Nonaccrual loans increased slightly to $48.7 million, but we remain comfortable with the composition and quality of the loan book and are not currently seeing any specific problem areas. Our $4.3 billion investment portfolio remains highly rated with 96.3% of securities rated AAA primarily in explicitly guaranteed U.S. government Ginnie Mae securities.

On Slide 14, we discuss the average cash and securities balance sheet with the summary interest rate sensitivity analysis. The balance sheet profile remains structurally moderately asset sensitive, although we continue to reduce that aggregate exposure, and we have gradually been extending duration and booking asset sensitivity into higher book yields. The interest rate sensitivity gap between Butterfield and U.S. peers continues to decrease as we grow our maturities.

I will now turn the call back to Michael Collins for concluding remarks.

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [5]

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Thank you, Michael. 2018 was a year of record profitability in Butterfield's history with core returns on equity in the mid-20s. As we enter 161st year of continuous operations, I believe Butterfield is really well positioned for continued profitability and growth. As a bank that specializes in offshore financial services, I believe we are operating from the right locations with strong regulatory oversight and great people. We have franchise-level market shares in Bermuda and Cayman, strong fee-generating businesses with the opportunity to grow in the Channel Islands organically and through acquisitions. We continue to seek out potential strategic acquisitions that are financially accretive.

Before we open up for Q&A, I would just like to thank the Butterfield staff, management team and Board of Directors for your hard work and dedication in 2018 and look forward to making 2019 another successful year. Thank you.

And with that, we'd be happy to take your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question today will be from Timur Braziler with Wells Fargo.

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Timur Felixovich Braziler, Wells Fargo Securities, LLC, Research Division - Associate Analyst [2]

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First question is on the deposits. If you can provide any kind of puts and takes on what occurred this quarter? What was the actual balance that was brought in from the Channel Islands and the Cayman deposits? And I guess, what happened within the larger trust relationships? Any additional pressure from that portfolio?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [3]

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Yes. Thanks, Timur. It's Michael Schrum, I'll maybe kick off and Dan can give a bit of an update on the integration activities on the DB book. But fundamentally, the deposit levels stabilized in the quarter and our core franchise deposits are holding up really well. I think as we mentioned last quarter, a reasonable way to think about deposit levels would be to start at the end of Q3 period end balance of just over $9 billion, I think, it was $9.1 billion, given that we had some outflow last quarter. And in terms of the DB book, that's becoming online in rolling closes. So as we discussed last quarter, Cayman completed late in Q3 with approximately a quarter of the total, so about $250 million. So that was sort of in the ending number there. The Channel Islands and Jersey rolling close in late Q4 added another half of the total book. So another $0.5 billion getting us to the $9.5 billion level at the end of the quarter, but obviously, the averages are a bit lower than that just because of the timing of that. And then finally, we expect another quarter of client deposits to be onboarded in 1Q. And it would, therefore, be our expectations that we should see an uplift at the end of Q1 by another $0.25 billion, which would then complete the rolling closes for the Deutsche Bank acquisition. As we've discussed previously as well, the expected currency mix and somewhat lower productivity levels of the deposits will kind of create some NIM dynamics in Q1 as well as the fact that we obviously didn't pay anything for the business, it was essentially free, and we didn't pay any consideration to the seller. So it should be still at the accretion levels that we talked about. And I will just hand it over to Dan to maybe give a little bit more of an update summary of the integration activities.

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [4]

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Thanks, Michael. So the integration is going well. Client response remains positive. The take on activity is on plan with the rolling closes. And again, I would just caution that in quarter 1 the rolling closes are staged towards the back end of the quarter just like quarter 4. So when you are thinking about average balance sheet for the first quarter, I would not build in the increasing deposits. It will come at the very tail end of the quarter, again, just because of the way we structured them. And that deposit book is -- deposit book we've been quite pleased with although it is, it's fund families mostly, so it's a bit of volatility. There is monies in and out. So spots always been tricky, and it does have meaningful fund flows. And as Michael says, it's a mix of pounds, euros and dollars. The staff has come onboard. Again, the onboarding process for staff is great. We're doing some cultural events in the first quarter to get everybody integrated. We currently have about 70 of the 75 staff we're going to have in place. The majority of those staff, however, joined us in January. So there will be of some uptick in expenses associated with the higher staffing levels, as we've highlighted previously. So again, I think it's going really well. We're really happy, as we said last quarter, Cayman has been fully integrated for the quarter. Those clients continue to operate well with good transaction levels and Cayman and -- I mean Guernsey and Jersey are making really good progress.

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Timur Felixovich Braziler, Wells Fargo Securities, LLC, Research Division - Associate Analyst [5]

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Okay. And I understand just from a liquidity standpoint the pressure or the perceived pressure on margin. But as far as the rates on those deposits coming in, are they much different from what's currently on the balance sheet?

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [6]

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No, not really. Not at all, actually.

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Timur Felixovich Braziler, Wells Fargo Securities, LLC, Research Division - Associate Analyst [7]

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Okay. And then just looking at the existing balance sheet, what portion of the term deposits have already been repriced at higher levels and what are still -- what's still kind of in the pipeline to be repriced at these higher levels?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [8]

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Yes, it's a great question. So the majority of the term deposits have relatively short tenure, so 3 to 6 months. So the majority of that will have been moved through the cycle already. Obviously, without any further fed rate moves, we would expect for those deposits rate levels to stay flat as well. We're not looking here to get ahead of the market obviously, but we're looking to just stay sort of competitive within the jurisdictions that we're in.

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [9]

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And the only thing I'd add to that, Timur, is we're not seeing a big shift from noninterest bearing to term. So again, you're not seeing term balances grow meaningfully. It's just the repricing in the existing bankbook.

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Timur Felixovich Braziler, Wells Fargo Securities, LLC, Research Division - Associate Analyst [10]

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Understood. And then just one last one for me. To the extent that you could provide any additional information on some of the disclosure from the December Financial Times article, any new information would be great there?

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [11]

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Yes. So basically, we haven't been contacted by the jury, prosecutor or anybody. So we're working through the client base and thus far haven't found anything that would give us any concern. But really our sense was we were sort of the byproduct to the story and at this point don't expect any real outcome from it. So no contact whatsoever at this stage.

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Operator [12]

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The next question will be from Michael Perito with KBW.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [13]

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A couple of questions I wanted to address. I guess, one, on the margins. So Michael Schrum, you've just mentioned if you assume no more fed fund hikes your expectation would be the deposit pricing pressure would kind of slow. But I was curious how should we think about your internal kind of base rate and the movement of that relative to what we could see from U.S. fed funds here? If fed funds stabilize, does that stabilize as well right away? Or is there kind of a lag behind it if fed fund starts to decrease? I mean, what's -- how do you guys -- can you just walk us through a little bit about how you are thinking about that? The relationship between your internal base rate and the U.S. fed funds as we see maybe the mix here changing a little with the slowdown in the hikes -- future hikes, rather?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [14]

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Yes. Yes. And I mean -- it kind of directly ties into why we didn't see further margin expansion -- NIM expansion this quarter because, obviously, as you'd recall there's a 90-day lag on any repricing that we do on the Bermuda dollar loan book, and we didn't reprice in September, we sort of passed -- didn't pass that on to customers with the fed funds there, but we did in December and we would obviously expect that to come through in 2Q more fully in terms of margin. So I think -- as I think about the NIM, there are a couple of things happening. We should see some stabilization in deposit costs. Obviously, there shouldn't be a lot of -- more pressure in there. There will be a bit on the loan book NIM expansion. There's a little bit from the investment book rolling over a couple of basis points as we roll into higher rates on maturities. But given the complexity of those instruments in the investment book, we'll continue to ladder out and season in that. The new monies started coming in -- as you can see, our cash balances and short-term securities were quite elevated at the end of the quarter. So that held at the short end, and we'll start to sort of season those in into the book overall, which should have a modest NIM expansion effect as well. And then obviously, the challenges or the headwinds there are going to be how do we deploy the sterling deposits at the moment. We're running a short sterling position because we anticipate more sterling to come on and they're productively engaged in loan assets in the U.K. But over time that would be some form of guilt and obviously lower productivity levels there. So that will -- all things being equal, have a downward -- downdraft on the NIM. So as I think through the whole year, there will be -- there should be some modest expansion coming throughout the year from the different asset classes. But I think, the loans are kind of without any further fed funds increases, we wouldn't expect to reprice loans again at this point. We tend to move in line with the fed funds up and down with some lag.

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [15]

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And Mike, I would also say that, I think our general outlook is obviously kind of reach the top of the cycle, and we're not expecting any real extension from NIM going forward, which has really focused our conversation to what we need to do and is becoming much more of an intense expense focus in using our Halifax and Mauritius offices to reduce our expenses in the higher cost jurisdictions. So it's a management team that has actually been through both sides in interest rate cycle in Bermuda and Cayman. So I think we have a pretty good sense when NIM flattens out, what our next moves are. So we're really intensely focused in expenses over the next 6 months.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [16]

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Yes, I do want to spend a minute there. But just one quick follow-up. So I mean -- and Michael, I guess, you kind of just addressed this. But so I mean, it would seem like then that while there could be maybe a drift down in the first half of this year because of liquidity that's coming on, this $335 million or $340 million margin is kind of a stabilization number that you guys will be comfortable from an outlook perspective maintaining?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [17]

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Yes, I think so. I don't see any reason why that would be further rooted. It should all -- it should definitely expand our NII, obviously, but it will be at the short end of the curve and then it will be -- if -- the only way that we might see the meaningful uptick and investment progress if the long end starts moving a bit. So at the moment, most of that asset sensitivity is kind of baked in to running book yields now. There's obviously some prepayment risk associated with those in terms of duration, but we've been extending duration and there's no real reason why we should see a meaningful downdraft in the NIM.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [18]

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Okay. And then on the expense side, it sounds like there could be a tick up coming in the first quarter. But you guys -- I think I saw a comment in the slides that there was some redundancy expenses, which I'm curious. So I guess, two-part question, I guess, what is kind of the run rate on expenses once this deal is fully integrated and those redundancy expenses are presumably moderated? And then second, what are some of the actions being looked at to make the overall franchise more efficient now that some of the benefits of the higher shorter-term interest rates has kind of played itself out?

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [19]

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To start off, I think, overall, the focus is clearly becoming more efficient in our operational processing. Automating everything and then moving what we can to Halifax and Mauritius and getting costs down that way. But I think that's one of the ways we can do it. There are other programs we're working on that we'll talk about next quarter that I think will give you a sense of how you reduce expenses in island population where when you reduce headcount, it has effect on the community, has effect on your clients, and we have a pretty good sense of how to do that without hurting our franchise. So we'll talk a little bit more about that in Q2, but I'll let Michael get to the specifics.

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [20]

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Yes. So I think in terms of expenses, and you're right. It was kind of redundancy in this quarter. I think, if you go back to Q1 and Q2, we always said we're going to probably end with the DB integration at an 84, 85 run rate a quarter, and I think at 83 there's still some staff to come on in Jersey. And so I think that's still holds, 84, 85. That still gets us to kind of the safety number pretty close if you backed out the redundancy cost there. That was really just a bit of a late one from the previous redundancies that we have in Q2. So I think that run rate kind of holds once we get the Channel Islands DB staff fully transferred in. And I think it's in line with expectations. I'm not seeing anything there. I would say, obviously, we are fighting any kind of headwinds with, as Michael said, becoming more efficient, setting up new operations, onboarding new staff and then embedding that and getting to a BAU is going be a sort of focus for the next couple of years, right, in Jersey, and that's going to definitely generate some efficiencies, and we're pushing pretty hard on that.

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Michael Perito, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [21]

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Helpful. And then just last one from me. On the capital side, and I apologize I jumped on the call a little bit late, so I'm sorry if I missed some commentary you guys made about this. But if I -- I think if I'm remembering the numbers right, you guys did 1 million the old -- completed the old 1 million share repurchase authorization at the end of last year. It looks like you did maybe another 300,000 of the new 2.5 million share authorization you guys put out before year-end. So you got about 2.2 million left. Just curious about we should be thinking about your appetite for that and utilizing the over the course of 2019?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [22]

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Yes. So again, I think, again, we haven't really changed our thinking about this. I'm hopeful that we're still looking, obviously, at the M&A opportunities there, but we're also conscious that we're at the very high end of our target range and the previous 4, 5 acquisitions we've made have been reasonably small in terms of the size of consideration and capital draw even from a balance sheet side -- point of view in terms of tangible. So I think, we're conscious. We want to commit to continuing to have a healthy dividend first and sustainable dividend first and foremost. And then, obviously, looking at accretive acquisitions and Dan can talk a bit about that. And then thirdly, share repurchases is a good way for us. So I think, we're certainly feeling that 8x, 9x earnings is a very good price for us to be in there. So I don't think we're looking at sort of a massive acceleration of that. We want to be mindful of market dynamics and opportunities for others as well. But I think, it can be a meaningful EPS accretion over time. And then fourthly, obviously, if we've brought our capacity there, we would also consider specials, but that would probably be our last priority in that mix. So again, it's kind of consistent with what we said before. We're, obviously, mindful of price-to-book dynamics as well, but we do feel that it's a low-risk and quite accretive way to deploy capital.

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Operator [23]

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The next question comes from Alex Twerdahl with Sandler O'Neill.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [24]

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I just want to make sure I fully understand your comments, really, on the deposit flows. So it sounds to me like the $1 billion-or-so that you guided to that was going to come onboard with the Deutsche deal. It's still very much on track to be $1 billion with $250 million being already in the numbers last -- at the end of last quarter, $500 million coming on this quarter and then another $250 million coming on at the end of the first quarter. Is that correct?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [25]

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Yes. That's how we're thinking about it, Alex. I would say, though, that deposit gathering is not sort of a linear or exact science. Clients do take money, but that's kind of -- that's exactly how we think about it.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [26]

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Okay. And so that would just imply that organic or legacy deposits were down a little bit over $100 million in the fourth quarter. Is that correct?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [27]

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Yes. I think deposits come and go, right. And as we said before, we have some trust in clients. We're still at the low end of that sort of deposit range of significant depositors, right? So we would expect some positive -- more positive momentum on those. But again, they come and go. So...

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [28]

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And it's nothing systemic we're seeing, Alex. It's just typical flows. So -- and there's nothing -- we're not -- again, we go through every deposit above a very small level. We go through to make sure it's not rate-driven and everything else, and we're just not -- we're not seeing anything actually, and we've actually -- so just typical flows.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [29]

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Okay. So I mean at the end of it, if, I guess, maybe the second quarter or so you guys kind of had a heads up or you sort of knew or had some inclination that there would be some outflows in the third quarter related to larger deposits that were part of the bank, part of that sort of volatilities. And at this time, there's nothing to suggest that -- I know that volatility is just saying is kind of towards cyclical lows, but there's nothing that would suggest any outflows in the first quarter from that -- or any meaningful outflows in the first quarter from that segment, correct?

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [30]

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Not that we're aware of, but again, you don't know what you don't know, but nothing we're aware of.

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [31]

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Okay. Going back to the big deposit outflows. As we talked about last time, those are really two clients and majority of it was one client, which we knew would eventually go and be put to work. And so that's the nature of our balance sheet, and that's kind of the way it works. I mean, it can come in and go out, but the big client that went out that -- those deposits aren't coming back because they put it to work in the market. So...

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [32]

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Okay. And then, Dan, in the past regarded to the -- in regard to the deal you kind of gave out some sort of deals metrics, sort of what the expectations were for fee income and expenses and NII, et cetera. It seems to me like the NII pie doesn't change a lot given the size of the balances haven't really changed. With the fee income piece or the expenses associated with those Deutsche deposits, is there a little more clarity now on kind of what that might shake out to in 2019?

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [33]

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And so I think we guided that it would be 4% to 5% accretive when stabilized. So we think that's right, Alex, with everything.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [34]

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Okay. And then for like the fee income this quarter was relatively elevated relative to the last quarter and the year ago quarter. Is any of that already coming from the new deposits that are coming online? Is that -- it was getting a little bit taste of what we could expect in 2019 or you think it's really just more seasonality in the fourth quarter that drove higher fee income this quarter?

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [35]

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So I think it's a combination of a few things. One is you'll notice the trust fees, I think, were the largest component of our noninterest income fee line for the second quarter in a row, I think, but for the first time in history. That really is a reflection of the GTS acquisition as you've seen those fees come through and be sticky and stay and been able to grow some of those fees marginally, but some growth. I think that's the first thing. There is a bit of seasonality. So if you look at fourth quarter of '17 versus fourth quarter of '18 in banking fees, there's a little bit of Christmas spending that occurs on the cards. There's a little bit more of funds flow that comes through, a little bit more of FX, people travel a little bit through that period. So there's a better seasonality. And then yes, we are seeing some custody and FX fees in the Cayman business as well as a bit in the Channel Islands associated with the Deutsche Bank acquisition. So it's a bit of a mix. Now those custody and FX fees aren't huge, but they're not insignificant either. So it's a combination of all those events.

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [36]

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Yes, Alex. The way I would think about it, so if I look at the delta of three between banking and FX, probably half of that might be sort of what you consider seasonality, which is sort of card usage, merchant acquiring as well as credit card usage.

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [37]

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The biggest part of the seasonality is just, as you know, Cayman is a big winter Christmas destination for tourists and so that always bumps up. So every fourth quarter is a bit high.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [38]

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Okay. And then do you just have the breakout for the U.K. mortgages handy at the end of the quarter?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [39]

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I don't -- sorry. When you say breakout -- balance -- the balance...

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [40]

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Yes, the balance.

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [41]

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Because we didn't disclose the financial, right, because...

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [42]

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I guess, we'll get it with the 20-F next week, but...

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [43]

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You'll get it with the 20-F.

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [44]

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And one of the reasons why -- I mean, this is our first year of sort of being an accelerated fellow, if you will, for the 20-F with the full integrated reporting. And so that's one of the reasons why we wanted to kind of give it a bit more time to kind of close off the book. So we're a bit late in reporting this year than some of the peers. But obviously, it's going forward that should be more in line.

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [45]

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But you will see in the 20-F, I think it's to fair to say that you will see further growth in residential loan book out of the U.K., and while overall loans have remained sort of flattish with the exception of Bermuda government loan moving up that's really been a mix shift for us, which bleeds through into the loan margin a bit. So I mean -- but again, you'll see that in the 20-F, Alex. I can't remember the exact numbers off the top of my head. And I don't want to guess. So -- but the trend is right. You will see more U.K. mortgages. And the mix of our loan book has continued to shift slightly, which does have a slight negative impact on loan margins. Completely accretive to NII, but a bit on loan margin.

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Alexander Roberts Huxley Twerdahl, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [46]

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Agreed and understood. I just wanted to ask though there is an article in The Wall Street Journal about 1.5 weeks ago about higher end U.K. real estate, and, I think, it's something that's been kind of under pressure for quite some time, but maybe it's getting a little bit more publicity with the whole Brexit thing going on. Is there anything that you're looking out? I know your LTVs are extremely conservative, and the market you're playing in is a little bit unique. But from your standpoint, with respect to the supply for these types of mortgages, for the credit quality, for everything, I mean, is there anything that's kind of changing? Or that is -- will sort of change your methodology and your standards with respect to Brexit and the kind of some things that are going on with the real estate market over there?

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [47]

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No, I definitely not. I think we've stuck to our underwriting guidelines. So 60% LTVs and any of these are sort of 3- to 5-year rolling mortgages. So they're pretty short term. We've really been disciplined about locations. So we've really stayed in Central London, and we haven't sort of drifted outside of that area. And I'd say a number of things happening in the U.K. in terms of stamp duty and concerns about Brexit, but there is a store of wealth in those 3 or 4 neighborhoods in Central London that is never going to drop sort of 40% or 50%. So we're really confident about the book. It's growing part of our loan portfolio. It's, obviously, the biggest growth area. And while everything in the U.K. will be affected somewhat by Brexit, depending on which way it goes, I think this is the most insulated part of the market and each loan is individually underwritten. We know the properties inside and out, we know the clients inside and out. So it's a very carefully underwritten book.

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Operator [48]

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(Operator Instructions) The next question will be from Will Nance with Goldman Sachs.

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William Alfred Nance, Goldman Sachs Group Inc., Research Division - Research Analyst [49]

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Most of the questions have been asked. I guess, the one I had, I guess, with interest rates being less of a driver of earnings growth going forward, how are you feeling about the potential and, I guess, the bandwidth for further M&A once we get past the Deutsche acquisition?

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [50]

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Yes. So I'll pass it over to Dan. But I think, overall our strategy really hasn't changed. We've got incredible franchises in Bermuda and Cayman with dominant market shares and high barriers of entry. But our growth area other than overlap acquisitions in Bermuda and Cayman is to continue to be the Channel Islands. So we continue to see opportunities, and we're very focused on it.

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [51]

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So I would tell you, again, -- well, there's lots of conversations going on. And again, it's that sort of natural cycle. People are getting through their year-end results. I think I have made some strategic decisions as they've gone through their strategy reviews in anticipation of year-end. They're now at a place where they can breathe again and those conversations have different levels of traction. And again, we're very focused on banking in the Channel Islands. For those who might want to exit that market, including custody operations, and we're very focused in the trust phase in markets we currently operate. And again, there is a fair amount of activity. I don’t know, if any, but it will bear fruit, but we're having a fair number of conversations.

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William Alfred Nance, Goldman Sachs Group Inc., Research Division - Research Analyst [52]

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Got it. And just -- I know some of the tax compliance cost this quarter. Any thoughts on when we might see some resolution on that?

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [53]

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On DOJ?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [54]

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Yes, the DOJ. Yes, I mean, there hasn't really been a lot of traction, but there is some activity in terms of reviews and supplying data, which is driving a bit of cost, but it's really just kind of a watching brief to some extent. But it is kind of working its way through. It's just not quite clear to us what would trigger resolution still, [unfortunately].

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [55]

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But there is still...

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [56]

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There's no bad news.

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Michael W. Collins, The Bank of N.T. Butterfield & Son Limited - Chairman & CEO [57]

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Still contact and open communication and in a very good relationship, I think, between the parties. So whereas Michael said, we're working through it.

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Operator [58]

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The next question is from Don Worthington of Raymond James.

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Donald Allen Worthington, Raymond James & Associates, Inc., Research Division - Research Analyst [59]

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I guess, just a question on the provisions. What's the outlook might be there? You've had reserve releases each quarter in '18. And what your thoughts are in terms of provisioning going forward?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [60]

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Yes, that's a great question. And the releases really have been about sort of the backward looking. So pre-seasonal, if you will, provisioning models. And the fact that some of the larger losses have dropped out of the -- of our 5-year look back and therefore, some of those qualitative overlays around hospitality and C&I loans have kind of dropped out of the history, if you will. And so that's created those general provision releases. I think we're at a level now where the coverage is looking as it should. There's no sort of qualitative overlays left there. We're still not seeing any problem spots in terms of the loans, but I would probably expect for -- I would probably not expect for those release to continue. I would expect for us to be sort of at the level we are now. We're preparing for seasonal implementation obviously at the end of this year, again not expecting a whole lot of movement there. But clearly, that's a work in progress as well. So we're kind of thinking -- it's going to be event-driven if we get any specifics and the general is kind of where it needs to be.

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Daniel Frumkin, The Bank of N.T. Butterfield & Son Limited - Group COO [61]

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And all I would add to that is that the mix of the loan portfolio being mostly residential, it's sort of 2/3 resi at the moment. It's very different than you'd see in a U.S. regional bank. And for those who know a resi portfolio should have less volatility than commercial real estate or C&I lending or asset-based lending to retailers or any of the other types of stuff that might be embedded in a U.S. regional bank.

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Operator [62]

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Our next question will be from Arren Cyganovich with Citi.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [63]

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The longer-term target for the efficiency ratios were 60%. What's the time frame, do you think, it will take you to achieve that?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [64]

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Yes. So I think, we've been close a couple of quarter. We had, obviously, a redundancy cost that's kind of not going to recur, but I don't see -- at the levels we're forecasting expenses right now, absent any other headwinds, it's a matter of quarters really. We're pretty close this quarter. We are continuing to see elevated prefunding, if you will, of Jersey until we get the business fully embedded in. We're taking the staff. We have a full space there. We have computers set up and all that kind of stuff. So there's a bit of -- there's just a bit of timing gap, but it's a matter of quarters really and then that will sort of bet down effectively. And then, obviously, if we get further rate rises, that could drift down further, but I think we're pretty much there.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [65]

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Okay. And then on the net interest margin, I think, you talked about it being expected to be kind of flattish going forward. I think I originally had expected the NIM to compress a little bit after you layered on a portion of the lower-yielding investment securities. I know I think that maybe it's the Great Britain -- the British pound or the small segment of euro that was going to have a negative impact. Is that going to drag down the NIM going once this is fully integrated, the Deutsche Bank deposit base?

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Michael L. Schrum, The Bank of N.T. Butterfield & Son Limited - Group CFO [66]

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Yes. I mean, it would tend -- that bit would tend to have a downdraft impact on the NIM. But then as -- if the longer-term rates stay where they are, we're still rolling over into higher rates on the investment portfolio in dollars. So that's tending to have a couple of bets plunge the other way than the mortgage repricing tends to be sort of 6-basis-point, 90-day lag type of thing. So upwards and then flat from there. So there's a couple of things over the next 3 to 4 quarters. And I think we'll certainly keep updating that a dragging NIM in either direction. I think the lower deposit levels, particularly the lower euro deposits in the Channel Islands is going to have a beneficial effect relative to our previous expectations. So we actually -- that would have been otherwise a drag on NIM in Q1. So it's good -- that's why I kind of sort of saying flattish. We will keep updating, obviously, but that's our expectation is flat to a little bit up.

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Operator [67]

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Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

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Noah Fields, The Bank of N.T. Butterfield & Son Limited - VP of IR [68]

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Thank you. And thanks to everyone for joining us today. We look forward to speaking with you soon. Have a great day.

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Operator [69]

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