Established in 1858, The Bank of N.T. Butterfield & Son Limited is Bermuda’s first bank, and one of only three banks licensed in Bermuda. It is also the leading bank in the Cayman Islands. Bermuda and the Cayman Islands generate approximately 90% of its income --- evenly split between the two jurisdictions. The remainder comes from a small European operation. The bank’s return on equity has averaged approximately 15% over the past decade. During the past three years, the ROE has exceeded 24%, as an intensive three-year operational turnaround has dramatically improved the bank’s efficiency ratio.
Bermuda and the Cayman Islands are two of the leading offshore domiciles in the world. Bermuda is Great Britain’s oldest crown colony and is home to subsidiary operations of more than 75% of the Fortune 500. It is also the leading captive insurance market with an estimated 40% of global underwriting capacity representing over 1,000 insurance firms with an estimated $80 billion+ of global assets.
Significant growth opportunities abound for NT Butterfield for several reasons: first, there are only three banks licensed to do business in Bermuda; second, Bermuda continues its healthy growth as a major financial center; and third, Butterfield has a very strong position in a relatively uncompetitive market.
I am particularly attracted to this bank because of its conservative balance sheet. Butterfield operates, in many respects, more like a trust company than a commercial bank. Liquid assets, cash and short term interbank deposits with major money center institutions (42%) and short duration investment grade marketable securities (32%), comprise approximately 74% of total assets. Loans represented only 26% of the bank’s $6.7 billion in total assets as of June 30, 2003. Approximately 40% of these loans are residential mortgages (mainly in Bermuda), while a large percentage of the remaining loans are secured commercial loans.
Fee-based activities generate more than 50% of income. Fee income is derived principally from general corporate banking and foreign exchange (60%) and trust and asset management (40%). Funds under management at Butterfield Asset Management, the bank’s investment management subsidiary, have grown over 25% annually over the past five years amounting to approximately $7.0 billion as of June 2003. Assets under administration approximate $50 billion as of June 30, 2003.
Over the past six years the bank has benefitted from the efforts of new management. M. Calum Johnston joined the bank as President and Chief Executive Officer in December 1997 from the Bank of Nova Scotia where he was Executive Vice President in charge of International Operations. Since joining the bank he led a major operational overhaul that has resulted in a reduction of more than 25% in the bank’s operating expense ratio, and he has recruited senior officers from Europe and Canada for several of the bank’s key positions, including a new Chief Financial Officer and Chief Credit Officer. Cal retired a bout a year ago and Allan Thompson, a thirty plus year banking executive with several major US banks including Bank One, has continued this focus on efficiency and risk management.
Since 1997 the bank’s earnings have tripled through significant improvement in efficiency and growth in the trust business. I believe the company’s already very conservative balance sheet has been improved over this period. While the stock has nearly tripled, I still believe it represents good value. It is trading at less than 8x 2003 earnings, and currently enjoys a 3.7% dividend yield. Additionally, in my opinion, the prospects for closing the gap between the bank’s share price and what I believe to be its intrinsic value have never been more favorable. The catalyst that I am most excited about is the prospect for the bank to list its shares in either Canada or the United States in addition to its current listing in Bermuda (where the stock market is quite illiquid). I also believe that there is the possibility, for the first time in the bank’s 142 year history, that it will partner, merge, or be acquired by a larger, international financial institution.
These events were made possible by an unprecedented change in Bermuda to relax foreign ownership regulations that had precluded non-Bermudians from owning more than 40% of Bermudian banks. These restrictions had made a takeover or broader listing of Butterfield’s shares impractical.
In January 2000, a new Bank Act was enacted by Bermuda’s Parliament allowing banks to apply to the Minister of Finance for exemption from foreign ownership restrictions that limited foreign ownership to 40% of a banks shares.The Bank of Butterfield received such an exemption in 2001 and has been converting its books to US GAAP (from Canadian GAAP). 2004 will be the first year that the bank will report in US GAAP. This will enable the bank to seek the most value maximizing alternative - whether it be listing in the US (which could easily yield a 40-60% increase in its P/E) or an outright sale of this valuable offshore franchise to any number of logical strategic acquires including - HSBC, Bank of Nova Scotia, Royal Bank of Scotland.
At 15x earnings, a reasonable acquisition valuation for an institution with Butterfield’s high quality franchise and low risk, predictable earnings stream, it is conceivable that a $60.00 takeover price is achievable.
1) Listing in U.S. or Canada
3) Continued compounding of earnings