The Bank of N.T. Butterfield & Son (NTB) - 2022 Q2 - Quarterly Report

Overview The Group operates under Basel III, preparing for Basel IV, with disclosures based on BCBS standards for the entire consolidated entity, published on its website Background The Group operates under the Basel III regulatory framework implemented by the Bermuda Monetary Authority (BMA) since January 1, 2015, mandating specific capital, leverage, and liquidity ratios, with additional D-SIB surcharges and preparations for Basel IV standards | Requirement | Minimum Ratio | | :--- | :--- | | CET1 Ratio | 7.0% (incl. 2.5% conservation buffer) | | Tier 1 Capital Ratio | 8.5% (incl. 2.5% conservation buffer) | | Total Capital Ratio | 10.5% (incl. 2.5% conservation buffer) | | D-SIB Surcharge (CET1) | 3.0% | | Leverage Ratio | ≥ 5.0% | | Liquidity Coverage Ratio (LCR) | ≥ 100% | | Net Stable Funding Ratio (NSFR) | ≥ 100% | - The BMA may impose additional Pillar 2 add-on capital requirements beyond the stated minimums based on its prudential supervision[3] - The Group is preparing for the finalization of Basel III reforms (often called "Basel IV"), which will revise standardized approaches for credit and operational risk, effective January 1, 2023[4] Basis of Disclosures This Pillar 3 disclosure document is prepared in accordance with BCBS standards as adopted by the BMA, with all figures as of June 30, 2022, and presented in US dollars unless stated otherwise - The report adheres to BCBS standards issued in January 2015 and March 2017, as adopted by the BMA[5] - All financial figures are as of June 30, 2022, and are expressed in US dollars[5] Scope of Application The Basel III framework applies to The Bank of N.T. Butterfield & Son Limited and all its BMA-regulated subsidiary undertakings, with consistent consolidation for accounting and prudential purposes - The disclosures apply to the entire Group, with the parent company being The Bank of N.T. Butterfield & Son Limited, regulated by the BMA[7] - The basis of consolidation is the same for both accounting and prudential reporting[8] - All principal operating entities are wholly owned, fully consolidated, and included in the disclosures[9] Location and Verification These disclosures have been approved by the Board and are published on the Group's corporate website, generally not subject to external audit unless equivalent to audited financial statements - The disclosures were published following Board approval[10] - The report is available on the Group's corporate website and is generally not subject to external audit[10] Risk Management Objectives and Policies The Group's risk management is overseen by the Board and its committees, supported by executive management, employing a "three lines of defense" model for comprehensive risk governance and control Risk Governance The Board of Directors holds ultimate responsibility for risk management strategy and appetite, executed through key Board committees and supported by specialized executive management committees overseeing specific risk areas - The Board has overall responsibility for risk management, delegated through the Risk Policy and Compliance Committee (RPCC) and the Audit Committee[13][14] - Executive management committees support the Board, including: - GRCC: Strategic assessment of all risks against appetite - GALCO: Manages liquidity, interest rate, and foreign exchange risk - GCC: Monitors and manages credit risks[16][17][18] Risk Management The Group employs a "three lines of defense" model for risk management, where business units own risks, independent risk and compliance groups provide oversight, and internal audit offers assurance on control effectiveness - First Line of Defense: Business units that own the risks they assume[20] - Second Line of Defense: Independent Risk Management and Compliance groups that identify, assess, and monitor risks[21] - Third Line of Defense: Group Internal Audit, which provides oversight and challenges the effectiveness of internal controls[26] Prudential Metrics As of June 30, 2022, the Group's capital levels decreased due to unrealized losses and dividends, while RWAs declined, and liquidity ratios (LCR and NSFR) improved, benefiting from BMA-approved assumptions and reduced deposit funding | Metric (as of Jun 30, 2022) | Value | Change from Dec 31, 2021 | | :--- | :--- | :--- | | CET1 Capital | $857.1M | ▼ $39.2M | | Total Capital | $1,040.7M | ▼ $39.6M | | Total RWA | $4,854.4M | ▼ $247.1M | | CET1 Ratio | 17.7% | ▲ 0.1% | | Total Capital Ratio | 21.4% | ▲ 0.2% | | Leverage Ratio | 5.8% | ▲ 0.2% | | LCR Ratio | 135% | ▲ 9% | | NSFR Ratio | 126% | ▲ 4% | - Capital levels decreased due to unrealized losses on AFS securities transferred to the HTM portfolio and dividend payments, partially offset by earnings[31] - The LCR and NSFR increased in the first half of 2022. The LCR was positively impacted by BMA approval for modified deposit outflow assumptions, while the NSFR benefited from reduced deposit funding levels[32] - The Group has elected to use transitional arrangements to defer the $7.8 million impact of CECL adoption on regulatory capital over a 5-year period[30] Capital Adequacy The Group manages capital to maintain stakeholder confidence, adhering to a three-pillar regulatory framework, with its capital structure primarily composed of CET1 capital and ratios well above minimum requirements Capital Management The Group's primary capital management objective is to maintain client, regulator, and shareholder confidence, managed through a group-wide CARP process considering stressed scenarios, regulatory requirements, and peer comparisons - A strong capital position is a primary objective to support profitable opportunities and withstand adverse events[33] - Capital is managed via the CARP process, which establishes guidelines and limits based on risk, regulatory rules, and peer levels[34] Regulatory Capital Framework The regulatory capital framework is based on three pillars. Pillar 1 sets minimum capital requirements for credit, market, and operational risk. Pillar 2 involves the Group's internal Capital Assessment and Risk Profile (CARP) process and the BMA's subsequent Supervisory Review and Evaluation Process (SREP). Pillar 3 promotes market discipline through public disclosure - Pillar 1: Sets minimum capital requirements for credit, market, and operational risk[37] - Pillar 2: Involves an internal assessment (CARP) of all material risks to determine capital adequacy, which is reviewed by the BMA[37] - Pillar 3: Focuses on promoting market discipline through regulatory disclosure requirements[35] Capital Structure As of June 30, 2022, the Group's Common Equity Tier 1 (CET1) capital was $857.1 million, which also constituted its entire Tier 1 capital. Total regulatory capital, including Tier 2 instruments and provisions, was $1,040.7 million. Capital levels decreased during the period, mainly due to unrealized losses on securities and dividend payments | Capital Component (Jun 30, 2022) | Amount (in millions of $) | | :--- | :--- | | Common Equity Tier 1 (CET1) | 857.1 | | Tier 1 Capital (T1) | 857.1 | | Tier 2 Capital (T2) | 183.6 | | Total Regulatory Capital (TC) | 1,040.7 | - CET1 capital is primarily composed of common share capital, retained earnings, and other reserves, with regulatory adjustments for items like goodwill, intangible assets, and pension obligations[36] - Tier 2 capital consists of subordinated notes and qualifying allowances for expected credit losses[36] Linkages Between Financial Statements and Regulatory Exposures This section provides a reconciliation between the Group's accounting balance sheet and its regulatory exposures as of December 31, 2021. It maps financial statement categories to regulatory risk frameworks, showing that total assets under the regulatory scope of consolidation were $15.2 billion, leading to total regulatory exposures of $16.5 billion after including off-balance sheet items - As of Dec 31, 2021, total assets under the regulatory scope of consolidation were $15,237.8 million[41][42] - After including $1,298.3 million in off-balance sheet amounts, the total exposure for regulatory purposes was $16,536.1 million[42] Minimum Capital Requirement: Pillar 1 As of June 30, 2022, the Group's capital ratios were well above the minimum requirements. The CET1, Tier 1, and Total capital ratios stood at 17.7%, 17.7%, and 21.4%, respectively. Total Risk-Weighted Assets (RWAs) were $4.85 billion, with credit risk being the largest component | Capital Ratios (Jun 30, 2022) | Value | | :--- | :--- | | CET1 Ratio | 17.7% | | Tier 1 Ratio | 17.7% | | Total Capital Ratio | 21.4% | | RWA by Risk Type (Jun 30, 2022) | Amount (in millions of $) | | :--- | :--- | | Credit risk | 3,210.5 | | Securitization exposures | 786.2 | | Operational risk | 850.5 | | Other | 7.2 | | Total RWA | 4,854.4 | Leverage Ratio The Group's Basel III leverage ratio was 5.8% as of June 30, 2022, exceeding the BMA's minimum requirement of 5.0%. The ratio increased from 5.5% at the end of the previous quarter, driven by a decline in balance sheet assets due to reduced deposit funding levels - The leverage ratio was 5.8% at June 30, 2022, which is above the 5.0% regulatory minimum[47][48] - The leverage ratio exposure measure was $14.86 billion, calculated from total consolidated assets of $14.35 billion plus adjustments for derivatives and off-balance sheet items[47] - The increase in the leverage ratio was driven by a decline in balance sheet assets resulting from reduced deposit funding[48] Credit Risk Measurement, Mitigation and Reporting The Group manages credit risk through policies, tiered approvals, internal ratings, and collateral, with exposures concentrated geographically and by product, mitigated by security and adherence to the CECL model Credit Risk Overview Credit risk, the potential for loss from counterparty default, is managed by CRM departments through policies, individual credit authorities, committee approvals, internal ratings, and collateral requirements - Credit risk is managed through CRM departments that set and apply uniform credit policies across the Group[49] - A tiered approval process is used, with larger exposures requiring approval from the Group Credit Committee (GCC)[50] - Risk management practices include assigning internal ratings, annual reviews, and obtaining collateral such as real estate, securities, and deposits[51][53] Credit Risk - Retail and Private Banking Retail and private lending credit risk is managed through specific policies and underwriting guidelines, considering affordability, credit history, and LTV ratios, with ongoing monitoring and specialist recovery teams for adverse exposures - Retail credit risk for products like mortgages and personal loans is managed via policies and guidelines approved by the GCC and GRCC[54] - Primary factors for credit assessment include affordability, credit history, employment, and LTV for residential properties[55] Credit Risk - Commercial Banking Commercial credit risks are managed via approved policies, limits, and quality measures, with lending decisions based on thorough analysis, internal risk ratings, and mitigation through guarantees, collateral, and financial covenants - Commercial credit risk management relies on delegated authority, thorough credit analysis, and internal borrower risk ratings[58] - Risk mitigation measures include third-party guarantees, collateral, legal documentation, and monitoring of financial covenants[59] Credit Risk - Treasury Treasury credit risks from investment portfolios and operations are managed through GCC-approved policies, with the FIC overseeing counterparty and country exposures, emphasizing diversification, limits, and external credit ratings - Treasury credit risks are managed via policies set by the GCC, with the FIC overseeing counterparty and country exposures[60] - The Group emphasizes diversification and sets exposure limits for countries and financial institutions[62] - External credit ratings from S&P, Fitch, and Moody's are used for assessing sovereign, financial institution, and corporate risks[63] Exposures As of June 30, 2022, the Group's total credit risk exposure was $14.8 billion, primarily in Securitizations, Residential Mortgages, and Claims on Sovereigns, with significant geographic concentrations in Bermuda and the Cayman Islands | Exposure Type (Jun 30, 2022) | Amount (in millions of $) | | :--- | :--- | | Securitizations | 4,914.6 | | Residential Mortgages | 3,475.9 | | Claims on Sovereigns | 2,581.8 | | Claims on Banks and Securities Firms | 1,296.1 | | Claims on Corporates | 698.5 | | Total | 14,826.8 | | Geographic Exposure (Jun 30, 2022) | Amount (in millions of $) | | :--- | :--- | | Bermuda | 5,807.0 | | Cayman | 4,717.7 | | Channel Islands & UK | 4,279.7 | | Other | 22.4 | | Total | 14,826.8 | - Total gross credit exposure, including loans, debt securities, and off-balance sheet items, was $8.4 billion, with $62.2 million classified as defaulted[65] Impairment Provisions The Group adopted the Current Expected Credit Losses (CECL) model on January 1, 2020, with total allowances for expected credit losses on loans at $25.0 million as of June 30, 2022, while defaulted loans increased to $62.2 million, mainly from Channel Islands and UK residential mortgages - The Group uses a CECL model to measure credit losses on financial instruments, which is based on expected losses rather than incurred losses[75] | Loan Allowances (as of Jun 30, 2022) | Amount (in millions of $) | | :--- | :--- | | Balance at beginning of period | 28.1 | | Provision increase (decrease) | 0.4 | | Recoveries | 0.8 | | Charge-offs | (4.1) | | Allowances at end of period | 25.0 | - Defaulted loans increased from $61.0 million to $62.2 million during the period, mainly due to residential mortgages in the Channel Islands and UK moving to non-accrual status[83] Credit Risk Concentrations The Group monitors various concentration risks, with primary focus on geographic and product concentrations, particularly in residential mortgages and real estate collateral, addressed through large exposure policies and stress testing Counterparty Concentration This is the risk from a high level of exposure to a single counterparty. Large exposures are reviewed quarterly by the GRCC and RPCC - Counterparty concentration risk is managed through quarterly reviews of large exposures by risk committees[94][95] Industry Concentration This risk arises from a high concentration of counterparties within a single industry. The Group notes potential concentration in property, insurance, and fund sectors but considers geographic and product concentration more relevant to measure - The Group identifies potential industry concentrations in property, insurance, and funds, but prioritizes monitoring geographic and product risks[96] Geographic Concentration This risk is monitored by analyzing the regional breakdown of the Group's property loan exposure, with reports provided to risk committees to manage over-weighting in any single area - Geographic concentration is monitored by subdividing property loan exposures into regional segments and analyzing the percentage breakdown per region[97] Product Concentration This risk involves over-weighting in a specific product type. The Group's largest product concentration is in residential mortgages, which make up 68.0% of the total loan book. This concentration in the property market is addressed via stress testing - The Group's primary product concentration is in residential mortgages, which constitute 68.0% of the total loan portfolio[98][99] Collateral Concentration This risk arises when the loan book is secured by a limited number of collateral types. The Group's most significant collateral concentration is in residential and commercial real estate. This risk is mitigated through stress testing scenarios that assume a significant devaluation of all real estate collateral - The largest collateral concentration is in residential and commercial property. The risk is managed by stress testing scenarios with property devaluations up to 30%[100][101] Maturity concentration This risk involves a concentration of loans maturing at a similar time or having fixed interest rates that reprice at similar times, which could impact portfolio value or increase default risk if rates rise - Maturity concentration risk is defined as a cluster of loans maturing or repricing at similar times, which could lead to a sudden fall in portfolio value or increased default risk[102] Credit Risk Mitigation The Group mitigates credit risk primarily by obtaining security for advanced funds, with $4.8 billion of loan exposures secured by residential and commercial property, and uses netting and collateralization for treasury and derivative activities - Of the Group's total loan and debt security exposure, $4,775.4 million is secured by collateral, while $2,651.9 million is unsecured[105] - Residential property is the main source of collateral for the residential mortgage portfolio. Commercial collateral includes property, life insurance policies, shares, and guarantees[110][112] - For derivative transactions, the Group uses ISDA Master Agreements and Credit Support Annexes to mitigate credit risk through collateral exchange[115] Securitization The Group does not securitize assets it originates but has exposure to purchased securitization positions. As of June 30, 2022, the total carrying value of these positions was $4.9 billion, predominantly in retail exposures like residential mortgages issued by U.S. government and federal agencies. These exposures resulted in Risk-Weighted Assets (RWA) of $786.2 million - The Group's exposure to purchased securitizations was $4.9 billion by carrying value as of June 30, 2022[121] - The majority of securitization exposure is in residential mortgages ($4.89 billion) from U.S. government and federal agencies[121][123] - The total securitization exposure of $4.9 billion resulted in RWA of $786.2 million and a capital charge of $62.9 million[124] Market and Liquidity Risk The Group manages market risk from interest rates and foreign exchange, with an asset-sensitive banking book, and maintains robust liquidity management, exceeding regulatory LCR and NSFR requirements Market Risk Overview Market risk, the potential for loss from adverse movements in market factors like interest rates and foreign exchange, is independently calculated and monitored by the Group Market Risk function and reported to GALCO - Market risk is defined as the potential for loss due to adverse movements in market factors such as interest rates and foreign exchange rates[125] - Exposures are monitored by the Group Market Risk function and reported to GALCO[126] Interest Rate Risk Interest rate risk, affecting earnings and economic value in the banking book, is managed to maximize profit while minimizing exposure, with the asset-sensitive balance sheet benefiting from rising rates in the first half of 2022 - The Group's balance sheet is asset-sensitive and positioned to benefit from further interest rate increases[132] - In the first half of 2022, rising rates led to an increase in Net Interest Income (NII) but also resulted in increased unrealized losses in the AFS investment portfolio[132][133] - The Group does not maintain a trading book; therefore, all interest rate risk is classified as Interest Rate Risk in the Banking Book (IRRBB)[127][128] Foreign Exchange Risk Foreign exchange risk arises from holding assets and liabilities in non-Bermuda Dollar (BMD) or non-U.S. Dollar (USD) currencies, and from investments in subsidiaries with different domestic currencies. The Group manages this risk through a clearly defined tolerance framework that limits exposures to select currencies - The Group is exposed to FX risk from assets, liabilities, and subsidiaries denominated in currencies not pegged to the USD[134] - A foreign exchange risk exposure tolerance framework is in place to limit exposures to specific currencies[135] Liquidity Risk The Group manages liquidity risk to meet funding requirements and capitalize on opportunities, maintaining significant liquid assets and adhering to stringent internal tolerances, while complying with LCR and NSFR requirements - The Group's objective is to ensure it can meet cash flow requirements in both normal and stressed conditions[137] - As of June 30, 2022, liquid assets (cash, short-term investments, securities) amounted to $8.8 billion, or 61.5% of total assets[139] - Bermuda has no central bank or 'lender of last resort', so the Group relies on uncommitted inter-bank funding and repurchase facilities[141] Liquidity Coverage Ratio The Group is required to maintain a Liquidity Coverage Ratio (LCR) of at least 100%. As of June 30, 2022, the Group was in compliance. The simple average LCR for the first half of 2022 was 130%, with total High-Quality Liquid Assets (HQLA) of $6.5 billion against total net cash outflows of $5.0 billion. The ratio was positively impacted by BMA approval for modified deposit outflow assumptions | LCR Component (Average for 1H 2022) | Value (in millions of $) | | :--- | :--- | | Total HQLA | 6,485.5 | | Total net cash outflows | 5,004.6 | | LCR Ratio (%) | 130% | - The Group complies with the BMA's minimum LCR requirement of 100%[142] Net Stable Funding Ratio The Group is required to maintain a Net Stable Funding Ratio (NSFR) of at least 100%. As of June 30, 2022, the Group was in compliance. The simple average NSFR for the first half of 2022 was 125%, with total available stable funding (ASF) of $6.0 billion exceeding the total required stable funding (RSF) of $4.8 billion. The ratio was positively impacted by reduced deposit funding levels | NSFR Component (Average for 1H 2022) | Value (in millions of $) | | :--- | :--- | | Total Available Stable Funding (ASF) | 5,951.9 | | Total Required Stable Funding (RSF) | 4,771.7 | | NSFR Ratio (%) | 125% | - The Group complies with the BMA's minimum NSFR requirement of 100%[146] Operational Risk Operational risk is the risk of loss from inadequate or failed internal processes, people, systems, or external events. The Group manages this risk through effective internal controls and risk management practices, guided by principles that emphasize day-to-day risk assessment and clear lines of responsibility. For regulatory capital purposes, the Group uses the Standardized Approach, where the capital charge is calculated based on gross losses over the preceding three years - Operational risk is defined as the risk of loss from failed internal processes, people, systems, or external events[151] - Management is based on four principles, including making risk assessment a day-to-day activity for all employees and making decisions at appropriate levels[153][155] - The Group uses the Standardized Approach to calculate operational risk capital, which uses gross income as a proxy for operational risk exposure[154] Other Information This section provides a glossary of abbreviations used in the Pillar 3 disclosure and includes cautionary statements regarding forward-looking information, advising readers of inherent risks and uncertainties Abbreviations This section provides a list of abbreviations and their definitions used throughout the Pillar 3 disclosure document, such as BMA (Bermuda Monetary Authority), CET1 (Common Equity Tier 1 capital), and RWA (Risk-weighted Assets) - This section contains a glossary of abbreviated terms used in the report to ensure clarity for the reader[156][157] Cautionary Statements Regarding Forward-Looking Statements This section contains a standard safe harbor statement under the U.S. Private Securities Litigation Reform Act of 1995. It cautions readers that forward-looking statements in the document are subject to known and unknown risks and uncertainties, and actual results may differ materially. The Group does not undertake to update these statements - The report includes forward-looking statements that are subject to risks and uncertainties which may cause actual results to differ[158] - Readers are cautioned not to place undue reliance on these statements, which are qualified by risks described in SEC filings[159]