The Bank of N.T. Butterfield & Son Limited (NTB) Q1 2020 Earnings Report, Transcript and Summary

Good morning, and welcome to the Butterfield First Quarter 2020 Earnings Call. [Operator Instructions]. 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. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining us. Today, we will be reviewing Butterfield's first quarter 2020 financial results and providing an update regarding how Butterfield is addressing the COVID-19 health crisis. On the call, I am joined by Butterfield's Chairman and Chief Executive Officer, Michael Collins; and Chief Financial Officer, Michael Schrum. 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 first quarter results. Press release, along with a slide presentation that we will refer to during our remarks on this call, are available on the Investor Relations section of our website at www.butterfieldgroup.com. Before I turn the call over to Michael Collins, I would like to remind everyone that today's discussions will refer to certain non-GAAP measures, which we believe are important in evaluating the company's performance. For a reconciliation of these measures to U.S. GAAP, please refer to the earnings press release and slide presentation.Today's call and associated materials may also contain certain forward-looking statements, which are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements.On Slide 23 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 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. While we are pleased with the bank's results in the first quarter, our current focus is on addressing the new realities developing from the COVID-19 health crisis.I will begin today's discussion with a quick review of the highlights from the first quarter and then provide an update regarding the bank's COVID-19-related actions and potential exposures. I will then turn the call over to Michael Schrum for additional details on COVID-19 from a credit perspective and comments on the first quarter results.Turning now to Slide 4 of the earnings deck. We reported net income of $40.3 million or $0.77 per share and core net income of $40.8 million and $0.78 per share. In the first quarter, net income was 8% lower than the previous quarter due to seasonal fee income and a $5.2 million CECL reserve build for future expected credit losses. Our core return on average tangible common equity was 18.6%, down from 21.1% in the prior quarter. Net interest margin was up 4 basis points to 2.63% compared to the last quarter, and our cost of deposits dropped 8 basis points to 42 basis points.Turning now to Slide 5. As we operate across small Island communities, Butterfield has an important role to play as an essential service provider, a domestic systemically important bank, an employer, a source of working capital for companies in need and an active corporate supporting our communities. We have a particularly strong sense of responsibility to balance the needs of all stakeholders during this time. The COVID-19 virus is evident in and impacting all of our operating jurisdictions. The number of infections and deaths in our various locations have been consistent with the statistics we're seeing globally. For Bermuda, there have been over 100 cases identified and sadly, 6 deaths. Cayman Islands have identified over 70 cases with 1 known death. And between Guernsey and Jersey, there have been hundreds of confirmed cases with known death as well. At this point, we only have 1 confirmed employee case in our Swiss office, who is expected to make a full recovery. We would like to express our deepest sympathies to anyone who has been directly affected or lost a loved one to the virus. We remain hopeful that the current shelter in place and social distancing practices will continue to slow the spread of the virus so that local economies and tourism can start to recover.When the severity of the crisis and health implications became known, the bank's initial focus was on the well-being of our customers and employees, including our ability to continue providing essential banking services. We quickly began mandating social distancing, providing protective equipment for staff, implementing split team and building strategies and establishing broad remote working conditions through our virtual desktop interface. We have remained operational as permitted, with just over 70% of employees working from home and providing all necessary equipment and services to support our employees and customers.To help ease the financial impact on the communities, we have temporarily deferred residential mortgage payments, reduced fees and increased our direct contributions to urgent care programs supporting the most vulnerable people. In the short term, we are working with clients to assess their needs and provide support. In Bermuda and Cayman, where tourism is an important contributor to local activity as well as exports, we are closely monitoring the situation and maintaining frequent engagement with clients. In our estimation, the duration of the temporary shelter-in-place lockdown conditions is one of the most critical factors which will determine the return of economic activity and ultimately, the future impact on Butterfield.The bank keeps a significant source of liquidity available, primarily $3 billion of cash and short-term securities as well as $4.5 billion of U.S. agency MBS. Together, this represents just under 2/3 of all customer deposits. The current interest rate environment will impact our interest earnings from short-term securities as well as our variable rate loans and while lower deposit rates are unlikely to entirely offset the lost interest income. We also are seeing significantly decreased card services fees with no tourism and subdued domestic economic activity.Over the coming periods, we may also see increased prepayment speeds in our investment portfolio as U.S. home borrowers seek to refinance home loans in a lower interest rate environment. As we think about the medium and longer-term implications in the 3- to 5-year time frames, a sustained long-term ultralow interest rate environment could likely erode profitability over time. The bank has historically benefited from lower-cost deposit funding. However, in an ultralow interest rate environment, the value of those deposits reduces significantly and lower agency reinvestment rates would combine to compress NIM. This could ultimately alter earnings profile of the bank and would result in increased reliance on fee businesses. If interest rates fall further to negative rates, we could be in a position to charge negative interest rates on deposits, as we have witnessed in Europe. We would also need to become more efficient through accelerated cost reductions.On the capital side, we are pleased to continue at the current quarterly dividend rate of $0.44 per share, which represents a strong yield at recent share prices and remain active on share repurchases. We continue to believe the dividend rate is sustainable and continues to be a capital management priority. It is possible that M&A opportunities could become available as larger onshore financial institutions with banking and trust operations in our current operating jurisdictions may decide to focus on their core businesses and may want to sell less strategically important assets.I'll now turn the call over to Michael Schrum to provide additional information on the bank's credit portfolio and potential COVID-exposed areas and then add some additional details regarding the first quarter results, including a discussion on the bank's capital position and management.

Thank you, Michael, and good morning, everyone. Before I give an overview of the first quarter results, I wanted to provide some information on some specific credit exposures. As you can see on the bottom left of Slide 5, we have fairly limited direct credit exposure to hotel and restaurant lending sectors, which is primarily in Bermuda and Cayman.Hotel operators and construction loans represent our biggest direct commercial COVID-related credit risk. However, given the structure of the deals, generally at below 50% pre-crisis LTVs and the underlying financial strength of the borrowers, we are not currently expecting significant losses from this area. If the crisis lingers several more quarters, one of the emerging areas where customers could start to see challenges may be in the part of the residential book with borrowers who currently work in tourism-related businesses. Finally, we do not have any direct exposure to the oil exploration or production sector.Turning now to Slide 7 and some details regarding the first quarter results. On Slide 7, we provide a summary of net interest income and NIM. In the first quarter, NIM of 2.63% increased 4 basis points as the cost of deposits, particularly home deposits, decreased from rollovers, which more than offset the decrease in interest income. Lower rates were partially passed along to borrowers, with yields on variable rate loans being 15 basis points lower in the quarter. Average loans increased during the first quarter as we had the benefit of a full quarter of lending to the Bermuda and Cayman governments, which were drawn late in the fourth quarter.On Slide 8, we provide an overview of average customer deposit balances by location, currency and contractual nature. Deposits at March 31, 2020, were $11.8 billion, a decrease of 5.5% from the end of the year. The decrease is the result of the expected attrition of euro balances in the Channel Islands, which is consistent with previous guidance on the ABN deal. Overall, the cost of deposits is down 8 basis points due to lower term deposit pricing on rollovers. It is also worth noting that during the '08, '09 financial crisis, overall customer deposit levels did not reduce significantly, and at this point, we continue to see stability in deposit levels.Looking now at Slide 9. Noninterest income was down 4.3% compared to the prior quarter due primarily to lower card services fees, which were negatively impacted by reduced volumes as economic activity stalled in March due to government lockdowns.On Slide 10, we provide an overview of core noninterest expense. As we discussed last quarter, first quarter expenses returned to the expected range after being elevated in the fourth quarter. The improvement was due to reduced headcount in the Channel Islands, lower marketing expenses, travel expenses and client event costs. We continue to target a true cycle efficiency ratio of 60%.Looking now at Slide 11, we provide a summary of regulatory and leverage capital levels. Butterfield continues with our conservative capital management philosophy that balances regulatory requirements with shareholder returns. Tangible book value per share increased 4.6% in the first quarter due to contributions from earnings and OCI related to the unrealized gains in the investment portfolio. We continue to view the dividend as the most direct and efficient way to translate the high ROE of the business to investor return. The dividend coverage ratio remains around 2x, and we believe the current dividend rate is sustainable. Our capital management priorities have not changed and continue to support the dividend, organic loan growth, share repurchases in appropriate market conditions and maintaining flexibility to pursue M&A deals when the right opportunities arise.Turning now to Slide 12. During the first quarter, the balance sheet was broadly stable, except for the continued decline in the euro-denominated deposits in the Channel Islands, as expected. End-of-period loan balances were down almost 3% due to the lower dollar value of pound sterling-denominated loans in the Channel Islands and the U.K. With the significant fall in U.S. interest rates, total net unrealized gains in the investment portfolio were $155 million at the end of the first quarter compared to $61 million at the year-end.On Slide 13, we continue to emphasize low credit risk in our investment portfolio, with the majority of investments in AAA-rated U.S. government-guaranteed agency securities. Loans are mostly residential and full recourse with 75% of the portfolio in the below 70% LTV bucket. In light of COVID-19 and its potential future impact on particularly unsecured loans, we have increased our reserve estimate by $5.2 million, and the total reserve under CECL is now 72 basis points of gross loans, reflective of the collateral-backed residential lending platforms built over the last decade.On Slide 14, we discuss the average cash and securities balance sheet with a summary interest rate sensitivity analysis. The structural asset sensitivity of the balance sheet has now been entirely realized by the reduction in front-end rates. Therefore, the downside 100 basis points scenario would start to increase NII if the bank passes negative rates on to customers by increasing spread on demand deposits. The assumption on negative U.S. dollar deposit rates would be similar to what we've seen in Europe. In the upside 100 basis point scenario, the bank starts to increase net interest income with a positive differential between deposit and market rates. Additionally, reinvestment rates would improve, thereby improving net interest income also.I'll now turn the call back to Michael Collins.

Thank you, Michael. Butterfield's integration in the Channel Island is progressing well and into its final stages. We now expect the full operational integration to be completed in the third quarter of 2020 as most clients are also working remotely, and it is practically much safer to upgrade their banking systems once customers are back in their offices sometimes in the second quarter of 2020.Following the success of the Channel Islands, we remain committed to exploring potential acquisitions in banking and trust, with most opportunities in the Channel Islands for banking and trust. For the trust network, we would also seek to build on the potential in Asia with a larger trust presence in Singapore. While we do not have any specific communications on this at the moment, these discussions are still continuing.The effect of this health crisis on Butterfield will depend on uncertain factors, including the length and depth of the pandemic and associated government lockdowns, how that impacts domestic economic activity and tourism, how quickly can these recover as well as the interest rate environment. Our communications with the regulators, rating agencies and governments remain constructive and supportive.The bank continues to have a strong and flexible capital position with a very liquid balance sheet. Learning from the financial crisis a decade ago, Butterfield's credit underwriting has been conservative, and as a result, our exposure to potentially problematic sectors is limited and should place the bank in a strong position to emerge from the current crisis.As a final note, I would like to take this opportunity again to thank our employees, particularly those in the front line and retail branches, continuing to welcome customers and helping them and us through a difficult period. Thank you.And with that, we'd be happy to take your questions. Operator?

[Operator Instructions]. Our first question comes from Timur Braziler with Wells Fargo.

Starting -- maybe just starting around broader CECL assumptions, many of the U.S. banks use the Moody's model in coming up with their CECL assumptions. I'm just wondering, do you guys use a third-party to help you formulate CECL impact? And if you could just talk through some of the broader economic assumptions you used in coming up with your CECL impact?

Yes. Thanks, Timur. It's Michael Schrum. Good question. A lot of work has gone into CECL over the last year, obviously, building the model. We don't use a third-party service provider to provide data as all of our loans are primarily manually underwritten. And so we use part of our own history -- repayment history, obviously, and local market conditions and where we operate. We do use, of course, external data in the model, including primarily unemployment forecasts as well as GDP forecasts. And for that, we use a combination of service providers, including Moody's and Bloomberg.The underlying assumptions for the model going in to this year, obviously, changed a lot since the end of the year, which is driving the additional reserve build in this quarter. So overall, we've landed on a negative 3 GDP -- U.S. GDP forecast for this year, which is one of the central assumptions. Obviously, that has a big shock in the second quarter to economic activity of double digits and then sort of a -- more of a U-shaped recovery into Q4. Again, the model is somewhat sensitive, obviously, to the external variables. But I would say, because most of the loan book is residential and manually underwritten, we have more of a straight line to realizing collateral in a troubled situation. So it mostly impacts the loan buckets that are -- where debt service coverage is really cash flow-based, so that would be the sort of C&I book and a credit card book. But again, those are relatively small in the overall scheme of things. So hopefully, that helps a bit.

Okay. That's good color. And then just your commentary around mortgage deferrals, are you deferring payments on the entire book? Or I guess, what portion of the mortgage book is currently in deferral status?

So we're deferring payments, principal and interest, on residential mortgage book. Obviously, those customers or clients or borrowers who are in default or had trouble previously, we're making exceptions of putting those to the side. And we took an approach where we did it automatically. And if you want to come in or call and basically say you want to continue paying for this 90-day period, then you can. And we are getting some of that where people don't want to stretch the term of the mortgage, but it's pretty much across the residential book.On the commercial side, we're working with all of our commercial customers, daily trying to find out how they're doing and figuring out where we can help. So that's obviously very specific discussions individually as opposed to any broader program. We're going to look at it in 3 months on the residential side, see where we are. There is some chance we could extend it for an additional period. But obviously, everything's so fluid right now. We're just going to wait and see. And it didn't really -- I think people reacted quite well in all -- in Bermuda and Cayman because it did put a lot of money back into the economy, which we're all trying to do.

Yes. I would say just in terms of the portion, there was about $1.4 billion between Bermuda and Cayman on the resi side that was included. So these obviously customers in good standing. And about sort of 10% to 15% of them opted out of the automatic deferral, so they're continuing on existing payment terms.

Yes. And we were very careful from a truth and lending perspective to make it very clear that this was extending the term of the mortgage, so you're going to pay more interest over the life of the mortgage. And so I think people understood that.

Okay. And then just lastly for me, just looking at your hotel exposure. Appreciate the color that at origination or pre-crisis, it's 50%-ish LTVs. If I remember correctly, I think a portion of that is backed by the Bermuda government as well, I think, $25 million on the St. George's project. Is that still the right number? Has that guaranteed portion been reduced? And maybe you can just talk through some of the guarantees on that hotel portfolio.

Yes. So as you can see on Page 5, we have a total of $214 million of hotel and restaurant exposure out of $5.2 billion book, so only about 4%. I mean, interestingly, restaurants are about $7 million, which is obviously really contained. In terms of the hotel book, we have a couple of big hotel loans that are currently in operation, 2 or 3. We think they're well underwritten. And they have sort of broader context. So one of them, as an example, has a large condominium project that's been running for years associated with it. So a big part of our repayment actually comes from expats in these condos as opposed to the hotel itself. One of the other operating loans is a wealthy relationship that we have a far broader deeper relationship and have real clear a lot of sight in terms of the family's wealth. So it's a hotel, it's secured by hotel, but it's really a much, much broader relationship than that.And then on the hotel construction, you hit it on the head. I mean we have the St. George's hotel that's really being built and is well on its way. We'll -- plan is to open up next year, which is hopefully not too bad timing given the fact it will be summer next year. We'll have some time to see how this all plays out. And on that loan, the Bermuda government has guaranteed $25 million out of our $60 million commitment. And lots of equity, lots of equity upfront, completely different underwriting than the bank did pre-financial crisis. So we feel pretty comfortable about both the total size relative to our total credit portfolio and also the individual credits within it. So we think it's pretty contained.

Our next question comes from Alex Twerdahl with Piper Sandler.

So first off, I was wondering if you can just kind of fill us in -- I think most of us on the call probably know all the stimulus programs in the United States. But can you maybe fill us in on some of the stimulus programs that might be impacting Bermuda, Cayman and the Channel Islands and maybe even in the U.K. as well, just so we kind of can sort of put some right comparisons together?

Yes. Sure. So I'll just give you a sense of where different the governments are projecting GDP for 2020. Bermuda's projection -- government projection is minus 7.5% to 12.5%. Cayman is minus 15%. That's actually a Chamber of Commerce projection as opposed to government. Guernsey is minus 15% and Jersey is minus 6%. Well, I -- it's -- everyone's sort of just trying to figure out where it's going. Obviously, Cayman has a bit more tourism exposure, so there, 25% of GDP is tourism, while Bermuda is only 17%, and the Channel Islands is very little. Jersey's got some. So I'd say it's fair to say it's going to be double-digit declines in 2020, maybe lower to mid double-digit. But obviously, this is uncharted territory, so let's just see how that goes.In Bermuda, there's been a few small stimulus steps so far. So really small, just a sort of a $12 million small business government-guaranteed program. Bermuda set up unemployment insurance for the first time and has put out close to $20 million. A few thousand people are getting unemployment, weekly checks, processed through banks, direct credit for the first time ever. So that's really stimulus. I think the Ministry of Finance will come out in the near term and come up with a broader program. But at this point, Bermuda hasn't really stated exactly what the broader stimulus is going to be. But we do know that there's going to be some more borrowing in Bermuda to support it. Cayman has a surplus, has some reserves that they can use. They're talking about potentially borrowing a few hundred million in Guernsey and Jersey as well. So they're all in different stages of thinking about using their reserves in the other 3 islands and figuring out what sort of amount they want to borrow.And I'd say it's -- sort of 10% of GDP is pretty much across the board, so a few hundred million, maybe up to $500 million. And we want to be as helpful as possible in all our jurisdictions from a credit perspective. We know these economies better than anybody, so it's a good time to be able to support the governments. So mixed stimulus. It's sort of evolving. The U.K., obviously, is in a different situation, much broader programs. But I think the islands actually are going to be somewhat contained in terms of throwing money at it. So that's sort of where it is.

No. That's very helpful. And then just in terms of the deposit balances and cash balances, I know a lot of those are part of the planned rundown of the book acquired with ABN AMRO. Where are you in that process of running off deposits? And kind of how much more could we expect to potentially leave the bank, is there a way to sort of ring-fence that?

Yes, Alex, it's -- so it's Michael Schrum. And obviously, the rate environment has changed quite dramatically over the last quarter. So I think we're in a stage where we are continuing obviously with the ABM repricing, but also being quite aggressive on deposit pricing, particularly term rollovers, et cetera. And so in essence, if you look at the euro balances, other currency balances on the slide, you'll see that's where most of the attrition is coming from, and that will continue for another quarter or so. I would expect, just, again, trying to land the strategically important relationship, even those who have euro balances, providing that they also do other business with us. But obviously, we can't activate those euro balances in the form of loans, and so they didn't need to be priced at market. In terms of what's left in that bucket, I would quantify it around $200 million to $300 million, most of it, again, ABN. We haven't really seen any -- we've seen great stability across the other platforms, and actually, in Cayman, we're a bit up in terms of deposit levels since year-end. So the rest of the bank is really fairly stable, but there is still a bit to go on the euro balances in the Channel Islands.

Great. And then just final question back to the loan modifications. Is the BMA and other regulators, do they have a similar view in terms of these loan modifications in the time of crisis, such that you're able to modify them, they don't become TDR, you have a lot of flexibility to work with your borrowers, et cetera?

Yes. I mean the prudential supervision here also -- we have, obviously, ongoing dialogues with all the regulators. Again, very supportive of the steps that the bank has taken to put money back into people's pockets, in particular, as that may then be passed on -- part of that may be passed on to rents, et cetera, which can alleviate some of the pressures from unemployment or temporary unemployment in the jurisdictions. The treatment of TDRs is really an accounting question. So it really comes from the U.S. GAAP accounting side and not necessarily from prudential side. So we obviously take the guidance from FASB on that, which has sort of broadly stated that, as you know, the TDR is up to 6 months, providing the customers good standing, it shouldn't necessarily become a TDR or loan modification if it's a forbearance that's granted on that basis. And that's clearly the approach that we are taking as well with PWC here.

Our next question comes from Michael Perito with KBW.

I wanted to spend a few minutes on a couple of items here. One, on the residential mortgage book, I was wondering if you guys had any additional kind of context of what -- I imagine the historical loss rates over a long period of time in that book are really, really low. But just in terms of any periods where there's stress on tourism on island, I mean, have you guys ever really seen any pickup in loss rates in mortgages? Is that something that's been experienced in the past or not quite at this point?

I'll start off. Post-financial crisis, we did get some strain in the residential mortgage book and did a lot of work getting our debt collection capability up to speed. We really -- if you go back to sort of 2011, '12, we really didn't have much of that because we never had any losses, and property prices in Bermuda and Cayman had never really gone down. So we did take -- property prices went down, depending on whether it's a condo or a property, 20% to 40%, and we did get some pressure. But again, as you can see, the net charge-off today and even back then never got too high. So we have had experience, and I say that positively in the sense that I think we have a debt collection capability that's really good at this point, which we didn't have 10 years ago. So we understand how to do it.

The other characteristic of -- that's a couple of characteristics of small island property markets, which tends to happen during periods of stress is that supply tends to withdraw because LTVs are very low. And so we get a lower number of transactions occurring for a period of time until prices sort of recover. And then the second thing is people -- there's a great deal of sort of social cohesion, like people know when they buy a property in Bermuda that they don't really want to lose it, and so they have uncles and aunts and family members kind of helping out during periods of stress where -- to share the burden. And I think that's kind of helped a lot through the post-financial crisis in terms of keeping the mortgage book current and not having too many TDRs.

I think if you look back in 2007, '08, Bermuda, as an example, had about 700 property transactions per year. It's been hovering around 200 for the last 5 to 7 years, and that's partially because Bermuda still has a lot of indigenous wealth that's on the island. And so when property prices fall, families just hold on to it as opposed to try to recoup some equity. So it just slows down basically. But I think, as we said, we don't have a lot of exposure on the tourism side. We -- directly, but we do, obviously, indirectly through mortgages, and we're going to have to watch that very carefully.

That's helpful. And then on the deposit side, it seems like a bit of the quarter-over-quarter drop was in term deposit, which I imagine was kind of pricing-related. But just on the transactional reduction, I mean, can you provide us a little bit more color on the drivers there? And it seems like based on your prepared remarks that deposits are pretty stable at this point. I mean, is that something you expect on the business side as well if volatility kind of persists globally from the COVID-19 pandemic?

Yes. So maybe I'll start. I mean the other piece of this is, obviously, if you look at average deposit balance versus this period end, there's that sterling weakness that's causing the translation difference of about $150 million in deposits.

Was that the entire piece, Michael, on the transactional side or was there any other kind of else...

Sorry?

Was that the entire -- the majority of the step down on the transactional deposits? Or was there anything else that was within that?

Normal commercial movements, but I wouldn't call anything specific out. I mean actually Cayman went up a little bit in -- during the quarter. So obviously, we have a cycle of captive insurance companies receiving premiums and paying out claims, et cetera. And then hedge funds in Cayman, obviously, during the -- post financial crisis a decade ago, we did see some redemption and further boosting of cash balances prior to them being paid out to investors from funds. So we are tuned to kind of movements on the balance sheet, but it's been what I would call normal commercial movements at this point.

Okay. Helpful. And then lastly, on noninterest income, I believe the vast majority of your trust fees really are not impacted by the market at all. I guess, one, can you just confirm that? And two, maybe provide a little bit more context about how you expect some of the fee items to be impacted next quarter, whether it's by lower global market values or kind of less transactional volume.

Yes. No. Absolutely, can do that. I can certainly confirm all the trust fees are being billed on as part of an annual fee. And then there's some activity fees when trust, restructure, et cetera, that we charge and/or enhanced tax reporting that we have to do under the common reporting standards or FATCA, et cetera. So those drive some activity-based fees, but they're not really related to an underlying market driver, if you will, it's more on a time spent basis. Again, so they're very capital efficient, very stable fees. And if you look over a period of -- since we went public, the only thing that's moved that fee number has been either acquisitions or sort of changes in underlying structures -- trust structures where the last beneficiaries passed away, et cetera. So those are very stable.Asset management, obviously, is impacted by underlying valuations. So we would expect those to be impacted and have been impacted, so you can see that over the quarters. Banking fees, in particular, is impacted through card services fees and merchant acquiring fees. So about 1/3 of the banking fees is in that bucket. And we would -- we've seen sort of leading indicators that seem to suggest maybe been an 80% drop in economic activity from debit card transactions, et cetera, during this period of stalled economic activity or government lockdowns that we've had in both Bermuda and Cayman, where you've got curfews and people have only been allowed to shop twice a week, et cetera. And that's just driven down, obviously -- not necessarily the number of transactions, but the value of the transactions so certainly in the short term, I would expect that to be impacted quite significantly. FX has actually been up due to the volatility in currency pairs, particularly the dollar sterling. We've seen a lot of fund activity in the Channel Islands, which had a record quarter in terms of FX. So it's more volatility-driven as opposed to -- obviously, it's total FX commissions, there's no proprietary positions in there. So it really will just depend on what happens in the FX markets. And the others are pretty small. Custody is pretty stable, it's a couple of basis points, as you would expect.

So net-net, there could be some near-term pressure on the $47.5 million of core noninterest income in the first quarter? It sounds like that's reasonable.

Yes. I would expect asset management fees to be impacted by lower valuation -- lower market values of underlying AUMs, and I would expect banking fees to be impacted in the short term from merchant acquiring card services volumes. But again, then as we get through this, and Bermuda and Cayman are coming out of lockdown, full lockdown over the weekend, we'll probably see a pickup, certainly in just domestic economic activity and will just depend on consumers' reactions then at that point.

Yes. I think -- I mean, I think we'll see a sharp hit in fees, particularly debit credit card transactions in April. It will get a little bit better in May because the domestic economies are opening back up this weekend. But it'll still be subdued until we actually open up the airports, which is anyone's guess to late, late May into June and July. So that's sort of the way it's going to play out.

Our next question comes from Will Nance from Goldman Sachs.

I was wondering -- I appreciate all the color that you guys have given on credit. I was wondering if maybe we could spend a little bit more time on some of the PPNR dynamics over the next several quarters. I appreciate some of the comments in the prepared remarks about the impact of lower interest rates on the net interest margin. I was wondering if you could walk us through some of the moving pieces, given a lot of the portfolio is floating rate, just what are some of the moving pieces in the portfolio? What are some of the actions that you've taken on the back of U.S. rate cuts? And are there any ameliorating factors that could kind of lessen the decline in your loan yields relative to what kind of U.S. benchmark rates have done?

Great question, Will. So I'll kick off, it's Michael Schrum. So yes, let's start with the March 18 actions that we took. So obviously, in Bermuda, we took resi down by 50 basis points with a 45-day lag. So you would expect to see 50 basis points on the floating part of that book, which is 80% of that book coming through in Q2. U.K., we've sort of more or less seen a 25 basis points reduction. Again, that's mostly a floating book. It does have a floor of 50 basis points on it. So we're not expecting any further compression on the U.K. book, but I would expect to see a full quarter following the Central Bank [indiscernible] in the U.K. as well. In Cayman, most of the book is floating. It's about 20% fixed. Again, between commercial and resi, we should expect the U.S. prime full impact of that, which will be around 100 basis points, obviously, a little bit into Q1, but most of it will come through in Q2. And then on the investment side or the non-loan asset side, on cash, short-term securities, those are mostly repriced. You'll recall that we have a sort of -- we manage our own liquidity, and we have a sort of 3-month T-Bill ladder, which tends to be set ahead of any Fed funds, obviously. So we've seen most of the impact there, but it could be another 15 to 25 basis points on cash and short-term securities.On the investment portfolio, some of that will depend on reinvestment rates, but I would expect some premium amortization, and to some extent, will depend on the CPT as well, which could be -- it's anyone's guess really, but we haven't seen accelerated prepayments yet, but it could be 5 to 15 basis points, call it, 10 basis points on the investment portfolio over the next couple of quarters. And then offsetting that, obviously, we would expect a continued decline in the cost of deposits, not as much from demand because we're not yet charging negative rates on dollar deposits. But certainly on the term side, I would expect a further rollover benefit coming through the next couple of quarters. Most of that term money is really sitting in 3, 6 months, so it'll rollover into lower rates and probably generate an offset of about 10 to 15 basis points on the cost of deposits.So if you put all that together, over the next couple of quarters, you could see sort of a 25 to 35 basis point NIM compression. It will depend to some extent on loan demand in the market, both from what Michael spoke about in terms of government lending. It will also depend on where the 10-year is. Currently, reinvestment rates in the $150 million range on MBS. And then obviously, the prepayment rates on MBS. So we're currently getting about $150 million to $200 million a quarter in maturities coming off that book. Again, if that obviously continues for a long period of time that will start to impact investment yields more meaningfully. But at the moment, we obviously bought that book to protect against interest rate risk in the banking book. We have an unrealized position now of $150 million in there. That will certainly help come through the coupons on the MBS securities over the next couple of years, and that was precisely why it's there in the first place.

That's very helpful. And maybe on the expense side, the expense levels came in a lot lower than I think most people were expecting this quarter. I would have guessed that maybe given the delay in some of the integration in the Channel Islands that there may be -- the risk might be to the upside there, but it seems like you've taken some pretty good cost actions in the near term. I guess, can you just kind of walk us through near-term expectations on expenses? What sort of environmental impacts from the health crisis we might see on the expense line? What kind of cost cuts we could see? And then maybe any kind of tail impact of the integration of the Channel Islands deal in the third quarter, what impact that might have? I know that there's a lot of moving pieces there.

Okay. Yes, sure. Let me deal with the short-term first. Obviously, travel's completely ceased as a corporate travel policy in mid-March. So that's one big expense item. When you operate these banks across multiple jurisdictions, obviously, there's a lot of travel, which is great. And obviously, client entertainment has also completely ceased at the moment or it's gone virtual at the moment, which obviously a lot less expensive. So we've seen a lot of benefit in the second part of March. And we would expect that to continue to come down in the discretionary bucket. But again, that will be a short-term benefit. Coming out of lockdown, obviously, we'll start to gear up again. We are a relationship bank. And so it's important to -- for us to stay in touch with our customers, not just virtually, but also to spend time with them and understand what their business plans are, et cetera.On the more strategic side, obviously, we've taken action and deferred some of the capital spending programs, particularly around buildings, around brand rollout, resequenced that into a much slower burn rate at this point. We think we'd still obtain substantially the same benefits, but over a longer period of time. So people are not automatically getting new business cards, they're using the existing ones. We're not replacing the whole bins on the credit and debit cards, we're doing that gradually as cards expire, et cetera. We're -- we keep investing in the front line side of the business. So the branch refurb in Bermuda will still go ahead, which I think will be great. But some of the back office capital programs have been put on hold or are being reevaluated, as you would expect.Finally, I think amortization, as we talked about in the past as well, Butterfield built a very expensive system about 10 years ago, $120 million, which is -- the amortization is running off at the end of this quarter. And so moving into Q4, we would expect that to start helping. Effectively, that's $10 million annualized cost saving a year, of which we will put $2 million to $3 million back in, I expect, as part of normal system upgrades, et cetera, so net a $7 million there. And then obviously, depending on how long this goes on for, we'll need to look again more on a 0 basis -- or zero-based budgeting basis about -- I think it's been a bit of a reset for us. How many people do we need in the buildings, what do we really need to operate this business, et cetera. And so I'll just set Michael tune in on that.

Yes. So I think -- I mean, our focus, obviously, right now, the next quarter or 2 is just making sure everyone is safe and operating well and being supported. So lots of communication. I would say it's remarkable how we've been able to operate working remotely, which is a really interesting part of the model today. So today, across our 1,500 employees, we mentioned 70% are working remotely, 15% are at home not working, 15% are in the office. So if you could just take Bermuda as an example, we're operating full retail services where the operations with 59 people in the office out of about 500 and it's similar ratios across the different jurisdictions. So I think we are stepping back, and we're thinking about what the model should be and what the cost structure should be, assuming that we're going to be in a 0 interest rate environment for the long term. And so I think that has implications for a bank like Butterfield, it's deposit led, and we understand that. So we're focused on what could the model look like as we come out of the pandemic.We have to be a little bit careful because while we're working remotely and things are operating very well, few client complaints at all, we have to recognize that volumes are way down as well. So we've got to sort of back test that to see how we could operate. But I think it is a real indication of a new working model that for a bank like Butterfield in very expensive jurisdictions, multiple currencies, multiple regulators. We are a pretty complex bank, and I think we're just going to do the work over the next quarter to see what a potential new cost structure model could look like. But first and foremost, the focus right now is, yes, do the work in the background, but at this point, we're here to support our employees as they service our client base.

Got it. That's very helpful. And then maybe lastly, just on the strategic front, you mentioned that this could catalyze large banks exiting kind of offshore jurisdictions and potentially create some opportunities for you guys. How are you thinking about -- it seems like Butterfield is relatively well positioned versus some of the other peers globally that might have kind of more severe credit exposures, maybe in more kind of capital preservation mode at this time. So I guess, how are you thinking about your ability to kind of serve as almost like a strategic acquirer at a time when a lot of global banks may be looking to exit and potentially raise capital?

Yes. I think we obviously learned a great deal from the financial crisis. And what Butterfield did in the past in terms of lending and our entire model has been focused on just in-market lending, no out-of-market lending, no credit exposure in the investment portfolio. So that's really positioned us quite well. That's not to say we won't have some residential mortgage issues here as the economies will start to open up, but from a broader perspective, repositioning ourselves from a credit perspective for this sort of event. So I think we feel pretty confident on that side. And I think you're right. It's a little -- obviously, right now, given the environment, no one's really doing much of anything in terms of necessarily near-term corporate development.But I think we do really believe that things will open up as markets start to operate again. And as we said, we're a decent-sized bank in Guernsey at this point, so 10%, 15% market share; 1% or 2%, Jersey. We do think there's still going to be some opportunities there as U.K. banks start to strategically reposition. And in Singapore, which is more or less shut down right now, but luckily, it's a trust company as opposed to a bank, is still a great market for us, and we just really need to find some scale. So we do think there's going to be opportunities. But I would temper just by saying in the next few months, people are just trying to get through the situation they're in. But I think going into the summer, things -- discussions may open up at that point. But to your point, we are -- have a really healthy balance sheet, and we're strategically positioned to execute the strategy we've been talking about for years.

[Operator Instructions]. Our next question comes from Arren Cyganovich with Citi.

Yes. I was wondering if you could talk a little bit about the behavior of your global trust clients in this environment. I know you said that the trust fees don't really change that much. But do you -- is there a change in some of the large deposits? Is there kind of a change in -- just in terms of the activity that they would typically bring through the bank?

I would say what we're seeing pretty much across the board is a lot of state planning and financial planning for obvious reasons. I think people are pretty nervous. We actually are seeing some more interest in our jurisdictions from an estate planning perspective. Again, it's driven by a handful of lawyers in New York, London to Miami. So we're seeing actually some really good inward connections in terms of possibly new trust. I think existing trust, it's -- I think really people focusing on making sure that the structures make sense, that the beneficiaries are right, that sort of thing. So it's sort of the day-to-day stuff we do anyway, but probably enhanced today. Yes, you could see some deposit weakness. So we have some very large trust clients. And I think as -- not so much pulling money out necessarily to sort of put in a box somewhere, it's really -- I think people are seeing real investment opportunities. And so I think people -- I think some of the larger trust clients will put some of that money to work, but we also expect it to sort of flow in and out. So there could be a little bit of weakness, but I think we've talked about in the past, we've had a handful of chunky clients, but the rest is pretty evenly spread.

This concludes our question-and-answer session. I would now like to turn the call back over to management for any closing remarks.

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

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