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Current/Nominal (in £ Millions) | | 2021 CE | | 2020 CE | | 2019 | | 2018 | | 2017 |
Guernsey GDP (GVA Market/GBP) | | 3,446 | | 3,125 | | 3,248 | | 3,170 | | 3,101 |
Annual Changes (%) | | 10.3% | | (3.8)% | | 2.6% | | 2.2% | | 5.7% |
Source: States of Guernsey
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| | 2021 | | 2020 | | 2019R | | 2018 | | 2017 |
Jersey GDP (GBP (in £ millions)) | | 5,087 | | 4,592 | | 5,108 | | 4,803 | | 4,710 |
Annual Changes (%) | | 10.8% | | (10.1)% | | 6.4% | | 2.0% | | 0.9% |
Source: States of Jersey
We continue to maintain a cautious stance with a liquid balance sheet, a conservative investment portfolio, and no reliance on wholesale funding. Total liquid cash and investments made up 61.3% of our balance sheet at December 31, 2022, which is slightly down from 63.3% at December 31, 2021.
The Bank continued to support customers and operate as permitted across all jurisdictions in 2022 without any support or concessions from governments or regulators in any of our operating jurisdictions.
2022 Overview
In 2022, our net income increased by $51.4 million to $214.0 million from $162.7 million in 2021. This increase is driven primarily by the impact of higher market interest rates on net interest income, increased non-interest income offset by higher non-interest expenses and a higher provision for future expected credit losses due to weaker macroeconomic forecasts. Management continued to focus on the diligent management of capital, expenses and risks, and maintaining our strong capital position with CET1 and Total capital ratios of 20.3% and 24.1%, respectively, as at December 31, 2022. For the year ended December 31, 2022, the Board declared four quarterly dividends of $0.44 per quarter totaling $1.76 for each common share held on record as of the applicable record dates, and repurchased 102,000 common shares from the existing share repurchase program. Subsequent to year end, the Board approved a new share repurchase program authorizing the purchase of up to 3.0 million common shares expiring on February 29, 2024. The Board will continue to evaluate capital planning options and the payment of future dividends as warranted, subject to regulatory requirements. See Item 8.A. "Consolidated Statements and Other Financial Information - Dividend Policy" and Item 3.D. "Risk Factors – General Risk Factors - Holders of our common shares may not receive dividends" elsewhere in this report for further details.
The quality of our assets remained strong and total assets decreased year-over-year by $1.0 billion to $14.3 billion, driven primarily by decreased deposit levels in Cayman and the Channel Islands. Deposits decreased by $0.9 billion to $13.0 billion while loans decreased by $0.1 billion to $5.1 billion. The decrease in deposit balances was driven by the anticipated normalization of pandemic-related surge deposit levels and the impact of a strengthening US dollar on non-US dollar denominated deposits. The decrease in loans was driven by the Channel Islands and UK segment as a result of a decrease in the GBP/USD foreign exchange rate, the early repayment of a number of commercial facilities and is partially offset by the extension of a government facility in the Cayman Islands. Investments decreased by $0.5 billion to $5.7 billion driven by an increase in total net unrealized losses on the available-for-sale portfolio that is carried at fair value as a result of rising long-term US dollar interest rates. Overall liquidity remained strong, as measured by cash and cash equivalents, securities purchased under agreements to resell, short-term investments and investments in securities as a percentage of total assets, ending the year at 61.3% compared to 63.3% in the prior year.
Our shareholders’ equity decreased year-over-year by $112.7 million to $864.8 million, which was a result of negative mark-to-market movements in the value of our fixed income investments as long term US dollar rates have increased, common share repurchases and retirements throughout the year, partially offset by organic growth through net income net of dividends paid out during the year.
Key contributors to our 2022 results were as follows:
•Profitability: Net income increased year-over-year by $51.4 million, or 31.6%, to $214.0 million, primarily due to higher market interest rates and increased non-interest income offset by higher non-interest expenses and a higher provision for future expected credit losses.
•Net interest margin: NIM increased by 39 basis points to 241 basis points compared to 202 basis points in 2021, and the cost of funding increased by 23 basis points to 34 basis points. The increase in NIM was due to increased market interest rates across the yield curve; loan yields increased by 64 basis points to 490 basis points; the investment portfolio yields increased by 12 basis points to 191 basis points; and yields on cash and cash equivalents, securities purchased under agreements to resell and short-term investments were up by 102 basis points to 106 basis points. The yield uptick on the investment portfolio was muted due to the slowing down of prepayment speeds in the rising interest rate environment thereby reducing the ability to reinvest at higher rates. The cost of funding increased and saw expense yields increasing by 23 basis points to 34 basis points, with pricing pressure coming from the more competitive Channel Islands markets.
•Expenses: Total non-interest expenses decreased year-over-year by $2.3 million to $331.6 million in 2022, largely due to a $7.1 million decrease in technology and communications spending due to the depreciation charges on the existing core banking system in the prior year continuing to outpace costs associated with the new technology projects. This was partially offset by a $4.9 million increase in staff-related costs due to higher staff incentive accruals, costs associated with the departure of a senior executive that was recorded as a non-core item, other non-recurring severance costs and inflationary salary adjustments. Our expenses also included $1.7 million of non-core expenses including those associated with the aforementioned departure of a senior executive; residual professional fees incurred in relation to the resolved US Department of Justice inquiry and costs associated with the settlement of a non-US corporate income tax inquiry in connection with the commercial affairs of a legacy custody client. The core efficiency ratio decreased from 65.5% in 2021 to 58.9% in 2022, reflecting the rate of core non-interest expense relative to the increase in revenue.
•Deposits: Deposits decreased year-over-year by $0.9 billion to $13.0 billion as at December 31, 2022. The decrease in deposit balances was driven by the anticipated normalization of pandemic-related surge deposit levels and the impact of a strengthening US dollar on non-US dollar denominated deposits. Interest bearing deposit costs increased by 30 basis points to 44 basis points in 2022. With non-interest bearing deposits totaling $3.0 billion on December 31, 2022, the average cost of deposits for the year increased by 23 basis points to 34 basis points. Cost of funds increased due to higher market rates and pricing pressure seen in the more competitive Channel Islands market.
•Loan quality: As at December 31, 2022, we had gross non-accrual loans of $63.1 million representing 1.2% of total gross loans, an increase from $61.0 million, or 1.2%, of total loans at December 31, 2021. The increase in non-accrual loans was driven by a few residential mortgages in the Channel Islands and UK segment moving into non-accrual and partially offset by a number of Bermuda residential mortgages improving to current status.
2021 Overview
In 2021, our net income increased by $15.5 million to $162.7 million from $147.2 million in 2020. Despite the headwinds of the continued low interest rate environment following the COVID-19 pandemic on net interest income, the Bank saw an uplift in net income of $15.5 million driven by an increase in fee income attributable to increased card service contributions and foreign exchange transactional volumes, a decrease in the provision for credit losses due primarily to improving macroeconomic forecasts, and decreases in non-interest expenses due primarily to realizing the benefits from the 2020 COVID-19 driven staff restructuring programs. These staff restructuring programs were considered non-core and contributed to non-core costs decreasing by $6.4 million in 2021 from $7.3 million in 2020. Management continued to focus on the diligent management of capital, expenses and risks, and maintaining our strong capital position with CET1 and Total capital ratios of 17.6% and 21.2%, respectively. For the year ended December 31, 2021, the Board declared four quarterly dividends of $0.44 per quarter totaling $1.76 for each common share held on record as of the applicable record dates, and repurchased 534,828 common shares from the existing share repurchase program. Subsequent to year end, the Board approved a new share repurchase program authorizing the purchase of up to 2.0 million common shares expiring on February 28, 2023. The Board will continue to evaluate capital planning options and the payment of future dividends as warranted, subject to regulatory requirements. See Item 8.A. "Consolidated Statements and Other Financial Information - Dividend Policy" and Item 3.D. "Risk Factors – General Risk Factors - Holders of our common shares may not receive dividends" elsewhere in this report for further details.
The quality of our assets remained strong and total assets increased year-over-year by $0.6 billion to $15.3 billion, driven primarily by increased deposit levels in Cayman and the Channel Islands. Deposits increased by $0.6 billion to $13.9 billion whilst loans remained stable at $5.2 billion. The increase in deposit balances was driven by corporate deposit increases in Cayman and the Channel Islands, and partially offset by expected corporate deposit decreases in Bermuda. Investments increased by $1.4 billion to $6.2 billion driven by increased depositor funding and the deployment of assets into the investment portfolio. Overall liquidity remained strong, as measured by cash and cash equivalents, securities purchased under agreements to resell, short-term investments and investments in securities as a percentage of total assets, ending the year at 63.3% compared to 62.2% in the prior year.
Our shareholders’ equity decreased marginally year-over-year by $4.5 million to $977.5 million, which was a result of negative mark-to-market movements in the value of our fixed income investments as long term US dollar rates have increased, common share repurchases and retirements throughout the year and partially offset by organic growth through net income net of dividends paid out during the year.
Key contributors to our 2021 results were as follows:
•Profitability: Net income increased year-over-year by $15.5 million, or 10.5%, to $162.7 million, which was largely attributable to increased fee revenues due to improved economic activity as economies re-opened, a decrease in the provision for credit losses and cost-savings from the prior year COVID-19 driven staff restructuring programs implemented in order to create operating leverage in a low interest rate environment.
•Net interest margin: NIM decreased by 40 basis points to 202 basis points compared to 242 basis points in 2020, and the cost of funding decreased by 10 basis point to 11 basis points. The decrease in NIM was due to margin declines across all interest earning asset categories, driven by lower market interest rates and increased paydowns of higher yielding investment positions with re-investment at lower rates; loan yields decreased by 28 basis points to 426 basis points; the investment portfolio yields decreased by 62 basis points to 179 basis points; and yields on cash and cash equivalents, securities purchased under agreements to resell and short-term investments were down 30 basis points to 4 basis points. The cost of funding offset the overall NIM decrease, with expense yields decreasing by 10 basis points to 11 basis points, primarily due to the active repricing of deposits in response to lower market rates.
•Expenses: Total non-interest expenses decreased year-over-year by $10.7 million to $333.9 million in 2021 due to a $12.3 million decrease in staff-related costs from reduced headcount as a result of non-core restructuring programs initiated in 2020 and a $1.3 million decrease in technology and communications spending due to the full depreciation of the Bank's core banking system outpacing costs associated with the new technology projects. This was offset by a $1.5 million increase in property costs driven by increased property maintenance costs and a $1.2 million increase in non-service employee benefits expense driven by increased costs from the post-retirement medical benefit plan. Our expenses also included $1.8 million of non-core expenses which relate to redundancy costs associated with the transfer of Channel Islands banking operations functions from Mauritius to Butterfield's service centers in Canada and Guernsey and professional fees related to the settlement of the US Department of Justice inquiry which commenced in 2013. After removing the effect of these items, core non-interest expenses decreased marginally by $4.5 million, from $336.6 million in 2020 to $332.1 million in 2021.
•Deposits: Deposits increased year-over-year by $0.6 billion to $13.9 billion as at December 31, 2021. The increase in deposit balances was driven by corporate deposit increases in Cayman and the Channel Islands, and partially offset by expected corporate deposit decreases in Bermuda. Interest bearing deposit costs decreased by 12 basis points to 14 basis points in 2021. With non-interest bearing deposits totaling $2.8 billion on December 31, 2021, the average cost of deposits for the year decreased by 10 basis points to 11 basis points. Cost of funds decreased due to the active repricing of deposits in response to lower market rates.
•Loan quality: As at December 31, 2021, we had gross non-accrual loans of $61.0 million representing 1.2% of total gross loans, a decrease from $72.5 million, or 1.4%, of total loans at December 31, 2020. The decrease in non-accrual loans was driven by the payoff of residential mortgages and a commercial mortgage in Bermuda and partially offset by a residential mortgage in the Channel Islands moving into non-accrual in the fourth quarter of 2021.
Financial Summary
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| | As at December 31 | | |
(in millions of $) | | 2022 | | 2021 | Dollar change | Percent change |
Assets | | | | | | |
Cash and cash equivalents | | 2,100.8 | | | 2,179.8 | | (79.0) | | (3.6) | % |
Of which cash and demand deposits with banks — non-interest bearing | | 93.0 | | | 115.7 | | (22.7) | | (19.6) | % |
Of which demand deposits with banks — interest bearing | | 258.2 | | | 437.6 | | (179.4) | | (41.0) | % |
Of which cash equivalents — interest bearing | | 1,749.5 | | | 1,626.5 | | 123.0 | | 7.6 | % |
Securities purchased under agreements to resell | | 59.9 | | | 96.1 | | (36.2) | | (37.7) | % |
Short-term investments | | 884.5 | | | 1,198.9 | | (314.4) | | (26.2) | % |
Investment in securities | | 5,727.2 | | | 6,237.3 | | (510.1) | | (8.2) | % |
Of which equity securities at fair value | | 0.2 | | | 0.2 | | — | | — | % |
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Of which available-for-sale(1) | | 1,988.9 | | | 3,473.7 | | (1,484.8) | | (42.7) | % |
Of which held-to-maturity(2) | | 3,738.1 | | | 2,763.3 | | 974.8 | | 35.3 | % |
Loans, net of allowance for credit losses | | 5,096.4 | | | 5,240.7 | | (144.3) | | (2.8) | % |
Premises, equipment and computer software, net of accumulated depreciation | | 146.1 | | | 138.7 | | 7.4 | | 5.3 | % |
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Goodwill | | 22.9 | | | 25.4 | | (2.5) | | (9.8) | % |
Other intangible assets, net | | 51.5 | | | 60.8 | | (9.3) | | (15.3) | % |
Equity method investments | | 12.5 | | | 12.6 | | (0.1) | | (0.8) | % |
Other real estate owned, net | | 0.8 | | | 0.7 | | 0.1 | | 14.3 | % |
Accrued interest and other assets | | 203.5 | | | 144.3 | | 59.2 | | 41.0 | % |
Total assets | | 14,306.1 | | | 15,335.2 | | (1,029.1) | | (6.7) | % |
Liabilities | | | | | | |
Total deposits | | 12,991.1 | | | 13,870.2 | | (879.1) | | (6.3) | % |
Of which — non-interest bearing | | 3,039.7 | | | 2,820.6 | | 219.1 | | 7.8 | % |
Of which — interest bearing | | 9,951.4 | | | 11,049.6 | | (1,098.2) | | (9.9) | % |
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Employee benefit plans | | 92.0 | | | 126.2 | | (34.2) | | (27.1) | % |
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Accrued interest and other liabilities | | 185.9 | | | 189.4 | | (3.5) | | (1.8) | % |
Long-term debt | | 172.3 | | | 171.9 | | 0.4 | | 0.2 | % |
Total liabilities | | 13,441.2 | | | 14,357.7 | | (916.5) | | (6.4) | % |
Total shareholders' equity(3)(4) | | 864.8 | | | 977.5 | | (112.7) | | (11.5) | % |
Of which common share capital(4) | | 0.5 | | | 0.5 | | — | | — | % |
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Total liabilities and shareholders' equity | | 14,306.1 | | | 15,335.2 | | (1,029.1) | | (6.7) | % |
Common shares outstanding (number)(4) | | 50.3 | | | 49.9 | | 0.4 | | 0.8 | % |
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(1)Amortized cost of AFS debt securities was $2,209.1 million as at December 31, 2022 and $3,495.6 million as at December 31, 2021.
(2)Fair value of HTM debt securities was $3,197.5 million as at December 31, 2022 and $2,786.1 million as at December 31, 2021.
(3)As at December 31, 2022, the number of outstanding awards of unvested common shares was 1.1 million (December 31, 2021: 1.0 million). Only awards for which the sum of 1) the expense that will be recognized in the future (i.e., the unrecognized expense) and 2) its exercise price, if any, was lower than the average market price of the Bank's common shares were considered dilutive and, therefore, included in the computation of diluted earnings per share.
(4)Figures reflect the retirement of 0.1 million shares during the year ended December 31, 2022 (December 31, 2021: 0.5 million).
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Summary Income Statement | | For the year ended December 31 | | Dollar change | | Percent change |
(in millions of $, except per share data) | | 2022 | 2021 | 2020 | | 2021 to 2022 | 2020 to 2021 | | 2021 to 2022 | 2020 to 2021 |
Interest income | | | | | | | | | | |
Loans | | 249.4 | | 221.5 | | 230.7 | | | 27.9 | | (9.2) | | | 12.6 | % | (4.0) | % |
Investments | | 115.8 | | 101.9 | | 109.2 | | | 13.9 | | (7.3) | | | 13.6 | % | (6.7) | % |
Deposits with banks and other | | 33.2 | | 1.4 | | 12.1 | | | 31.8 | | (10.7) | | | 2,271.4 | % | (88.4) | % |
Interest expense | | (54.8) | | (25.1) | | (34.4) | | | (29.7) | | 9.3 | | | 118.3 | % | (27.0) | % |
Net interest income before provision for credit losses | | 343.6 | | 299.8 | | 317.6 | | | 43.8 | | (17.8) | | | 14.6 | % | (5.6) | % |
Non-interest income | | 206.6 | | 198.1 | | 183.9 | | | 8.5 | | 14.2 | | | 4.3 | % | 7.7 | % |
Net revenue | | 550.2 | | 497.9 | | 501.5 | | | 52.3 | | (3.6) | | | 10.5 | % | (0.7) | % |
Provision for credit (losses) recoveries | | (2.4) | | 3.1 | | (8.5) | | | (5.5) | | 11.6 | | | (177.4) | % | (136.5) | % |
Salaries and other employee benefits | | (166.2) | | (161.3) | | (173.7) | | | (4.9) | | 12.4 | | | 3.0 | % | (7.1) | % |
Other non-interest expenses (including income taxes) | | (169.1) | | (175.7) | | (173.3) | | | 6.6 | | (2.4) | | | (3.8) | % | 1.4 | % |
Net income before other gains (losses) | | 212.5 | | 164.0 | | 146.0 | | | 48.5 | | 18.0 | | | 29.6 | % | 12.3 | % |
Total other gains (losses) | | 1.5 | | (1.4) | | 1.2 | | | 2.9 | | (2.6) | | | (207.1) | % | (216.7) | % |
Net income | | 214.0 | | 162.7 | | 147.2 | | | 51.3 | | 15.5 | | | 31.5 | % | 10.5 | % |
Non-core items | | 1.7 | | 0.9 | | 7.3 | | | 0.8 | | (6.4) | | | 88.9 | % | (87.7) | % |
Core net income (Non-GAAP) | | 215.7 | | 163.6 | | 154.5 | | | 52.1 | | 9.1 | | | 31.8 | % | 5.9 | % |
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Core earnings to common shareholders (Non-GAAP) | | 215.7 | | 163.6 | | 154.5 | | | 52.1 | | 9.1 | | | 31.8 | % | 5.9 | % |
Common dividends paid | | (87.3) | | (87.3) | | (88.9) | | | — | | 1.6 | | | — | % | (1.8) | % |
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Earnings per common share from continuing operations (in US$) | | | | | | | | | | |
Basic | | 4.32 | | 3.28 | 2.91 | | | 1.04 | | 0.37 | | | 31.7 | % | 12.7 | % |
Diluted(1) | | 4.29 | | 3.26 | 2.90 | | | 1.03 | | 0.36 | | | 31.6 | % | 12.4 | % |
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(1) Reflects only "in the money" options and certain unvested share awards, which have a dilutive effect.
Financial Ratios and Other Performance Indicators
We use a number of financial measures to track the performance of our business and guide our management. Some of these measures are defined by, and calculated in compliance with, applicable banking regulations, but such regulations often provide for certain discretion in defining and calculating the measures. These measures allow management to review our core activities, and enable us and our investors to evaluate relevant trends meaningfully when considered in conjunction with (but not in lieu of) measures that are calculated in accordance with GAAP. Non-GAAP measures used in this report are not a substitute for GAAP measures and readers should consider the GAAP measures as well.
The following table shows certain of our key financial measures for the periods indicated. Because of the discretion that we and other banks and companies have in defining and calculating these measures, care should be taken in comparing such measures used by us with similarly titled measures of other banks and companies, as such measures may not be directly comparable.
Many of these measures are non-GAAP financial measures. We believe that each of these measures is useful for investors in understanding trends in our business that may not otherwise be apparent when relying solely on our GAAP-calculated results. For more information on the non-GAAP financial measures presented below, including a reconciliation to the most directly comparable GAAP financial measures, see Item 5.A. "Item 5 - Operating and Financial Review and Prospects - Overview and highlights - Reconciliation of Non-GAAP Financial Measures".
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| | For the year ended December 31 |
(in %, unless otherwise indicated) | | 2022 | | 2021 | | 2020 |
Return on average common shareholders' equity(1) | | 25.7 | | | 16.8 | | | 15.0 | |
Core return on average tangible common equity(2) | | 28.6 | | | 18.7 | | | 17.3 | |
Return on average assets(3) | | 1.5 | | | 1.1 | | | 1.1 | |
Core return on average tangible assets(4) | | 1.5 | | | 1.1 | | | 1.1 | |
Net interest margin(5) | | 2.41 | | | 2.02 | | | 2.42 | |
Efficiency margin(6) | | 59.2 | | | 65.9 | | | 67.6 | |
Core efficiency ratio(7) | | 58.9 | | | 65.5 | | | 66.0 | |
Fee income ratio(8) | | 37.7 | | | 39.5 | | 37.3 | |
Common equity Tier 1 capital ratio(9)(10) | | 20.3 | | | 17.6 | | | 16.1 | |
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Tier 1 capital ratio(9) | | 20.3 | | | 17.6 | | | 16.1 | |
Total capital ratio(9) | | 24.1 | | | 21.2 | | | 19.8 | |
Leverage ratio(9)(10) | | 6.7 | | | 5.6 | | | 5.3 | |
Tangible common equity/tangible assets(10) | | 5.6 | | | 5.8 | | | 6.1 | |
Tangible total equity/tangible assets(11) | | 5.6 | | | 5.8 | | | 6.1 | |
Non-performing assets ratio(12) | | 0.5 | | | 0.5 | | | 0.6 |
Non-accrual ratio(13) | | 1.2 | | | 1.2 | | | 1.4 |
Non-performing loan ratio(14) | | 1.5 | | | 1.4 | | | 1.8 |
Net charge-off (recoveries) ratio(15) | | 0.1 | | | 0.1 | | | 0.1 | |
Core net income attributable to common shareholders(16)(17) (in $ million) | | 215.7 | | | 163.6 | | 154.5 | |
Core net income per common share fully diluted(18)(20) (in $) | | 4.33 | | | 3.28 | | 3.04 | |
Common equity per share(19) (in $) | | 17.42 | | | 19.83 | | 19.88 | |
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(1)ROE measures profitability by revealing how much profit is generated with the money invested by common shareholders. ROE represents the amount of net income to common shareholders as a percentage of average common equity and is calculated as net income to common shareholders / average common equity. Net income to common shareholders is net income for the full fiscal year, before dividends paid to common shareholders but after dividends to preference shareholders. Average common equity does not include the preference shareholders' equity.
(2)Core ROATCE is a non-GAAP financial measure. Core ROATCE measures core profitability as a percentage of average tangible common equity. Core ROATCE is the amount of core income to common shareholders as a percentage of average tangible common equity and is calculated as core earnings to common shareholders / average tangible common equity. Core earnings to common shareholders is net earnings to common shareholders for the full fiscal year (before dividends paid to common shareholders but after dividends to preference shareholders) adjusted to exclude certain items that are included in the financial results presented in accordance with GAAP. Average tangible common equity does not include the preference shareholders' equity or goodwill and intangible assets. For more information on the non-GAAP financial measures, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(3)ROA is an indicator of profitability relative to average total assets and is intended to demonstrate how efficient management is at using the assets to generate earnings. The ROA ratio is calculated as net income / average total assets.
(4)Core ROATA is a non-GAAP financial measure. Core ROATA is an indicator used to assess the core profitability of average tangible assets and is intended to demonstrate how efficiently management is utilizing its tangible assets to generate core net income. Core ROATA is calculated by taking the core income as a percentage of average tangible assets and is calculated as core net income / average tangible assets. Core net income is the net income adjusted to exclude certain items that are included in the financial results presented in accordance with GAAP. For more information on the non-GAAP financial measures, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(5)NIM is a performance metric that examines how successful the Bank's investment decisions are compared to its cost of funding assets and is expressed as net interest income as a percentage of average interest-earning assets. NIM is calculated as net interest income before provision for credit losses / average interest-earning assets. Net interest income is the interest earned on cash and cash equivalents, investments, loans and other interest earning assets minus the interest paid for deposits, short-term borrowings and long-term debt. The average interest-earning assets is calculated using daily average balances of interest-earning assets.
(6)Efficiency margin is a non-GAAP financial measure. Efficiency margin is an indicator used to assess operating efficiencies and is intended to demonstrate how efficiently management is controlling expenses relative to generating revenues. The efficiency margin is calculated by taking the non-interest expenses as a percentage of total net revenue before total other gains (losses) and provisions for credit losses, and is calculated as (non-interest expense - amortization of intangible assets) / (total non-interest income + net interest income before provision for credit losses). For more information on the non-GAAP financial measures, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(7)The core efficiency ratio is a non-GAAP financial measure. The core efficiency ratio is an indicator used to assess operating efficiencies and is intended to demonstrate how efficiently management is controlling expenses relative to generating revenues on our core activities. The core efficiency ratio is calculated by taking the core non-interest expenses as a percentage of total net revenue before provision for credit losses and other gains and losses and is calculated as (core non-interest expenses - amortization of intangible assets) / (core non-interest income + core net interest income before provision for credit losses). Core non-interest expenses exclude certain items that are included in the financial results presented in accordance with GAAP including income taxes and amortization of intangible assets. For more information on the non-GAAP financial measures, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(8)The fee income ratio is a measure used to determine the proportion of revenues derived from non-interest income sources. The ratio is calculated as non-interest income / (non-interest income + net interest income after provision for credit losses).
(9)The Bank's regulatory capital is determined in accordance with Basel III guidelines as issued by the BMA. The total capital ratio measures the amount of the Bank's capital in relation to the amount of risk it is taking. All banks must ensure that a reasonable proportion of their risk is covered by permanent capital. Under Basel III, Pillar I, banks must maintain a minimum total capital ratio of 13.5%, inclusive of all capital buffers. In effect, this means that 13.5% of the RWA must be covered by permanent or near
permanent capital. The risk weighting process takes into account the relative risk of various types of lending and asset placements. The higher the capital adequacy ratio a bank has, the greater the level of unexpected losses it can absorb before becoming insolvent. The tier 1 capital ratio is the ratio of the Bank's core equity capital to its total RWA. RWA is the total of all assets held by the Bank weighted by credit risk according to a formula determined by the BMA which follows the BCBS guidelines in setting formulas for asset risk weights. The CET1 ratio is equivalent to the tier 1 capital ratio except that it only includes common equity in the numerator and we must maintain a minimum CET1 ratio of 10%. The Leverage Ratio is calculated by dividing tier 1 capital by an exposure measure and banks must maintain a minimum Leverage Ratio of 5.0%. The exposure measure consists of total assets (excluding items deducted from tier 1 capital) and certain off balance sheet items converted into credit exposure equivalents as well as adjustments for derivatives to reflect credit and other risks.
(10)The TCE/TA ratio is a non-GAAP financial measure. The TCE/TA ratio is a measure used to determine how significant of an unexpected loss can be incurred by the Bank before other forms of capital, other than common equity, are impacted. The TCE/TA ratio is calculated as (common equity - intangible assets - goodwill) / tangible assets. Tangible common equity does not include the preference shareholders' equity or goodwill and intangible assets. Tangible assets are the Bank's total assets from continuing operations less goodwill and intangibles. For more information on the non-GAAP financial measures, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(11)The TE/TA ratio is a non-GAAP financial measure. The TE/TA ratio is a measure used to determine how much loss the Bank can absorb before subordinated debt capital is impacted. The TE/TA ratio is calculated as (total shareholders' equity - intangible assets - goodwill) / tangible assets. Tangible assets are the Bank's total assets from continuing operations less intangible assets and goodwill. For more information on the non-GAAP financial measures, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(12)The NPA ratio is an indicator of the credit quality of the Bank's total assets by expressing the non-performing assets as a percentage of total assets. The NPA ratio is calculated as (gross non-accrual loans + accruing loans past due 90 days + OREO) / total assets.
(13)The NACL ratio is an indicator used to assess the credit performance of the Bank's loan portfolio by calculating the non-accrual loans as a percentage of loans. The NACL ratio is calculated as gross non-accrual loans / gross total loans. Note the reference to gross implies the amounts prior to loan allowances for credit losses.
(14)The NPL ratio is an indicator used to assess the credit performance of the Bank's loan portfolio by calculating the non-performing loans as a percentage of loans. The NPL ratio is calculated as total gross non-performing loans / total gross loans.
(15)The NCO ratio is an indicator used to assess the net credit loss of the Bank's loan portfolio by calculating the net charge-offs as a percentage of average total loans. The NCO ratio is calculated as net charge-off expense / average total loans. Average total loan is calculated as the average of the month-end asset balances during the relevant period.
(16)Core net income is a non-GAAP financial measure. Core net income measures net income on a core basis. Core net income is calculated by adjusting net income for income or expense items which are not representative of the ongoing operations of our business. For a reconciliation of core net income to net income, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(17)CEACS is a non-GAAP financial measure. CEACS measures profitability attributable to common shareholders on a core basis. For a reconciliation of CEACS to net income, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(18)Core net income per common share — fully diluted is a non-GAAP financial measure. Core net income per common share — fully diluted measures core profitability attributable to common shareholders on a per share basis. For a reconciliation to net income per share, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(19)Common equity per share is calculated as total common equity / number of common shares issued and outstanding at period end.
Reconciliation of Non-GAAP Financial Measures
The tables below present computations of earnings and certain other financial measures, which exclude certain significant items that are included in the financial results presented in accordance with GAAP.
We focus on core net income in many of these measures and ratios, which we calculate by adjusting net income for income or expense items which are not representative of the ongoing operations of our business, which results in non-core gains, losses and expense measures. Core net income includes revenue, gains, losses and expense items incurred in the normal course of business. We consider the normal course of business to be the general operations of our business lines of banking and wealth management. We believe that expressing earnings and certain other financial measures excluding these non-core items provides a meaningful base for period-to-period comparisons, which management believes will assist investors in analyzing the operating results of the Bank and predicting future performance. Non-core items are determined by the CFO in conjunction with the CEO, and approved by our Board of Directors. Consideration is given as to whether the expense, gain or loss is a result of exceptional circumstances or other decisions made not in the normal course of business. Items which are not in the normal course of business, such as business acquisition costs or impairment losses, or a result of exceptional circumstances, such as business restructuring costs, are considered non-core. These non-GAAP financial measures based on core net income are also used by management to assess the performance of the Bank's business because management does not consider the activities related to the adjustments to be indications of core operations. We believe that presentation of these non-GAAP financial measures will permit investors to assess the performance of the Bank on the same basis as that applied by management. Management and the Board utilize these non-GAAP financial measures as follows:
•Preparation of the Bank's operating budgets;
•Quarterly financial performance reporting; and
•Monthly reporting of consolidated results (management reporting only).
We calculate core net income attributable to common shareholders by deducting preference dividends and guarantee fees from core net income. We calculate core net income per common share by dividing the core net income attributable to common shareholders by the average number of common shares issued and outstanding during the relevant period.
The core efficiency ratio (non-GAAP), which is a measure of productivity, is generally calculated by taking the core non-interest expenses (which is the total non-interest expenses excluding non-core non-interest expenses) as a percentage of total net revenue before provision for credit losses and other gains and losses and is calculated as (core non-interest expenses - amortization of intangible assets) / (core non-interest income + core net interest income before provision for credit losses). Management uses this ratio to monitor performance regarding the efficiency of expense management and believes this measure provides meaningful information to investors.
Tangible common shareholders' equity ratios and tangible total asset ratios have become a focus of some investors in analyzing the capital position of the Bank absent the effects of intangible assets and preference shareholders' equity. The BMA and other banking regulatory bodies assess a bank's capital adequacy based on CET1 capital, the calculation of which is codified in the Basel III framework as implemented by the BMA. Because tangible common shareholders' equity and tangible total assets are not formally defined by GAAP, these measures are considered to be non-GAAP financial measures and other entities may calculate them differently. Since analysts and banking regulators may assess the Bank's capital adequacy using tangible common shareholders' equity or tangible assets, the Bank believes that it is useful to provide investors the ability to assess the Bank's capital adequacy on this same basis. The Bank calculates tangible common equity and tangible total assets on a period-end basis. The Bank also measures
performance relative to core net income over average tangible common shareholders' equity and average tangible assets to monitor performance and efficiency relative to the Bank's capital adequacy.
We believe the non-GAAP financial measures presented in this report provide useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, these non-GAAP financial measures should not be viewed as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use.
The following tables provide: (1) a reconciliation of net income (GAAP) to core net income and core net income attributable to common shareholders (non-GAAP), (2) a computation of core net income attributable to common shareholders per common share fully diluted (non-GAAP), (3) a reconciliation of average and total shareholders' equity (GAAP) to average and total equity and average tangible common equity (non-GAAP), (4) a computation of core return to average tangible common equity (non-GAAP), (5) a reconciliation of average total assets (GAAP) to average tangible assets (non-GAAP), (6) a computation of core return on average tangible assets (non-GAAP), (7) a computation of tangible common equity to tangible assets (non-GAAP), (8) a computation of tangible total equity to tangible assets (non-GAAP), (9) a reconciliation of non-interest expenses (GAAP) to core non-interest expenses (non-GAAP), (10) a computation of the efficiency ratio (non-GAAP), and (11) a computation of the core efficiency ratio (non-GAAP).
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| | For the year ended December 31 |
(in millions of $, unless otherwise indicated) | | 2022 | | 2021 | | 2020 | |
| | | | | | | |
Reconciliation of net income (GAAP) to core net income (non-GAAP) | | | | | | | |
Net income | A | 214.0 | | | 162.7 | | | 147.2 | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Non-core (gains), losses and expenses | | | | | | | |
Non-core (gains) losses | | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Distribution from equity method investment(1) | | — | | | — | | | (0.7) | | |
| | | | | | | |
Gain on disposal of Visa Inc. Class B shares(2) | | — | | | (0.9) | | | — | | |
Total non-core (gains) losses | B | — | | | (0.9) | | | (0.7) | | |
Non-core expenses | | | | | | | |
Early retirement program, redundancies and other non-core compensation costs(3) | | 1.0 | | | 1.5 | | | 8.0 | | |
Tax compliance review costs(4) | | 0.4 | | | 0.2 | | | — | | |
| | | | | | | |
| | | | | | | |
Provision in connection with tax compliance review(4) | | 0.2 | | | 0.1 | | | — | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Total non-core expenses | C | 1.7 | | | 1.8 | | | 8.0 | | |
Total non-core (gains), losses and expenses | D=B+C | 1.7 | | | 0.9 | | | 7.3 | | |
Core net income attributable to common shareholders | E=A+D | 215.7 | | | 163.6 | | | 154.5 | | |
Reconciliation of return on equity (GAAP) to core return on average tangible common equity (non-GAAP) | | | | | | | |
Core net income attributable to common shareholders | E=A+D | 215.7 | | | 163.6 | | | 154.5 | | |
| | | | | | | |
| | | | | | | |
Average common equity | F | 833.2 | | | 965.7 | | | 981.0 | | |
Less: average goodwill and intangible assets | | (78.5) | | | (90.0) | | | (92.3) | | |
Average tangible common equity | G | 754.7 | | | 875.8 | | | 888.8 | | |
Return on equity | A/F | 25.7 | | % | 16.8 | | % | 15.0 | | % |
Core return on average tangible common equity | E/G | 28.6 | | % | 18.7 | | % | 17.3 | | % |
Reconciliation of diluted earnings per share (GAAP) to core earnings per common share fully diluted (non-GAAP) | | | | | | | |
Adjusted weighted average number of diluted common shares (in thousands) | F | 49.9 | | | 49.9 | | | 50.9 | | |
Earnings per common share fully diluted | A/J | 4.29 | | | 3.26 | | | 2.90 | | |
Non-core items per share | D/F | 0.04 | | | 0.02 | | | 0.14 | | |
Core earnings per common share fully diluted | | 4.33 | | | 3.28 | | | 3.04 | | |
Reconciliation of return on average assets (GAAP) to core return on average tangible assets (non-GAAP) | | | | | | | |
Total average assets | G | 14,596.1 | | | 15,261.8 | | | 13,618.2 | | |
Less: average goodwill and intangible assets | | (78.5) | | | (90.0) | | | (92.3) | | |
Average tangible assets | H | 14,517.6 | | | 15,171.9 | | | 13,525.9 | | |
Return on average assets | A/G | 1.5 | | % | 1.1 | | % | 1.1 | | % |
Core return on average tangible assets | E/H | 1.5 | | % | 1.1 | | % | 1.1 | | % |
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| | For the year ended December 31 |
(in millions of $, unless otherwise indicated) | | 2022 | | 2021 | | 2020 | |
Tangible equity to tangible assets | | | | | | | |
Shareholders' equity | | 864.8 | | | 977.5 | | | 981.9 | | |
Less: goodwill and intangible assets | | (74.4) | | | (86.1) | | | (92.8) | | |
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Tangible common equity | I | 790.4 | | | 891.4 | | | 889.1 | | |
Total assets | | 14,306.1 | | | 15,335.2 | | | 14,738.6 | | |
Less: goodwill and intangible assets | | (74.4) | | | (86.1) | | | (92.8) | | |
Tangible assets | J | 14,231.7 | | | 15,249.1 | | | 14,645.8 | | |
Tangible common equity to tangible assets | I/J | 5.6 | | % | 5.8 | | % | 6.1 | | % |
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Efficiency ratio | | | | | | | |
Non-interest expenses | | 331.6 | | | 333.9 | | | 344.6 | | |
Less: amortization of intangibles | | (5.7) | | | (6.0) | | | (5.8) | | |
Non-interest expenses before amortization of intangibles | K | 325.9 | | | 327.9 | | | 338.8 | | |
Non-interest income | | 206.6 | | | 198.1 | | | 183.9 | | |
Net interest income before provision for credit losses | | 343.6 | | | 299.8 | | | 317.6 | | |
Net revenue before provision for credit losses and other gains/losses | L | 550.2 | | | 497.9 | | | 501.5 | | |
Efficiency ratio | K/L | 59.2 | | % | 65.9 | | % | 67.6 | | % |
Core efficiency ratio | | | | | | | |
Non-interest expenses | | 331.6 | | | 333.9 | | | 344.6 | | |
Less: non-core expenses | C | (1.7) | | | (1.8) | | | (8.0) | | |
Less: amortization of intangibles | | (5.7) | | | (6.0) | | | (5.8) | | |
Core non-interest expenses before amortization of intangibles | M | 324.2 | | | 326.1 | | | 330.8 | | |
Core revenue before other gains and losses and provision for credit losses | N | 550.2 | | | 497.9 | | | 501.5 | | |
Core efficiency ratio | M/N | 58.9 | | % | 65.5 | | % | 66.0 | | % |
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(1)Relates to gain on distribution from an equity method investment as a result of the sale of a legacy business interest.
(2)Relates to gain on disposal of Visa Inc. Class B shares which were received as part of the restructuring of Visa U.S.A. in 2007.
(3)In 2020, primarily relates to the efficiency program, including voluntary separation, early retirement and redundancy costs. Management does not consider the costs associated with these projects to be core to the strategy of the business.
In 2021, primarily relates to redundancy costs associated with the transfer of Channel Islands banking operations functions from Mauritius to Butterfield's service centers in Canada and Guernsey.
In 2022, primarily relates to costs associated with the departure of a senior executive.
(4)Relates to the professional fees and final settlement of the US Department of Justice inquiry which commenced in 2013 and the settlement of a non-US corporate income tax inquiry in connection with the commercial affairs of a legacy custody client.
The following charts show the trajectory of our performance from 2018 to 2022:
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(1) Core Net Income to Common is a non-GAAP financial measure that is calculated by adjusting net income for income or expense items which management considers not to be representative of the ongoing operations of our business and preference share dividends, guarantee fees and premiums paid on preference share repurchases and redemptions. For a reconciliation of Core Net Income to Common to GAAP net income to common, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
(2) Core Earnings per Common Share Fully Diluted is a non-GAAP financial measure that is calculated by dividing Core Earnings to Common by the weighted average shares outstanding. For a reconciliation of Core Earnings per Common Share Fully Diluted to GAAP earnings per share, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
Our return on equity for 2022 of 25.7% and our Core ROATCE1 for 2022 of 28.6% were driven by a number of factors, including: significant fee income with historically low capital requirements; increasing market interest rates benefiting net interest income; reductions in AOCIL, specifically in the AFS investment portfolio due to higher US dollar market interest rates; and our operations in corporate income tax neutral jurisdictions. As a result, our business generated core net income in 2022 well in excess of that needed to execute our organic balance sheet growth strategy.
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(1)Core ROATCE is a non-GAAP financial measure that is calculated by dividing core earnings to common shareholders by average tangible common equity. Average tangible common equity does not include the preference shareholders' equity or goodwill and intangible assets. For more information on the non-GAAP financial measures, see Item 5.A. "Operating Results - Reconciliation of Non-GAAP Financial Measures".
The following chart shows total deposit trends for 2018 to 2022:
Historically, the markets in which we operate generate fewer loans than deposits, which has led us to take a conservative approach to managing our balance sheet. We accomplish this by maintaining a large cash balance and investing in high quality and liquid securities. The following chart illustrates our asset composition from 2018 to 2022:
As at December 31, 2022, 15% of our balance sheet was cash and cash equivalents, which included cash and demand deposits with banks, unrestricted term deposits, and treasury bills with a maturity of less than three months.
In addition to maintaining a large cash and cash equivalents balance, we also have a large and conservative securities investment portfolio. We have a disciplined investment portfolio selection process and invest in highly rated securities. We also seek to ensure that our portfolio remains liquid across market cycles: 94.7% of our portfolio was invested in US government treasuries and mortgage-backed securities issued by US governmental agencies. Our investment strategy as at December 31, 2022, aims to align the behavioral interest rate risk profile of our assets and liabilities — as at December 31, 2022, the average duration of our AFS investment portfolio was 3.6 years, the average duration of our HTM investment portfolio was 6.5 years, and the average duration of our total investment portfolio was 5.4 years. As at December 31, 2022, the total carrying value of our AFS investment portfolio was $2.0 billion, and the total carrying value of our HTM investment portfolio was $3.7 billion.
The following charts show the composition of our investment portfolio by rating and asset type from 2018 to 2022:
The combination of our significant cash and securities portfolios helps drive our capital efficient balance sheet, with risk-weighted assets equal to 33.9% of our total assets and a Basel III total capital ratio of 24.1%, each as at December 31, 2022.
Our loan underwriting process requires that we complete a full credit assessment of every customer prior to committing to a loan, which we believe has resulted in a high quality loan portfolio. Our lending markets do not have secondary markets for loans and as such we hold all of our originated loans on our balance sheet. In 2021 and 2022,
net charge-offs represented 0.05% and 0.11%, respectively, of average loans. As at December 31, 2022, our non-accrual loan balance was $63.1 million, or 1.2% of total gross loans, and our loans past due were $108.7 million or 2.1% of total gross loans, of which 77.7% were full recourse residential mortgages. As at December 31, 2022, our loan portfolio consisted of 57% floating-rate loans and 43% fixed-rate loans generally with contractual rate resets of 3 to 5 years.
The following chart shows the segment composition of our loan portfolio from 2018 to 2022:
Our loan portfolio has exhibited stability over time. The following chart shows loan portfolio trends for 2018 to 2022:
The domestic lending markets in Bermuda, the Cayman Islands, and the Channel Islands have a limited number of participants and significant barriers to entry. 69.7% of our loan balances were residential mortgages as at December 31, 2022. These loans are attractive for a number of reasons. Our mortgages have exhibited predictable cash flows, with historically negligible refinancing activity due to significant transaction costs to refinance in these lending markets. Additionally, our mortgages in these markets have historically benefited from a manual underwriting process, low LTVs (with 59% of residential loans below 70% LTV as at December 31, 2022), and a full recourse legal system.
We have also generated balanced sources of non-interest income from a well-diversified customer base. For the five-year period ended December 31, 2022, our non-interest income is evenly split between banking which consists of banking and foreign exchange revenue, and wealth management, which consists of trust, asset management, and custody and other administration services.
Fee income from a typical trust client serviced in our wealth management business line is driven primarily by the size and complexity of our clients’ assets and holdings, which are generally diversified across multiple geographies; the performance of these businesses is not typically linked to the performance of the domestic economies of our local markets. Non-interest income represented 37.7% of our total Net Revenue (our fee income ratio) in 2022, and contributed significantly to the Company’s high Core ROATCE and excess capital generation as limited capital is required for our fee income business.
The following chart shows our various sources of non-interest income from 2018 to 2022:
2022 Non-Interest Income: $206.6 million / 37.7% Fee Income Ratio
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(1) Foreign exchange revenue represents income generated from client-driven transactions in the normal course of business. We do not engage in proprietary trading.
Growth Opportunities
We expect that, all else being equal, a rising interest rate environment would increase our net interest income before provision for credit losses because an increase in our cost of deposits would lag an increase in yield of our cash, securities and loans. In addition, a significant portion of our deposits are non-interest bearing (23% as at December 31, 2022), and as a result, a portion of our funding is only partially sensitive to rising rates. Our non-interest bearing deposit balances have historically exhibited low correlation with market interest rates, a behavior that we attribute in part to a sizable client base that utilizes our bank for custody and clearing services as well as cash management purposes. Potential changes to our net interest income in hypothetical rising and declining rate scenarios, measured over a 12-month period, are presented in the chart below (these projections assume parallel shifts of the yield curves occurring immediately and no changes in other potential variables):
A negative 100 basis points interest rate shock reflects a reduction in projected 12-month net interest income of 5.6% compared to the flat rate scenario. The loss of income is driven by lower loan and investment yields, which more than offset reduced rates paid on deposits. Mitigating against the loss of income is the potential to charge negative interest rates on deposits (which we did for certain currencies in 2020 and 2021 in the low interest rate environment) and certain loans that have rate floors. Refer to discussion under "- Risk Management".
In addition, we are well-positioned as an acquirer of certain businesses, in private trust and banking. Our acquisition strategy seeks to capitalize on opportunities created by international financial institutions and trust companies that wish to simplify their businesses and deploy capital to other markets or business lines. We consider a wide range of potential acquisition opportunities, and we have a well-defined, disciplined approach to identifying potential acquisition targets across numerous criteria including: geography, business alignment, size, timing, quality, buyer universe and financial hurdles. Our focus has been on the private trust business and banking in our core markets where we have expertise, scale and a strong brand.
In October 2017, we entered into an agreement to acquire Deutsche Bank’s Global Trust Solutions business, excluding its US operations. This transaction added the ongoing management and administration of the GTS portfolio, comprising approximately 1,000 trust structures for approximately 900 private clients in Guernsey, Switzerland, the Cayman Islands, and Singapore. As part of the deal, we also purchased a service company in Mauritius to provide operations and support services to the Cayman and Channel Islands banking and custody businesses. This transaction was completed in March 2018.
In February 2018, we entered into an agreement to acquire Deutsche Bank’s banking and custody business in the Cayman Islands, Jersey and Guernsey, which provide services primarily to financial intermediaries and corporate clients. The Bank began to onboard certain customer deposits relating to the acquisition in 2018, and this activity was completed in the first half of 2019.
In April 2019, we entered into an agreement to acquire ABN AMRO (Channel Islands) Limited which provides banking, investment management and custody products to three distinct client groups, including trusts, private clients, and funds in Jersey and Guernsey. The transaction was completed in July 2019.
In September 2022, we entered into an agreement to acquire the Credit Suisse global trust businesses operating in Singapore, Guernsey and The Bahamas. This transaction is expected to close in the latter half of 2023.
Our relationship-driven business model and international corporate clientele have allowed us to develop a stable core deposit base with historically low funding costs. We believe our customers’ deposit activity has historically been relatively inelastic to deposit pricing given the nature of corporate activity and competition in retail deposit taking in our segments. From 2018 to 2022, deposits have grown at a CAGR of approximately at +5% in the Cayman Islands and +21% in the Channel Islands and the UK while it has remained flat in Bermuda, taking into account the Deutsche Bank's banking and custody businesses acquisition in February 2018 that added $0.9 billion of new deposits, and the ABN AMRO (Channel Islands) acquisition in April 2019 that added $3.5 billion in deposits. As at December 31, 2022, we had $13.0 billion in deposits at a cost of 0.34%, of which 23% were non-interest bearing demand deposits, 53% were interest bearing demand deposits with a weighted-average cost of 0.12%, and 24% were term deposits with a weighted-average cost of 2.54% and an average contractual or remaining maturity of 101 days. We believe the current market conditions in Bermuda, the Cayman Islands, and the Channel Islands will allow us to continue to benefit from favorable deposit pricing, despite the pricing pressure experienced in the Channel Islands in 2022.
Consolidated Results of Operations and Discussion for Fiscal Years Ended December 31, 2022, 2021 and 2020
Net Revenue
2022 vs. 2021
Total net revenue before provision for credit losses and other gains and losses for 2022 was $550.2 million, up $52.3 million, or 10.5%, from 2021. Net interest income before provision for credit losses increased from $299.8 million in 2021 to $343.6 million in 2022, an increase of $43.8 million, or 14.6%, which was primarily due to higher margins on all interest-earning assets and liabilities as major central banks raised interest rates with 10-year US Treasuries reaching their highest levels since 2008. Loan interest income increased by $27.8 million to $249.4 million as yields increased by 64 basis points. The average volume of loans outstanding decreased by $106.4 million. The decrease was driven by the Channel Islands and UK segment as a result of a decrease in the GBP/USD foreign exchange rate, the maturity and early repayment of a few commercial facilities and partially offset by the extension of a government facility in the Cayman Islands. Investment interest income increased by $13.9 million to $115.8 million, the average volume of investments increased by $0.4 billion, and yields on investments increased by 12 basis points. Deposits with banks interest income increased by $31.8 million, or 2,199.2%, whilst the average volume decreased by $839.6 million as a result of reduced depositor funding. The total cost of deposits increased by $29.7 million or 191.6%, reflecting a 23 basis points increase to 34 basis points, driven by pricing pressure in the more competitive Channel Islands markets. In addition, non-interest income was up by $8.5 million, or 4.3%, principally attributable to volume-driven increases in both banking and foreign exchange revenue coupled with one-off loan restructuring and breakage fees.
2021 vs. 2020
Total net revenue before provision for credit losses and other gains and losses for 2021 was $497.9 million, down $3.5 million, or 0.7%, from 2020. Net interest income before provision for credit losses decreased from $317.6 million in 2020 to $299.8 million in 2021, a decline of $17.8 million, or 5.6%, and was due to margin declines across interest earning assets driven by lower global market interest rates. Loan interest income decreased by $9.1 million to $221.5 million as yields decreased by 28 basis points due to lower rates, the repayment of a few large commercial facilities and paydowns in the higher-yielding Bermuda residential mortgage portfolio. The average volume of loans outstanding increased by $138.2 million. Cayman and the Channel Islands and UK segments saw growth in their residential mortgage portfolios, which was partially offset by the repayment of a number of commercial and commercial real estate facilities in Bermuda and the Channel Islands and UK segments during the period. Investment interest income decreased by $7.3 million to $101.9 million, the average volume of investments increased by $1.2 billion, and yields on investments decreased by 62 basis points due to the aforementioned decrease in global market interest rates, increasing prepayment speeds with re-investment at lower rates in the investment portfolio. Deposits with banks interest income decreased by $10.7 million, or 88.1%, the average volume increased by $441.6 million which was driven by corporate deposit funding increases in Cayman and the Channel Islands, and partially offset by expected corporate deposit decreases in Bermuda. The total cost of deposits improved by $9.6 million or 38.3%, reflecting a 10 basis points decrease to 11 basis points. In addition, non-interest income was up by $14.2 million, or 7.7%, principally attributable to volume-driven increases in both banking and foreign exchange revenue coupled with higher facility non-utilization fees and one-off loan breakage fees.
Net Interest Income Before Provision for Credit Losses
Net interest income is the amount of interest earned on our interest-earning assets less interest paid on our interest bearing liabilities. There are several drivers of the change in net interest income, including changes in the volume and mix of interest-earning assets and interest bearing liabilities, their relative sensitivity to interest rate movements, and the proportion of non-interest bearing sources of funds, such as equity and non-interest bearing current accounts.
The following table presents the components of net interest income for the years ended December 31, 2022, 2021 and 2020:
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| | Year ended December 31 |
| | 2022 | | 2021 | | 2020 |
(in millions of $) | | Average balance ($) | Interest ($) | Average rate (%) | | Average balance ($) | Interest ($) | Average rate (%) | | Average balance ($) | Interest ($) | Average rate (%) |
Assets | | | | | | | | | | | | |
Cash and cash equivalents, securities purchased under agreements to resell, and short-term investments | | 3,132.6 | | 33.2 | | 1.06 | % | | 3,972.2 | | 1.4 | | 0.04 | % | | 3,530.6 | | 12.1 | | 0.34 | % |
Investment in securities | | 6,058.1 | | 115.8 | | 1.91 | % | | 5,693.2 | | 101.9 | | 1.79 | % | | 4,512.5 | | 109.2 | | 2.41 | % |
Loans | | 5,093.5 | | 249.4 | | 4.90 | % | | 5,199.9 | | 221.5 | | 4.26 | % | | 5,061.7 | | 230.7 | | 4.54 | % |
Interest earning assets | | 14,284.3 | | 398.4 | | 2.79 | % | | 14,865.3 | | 324.9 | | 2.19 | % | | 13,104.9 | | 352.0 | | 2.68 | % |
Other assets | | 370.3 | | | — | | | 367.4 | | | — | | | 395.4 | | | — | |
Total assets | | 14,654.6 | | 398.4 | | 2.72 | % | | 15,232.7 | | 324.9 | | 2.13 | % | | 13,500.3 | | 352.0 | | 2.60 | % |
Liabilities | | | | | | | | | | | | |
Deposits | | 10,269.1 | | (45.2) | | (0.44) | % | | 10,845.3 | | (15.5) | | (0.14) | % | | 9,710.8 | | (25.1) | | (0.26) | % |
Securities sold under agreement to repurchase | | 0.6 | | — | | (3.95) | % | | — | | — | | — | % | | — | | — | | — | % |
Long-term debt | | 172.1 | | (9.6) | | (5.58) | % | | 171.7 | | (9.6) | | (5.59) | % | | 173.4 | | (9.3) | | (5.35) | % |
Interest bearing liabilities | | 10,441.8 | | (54.8) | | (0.52) | % | | 11,016.9 | | (25.1) | | (0.23) | % | | 9,884.2 | | (34.4) | | (0.35) | % |
Non-interest bearing current accounts | | 3,033.3 | | | | | 2,895.0 | | | | | 2,363.9 | | | |
Other liabilities | | 284.3 | | | | | 295.1 | | | | | 280.6 | | | |
Total liabilities | | 13,759.3 | | (54.8) | | (0.40) | % | | 14,207.0 | | (25.1) | | (0.18) | % | | 12,528.6 | | (34.4) | | (0.27) | % |
Shareholders' equity | | 895.3 | | | | | 1,025.7 | | | | | 971.7 | | | |
Total liabilities and shareholders' equity | | 14,654.6 | | | | | 15,232.7 | | | | | 13,500.3 | | | |
Non-interest bearing funds net of non-interest earning assets (free balance) | | 3,842.5 | | | | | 3,848.4 | | | | | 3,220.7 | | | |
Net interest margin | | | 343.6 | | 2.41 | % | | | 299.8 | | 2.02 | % | | | 317.6 | | 2.42 | % |
2022 vs. 2021
Net interest income before provision for credit losses of $343.6 million in 2022 represented an increase of $43.8 million (or 14.6%) compared to 2021. Net interest income is generated by our main segments of Bermuda, the Cayman Islands, and the Channel Islands and the UK. Interest income increased by $73.5 million in 2022, which was driven by higher market interest rates across the yield curve as major central banks increased rates in response to inflation concerns.
Loan interest income increased in 2022 by $27.8 million as base rate increases in all segments increased during the year. The yield pick-up was partially offset by a decline in average balances driven by the maturity and early repayment of a few commercial facilities.
Investment interest income increased by $13.9 million, primarily driven by the increase in the US treasury rates. The overall duration of the portfolio at year-end was 5.4 years, an increase of 1.2 years from 2021 as prepayments slowed in response to the rising rate environment.
Interest bearing liability costs increased to 52 basis points, which resulted in an increase in interest expense by $29.7 million, attributable to the active repricing of deposits in response to market conditions, particularly in the Channel Islands and UK segment.
Average free balances for 2022 were $3.8 billion (2021: $3.8 billion), including non-interest bearing current accounts of $3.0 billion (2021: $2.9 billion), shareholders' equity of $895.3 million (2021: $1,025.7 million), net of other assets and other liabilities totaling $86.0 million (2021: $72.3 million). See "-Risk Management" below for more information on how interest rate risk is managed.
2021 vs. 2020
Net interest income before provision for credit losses of $299.8 million in 2021 represented a decrease of $17.8 million (or 5.6%) over our net interest income before provision for credit losses in 2020. Net interest income is generated by our main segments of Bermuda, the Cayman Islands, and the Channel Islands and the UK. Interest income decreased by $27.1 million in 2021, which was driven by lower market interest rates across the yield curve.
Loan interest income decreased in 2021 by $9.1 million due to lower rates, the repayment of a few large commercial facilities and paydowns in the higher-yielding Bermuda residential mortgage portfolio.
Investment interest income decreased by $7.3 million, primarily driven by increased paydowns and reinvestment at lower yields in the low market rate environment. This was partially offset by an increase of $1.2 billion in average investment balances which was driven by both increased depositor funding and the redeployment of funds from cash and cash equivalents. The overall duration of the portfolio at year-end was 4.2 years, an increase of 1.5 years from 2020.
Interest bearing liability costs decreased to 23 basis points, which resulted in a decrease in interest expense of $9.3 million, attributable to the active repricing of deposits in response to market conditions.
Average free balances for 2021 were $3.8 billion (2020: $3.2 billion), including non-interest bearing current accounts of $2.9 billion (2020: $2.4 billion), shareholders' equity of $1,025.7 million (2020: $971.7 million), net of other assets and other liabilities totaling $72.3 million (2020: $114.9 million). See "-Risk Management" below for more information on how interest rate risk is managed.
Provision for Credit Losses
2022 vs. 2021
Our net provision for credit losses in 2022 was a charge of $2.4 million compared to a release of $3.1 million in 2021. The movement is due to weaker macroeconomic forecasts impacting future expected credit loss estimates, the extension of a large, long-term government facility in the Cayman Islands and charge-offs on a commercial facility.
2021 vs. 2020
Our net provision for credit losses in 2021 was a release of $3.1 million compared to a charge of $8.5 million in 2020. Provisions decreased due to both the improvement in macroeconomic forecasts impacting future expected credit loss estimates and a reduction in non-performing loans.
Other Gains (Losses)
The following table represents the components of other gains (losses) for the years ended December 31, 2022, 2021 and 2020:
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| | For the year ended December 31 | | Dollar Change | | Percent Change |
(in millions of $) | | 2022 | 2021 | 2020 | | 2021 to 2022 | 2020 to 2021 | | 2021 to 2022 | 2020 to 2021 |
Net gains (losses) on equity securities | | — | | 0.1 | | 0.7 | | | (0.1) | | (0.6) | | | (100.0) | % | (85.7) | % |
Net realized gains (losses) on available-for-sale investments | | — | | (0.2) | | 1.2 | | | 0.2 | | (1.4) | | | (100.0) | % | (116.7) | % |
Net gains (losses) on other real estate owned | | 0.4 | | (0.1) | | (0.1) | | | 0.5 | | — | | | (500.0) | % | — | % |
| | | | | | | | | | |
Net other gains (losses) | | 1.1 | | (1.2) | | (0.6) | | | 2.3 | | (0.6) | | | (191.7) | % | 100.0 | % |
Total other gains (losses) | | 1.5 | | (1.4) | | 1.2 | | | 2.9 | | (2.6) | | | (207.1) | % | (216.7) | % |
Net Gains (Losses) on Equity Securities
The balance in 2021 reflected the net realized gain on the sale of seed investments in Butterfield mutual funds. The balance in 2020 reflected lower mark-to-market gains on equity securities, partly due to mark-to-market losses recognized earlier in 2020 due to market volatility as a result of the COVID-19 pandemic.
Net Realized Gains (Losses) on Available-for-Sale Investments
Net realized losses of $0.2 million were recorded in 2021 and gains of $1.2 million in 2020. In 2021, the loss was due to the strategic disposal of lower yielding explicitly guaranteed and implicitly guaranteed US government and federal agency securities. In 2020, the gain was due to the strategic decision to liquidate floating rate and purchase fixed rate US government and federal agency securities.
Net Gains (Losses) on Other Real Estate Owned
Valuation adjustments and realized gains and losses related to real estate held for sale resulted in gains of $0.4 million in 2022 compared to losses of $0.1 million in 2021 and $0.1 million in 2020. In 2022, these gains relate to the disposal of foreclosed property in the Channel Islands and UK segment. In 2021 and 2020, these losses relate to the net revaluation losses on foreclosed properties.
Net Other Gains (Losses)
Net other gains were $1.1 million in 2022 compared to net other losses of $1.2 million in 2021 and $0.6 million in 2020. The gains in 2022 mainly relate to the reversal of a defined benefit settlement accounting adjustment in the Channel Islands and UK segment recorded in the previous year. The aforementioned losses in 2021 were partially offset by a gain on the disposal of Visa Inc. Class B shares which were received as part of the restructuring of Visa U.S.A. in 2007 and which management considers to be non-core. The losses in 2020 relate to a defined benefit pension plan adjustment offset by a distribution from an equity method investment as a result of the sale of a legacy business interest.
Non-Interest Income
Non-interest income represents capital efficient and stable revenue sources for the Group. Non-interest income is derived primarily from banking, including cards, foreign exchange commissions, asset management fees as well as trust fees. Our trust fee structure provides for varied pricing that depends primarily on the size of the relationship and the nature of services provided. As a result, it is not always possible to draw a direct relationship between the value of client assets and the level of non-interest income, though the trend of non-interest income generally follows the trend in client asset levels.
Total non-interest income increased by $8.5 million from $198.1 million in 2021 to $206.6 million in 2022. Non-interest income as a percentage of total net revenue decreased from 39.5% in 2021 to 37.7% in 2022 as a result of the increased contribution of net interest income to total net revenue in the rising rate environment.
Total non-interest income increased by $14.2 million from $183.9 million in 2020 to $198.1 million in 2021. Non-interest income as a percentage of total net revenue increased from 37.3% in 2020 to 39.5% in 2021.
The following table presents the components of non-interest income for the years ended December 31, 2022, 2021 and 2020:
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| | For the year ended December 31 | | Dollar change | | Percent change |
(in millions of $) | | 2022 | 2021 | 2020 | | 2021 to 2022 | 2020 to 2021 | | 2021 to 2022 | 2020 to 2021 |
Asset management | | 29.7 | | 29.9 | | 29.2 | | | (0.2) | | 0.7 | | | (0.7) | % | 2.4 | % |
Banking | | 57.1 | | 51.9 | | 47.3 | | | 5.2 | | 4.6 | | | 10.0 | % | 9.7 | % |
Foreign exchange revenue | | 47.8 | | 43.4 | | 37.2 | | | 4.4 | | 6.2 | | | 10.1 | % | 16.7 | % |
Trust | | 52.3 | | 52.9 | | 50.7 | | | (0.6) | | 2.2 | | | (1.1) | % | 4.3 | % |
Custody and other administration services | | 13.6 | | 15.2 | | 13.8 | | | (1.6) | | 1.4 | | | (10.5) | % | 10.1 | % |
Other non-interest income | | 6.0 | | 4.8 | | 5.6 | | | 1.2 | | (0.8) | | | 25.0 | % | (14.3) | % |
Total non-interest income | | 206.6 | | 198.1 | | 183.9 | | | 8.5 | | 14.2 | | | 4.3 | % | 7.7 | % |
Asset Management
Asset management revenues are generally based on the market value of assets managed and the volume of transactions and fees for other services rendered. We provide asset management services from our offices in Bermuda, the Cayman Islands, and the Channel Islands. Revenues from asset management were $29.7 million in 2022, compared to $29.9 million in 2021, and $29.2 million in 2020.
The table that follows shows the changes in the year-end values of clients' assets under management, sub-divided between those managed for clients on a discretionary basis and client funds invested in mutual funds that Butterfield manages ("Butterfield Funds"):
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| | Year ended December 31 | | Dollar Change |
(in millions of $) | | 2022 | 2021 | 2020 | | 2021 to 2022 | 2020 to 2021 |
Butterfield Funds | | 1,753 | | 1,758 | | 2,029 | | | (5) | | (271) | |
Other assets under management | | 3,296 | | 3,740 | | 3,529 | | | (444) | | 211 | |
Total assets under management | | 5,049 | | 5,498 | | 5,558 | | | (449) | | (60) | |
2022 vs. 2021
Asset management fees are generated primarily from management fees earned from Butterfield Funds and discretionary portfolios, as well as custody and brokerage fees. AUM decreased by $0.4 billion to $5.0 billion as at December 31, 2022, compared to $5.5 billion as at December 31, 2021, driven by reduced discretionary portfolio values in Bermuda and Cayman and the impact of the strengthening of the USD on the Channel Islands discretionary portfolio values. Asset management fees earned remained flat at $29.7 million compared to 2021.
2021 vs. 2020
Asset management fees are generated primarily from management fees earned from Butterfield Funds and discretionary portfolios, as well as custody and brokerage fees. AUM were relatively unchanged at $5.5 billion as at December 31, 2021, compared to $5.6 billion as at December 31, 2020. Asset management fees earned increased by $0.7 million or 2.4% in 2021, compared to 2020. This was driven by an increase in brokerage fees coupled with market growth and new business, primarily in the Channel Islands and Cayman Islands.
Banking
We provide a full range of community, commercial, and private banking services in select jurisdictions. Banking services are offered to individuals and small to medium-sized businesses through branch locations, internet banking, automated teller machines, debit and credit cards, and mobile banking in Bermuda and the Cayman Islands, while private banking services are offered in Bermuda, the Cayman Islands, and Guernsey. Banking revenues reflect loan, transaction processing, and other fees earned in these jurisdictions.
Banking fee revenues increased by 10.0% in 2022 to $57.1 million, compared to $51.9 million in 2021, primarily due to volume-driven increases in both banking and foreign exchange revenue coupled with one-off loan restructuring and breakage fees.
Banking fee revenues increased by 9.7% in 2021 to $51.9 million, compared to $47.3 million in 2020, primarily due to volume-driven increases from increased economic activity and higher facility non-utilization and one-off breakage fees.
Foreign Exchange
We provide foreign exchange services in the normal course of business in all jurisdictions. The major contributors to foreign exchange revenues are Bermuda and the Cayman Islands, accounting for 81% of our foreign exchange revenue (2021: 78%; 2020: 79%). We do not maintain a proprietary trading book. Foreign exchange income is generated from client-driven transactions and totaled $47.8 million in 2022, compared to $43.4 million in 2021 and $37.2 million in 2020. The $4.4 million increase from 2021 to 2022 and $6.3 million increase from 2020 to 2021 were primarily due to volume-driven increases driven by market volatility in 2022 and increased economic activity in 2021.
Trust
We provide both personal and institutional fiduciary services from our operations in Bermuda, The Bahamas, the Cayman Islands, Guernsey, Singapore and Switzerland. Revenues are derived from a combination of fixed fees, fees based on the size and complexity of the trust relationship and fees based on time spent in relation to the range of personal trust and company administration services and pension and employee benefit trust services we provide.
In 2022, trust revenues represented 25.3% of our non-interest income, slightly down from 26.7% in 2021. In 2022, trust revenues totaled $52.3 million, $0.6 million lower than 2021. This was driven by lower contributions by the Channel Islands and UK segment impacted by the strengthening USD as well as lower special and accounting fees charged. This was partially offset by net new business and increased activity-based fees charged in Bermuda and Cayman.
In 2021, trust revenues represented 26.7% of our non-interest income, down from 27.5% in 2020. In 2021, trust revenues totaled $52.9 million, an increase of $2.2 million or 4.4% over 2020. This increase was driven primarily by higher activity-based fees.
Trust AUA remained relatively flat at $106.2 billion at the end of 2022 compared to the end of 2021.
Custody and Other Administration Services
Custody fees are generally based on market values of assets in custody, the volume of transactions and flat fees for other services rendered. We provide custody services from our offices in Bermuda, Guernsey, and Jersey. In 2022, revenues were $13.6 million, a decrease of $1.6 million from 2021 due to lower market values impacting the AUA. From 2020 to 2021, revenues increased by $1.4 million due to the on-boarding of new business.
Total AUA for the custody and other administration services business were $32.2 billion on December 31, 2022, a decrease from $36.8 billion as at December 31, 2021 and $32.4 billion as at December 31, 2020.
Other Non-Interest Income
The components of our other non-interest income for the years ended December 31, 2022, 2021 and 2020 are set forth in the following table:
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| | Year ended December 31 | | Dollar Change | | Percent Change |
(in millions of $) | | 2022 | 2021 | 2020 | | 2021 to 2022 | 2020 to 2021 | | 2021 to 2022 | 2020 to 2021 |
Net share of earnings from equity method investments | | — | | 0.1 | | 0.6 | | | (0.1) | | (0.4) | | | (100.0) | % | (66.7) | % |
Rental income | | 1.8 | | 2.2 | | 1.7 | | | (0.4) | | 0.5 | | | (18.2) | % | 29.4 | % |
Other | | 4.1 | | 2.5 | | 3.3 | | | 1.6 | | (0.8) | | | 64.0 | % | (24.2) | % |
Total other non-interest income | | 5.9 | | 4.8 | | 5.6 | | | 1.1 | | (0.8) | | | 22.9 | % | (14.3) | % |
In 2021, we recorded our net share of earnings from equity method investments as a gain of $0.1 million, a $0.4 million decrease due to lower equity pick-up by equity method investments. Rental income decreased by $0.4 million to $1.8 million in 2022 due to a reduction in tenants as Bermuda's Head Office undergoes refurbishment. In 2021, rental income increased by $0.5 million from 2020 to 2021 due to increased sub-let income in the Channel Islands. Increases in the "Other" category are due to the scheduled recognition of long-held unclaimed assets.
Non-Interest Expenses
Expense management continued to be a key focus in 2022 with management targeting a 60% efficiency ratio through the cycle. Total non-interest expenses in 2022 were $331.6 million compared to $333.9 million in 2021 and $344.6 million in 2020. These figures include non-core expenses in 2022, 2021 and 2020 of $1.7 million, $1.8 million and $8.0 million, respectively.
After adjusting for these non-core items, 2022 core expenses decreased by $2.2 million or 0.7% with a corresponding decrease in the core efficiency ratio to 58.9% from 65.5% in 2021, driven by the uplift in revenue in the rising rate environment. From 2020 to 2021, core non-interest expenses decreased by $4.5 million with a corresponding decrease in the core efficiency ratio to 65.5% from 66.0% in 2020.
In 2022, salaries and other employee benefits accounted for 50.1% of non-interest expenses, with technology and communications and property making up 26.6% combined.
The following table presents the components of non-interest expenses for the years ended December 31, 2022, 2021 and 2020:
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| | Year ended December 31 | | Dollar Change | | Percent Change |
(in millions of $) | | 2022 | 2021 | 2020 | | 2021 to 2022 | 2020 to 2021 | | 2021 to 2022 | 2020 to 2021 |
Salaries and other employee benefits | | 166.2 | | 161.3 | | 173.7 | | | 4.9 | | (12.3) | | | 3.0 | % | (7.1) | % |
Technology and communications | | 56.7 | | 63.8 | | 65.2 | | | (7.1) | | (1.3) | | | (11.1) | % | (2.0) | % |
Professional and outside services | | 19.6 | | 21.4 | | 21.3 | | | (1.8) | | 0.1 | | | (8.2) | % | 0.6 | % |
Property | | 31.4 | | 30.9 | | 29.4 | | | 0.6 | | 1.5 | | | 1.9 | % | 5.0 | % |
Indirect taxes | | 22.0 | | 22.1 | | 21.3 | | | (0.1) | | 0.8 | | | (0.5) | % | 3.6 | % |
Non-service employee benefits expense | | 3.8 | | 3.9 | | 2.6 | | | (0.1) | | 1.2 | | | (2.9) | % | 47.3 | % |
Marketing | | 6.4 | | 4.6 | | 4.4 | | | 1.8 | | 0.1 | | | 39.4 | % | 2.7 | % |
| | | | | | | | | | |
Amortization of intangible assets | | 5.7 | | 6.0 | | 5.8 | | | (0.3) | | 0.2 | | | (5.5) | % | 3.3 | % |
Other non-interest expenses | | 19.8 | | 19.9 | | 20.9 | | | (0.1) | | (1.0) | | | (0.6) | % | (4.7) | % |
Total non-interest expenses | | 331.6 | | 333.9 | | 344.6 | | | (2.3) | | (10.7) | | | (0.7) | % | (3.1) | % |
Non-core items (Non-GAAP) | | (1.7) | | (1.8) | | (8.0) | | | 0.1 | | 6.2 | | | (5.6) | % | (77.5) | % |
Core non-interest expenses (Non-GAAP) | | 329.9 | | 332.1 | | 336.6 | | | (2.2) | | (4.5) | | | (0.7) | % | (1.3) | % |
For a full reconciliation of GAAP net income to core net income, please see Item 5.A. "Operating Results — Reconciliation of Non-GAAP Financial Measures".
Salaries and Other Employee Benefits
Total salaries and other employee benefits costs were $166.2 million in 2022, an increase of $4.9 million compared to 2021. Included in 2022 were $1.0 million of non-core expenses in relation to the departure of a senior executive. Included in 2021 were $1.5 million of non-core expenses in relation to redundancy costs associated with the transfer of Channel Islands banking operations functions from Mauritius to Butterfield's service centers in Canada and Guernsey. In 2020, $8.0 million relates to COVID-19 related cost restructure programs (voluntary separation and redundancy costs).
Core salaries, which exclude these amounts, and other employee benefits costs were $165.2 million in 2022, up $5.3 million compared to $159.9 million in 2021 primarily due to higher staff incentive accruals and inflationary salary adjustments. From 2020 to 2021, core salaries decreased by $5.8 million primarily due to the resulting benefits from previous restructuring programs.
Headcount on a full-time equivalency basis at the end of 2022 was 1,341, compared to 1,277 in 2021 and 1,314 in 2020. The increase in 2022 from 2021 was mostly a result of the Service Center expansion in Halifax and Mauritius. The decrease in 2021 from 2020 was a result of the COVID-19 related cost restructuring program, which included voluntary separation, early retirement and redundancies across all operating segments.
Technology and Communications
Technology and communication costs reflect expenses relating to the support for our IT infrastructure and decreased by $7.1 million from 2021 to 2022 and by $1.3 million from 2020 to 2021, all due to the depreciation of the Bank's core banking system outpacing costs associated with the new technology projects.
Professional and Outside Services
Professional and outside services primarily include consulting, legal, audit and other professional services. Professional and outside services costs were $19.6 million in 2022, lower compared to $21.4 million in 2021 due to lesser outsourced consultancy and legal professionals. From 2020 to 2021, professional and outside services costs were relatively flat.
Property
Property costs, which reflect occupancy expenses, building maintenance, and depreciation of property, plant and equipment, increased by $0.6 million from 2021 to 2022 and by $1.5 million from 2020 to 2021, driven by the continued investment in property projects and renovations of our Head Office branch in Bermuda.
Indirect Taxes
These taxes reflect taxes levied in the jurisdictions in which we operate, including employee-related payroll taxes, customs duties, and business licenses. In 2022, the expense was $22.0 million which remains flat when compared with 2021. From 2020 to 2021, indirect taxes increased by $0.8 million which mainly relates to the elevated deposit and gross asset volumes which impact deposit insurance and financial services tax contributions, increased insurance costs, banking license fees and partially offset by lower payroll taxes due to reduced headcount. Of the $22.0 million in indirect taxes, $17.2 million was paid to the Bermuda government agencies for payroll tax, business licenses, deposit insurance, land taxes, and financial services tax and $4.8 million was paid to other governments for business licenses, insurance tax, land taxes and work permit fees.
Marketing
Marketing expenses reflect costs incurred in advertising and promoting our products and services. Marketing expenses totaled $6.4 million in 2022, an increase of $1.8 million compared to 2021 due to increased sponsored event costs during the year. From 2020 to 2021, marketing expenses were relatively flat.
Amortization of Intangible Assets
Intangible assets relate to client relationships acquired from business acquisitions and are amortized on a straight-line basis over their estimated useful lives, not exceeding 15 years. The estimated lives of these acquired intangible assets are re-evaluated annually and tested for impairment. The amortization expense associated with intangible assets was $5.7 million in 2022 compared to $6.0 million in 2021 and $5.8 million in 2020. Amortization decreased by $0.3 million from 2021 to 2022 and increased by $0.2 million from 2020 to 2021, all due to the impact of foreign currency exchange rates.
Other Non-Interest Expenses
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| | For the year ended December 31 | | Dollar Change | | Percent Change |
(in millions of $) | | 2022 | 2021 | 2020 | | 2021 to 2022 | 2020 to 2021 | | 2021 to 2022 | 2020 to 2021 |
Stationery & supplies | | 1.0 | | 1.0 | | 1.2 | | | — | | (0.2) | | | 2.1 | % | (13.5) | % |
Custodian & handling | | 3.4 | | 3.4 | | 3.0 | | | (0.1) | | 0.4 | | | (1.6) | % | 14.5 | % |
Charitable donations | | 1.1 | | 1.1 | | 1.6 | | | (0.1) | | (0.4) | | | (6.1) | % | (27.6) | % |
Professional lines insurance | | 4.2 | | 3.9 | | 3.7 | | | 0.3 | | 0.3 | | | 6.6 | % | 7.3 | % |
Other expenses | | 10.1 | | 10.4 | | 11.5 | | | (0.3) | | (1.1) | | | (2.6) | % | (9.5) | % |
Total other non-interest expenses | | 19.8 | | 19.9 | | 20.9 | | | (0.1) | | (1.0) | | | (0.6) | % | (4.7) | % |
Other non-interest expenses of $19.8 million in 2022 were relatively flat compared to 2021.
From 2020 to 2021, other non-interest expenses decreased by $1.0 million, driven by lower operational losses and write-offs.
Income Taxes
Each jurisdiction in which we operate is subject to different corporate income tax laws. See Item 3.D. "Risk Factors - Regulatory and Tax-Related Risks". We are incorporated in Bermuda as a local company and, pursuant to Bermuda law, not obligated to pay any direct corporate taxes in Bermuda on either income or capital gains. Our subsidiaries in the Cayman Islands and The Bahamas are not subject to any taxes on either income or capital gains under current laws applicable in the respective jurisdictions. In general, entities in Bermuda and the Cayman Islands are not subject to corporate income taxes but are required to pay higher rates of indirect taxes (included above) such as license fees and, in Bermuda, payroll taxes and import duties.
Our subsidiaries in the UK, Guernsey, Jersey, Switzerland, Canada, Singapore, and Mauritius are subject to the tax laws of those jurisdictions. See "Note 25 Income taxes" in the Audited Consolidated Financial Statements for a reconciliation between the effective income tax rate and the statutory income tax rate.
In 2022, income tax expense netted to an expense of $3.7 million compared to $3.1 million in 2021. The increase of $0.6 million in 2022 was driven by increased profitability in our Channel Islands and UK segment and partially offset by changes in the deferred tax valuation allowance. The increase of $0.7 million in 2021 was driven by an increase in profitability in our Guernsey subsidiary, changes in the deferred tax valuation allowance and offset by the impact of a change in tax rates.
Consolidated Balance Sheet and Discussion
The following table shows the balance sheet as reported as at December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | |
| | As at December 31 | | |
(in millions of $) | | 2022 | 2021 | | Dollar Change | Percent Change |
Assets | | | | | | |
Cash and cash equivalents | | 2,101 | | 2,180 | | | (79) | | (3.6) | % |
Securities purchased under agreement to resell | | 60 | | 96 | | | (36) | | (37.5) | % |
Short-term investments | | 884 | | 1,199 | | | (315) | | (26.3) | % |
Investment in securities | | 5,727 | | 6,237 | | | (510) | | (8.2) | % |
Loans, net of allowance for credit losses | | 5,096 | | 5,241 | | | (145) | | (2.8) | % |
Premises, equipment and computer software | | 146 | | 139 | | | 7 | | 5.0 | % |
Goodwill and intangibles | | 74 | | 86 | | | (12) | | (14.0) | % |
Other assets | | 217 | | 158 | | | 59 | | 37.3 | % |
Total assets | | 14,306 | | 15,335 | | | (1,029) | | (6.7) | % |
| | | | | | |
Liabilities | | | | | | |
Total deposits | | 12,991 | | 13,870 | | | (879) | | (6.3) | % |
Total other liabilities | | 278 | | 316 | | | (38) | | (12.0) | % |
Long-term debt | | 172 | | 172 | | | — | | — | % |
Total liabilities | | 13,441 | | 14,358 | | | (917) | | (6.4) | % |
| | | | | | |
Common shareholders' equity | | 865 | | 977 | | | (112) | | (11.5) | % |
Total shareholders' equity | | 865 | | 977 | | | (112) | | (11.5) | % |
Total liabilities and shareholders' equity | | 14,306 | | 15,335 | | | (1,029) | | (6.7) | % |
| | | | | | | | | | | |
| | As at December 31 |
| | 2022 | 2021 |
Capital Ratios | | | |
Risk-weighted assets | | 4,843 | 5,101 |
Tangible common equity (TCE) | | 790 | 891 |
Tangible assets (TA) | | 14,232 | 15,249 |
TCE/TA | | 5.6 | % | 5.8 | % |
Common Equity Tier 1 | | 20.3 | % | 17.6 | % |
Total Tier 1 | | 20.3 | % | 17.6 | % |
Total Capital | | 24.1 | % | 21.2 | % |
Leverage ratio | | 6.7 | % | 5.6 | % |
We maintain a liquid balance sheet and are well capitalized. As at December 31, 2022, total cash and cash equivalents, short-term investments and investment in securities represented $8.8 billion, or 61.3% of total assets, down from 63.3% at the end of 2021. Shareholders' equity at December 31, 2022 was $864.8 million, down from $977.5 million at the end of 2021 due primarily to the unrealized losses on AFS investments included in AOCIL in 2022 as a result of rising long-term US dollar interest rates and partially offset by net income for the year net of dividends paid and shares repurchased.
Total assets decreased by $1.0 billion to $14.3 billion from 2021 to 2022, primarily due to the decrease in depositor funding which is reflected in the decrease in cash and cash equivalents, short-term investments and investment in securities balances.
As at December 31, 2022, our capital ratios were strong, and were significantly in excess of regulatory requirements. The Bank's regulatory capital is determined in accordance with current Basel III guidelines as issued by the BMA.
The TCE/TA ratio at the end of 2022 was 5.6% (2021: 5.8%), while the CET1 and total Tier 1 capital ratios at the end of 2022 were 20.3% (2021: 17.6%) and 20.3% (2021: 17.6%), respectively. These ratios continue to remain in excess of regulatory minimums at December 31, 2022.
Cash and cash equivalents, Securities Purchased Under Agreement to Resell and Short-Term Investments
We only place deposits with highly-rated institutions and ensure that there is appropriate geographic and sector diversification in our exposures. Limits are set for aggregate geographic exposures and for every counterparty for which we place deposits. Those limits are monitored and reviewed by our Credit Risk Management division and approved by the Financial Institutions Committee. We define cash and cash equivalents to include cash on hand, cash items in the process of collection, amounts due from correspondent banks and liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of change in fair value. Such investments are those with less than three months maturity from the date of acquisition and include unrestricted term deposits, certificates of deposit and treasury bills. Investments of a similar nature that are either restricted or have a contractual maturity of more than three months but one year or less are classified as short-term investments. Securities purchased under agreement to resell are treated as collateralized lending transactions, and are referred to as repurchase agreements. We utilize repurchase agreements to manage liquidity. The risks of these transactions include changes in the fair value in the securities posted or received as collateral and other credit-related events. The Bank manages these risks by ensuring that the collateral involved is appropriate and by monitoring the value of the securities posted or received as collateral on a daily basis.
As at December 31, 2022, cash and cash equivalents, securities purchased under agreements to resell and short-term investments were $3.0 billion, compared to $3.5 billion as at December 31, 2021. The decrease from 2021 to 2022 is primarily due to the decrease in depositor funding.
See "Note 3: Cash and cash equivalents", "Note 4: Short-term investments" and "Note 12: Credit related arrangements, repurchase agreements and commitments" to our audited consolidated financial statements as at and for the year ended December 31, 2022 for additional tables and information.
Investment in Securities
Our investment policy requires management to maintain a portfolio of securities that provide the liquidity necessary to cover our obligations as they come due, and mitigate our overall exposure to credit and interest rate risk, while achieving a satisfactory return on the funds invested. The securities in which we invest are limited to securities that are considered investment grade. Securities in our investment portfolio are accounted for as either equity securities at fair value, AFS or HTM. Investment policies are approved by the Board, governed by the Group Asset and Liability Committee and monitored by Group Market Risk, a department of the Group Risk Management division.
Consistent with industry and rating agency designations, we define investment grade as "BBB" or higher. As at December 31, 2022, 100% (2021: 100%) of our total investments were investment grade. Of these securities, 100% (2021: 100%) are rated "A" or higher.
The following table presents the carrying value of investment securities by balance sheet category as at December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | |
| | As at December 31 | | | | |
(in millions of $) | | 2022 | 2021 | | Dollar Change | | Percent Change |
| | | | | | | |
Available-for-sale | | 1,989 | | 3,474 | | | (1,485) | | | (42.7) | % |
Held-to-maturity | | 3,738 | | 2,763 | | | 975 | | | 35.3 | % |
Total Investment in Securities | | 5,727 | | 6,237 | | | (510) | | | (8.2) | % |
The investments were placed almost exclusively in US government and federal agency securities totaling $4.9 billion, based upon carrying value, or 95.2% of the total investment portfolio, as at December 31, 2022. Total net unrealized losses in the investment portfolio were $761.3 million, compared to net unrealized gains of $0.4 million at the end of 2021. The movement in unrealized losses for the year was a result of rising long-term US dollar interest rates. The 10-year treasury rate was 3.87% as of December 31, 2022 compared to 1.51% the year before.
Equity securities at fair value remains flat at $0.2 million at the end of 2022. As at December 31, 2022, the equity securities at fair value consisted of real estate mutual funds.
AFS securities totaled $2.0 billion at the end of 2022, compared to $3.5 billion at the end of 2021. As at December 31, 2022, 86.1% or $1.7 billion (2021: 90.5%, or $3.1 billion) of AFS securities consisted of holdings of securities issued by the US government and federal agencies. As at December 31, 2022, the remaining 13.9%, or $276.1 million of AFS securities (2021: 9.5% or $330.1 million) was comprised primarily of guaranteed student loan-backed securities of 0.3%, or $5.6 million (2021: 0.4%, or $13.2 million), debt securities issued by non-US governments of 12.6%, or $251.5 million (2021: 8.3%, or $289.6 million) and residential mortgage-backed securities of 1.0%, or $19.0 million (2021: 0.8%, or $27.3 million). The overall decrease in US government and federal agency securities was due to the Q1 and Q2 transfers totaling $1.0 billion of securities from the AFS to HTM portfolio at fair value and the increase in total net unrealized losses from rising long-term US dollar interest rates`. Securities were transferred from the AFS to HTM portfolio in order to mitigate any further downward impacts to AOCIL as a result of the rapidly rising interest rate environment.
HTM investments were $3.7 billion as at December 31, 2022 (2021: $2.8 billion) and consisted entirely of mortgage-backed securities issued by US federal agencies that management does not intend to sell before contractual maturity. The increase in US government and federal agency securities was due to the aforementioned transfer of $1.0 billion of securities from the AFS to HTM portfolio at fair value and offset by scheduled paydowns.
Investment Valuation — Impairment and Credit Loss Considerations
Securities in unrealized loss positions are analyzed as part of management's ongoing assessment of impairment and credit losses. For debt securities, where management does not expect to recover the entire amortized cost basis of the security and intends to sell such securities or it is more likely than not that the Bank will be required to sell the securities before recovering the amortized cost, it recognizes an impairment loss equal to the full difference between the amortized cost basis and the fair value of those securities through the income statement. Following the recognition of impairment, the security's new amortized cost basis is the previous basis less impairment.
When management does not intend to sell or it is more likely than not that the Bank will hold such securities until recovering the amortized cost, management determines whether any credit losses exist. See "Note 2.H: Investments" and "Note 2.J: Allowance for Credit Losses".
While management sold AFS securities during 2022 and 2021, these securities were sold for a net loss of minimal amount in 2022 and $0.2 million in 2021. The sale in 2022 involved asset-backed securities-student loans. The sale in 2021 involved selling US agency securities as part of a portfolio rebalancing strategy in order to manage duration and interest rate sensitivity. This also included selling lower yielding explicitly guaranteed US agency securities and purchasing higher yielding implicitly guaranteed US agency securities. Management does not have the intention or does not foresee a more likely than not scenario where the Bank will be required to sell any further securities which are in an unrealized loss position, and accordingly, management has concluded that these sales are not credit loss indicators for any remaining securities in a loss position as at December 31, 2022.
See "Note 5: Investment in securities" to our audited consolidated financial statements as at December 31, 2022 for additional tables and information.
Loans
The loan portfolio decreased from $5.2 billion at the end of 2021 to $5.1 billion as at December 31, 2022. The decrease was driven by the impact of the strengthening of the US dollar on GBP denominated balances, the early repayment of a number of commercial facilities and partially offset by the extension of a government facility in the Cayman Islands.
The loan portfolio represented 35.6% of total assets as at December 31, 2022 (2021: 34.2%), while loans as a percentage of total deposits increased from 37.8% at the end of 2021 to 39.2% at the end of 2022. The increase in both ratios were attributable principally to a decrease in deposit balances at December 31, 2022 driven by the expected withdrawal of some pandemic-related deposits as well as the impact of the strengthening US dollar on non-US dollar denominated balances.
Allowance for credit losses as at December 31, 2022 totaled $25.0 million, a decrease of $3.1 million from the prior year. The movement was driven by a decrease in provisioned non-accrual loans, net paydowns and foreign exchange movements in the portfolio. This was partially offset by slightly weaker economic forecasts and the extension of a large, long-term government facility in the Cayman Islands.
Gross non-accrual loans totaled $63.1 million as at December 31, 2022, $2.0 million higher than $61.0 million as at December 31, 2021, and represented 1.2% of the total loan portfolio as at December 31, 2022, compared to 1.2% as at December 31, 2021.The increase in non-accrual loans was driven by a few residential mortgages in the Channel Islands and UK segment moving into non-accrual and partially offset by a number of Bermuda residential mortgages improving to current status. In 2022, we held OREO amounting to $0.8 million (2021: $0.7 million), a decrease of $0.1 million due to the foreclosure of three loans in the Bermuda and Channel Islands and UK segments and which was partially offset by the sale of three properties in the Bermuda and Channel Islands and UK segments.
Overall, the credit quality of the Bank's lending portfolio held steady from December 31, 2021 to December 31, 2022.
Government
Loans to governments were $281.5 million, which was a $21.9 million increase from 2021, due primarily to the extension of a long-term facility to the Cayman Islands Government and partially offset by the repayment of facilities in Bermuda and the Channel Islands.
Commercial
The commercial and industrial loan portfolio includes loans and overdraft facilities advanced primarily to corporations and small and medium-sized entities, which are generally not collateralized by real estate and where loan repayments are expected to flow from the operation of the underlying businesses.
Commercial real estate loans are offered to real estate investors, developers and builders based primarily in Bermuda and the Cayman Islands. To manage our credit exposure on such loans, the principal collateral is real estate held for commercial purposes and is supported by a registered mortgage. Cash flows from the properties, primarily from rental income, are generally supported by non-cancellable long-term leases to high quality international businesses. These cash flows are generally sufficient to service the loan. The portfolio decreased by $65.8 million to $627.3 million at December 31, 2022.
Commercial loans outstanding as at December 31, 2022 were $441.9 million, which represented a decrease of $36.4 million from the previous year driven by the repayment of two facilities in Bermuda and Cayman and the maturity of a facility in Bermuda.
Residential
The residential mortgage portfolio comprises mortgages to clients with whom we are seeking to establish (or already have) a comprehensive financial services relationship. It includes mortgages to individuals and corporate loans secured by residential property.
All mortgages were underwritten utilizing our stringent credit standards. See Item 5.A. "Operating Results". Residential loans consist of conventional home mortgages and equity credit lines.
As at December 31, 2022, residential mortgages totaled $3.6 billion (or 69.7% of total gross loans), a $52.8 million decrease from December 31, 2021. This decrease was attributed mainly to the impact of the strengthening USD exchange rate on the Channel Islands and UK mortgage books, repayments exceeding new loan growth in Bermuda and partially offset by net new loan growth in the Cayman Islands.
Other Loan Portfolios
We provide loans, as part of our normal banking business, in respect of automobile financing, consumer financing, credit cards, commercial financing, loans to financial institutions and overdraft facilities to retail, corporate and private banking clients in the jurisdictions in which we operate. As at December 31, 2022, other consumer loans totaled $200.5 million (or 3.9% of total gross loans), a $14.3 million decrease from December 31, 2021. This was primarily driven by the completion of residential construction projects in the Cayman Islands.
See "Note 6: Loans" and "Note 7: Credit risk concentrations" to our audited consolidated financial statements as at December 31, 2022 for more information on our loan portfolio and contractual obligations and arrangements.
Deposits
Deposits are our principal funding source for use in lending, investments and liquidity. We are a deposit-led bank and do not require the use of wholesale or institutional markets to fund our loan business. See Item 5.A. "Operating Results - Liquidity Risk" and "- Credit Risk". Deposit balances at the end of reporting periods can fluctuate due to significant balances that flow in and out from private trust, fund and insurance clients to meet quarter-end operational requirements.
The table below shows the year-end and average total deposit balances by jurisdiction for the year ended and as at December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | As at December 31 | | Dollar change | | Average balance | | Dollar change |
(in millions of $) | | 2022 | | 2021 | | | 2022 | | 2021 | |
Bermuda | | 4,488 | | | 4,511 | | | (23) | | | 4,658 | | | 4,616 | | | 42 | |
Cayman Islands | | 4,293 | | | 4,612 | | | (319) | | | 4,437 | | | 4,400 | | | 37 | |
Channel Island and the UK | | 4,210 | | | 4,747 | | | (537) | | | 4,208 | | | 4,724 | | | (516) | |
| | | | | | | | | | | | |
Total deposits | | 12,991 | | | 13,870 | | | (879) | | | 13,303 | | | 13,740 | | | (437) | |
Average total deposits decreased by $0.4 billion to $13.3 billion in 2022. On a year-end basis, total deposits were down by $0.9 billion from $13.7 billion at the end of 2021. The decrease in deposit balances was driven by the normalization of pandemic surge deposit levels and the impact of a strengthening US dollar on non-US dollar denominated deposits.
Demand deposits, which include checking accounts (both interest bearing and non-interest bearing), savings and call accounts, totaled $9.9 billion, or 76.1% of total deposits at the end of 2022, compared to $10.9 billion or 78.8%, at the end of 2021. Term deposits increased by $0.2 billion to $3.1 billion compared to the prior year. The cost of funds on deposits increased from 11 basis points in the full year ended 2021 to 34 basis points in 2022 primarily due to higher market interest rates. Average non-interest bearing deposits increased to $3.0 billion from $2.9 billion in 2021.
Included in total deposits are deposits from banks of $12.6 million at the end of 2022, down from $26.4 million at the end of 2021.
See "Note 10: Deposits" to our audited consolidated financial statements as at December 31, 2022 for additional tables and information.
Borrowings
We have no issuances of certificates of deposit ("CD"), commercial paper ("CP") or senior notes outstanding and have no CD or CP issuance programs. We use funding from the inter-bank market as part of interest rate risk and liquidity management. As at December 31, 2022, deposits from banks totaled $12.6 million, $13.8 million lower than the prior year.
Employee Future Benefits
We maintain trusteed pension plans including non-contributory defined benefit plans and a number of defined contribution plans, and provide post-retirement healthcare benefits to our qualifying retirees. The defined benefit provisions under the pension plans are generally based upon years of service and average salary during the final years of employment. The defined benefit pension and post-retirement healthcare plans are not open to new participants, are non-contributory and thus the funding required is provided by us, based upon the advice of an independent actuary. The defined benefit pension plans are in the Bermuda, Guernsey and UK jurisdictions, and the defined benefit post-retirement medical plan is in Bermuda. The Bank also has a residual obligation in addition to its defined contribution plan in Mauritius.
Effective December 31, 2011, the Bermuda defined benefit pension benefits were amended to freeze credited service and final average earnings for remaining active members. Effective January 2012, all the participants of the Bermuda defined benefit pension plan are inactive and in accordance with GAAP, the net actuarial loss of the Bermuda defined benefit pension plan is amortized over the estimated average remaining life expectancy of the inactive participants of 22.8 years. Prior to all Bermuda participants being inactive, the net actuarial loss of the Bermuda defined benefit pension plan was amortized to net income over the estimated average remaining service period for active members of 4.5 years.
Effective September 30, 2014, the defined benefit pension benefits of our Guernsey operations were amended to freeze credited service and final average earnings for remaining active members. The benefits amendment resulted in a further reduction in the Guernsey defined benefit pension liability of $4.6 million as at September 30, 2014.
Effective October 2014, all of the participants of the Guernsey defined benefit pension plan are inactive and in accordance with GAAP, the net actuarial loss of the Guernsey defined benefit pension plan will be amortized over the estimated average remaining life expectancy of the inactive participants of 39 years. Prior to all Guernsey participants being inactive, the net actuarial loss of the Guernsey defined benefit pension plan was amortized to net income over the estimated average remaining service period for active members of 15 years.
For the year ended December 31, 2014, numerous changes in the plan provisions were made to align the plan provisions with our administrative practices resulting in a further increase in the Bermuda defined benefit post-retirement healthcare plan liability of $7.9 million. We amortize prior service credit resulting from plan amendments that occurred when plan members were active employees, on a linear basis over the expected average remaining service period (to full eligibility) of active members expected to receive benefits under the plan. Such remaining service periods are as follow: 3.1 years for the 2010 plan amendments and 4.6 years for the 2011 plan amendments. Plan amendments occurring in 2014 resulted in the recognition of new prior service cost on December 31, 2014 on a plan for which substantially all members are now inactive and, in accordance with GAAP, we have elected to amortize this new prior service cost on a linear basis over 21 years, which is the average remaining life expectancy of members eligible for benefits under the plan at the time of the amendments.
As at December 31, 2022, we had a net obligation for employee future benefits in the amount of $92.0 million, down $34.2 million (27.1%) from $126.2 million at the end of 2021. The decrease was driven primarily by experienced gains from increases in discount rate assumptions used to measure the obligation.
See "Note 11: Employee benefit plans" to our audited consolidated financial statements as at December 31, 2022 for additional tables and information.
Long-Term Debt, Interest Payments and Maturities
We had outstanding issuances of long-term debt with a carrying value of $172.3 million as at December 31, 2022 and $171.9 million as at December 31, 2021, all issued in US Dollars. On June 11, 2020, the Bank issued US $100 million of Subordinated Lower Tier II capital notes. The notes were issued at par and are due on June 15, 2030. The issuance was by way of a registered offering with US institutional investors. The notes are listed on the BSX in the specialist debt securities category. The proceeds of the issue were used, amongst other, to repay the entire amount of the US $45 million outstanding subordinated notes series 2005-B which matured on July 2, 2020 and the entire amount of the US $25 million outstanding subordinated notes series 2008-B which were eligible for redemption. As at December 31, 2022, all of our outstanding long-term debt was eligible for inclusion in our Tier 2 regulatory capital base, limited to 50% of Tier 1 capital.
The following table presents the contractual maturity, interest rates and principal outstanding as at December 31, 2022:
| | | | | | | | | | | | | | | | | |
Long-term debt (in millions of $) | Earliest date redeemable at the Bank's option | Contractual maturity date | Interest rate until date redeemable | Interest rate from earliest date redeemable to contractual maturity | Principal outstanding |
| | | | | |
| | | | | |
2018 issuance | June 1, 2023 | June 1, 2028 | 5.25% | 3 months US$ LIBOR + 2.255% | 75.0 |
2020 issuance | June 15, 2025 | June 15, 2030 | 5.25% | 3 months US$ SOFR + 5.060% | 100.0 |
Unamortized debt issuance costs | | | | | (2.7) |
Total | | | | | 172.3 |
| | | | | |
See "Note 19: Long-term debt" to our audited consolidated financial statements as at December 31, 2022 for additional information.
Other Liabilities
Other liabilities include operating lease liabilities, derivative liabilities, current employee salaries and benefits payable and related payroll tax, as well as sundry liabilities. Other liabilities decreased by $3.5 million to $185.9 million as at December 31, 2022. The decrease was a result of decreased mark-to-market losses on derivatives and offset by higher sundry liabilities.
Leases
In the normal course of operation, the Bank enters into leasing agreements either as the lessee or the lessor, mostly for office and parking spaces as well as for small office equipment. The Bank recognizes right-of-use assets and lease liabilities for operating leases. Lease liabilities are measured as the present value of future lease payments, including term renewals that are reasonably certain to occur, discounted using the Bank’s incremental borrowing rate. The Bank has used the rate of its June 11, 2020 debt issuance as the incremental borrowing rate for existing lease liabilities and, for any new leases commencing in 2023 but recognized as at December 31, 2022, has adjusted this rate upwards to reflect the movements in relevant reference rate indices since this issuance.
The terms of the existing leases, including renewal options that are reasonably certain to be exercised, extend up to the year 2035. Certain lease payments will be adjusted during the related leases’ terms based on movements in the relevant consumer price index.
See "Note 13: Leases" to our audited consolidated financial statements as at December 31, 2022 for additional information.
Repurchase Agreements
We also obtain funds from time to time from the sale of securities to institutional investors under repurchase agreements. In a repurchase agreement transaction, we will generally pledge investment securities as collateral in a borrowing transaction, agreeing to repurchase the identical security on a specified later date, generally not more than 90 days, at a price greater than the original sales price. The difference between the sale price and repurchase price is the cost of the use of the proceeds, or interest expense. The investment securities underlying these agreements may be delivered to securities dealers who arrange such transactions as collateral for the repurchase obligation. Repurchase agreements represent a cost competitive funding source and also provide liquidity on agency paper for us. However, we are subject to the risk that the borrower of the securities may default at maturity and not return the collateral. In order to minimize this potential risk when entering into such transactions, we generally deal with large, established investment brokerage firms with whom we have master repurchase agreements. Repurchase transactions are accounted for as collateralized financing arrangements rather than as sales of such securities, and the obligation to repurchase such securities is reflected as a liability in our consolidated financial statements. As at December 31, 2022 and 2021, there were no repurchase agreements outstanding.
Shareholders' Equity
Shareholders' equity decreased during the year ended December 31, 2022 by $112.7 million to $864.8 million.
Increases totaling $273.0 million included:
•$214.0 million of net income for the year;
•$41.9 million from adjustments to employee benefit plans; and
•$17.1 million for share-based compensation and settlements.
The increases were offset by the following decreases of $385.7 million:
•$87.3 million of common share dividends;
•$3.9 million from net increases in treasury shares;
•$4.8 million from net change in unrealized gains (losses) on translation of net investment in foreign operations;
•$91.3 million from net change in unrealized gains (losses) on HTM investments; and
•$198.4 million from net change in unrealized gains (losses) on AFS investments.
Segment Overview
The Bank is managed by the Chairman & CEO on a geographic basis. The Bank presents four reportable segments, three geographical and one other: Bermuda, Cayman Islands, Channel Islands and the UK, and Other. The Other segment is composed of several non-reportable operating segments that have been aggregated in accordance with GAAP. Each reportable segment has a managing director who reports to the Chairman & CEO. The Chairman & CEO and the segment managing director have final authority over resource allocation decisions and performance assessment.
Transactions between segments are accounted for on an accrual basis and are all eliminated upon consolidation. The Bank generally does not allocate assets, revenues and expenses among its business segments, with the exception of certain corporate overhead expenses and loan participation revenue and expenses. Loan participation revenue and expenses are allocated pro-rata based on the percentage of the total loan funded by each jurisdiction participating in the loan.
Bermuda (Including Head Office)
For more than 150 years, Bermuda has served as home to our headquarters and remains our largest jurisdiction in terms of number of employees and business volume. The following table provides certain financial information for our Bermuda segment for the years ended December 31, 2022, 2021 and 2020.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Summary Income Statement | | For the year ended December 31 | Dollar change | Percent change |
(in millions of $) | | 2022 | 2021 | 2020 | 2021 to 2022 | 2020 to 2021 | 2021 to 2022 | 2020 to 2021 |
Net interest income | | 161.9 | | 146.0 | | 159.6 | | 15.9 | | (13.6) | | 10.9 | % | (8.5) | % |
Provision for credit recoveries (losses) | | (1.2) | | 2.2 | | (8.8) | | (3.4) | | 11.0 | | (154.5) | % | 125.0 | % |
Non-interest income | | 87.9 | | 84.6 | | 85.2 | | 3.3 | | (0.6) | | 3.9 | % | (0.7) | % |
Net revenue before other gains (losses) | | 248.6 | | 232.8 | | 236.0 | | 15.8 | | (3.2) | | 6.8 | % | (1.4) | % |
Operating expenses | | (188.7) | | (186.8) | | (192.8) | | (1.9) | | 6.0 | | 1.0 | % | (3.1) | % |
Net income before other gains (losses) | | 59.9 | | 46.0 | | 43.2 | | 13.9 | | 2.8 | | 30.2 | % | 6.5 | % |
Total other gains (losses) | | — | | 0.9 | | 2.0 | | (0.9) | | (1.1) | | (100.0) | % | (55.0) | % |
Net income | | 59.9 | | 46.9 | | 45.2 | | 13.0 | | 1.7 | | 27.7 | % | 3.8 | % |
| | | | | | | | | | | | | | | | | |
Summary Balance Sheet | | As at December 31 | | |
(in millions of $) | | 2022 | 2021 | Dollar change | Percent change |
Total deposits | | 4,488 | | 4,511 | | (23) | | (0.5) | % |
Loans, net of allowance for credit losses | | 1,879 | | 2,023 | | (144) | | (7.1) | % |
Total assets | | 5,405 | | 5,728 | | (323) | | (5.6) | % |
Assets under administration | | | | | |
Custody and other administration services | | 14,534 | | 16,099 | | (1,565) | | (9.7) | % |
Trust | | 57,617 | | 54,452 | | 3,165 | | 5.8 | % |
Assets under management | | | | | |
Butterfield Funds | | 1,529 | | 1,531 | | (2) | | (0.1) | % |
Other assets under management | | 2,046 | | 2,272 | | (226) | | (9.9) | % |
Total assets under management | | 3,575 | | 3,803 | | (228) | | (6.0) | % |
Number of employees | | 413 | | 413 | | — | | — | % |
2022 vs. 2021
Net income before other gains and losses was $59.9 million for the year ended December 31, 2022, up by $13.9 million from $46.0 million in the prior year. This increase is due principally to the following movements in net interest income, provision for credit losses, non-interest income and operating expenses:
Net interest income before provision for credit losses increased by $15.9 million to $161.9 million in 2022, driven primarily by higher market interest rates across the yield curve.
There is a provision for credit losses of $1.2 million in 2022 compared to a provision for credit recoveries of $2.2 million in 2021. The movement is due to weaker macroeconomic forecasts impacting future expected credit loss estimates and charge-offs on a commercial facility.
Non-interest income increased by $3.3 million to $87.9 million in 2022. This was primarily due to higher banking income and foreign exchange revenue as a result of one-off breakage fees and increased volumes; increased asset management fees due to an increase in net asset values driven by rising rates and increased trust income driven by new business and accounting fees. These increases were partially offset by lower custody and other administration fees driven by declining AUAs from market declines and decreases in other income due to the timing of recognizing unclaimed assets.
Operating expenses increased by $1.9 million to $188.7 million in 2022 which was driven by the increase in staff related costs due to higher staff incentive accruals and costs associated with the departure of a senior executive recorded as a non-core item; increased professional and outside services costs due to an increase in inter-company charges related to increased staff levels in support centers and higher marketing costs driven by an increase in sponsored event costs. This was partially offset by a decrease in technology and communications cost due to the depreciation charges on the existing core banking system in the prior year continuing to outpace costs associated with the new technology projects.
Total assets as at December 31, 2022 were $5.4 billion, down $0.3 billion from December 31, 2021. Total deposits were $4.5 billion in December 31, 2022, mostly flat from December 31, 2021, and loan balances at December 31, 2022 were $144.0 million lower at $1.9 billion, driven by the early repayment of government and other commercial facilities.
Client AUA for the trust and custody businesses as at December 31, 2022 were $57.6 billion and $14.5 billion, respectively, while assets under management were $3.6 billion. This compares with $54.5 billion, $16.1 billion and $3.8 billion, respectively, as at December 31, 2021.
2021 vs. 2020
Net income before other gains and losses was $46.0 million for the year ended December 31, 2021, up by $2.8 million from $43.2 million in the prior year. This increase is due principally to the following movements in net interest income, provision for credit losses, non-interest income and operating expenses:
Net interest income before provision for credit losses decreased by $13.6 million to $146.0 million in 2021, due primarily to the impact of lower market rates across the yield curve as a result of the COVID-19 pandemic, which was partially offset by lower deposit costs.
There was a provision for credit recoveries of $2.2 million in 2021 compared to a provision for credit losses of $8.8 million in 2020. The movement is due to both the improvement in macroeconomic forecasts impacting future expected credit loss estimates and a reduction in non-performing loans.
Non-interest income decreased by $0.6 million to $84.6 million in 2021. This was primarily due to lower administration fees on loan participations; lower asset management fees and reduced dividends as a result of the liquidation of a private equity investment. These decreases were partially offset by increases in foreign exchange revenue, trust income and custody income from higher volumes, increased fees and onboarding of new clients during the year, respectively.
Operating expenses decreased by $6.0 million to $186.8 million in 2021 which was driven by the decrease in staff related costs due primarily to the resulting benefits from previous restructuring programs and partially offset by increases in property maintenance costs and non-service employee benefits expense due to increased costs from the post-retirement medical benefit plan.
Total assets as at December 31, 2021 were $5.7 billion, down $0.2 billion from December 31, 2020. Total deposits were $4.5 billion in December 31, 2021, down $0.3 billion from December 31, 2020, and loan balances at December 31, 2021 were relatively flat at $2.0 billion.
Client AUA for the trust and custody businesses as at December 31, 2021 were $54.5 billion and $16.1 billion, respectively, while assets under management were $3.8 billion. This compares with $53.5 billion, $16.1 billion and $4.0 billion, respectively, as at December 31, 2020.
Cayman Islands
We are a leading financial services provider in the Cayman Islands, offering a comprehensive range of personal and corporate financial services. In addition to our strong retail presence, we are focused on the provision of wealth management services including private banking, asset management and trust services.
We have continued to enhance our client delivery channels and online and mobile banking platform upgrades. With four banking centers in desirable locations and 17 ATMs strategically located in Grand Cayman, we continue to be a leading provider of financial services locally. The following table provides certain financial information for our Cayman Islands segment for the years ended December 31, 2022, 2021 and 2020.
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Summary Income Statement | | For the year ended December 31 | Dollar change | Percent change |
(in millions of $) | | 2022 | 2021 | 2020 | 2021 to 2022 | 2020 to 2021 | 2021 to 2022 | 2020 to 2021 |
Net interest income | | 115.9 | | 91.0 | | 95.4 | | 24.9 | | (4.4) | | 27.4 | % | (4.6) | % |
Provision for credit (losses) recoveries | | (0.6) | | 1.4 | | 0.5 | | (2.0) | | 0.9 | | (142.9) | % | 180.0 | % |
Non-interest income | | 66.7 | | 58.1 | | 49.3 | | 8.6 | | 8.8 | | 14.8 | % | 17.8 | % |
Net revenue before other gains (losses) | | 182.0 | | 150.5 | | 145.2 | | 31.5 | | 5.3 | | 20.9 | % | 3.7 | % |
Operating expenses | | (62.1) | | (58.9) | | (62.6) | | (3.2) | | 3.7 | | 5.4 | % | (5.9) | % |
Net income before other gains (losses) | | 119.9 | | 91.5 | | 82.6 | | 28.4 | | 8.9 | | 31.0 | % | 10.8 | % |
Total other gains (losses) | | — | | 0.2 | | 0.4 | | (0.2) | | (0.2) | | (100.0) | % | (50.0) | % |
Net income | | 119.9 | | 91.7 | | 83.0 | | 28.2 | | 8.7 | | 30.8 | % | 10.5 | % |
| | | | | | | | | | | | | | | | | |
Summary Balance Sheet | | As at December 31 | | |
(in millions of $) | | 2022 | 2021 | Dollar change | Percent change |
Total deposits | | 4,293 | | 4,612 | | (319) | | (6.9) | % |
Loans, net of allowance for credit losses | | 1,270 | | 1,137 | | 133 | | 11.7 | % |
Total assets | | 4,566 | | 4,973 | | (407) | | (8.2) | % |
Assets under administration | | | | | |
Custody and other administration services | | 3,444 | | 4,396 | | (952) | | (21.7) | % |
Trust | | 6,614 | | 8,008 | | (1,394) | | (17.4) | % |
Assets under management | | | | | |
Butterfield Funds | | 175 | | 163 | | 12 | | 7.4 | % |
Other assets under management | | 622 | | 702 | | (80) | | (11.4) | % |
Total assets under management | | 797 | | 866 | | (69) | | (8.0) | % |
Number of employees | | 244 | 241 | | 3 | | 1.2 | % |
2022 vs. 2021
Net income before other gains and losses for the year ended December 31, 2022 was $119.9 million, up by $28.4 million from $91.5 million in 2021. This increase is due principally to the following movements in net interest income, provision for credit losses, non-interest income and operating expenses:
Net interest income before provision for credit losses was $115.9 million in 2022, up by $24.9 million compared to 2021. The increase from 2021 to 2022 was due to higher market interest rates across the yield curve.
Provision for credit losses of $0.6 million in 2022 represented a decrease of $2.0 million compared to credit recoveries of $1.4 million in 2021. The decrease was driven by the extension of a large, long-term government facility in the Cayman Islands as well as decreasing macroeconomic forecasts impacting future expected credit loss estimates.
Non-interest income was $66.7 million, up $8.6 million from 2021 driven by favorable volume variances impacting banking and foreign exchange revenue and the scheduled recognition of unclaimed assets.
Operating expenses increased by $3.2 million from 2021 to $62.1 million in 2022, driven by an increase in staff related costs due to higher staff incentive accruals coupled with higher property maintenance costs. The increases were partially offset by a decrease in technology and communications costs due to the existing core banking system being fully depreciated in the prior year.
Total assets as at December 31, 2022 were $4.6 billion, down $0.4 billion from December 31, 2021, reflecting lower depositor funding levels. Net loans were up at $1.3 billion at December 31, 2022 mainly from the extension of a government facility in the Cayman Islands and residential mortgage growth.
Client AUA for the trust and custody businesses were $6.6 billion and $3.4 billion, respectively, while AUM were $0.8 billion at December 31, 2022. This compares with $8.0 billion, $4.4 billion and $0.9 billion, respectively, on December 31, 2021.
2021 vs. 2020
Net income before other gains and losses for the year ended December 31, 2021 was $91.5 million, up by $8.9 million from $82.6 million in 2020. This increase is due principally to the following movements in net interest income, provision for credit losses, non-interest income and operating expenses:
Net interest income before provision for credit losses was $91.0 million in 2021, down by $4.4 million compared to 2020. The decrease from 2020 to 2021 was due primarily to the impact of lower market rates across the yield curve as a result of the COVID-19 pandemic and was partially offset by lower deposit costs.
Provision for credit recoveries of $1.4 million in 2021 represented an increase of $0.9 million compared to credit recoveries of $0.5 million in 2020. The favorable variance was mainly due to the completion of a large condominium development and repayment of the associated construction loan during the year.
Non-interest income was $58.1 million, up $8.8 million from 2020 driven by increased economic activity impacting card service fee contributions and foreign exchange transactional volumes coupled with higher non-utilization fees on certain credit facilities.
Operating expenses decreased by $3.7 million from 2020 to $58.9 million in 2021, driven by a decrease in staff related costs due primarily to the resulting benefits from previous restructuring programs and lower technology and communications costs due to lower depreciation costs which is outpacing the new system roll-out. This was partially offset by an increase in professional and outside services due to higher intercompany charges from increased utilization of our Canadian service center.
Total assets as at December 31, 2021 were $5.0 billion, up $0.5 billion from December 31, 2020, reflecting higher depositor funding levels. Net loans were relatively stable at $1.1 billion at December 31, 2021 with growth in residential mortgage lending offsetting repayments from commercial facilities.
Client AUA for the trust and custody businesses were $8.0 billion and $4.4 billion, respectively, while AUM were $0.9 billion at December 31, 2021. This compares with $7.6 billion, $3.2 billion and $0.8 billion, respectively, on December 31, 2020.
Channel Islands and the UK
The Channel Islands and UK segment includes the jurisdictions of Guernsey, Jersey (both in the Channel Islands), and the UK. In the Channel Islands, a broad range of services are provided to private clients and financial institutions including private banking, corporate banking and treasury services, internet banking, wealth management, mortgage lending and fiduciary services. In 2021, the segment entered the local mortgage market offering various products to local residents. The UK jurisdiction provides mortgages for high-value residential properties. The following table provides certain financial information for our Channel Islands and the UK segment for the years ended December 31, 2022, 2021 and 2020.
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Summary Income Statement | | For the year ended December 31 | Dollar change | Percent change |
(in millions of $) | | 2022 | 2021 | 2020 | 2021 to 2022 | 2020 to 2021 | 2021 to 2022 | 2020 to 2021 |
Net interest income | | 65.7 | | 62.8 | | 62.7 | | 2.9 | | 0.1 | | 4.6 | % | 0.2 | % |
Provision for credit (losses) recoveries | | (0.6) | | (0.5) | | (0.2) | | (0.1) | | (0.3) | | 20.0 | % | 150.0 | % |
Non-interest income | | 40.5 | | 45.3 | | 40.7 | | (4.8) | | 4.6 | | (10.6) | % | 11.3 | % |
Net revenue before other gains (losses) | | 105.6 | | 107.6 | | 103.2 | | (2.0) | | 4.4 | | (1.9) | % | 4.3 | % |
Operating expenses | | (74.0) | | (81.7) | | (82.2) | | 7.7 | | 0.5 | | (9.4) | % | (0.6) | % |
Net income before other gains (losses) | | 31.6 | | 25.9 | | 21.0 | | 5.7 | | 4.9 | | 22.0 | % | 23.3 | % |
Total other gains (losses) | | 1.5 | | (2.4) | | (1.2) | | 3.9 | | (1.2) | | 162.5 | % | 100.0 | % |
Net income | | 33.1 | | 23.5 | | 19.8 | | 9.6 | | 3.7 | | 40.9 | % | 18.7 | % |
| | | | | | | | | | | | | | | | | |
Summary Balance Sheet | | As at December 31 | | |
(in millions of $) | | 2022 | 2021 | Dollar change | Percent change |
Total deposits | | 4,210 | | 4,747 | | (537) | | (11.3) | % |
Loans, net of allowance for credit losses | | 2,017 | | 2,171 | | (154) | | (7.1) | % |
Total assets | | 4,626 | | 5,235 | | (609) | | (11.6) | % |
Assets under administration | | | | | |
Custody and other administration services | | 14,203 | | 16,263 | | (2,060) | | (12.7) | % |
Trust | | 10,010 | | 10,374 | | (364) | | (3.5) | % |
Assets under management | | | | | |
Butterfield Funds | | 48 | | 64 | | (16) | | (25.0) | % |
Other assets under management | | 629 | | 766 | | (137) | | (17.9) | % |
Total assets under management | | 677 | | 830 | | (153) | | (18.4) | % |
Number of employees | | 379 | | 369 | | 10 | | 2.7 | % |
2022 vs. 2021
Our Channel Islands and UK segment posted net income before gains and losses of $31.6 million in 2022, an increase of $5.7 million when compared to 2021. This increase is due principally to the following movements in net interest income, provision for credit losses, non-interest income and operating expenses:
Net interest income before provision for credit losses reflected an increase of $2.9 million to $65.7 million in 2022, compared to $62.8 million in 2021. The increase was due to higher market interest rates across the yield curve and partially offset by the strengthening of the US dollar.
Provision for credit losses remained mostly flat at $0.6 million in 2022.
Non-interest income decreased by $4.8 million to $40.5 million in 2022 due to the strengthening of the US dollar as it was mostly flat in local GBP. In local currency, favorable volume-driven variances in banking and foreign exchange revenue were offset by decreased trust revenues as a result of lower special and accounting fees and decreased asset management revenues due to lower brokerage fees.
Operating expenses of $74.0 million in 2022 were $7.7 million lower than 2021, again due to the strengthening of the US dollar as it was mostly flat in local GBP. In local currency, a favorable professional and outside services fees variance driven by lower inter-company charges was offset by an increase in staff related costs due to higher staff incentive accruals and inflationary salary adjustments.
Total other gains (losses) for 2022 were gains of $1.5 million, an increase of $3.9 million compared to losses in 2021 due to losses related to defined benefit settlement accounting recorded in the previous year that did not re-occur.
Total assets of $4.6 billion as at December 31, 2022, a decrease from $5.2 billion as at December 31, 2021 reflecting lower depositor funding levels and the strengthening of the US dollar. Net loans decreased $0.2 billion to $2.0 billion at December 31, 2022 as a result of the aforementioned strengthening of the US dollar .
As at December 31, 2022, client AUA for the trust and custody businesses were $10.0 billion and $14.2 billion, respectively, while AUM were $0.7 billion. This compares with $10.4 billion, $16.3 billion and $0.8 billion, respectively, as at December 31, 2021.
2021 vs. 2020
Our Channel Islands and UK segment posted net income before gains and losses of $25.9 million in 2021, an increase of $4.9 million when compared to 2020. This increase is due principally to the following movements in net interest income, provision for credit losses, non-interest income and operating expenses:
Net interest income before provision for credit losses reflected an increase of $0.1 million to $62.8 million in 2021, compared to $62.7 million in 2020. Favorable GBP/USD foreign exchange rates throughout 2021 more than offset the impact of lower market rates across the yield curve as a result of the COVID-19 pandemic which were also partially offset by lower deposit costs.
Provision for credit losses was up $0.3 million to $0.5 million in 2021, due to an increased provision on a residential mortgage which moved into non-accrual status.
Non-interest income increased by $4.6 million to $45.3 million in 2021, due to increases in foreign exchange revenue, asset management fees and custody income driven by a combination of higher volumes, increased fees and onboarding of new clients during the year.
Operating expenses of $81.7 million in 2021 were $0.5 million lower than 2020, driven by a decrease in staff related costs due primarily to the resulting benefits from previous restructuring programs and lower operational losses and write-offs. This was partially offset by an increase in professional and outside services due to higher intercompany charges from increased utilization of our Canada and Mauritius service centers and higher legal and professional fees.
Total other gains (losses) for 2021 increased by $1.2 million compared to 2020 due to a defined benefit pension plan adjustment.
Total assets of $5.2 billion as at December 31, 2021, an increase from $4.8 billion as at December 31, 2020 reflecting higher depositor funding levels. Net loans increased $0.1 billion to $2.2 billion at December 31, 2021 driven primarily by the growth in the residential mortgage portfolios.
As at December 31, 2021, client AUA for the trust and custody businesses were $10.4 billion and $16.3 billion, respectively, while AUM were $0.8 billion. This compares with $19.2 billion, $13.2 billion and $0.8 billion, respectively, as at December 31, 2020. The decrease in AUA for trust is mainly due to the revision of fee agreements for a trust structure in Guernsey. The increase in AUA for custody is mainly due to the on-boarding of new business while AUM remains stable.
Off Balance Sheet Arrangements
Assets Under Administration and Assets Under Management
In the normal course of business, we hold AUA and AUM in a fiduciary or agency capacity for our clients. In accordance with GAAP, these assets are not our assets and are not included in our consolidated balance sheets.
Credit-Related Arrangements
We enter into standby letters of credit, letters of guarantee and contractual commitments to extend credit in the normal course of business, which are not required to be recorded on the balance sheet. Since many commitments expire unused or only partially used, these arrangements do not necessarily reflect future cash requirements. Management believes there are no material commitments to extend credit that represent risks of an unusual nature.
Standby letters of credit and letters of guarantee are issued at the request of our clients in order to secure a client's payment or performance obligations to a third party. These guarantees represent our irrevocable obligation to pay the third-party beneficiary upon presentation of the guarantee and satisfaction of the documentary requirements stipulated therein, without investigation as to the validity of the beneficiary's claim against the client. Generally, the term of the standby letters of credit does not exceed one year, while the term of the letters of guarantee does not exceed four years.
Credit risk is the principal risk associated with these instruments. The contractual amounts of these instruments represent the credit risk should the instrument be fully drawn upon and the client defaults. To control the credit risk associated with issuing letters of credit and letters of guarantee, we subject such activities to the same credit quality and monitoring controls as our lending activities. The types and amounts of collateral security we hold for these standby letters of credit and letters of guarantee are generally represented by our deposits or a charge over assets held in mutual funds. We are obligated to meet the entire financial obligation of these agreements and in certain cases are able to recover the amounts paid through recourse against the collateral security.
Risk Management
Risk Oversight and Management
Organizational Structure
The Board has overall responsibility for determining the strategy for risk management, setting the Bank's risk appetite and ensuring that risk is monitored and controlled effectively. It accomplishes its mandate through the activities of two dedicated committees:
The Risk Policy and Compliance Committee ("RPCC"): This committee of the Board assists the Board in fulfilling its responsibilities by overseeing the Group's risk profile and its performance against approved risk appetites and tolerance thresholds. Specifically, the committee considers the sufficiency of the Group's policies, procedures and limits related to the identification, measurement, monitoring and control of activities that give rise to credit, market, liquidity, interest rate, operational, regulatory, compliance, climate and reputational risks, as well as overseeing its compliance with laws, regulations and codes of conduct.
The Audit Committee: This committee reviews the overall adequacy and effectiveness of the Group's system of internal controls and the control environment, including in respect of the risk management process. It reviews recommendations arising from internal and independent audit review activities and management's response to any findings raised.
Both the RPCC and Audit Committee are supported in the execution of their respective mandates by the dedicated Audit, Compliance and Risk Policy Committees for our UK, Guernsey, Jersey, Cayman Islands and The Bahamas operations, which oversee the sufficiency of local risk management policies and procedures and the effectiveness of the system of internal controls that are in place. These committees are chaired by non-executive directors drawn from the boards of directors for each segment.
The Group executive management team is led by the Chairman & CEO and includes the members of executive management reporting directly to the Chairman & CEO. The executive management team is responsible for setting business strategy and for monitoring, evaluating and managing risks across the Group. It is supported by the following management committees:
The Group Risk and Compliance Committee ("GRCC"): This committee comprises executive and senior management team members and is chaired by the Group Chief Risk Officer. It provides a forum for the strategic assessment of risks assumed across the Group as a whole based on an integrated view of credit, market, liquidity, legal, regulatory and financial crime compliance, fiduciary, operational, cybersecurity, climate, insurance, pension, investment, capital and reputational risks, ensuring that these exposures are consistent with the risk appetites and tolerance thresholds promulgated by the Board and oversees the compliance of regulatory obligations arising under applicable laws, rules and regulations. It is responsible (i) for reviewing, evaluating and recommending the Group's Risk Appetite Framework, the results of the Capital Assessment and Risk Profile and recovery and resolution planning processes (including all associated stress testing performed) and the Group's key risk policies to the Board for approval; (ii) for reviewing and evaluating current and proposed business strategies in the context of our risk appetites; and (iii) for identifying, reviewing and advising on current and emerging risk issues and associated mitigation plans; and (iv) for reviewing the Group’s compliance with external regulations and internal policies.
The Group Asset and Liability Committee ("GALCO"): This committee comprises executive and senior management team members and is chaired by the Group CFO. The committee is responsible for liquidity, interest rate and exchange rate risk management and other balance sheet issues. It also oversees key policies and the execution of the Group's investment and capital management strategies and monitors the associated risks assumed. It is supported in the execution of its mandate by the work undertaken by the dedicated Asset & Liability Committees in each of the Bank's segments.
The Group Credit Committee ("GCC"): This committee comprises executive and senior management and is chaired by the Group Chief Risk Officer. The committee is responsible for a broad range of activities relating to the monitoring, evaluation and management of credit risks assumed across the Group at both transaction and portfolio levels. It is supported in the execution of its mandate by the Financial Institutions Committee ("FIC"), a dedicated sub-committee that is responsible for the evaluation and approval of recommended inter-bank and counterparty exposures assumed in the Group's treasury and investment portfolios, and by the activities of the jurisdictional Credit Committees, which review and approve transactions within delegated authorities and recommends specific transactions outside of these limits to the GCC for approval.
The Provisions and Impairments Committee: This committee comprises executive and senior management team members and is chaired by the Group Chief Risk Officer. The committee is responsible for approving significant provisions and other impairment charges. It also oversees the overall credit risk profile of the Group in regards to non-accrual loans and assets. It is supported in the execution of its mandate by jurisdictional credit committees and the GCC, which make recommendations to this committee.
Risk Management
We manage our exposure to risk through a three "lines of defense" model.
The first "line of defense" is provided by our jurisdictional business units, which retain ultimate responsibility for the risks they assume and for bearing the cost of risks associated with these exposures.
The second "line of defense" is provided by our Risk Management and Compliance groups, which work in collaboration with our business units to identify, assess, mitigate and monitor the risks associated with our business activities and strategies. They do this by:
•making recommendations to the GRCC regarding the constitution of the Risk Appetite Framework;
•setting risk strategies that are designed to manage risk exposures assumed in the course of pursuing our business strategies and aligning them with agreed appetites;
•establishing and communicating policies, procedures and limits to control risks in alignment with these risk strategies;
•measuring, monitoring and reporting on risk levels;
•opining on specific transactions that fall outside delegated risk limits; and
•identifying and assessing emerging risks.
The functions within the Risk Management group that support our risk management activities are outlined below.
Group Market Risk: This unit provides independent oversight of the measurement, monitoring and control of liquidity and funding risks, interest rate and foreign exchange risks as well as the market risks associated with our investment portfolios. It also monitors compliance with both regulatory requirements and our internal policies and procedures relating to the management of these risks.
Group Credit Risk Management: This unit is responsible for the adjudication and oversight of credit risks associated with our retail and commercial lending activities and the management of risks associated with our investment portfolios and counterparty exposures. It also establishes the parameters and delegated limits within which credit risks may be assumed and promulgates guidelines on how exposures should be managed and monitored.
Group Operational Risk: This unit assesses the effectiveness of our procedures and internal controls in managing our exposure to various forms of operational risk, including those associated with new business activities and processes and the deployment of new technologies. It is also responsible for our incident management processes and reviews the effectiveness of our loss data collection activities.
Group Compliance: This unit provides independent analysis and assurance of our compliance with applicable laws, regulations, codes of conduct and recommended best practices, including those associated with the prevention of financial crime, including money laundering and terrorist financing. It is also responsible for assessing our potential exposure to upstream risks and for providing guidance on the preparations that should be made in advance of these changes coming into effect.
The third "line of defense" is provided by our Group Internal Audit function, which performs oversight and ongoing review, and challenges the effectiveness of the internal controls that are executed by the business and Risk Management. The Group Head of Internal Audit has a dual reporting line to both the Chair of the Audit Committee and the Chairman & CEO.
Regulatory Review Process
Our banking, trust and investment business activities in Bermuda are monitored by the BMA as the lead regulator. One of the principal objectives of the BMA is to supervise, regulate and inspect Bermuda-based financial institutions to ensure their financial stability and soundness.
In addition to conducting on-site reviews, the BMA utilizes a comprehensive quarterly statistical return system that enables off-site monitoring. The statistical system is consistent with Basel Committee Standards, and provides the BMA with a detailed breakdown of a bank's balance sheet and profit-and-loss accounts on both a consolidated and unconsolidated basis. This information enables the BMA to monitor the soundness of a bank's financial position and ensure that it meets certain capital requirements. For more information, see Item 4.B. "Business Overview - Supervision and Regulation - Bermuda - Supervision and Monitoring by the BMA".
Each of our regulated entities is separately monitored by the local regulatory authority in that jurisdiction to ensure its financial stability and soundness.
The Risk Appetite Framework
In pursuit of its strategic goals and objectives, the Bank is exposed to a broad range of risks. In support of effective governance and risk informed decision-making, the Bank has set out a risk appetite statement and framework covering its principal risk exposures and approach to managing risk. The Bank’s risk appetite is set annually by the Board with the goal of aligning risk taking with statutory requirements, strategic business objectives and capital planning activities. It serves to express a clear and unambiguous methodology to foster a common risk culture across the organization, predicated on a common risk language and guide for internal stakeholders regarding acceptable and unacceptable behavior.
Our framework comprises the following elements:
(1) Level 1: Principle categories of Financial, Compliance, Operational, Reputational and Strategic risk.
(2) Level 2: These risks more granularly classified to sub-risk types which represent the various risks that the Group assumes across the entirety of its operations in the pursuit of its strategic initiatives:
•Financial (Credit, Liquidity, Market)
•Compliance (Regulatory Compliance, Financial Crime)
•Operational (Outsourcing, Fiduciary, Investment, Tax Reporting, Financial Reporting, Correspondent Banking, People, Cyber, Technology Performance, Governance)
•Reputational
•Strategic
(3) There are three options for our risk appetite (set out in the following table) for each Level 2 risk type, with each appetite designed to convey a clear strategic direction in terms of the risk/reward profile assumed, to ensure consistency in our risk conversations.
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Appetite | | Definition | | Profile |
Conservative | | Areas in which the Group avoids risk, or acts to minimize or eliminate the likelihood that the risk will occur, because we have determined the likelihood and impact of potential implications are intolerable. | | Our processes and controls are defensive and focus on detection and prevention. |
Balanced | | Areas in which the Group must constantly strike a balance between the potential upside benefits and potential downside costs of a given decision. | | Exposures are only assumed when the risk can be quantified accurately and is assessed as being acceptable. |
Tolerant | | Areas in which the Group prefers disciplined risk-taking because we have determined the potential upside benefits outweigh the potential costs. | | Exposures can be estimated reliably and structures, systems and processes are in place to manage them. |
(4) A statement of our governing principles relating to each risk category. This establishes the characteristics of the risks that the Bank is willing to assume and the management behaviors it should exhibit when doing so.
Specific performance measures (Key Risk Indicators) and tolerance thresholds have been established with respect to each risk category, combining quantitative and qualitative targets (which are designed to reflect both forward-looking as well as historical perspectives), to help provide executive management and the Board with an indication of the "direction" of our exposure relative to our declared risk appetite and an early warning of material adverse developments requiring remedial action.
The limits, targets and thresholds used to measure performance continue to be refined through the Enterprise Risk Management framework, including the expansion of Level 2 risk types, in an effort to express more granular exposure of risk relative to the stated appetite. All changes proposed pass through a formal review and approval process at both the executive management and Board levels prior to their adoption. Through this approach, the risk appetite statement sets the tone for our risk culture across the Group as a whole, influencing behaviors at all levels of the organization and reinforcing accountability for decisions taken.
Market Risks
Interest Rate Risk Management
Our primary market risk is interest rate risk, which is defined as the risk of loss of net interest income or changes in net interest margin because of changes in interest rates. Interest rate risk for the Bank is confined to the banking book as the bank does not engage in proprietary trading.
We seek to measure and manage the potential impact of interest rate risk. Interest rate risk occurs when interest earning assets and interest bearing liabilities mature or re-price at different times, on a different basis or in unequal amounts. Interest rate risk also arises when our assets, liabilities and off-balance sheet contracts each respond differently to changes in interest rates, including as a result of explicit and implicit provisions in agreements related to such assets and liabilities and in off-balance sheet contracts that alter the applicable interest rate and cash flow characteristics as interest rates change. The two primary examples of such provisions that we are exposed to are the duration and rate sensitivity associated with indeterminate-maturity deposits (e.g., interest bearing call accounts) and the rate of prepayment associated with fixed-rate lending and mortgage-backed securities. Interest rates may also affect loan demand, credit losses, mortgage origination volume and other items affecting earnings.
Our management of interest rate risk is overseen by the RPCC, which outlines reporting and measurement requirements. In particular, this infrastructure sets limits and management targets, calculated for various metrics, including our economic value sensitivity, our economic value of equity and net interest income simulations involving parallel shifts in interest rate curves, steepening and flattening yield curves, and various prepayment and deposit duration assumptions. Our risk management infrastructure also requires a periodic review of all key assumptions used, such as identifying appropriate interest rate scenarios, setting loan prepayment rates based on historical analysis, non-interest bearing and interest bearing demand deposit durations based on historical analysis, and the targeted investment term of capital.
The principal objective of our interest rate risk management is to maximize profit potential while minimizing exposure to changes in interest rates. Our actions in this regard are taken under the guidance of GALCO. The committee is actively involved in formulating the economic assumptions that we use in our financial planning and budgeting processes and establishes policies which control and monitor the sources, uses and pricing of funds. From time to time, we utilize hedging techniques to reduce interest rate risk. GALCO uses interest income simulations and economic value of equity analysis to measure inherent risk in our balance sheet at specific points in time.
Appetite for interest rate risk is documented in the Group's policies on market risk and investments. This includes the completion of stress testing on at least a quarterly basis of the impact of an immediate and sustained shift in interest rates of +/– 200 basis points on net interest income, economic value of equity and the ratio of tangible total equity to average assets. If any of the parameters established by policy are exceeded, GALCO will provide a plan to executive management to bring the exposure back within tolerance under advice to the Board. The plan does not have to bring the exposure back within limit immediately, but must adjust the exposure within Board and management approved timeframes.
We also use derivatives in the asset and liability management of positions to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. Our derivative contracts principally involve over-the-counter transactions that are privately negotiated between the Group and the counterparty to the contract. Derivative instruments that may be used as part of our interest rate risk management strategy include interest rate swaps. Interest rate swaps generally involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date.
Interest Rate Risk
The following table sets out the assets, liabilities and shareholders' equity and off-balance sheet instruments on the date of the earlier of contractual maturity, expected maturity and repricing date. Use of these tables to derive information about our interest rate risk position is limited by the fact that customers may choose to terminate their financial instruments at a date earlier than the contractual maturity or repricing date. Examples of this include fixed-rate mortgages, which are shown at contractual maturity but which may pre-pay earlier, and certain term deposits, which are shown at contractual maturity but which may be withdrawn before their contractual maturity subject to prepayment penalties. Investments are shown based on remaining contractual maturities. The remaining contractual principal maturities for mortgage-backed securities (primarily US government agencies) do not consider prepayments. Remaining expected maturities differ from contractual maturities because borrowers may have the right to prepay obligations before the underlying mortgages mature.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2022 | | Earlier of contractual maturity or repricing date | |
(in $ millions) | | Within 3 months | 3 to 6 months | 6 to 12 months | 1 to 5 years | After 5 years | Non-interest bearing | Total | Total fair value(1) |
Assets | | | | | | | | | |
Cash and deposits with banks | | 2,008 | | — | | — | | — | | — | | 93 | | 2,101 | | 2,101 | |
Securities purchased under agreement to resell | | 60 | | — | | — | | — | | — | | — | | 60 | | 60 | |
Short-term investments | | 406 | | 422 | | 56 | | — | | — | | — | | 884 | | 884 | |
Investments(2) | | 6 | | 8 | | 179 | | 943 | | 4,592 | | — | | 5,728 | | 5,187 | |
Loans(3) | | 2,927 | | 35 | | 166 | | 1,533 | | 406 | | 29 | | 5,096 | | 5,050 | |
Other assets | | — | | — | | — | | — | | — | | 437 | | 437 | | 437 | |
Total assets | | 5,407 | | 465 | | 401 | | 2,476 | | 4,998 | | 559 | | 14,306 | | 13,719 | |
Liabilities and shareholders' equity | | | | | | | | | |
Demand deposits | | 6,819 | | 25 | | — | | — | | — | | 3,040 | | 9,884 | | 9,884 | |
Term deposits(4) | | 2,126 | | 457 | | 437 | | 87 | | — | | — | | 3,107 | | 3,109 | |
Other liabilities | | — | | — | | — | | — | | — | | 278 | | 278 | | 278 | |
Subordinated capital(4) | | — | | 75 | | — | | 97 | | — | | — | | 172 | | 178 | |
Shareholders' equity | | — | | — | | — | | — | | — | | 865 | | 865 | | 271 | |
Total liabilities and shareholders' equity | | 8,945 | | 557 | | 437 | | 184 | | — | | 4,183 | | 14,306 | | 13,719 | |
Interest rate sensitivity gap | | (3,538) | | (92) | | (36) | | 2,292 | | 4,998 | | (3,624) | | — | | |
Cumulative interest rate sensitivity gap | | (3,538) | | (3,630) | | (3,666) | | (1,374) | | 3,624 | | — | | — | | |
____________________________
(1)See Item 5.A. "Operating Results - Critical Accounting Policies and Estimates - Fair Values" and "Note 17: Fair value measurements" of the audited consolidated financial statements for further detail on the determination of fair value.
(2)Investments include (i) HTM, which are carried at their amortized cost on the consolidated balance sheet, and (ii) equity securities and AFS investments, each of which are carried at fair value on the consolidated balance sheet. The fair value column presents all classifications at their fair value.
(3)Loans are carried on the consolidated balance sheet as the principal amount outstanding, net of allowance for credit losses, unearned income, fair value adjustments arising from hedge accounting and net deferred loan fees.
(4)Term deposits and subordinated capital are carried on the consolidated balance sheet as the principal outstanding.
Asset/Liability Management and Interest Rate Risk
The principal objective of our asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing net income and preserving adequate levels of liquidity funding and capital.
As a financial institution, our primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the fair value of all interest earning assets and interest bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.
We manage our exposure to interest rates primarily by structuring our balance sheet in the ordinary course of business. We do not typically enter into derivative contracts for the purpose of managing interest rate risk, but we may elect to do so in the future. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. Our exposure to holdings categorized as "trading positions" falls below the de minimis threshold established of 5% (ratio of total trading book open position compared to the sum of on- and off-balance sheet assets that are not part of the trading book).
We use an interest rate risk simulation model to test the interest rate sensitivity of net interest income and the balance sheet. Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and use various assumptions, including, but not limited to, prepayments on securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows. We also analyze the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the fair value of assets less the fair value of liabilities. The economic value of equity is a longer-term view of interest rate risk because it measures the present value of all future cash flows. The impact of changes in interest rates on this calculation is analyzed for the risk to our future earnings and is used in conjunction with the analysis on net interest income.
The following table summarizes the simulated change in net interest income versus unchanged rates as at December 31, 2022 and December 31, 2021:
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| | For the year ended |
| | December 31, 2022 | | December 31, 2021 |
| | Following 12 Months | | Months 13 - 24 | | Following 12 Months | | Months 13 - 24 |
+300 basis points | | 4.9 | % | | 10.1 | % | | 21.6 | % | | 24.8 | % |
+200 basis points | | 3.3 | % | | 6.7 | % | | 14.2 | % | | 16.6 | % |
+100 basis points | | 1.6 | % | | 3.4 | % | | 6.6 | % | | 8.1 | % |
Flat rates | | 0.0 | % | | 0.0 | % | | 0.0 | % | | 0.0 | % |
−100 basis points | | (5.6) | % | | (7.4) | % | | 17.8 | % | | 15.7 | % |
The following table presents the change in our economic value of equity as at December 31, 2022 and December 31, 2021, assuming immediate parallel shifts in interest rates: | | | | | | | | | | | | | | |
| | For the year ended |
| | December 31, 2022 | | December 31, 2021 |
+300 basis points | | (17.1) | % | | (7.4) | % |
+200 basis points | | (11.2) | % | | (5.2) | % |
+100 basis points | | (5.4) | % | | (2.0) | % |
Flat rates | | 0.0 | % | | 0.0 | % |
−100 basis points | | 3.5 | % | | (0.6) | % |
With interest rates rising rapidly in 2022, the duration of our investment portfolio expanded as prepayments slowed and our ratio of fixed versus floating rate loans increased. Deposit costs are also getting more sensitive to market rates, most notably in our Channel Islands market, which explains the change in the IRR profile i.e. showing less NII sensitivity to upside shocks and a higher (negative) impact of those shocks on EVE.
Many assumptions are used to calculate the impact of interest rate fluctuations. Actual results may be significantly different than our projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. The computations of interest rate risk shown above do not include the full suite of actions that our management may undertake to manage the risks in response to anticipated changes in interest rates, and actual results may also differ materially.
Foreign Exchange Risk
The Group holds various non-USD denominated assets and liabilities and maintains investments in subsidiaries whose domestic currency is either not USD or whose domestic currency is not pegged to USD. Assets and liabilities denominated in currencies other than USD are translated to USD at the rates of exchange prevailing at the balance sheet date. The resulting gains or losses are included in foreign exchange revenue in the consolidated statements of operations. Assets and liabilities of subsidiaries outside of Bermuda are translated at the rate of exchange prevailing on the balance sheet date while associated revenues and expenses are translated to USD at the average rate of exchange prevailing through the accounting period. Unrealized translation gains or losses on investments in foreign currency based subsidiaries are recorded as a separate component of shareholders' equity within accumulated other comprehensive loss. Such gains or losses are recorded in the consolidated statements of operations only when realized. Our foreign currency subsidiaries may give rise to significant foreign currency translation movements against the USD. We also provide foreign exchange services to our clients, principally in connection with our banking and wealth management businesses, and effect other transactions in non-USD currencies. Foreign currency volatility and fluctuations in exchange rates may impact the value of non-USD denominated assets and liabilities and raise the potential for losses resulting from foreign currency trading positions where aggregate obligations to purchase and sell a currency other than USD do not offset one another, or offset each other in different time periods. If the policies and procedures we have in place to assess and mitigate potential impacts of foreign exchange volatility are not followed, or are not effective to mitigate such risks, our results and earnings may be negatively affected. The Group maintains a clearly articulated foreign exchange risk exposure tolerance framework which limits exposures to select major currencies.
Liquidity Risk
The objectives of liquidity risk management are to ensure that the Group can meet its cash flow requirements and capitalize on business opportunities on a timely and cost-effective basis. Liquidity is defined as the ability to hold and/or generate cash adequate to meet our needs for day-to-day operations and material long and short-term commitments. Liquidity risk is the risk of potential loss if the Group were unable to meet its funding requirements at a reasonable cost.
We monitor and manage our liquidity by banking location and on a Group-wide basis. The treasury functions in the Group's banking operations, located in Bermuda, the Cayman Islands, Guernsey, and Jersey, manage day-to-day liquidity. The Group market risk function has the responsibility for measuring and reporting to senior management on liquidity risk positions. We manage our liquidity based on demand, commitments, specific events and uncertainties to meet current and future financial obligations of a short-term nature. Our objective in managing liquidity is to respond to the needs of depositors and borrowers as well as to earnings enhancement opportunities in a changing marketplace. Management is responsible for establishing and monitoring liquidity targets as well as strategies to meet these targets. The Group adopts a conservative liquidity risk appetite with internal quantitative liquidity risk tolerances more stringent than regulatory requirements. Specifically, the Group manages liquidity against internal limits established by the market risk management policy and its related liquidity risk standard and quarterly stress testing methodology.
We maintained a balance sheet with loans representing 35.6% of total assets as at December 31, 2022. Further, at that date there were significant sources of liquidity within our balance sheet in the form of cash and cash equivalents, short-term investments, securities purchased under agreements to resell and investments amounting to $8.8 billion, or 61.3%, of total assets.
An important element of our liquidity management is our liquidity contingency plan which can be employed in the event of a liquidity crisis. The objective of the liquidity contingency plan is to ensure that we maintain our liquidity during periods of stress. This plan takes into consideration a variety of scenarios that could challenge our liquidity. These scenarios include specific and systemic events that can impact our on- and off-balance sheet sources and uses of liquidity. This plan is reviewed and updated at least annually.
Credit Risk
Credit risk is defined as the risk that unexpected losses arise as a result of the Group's borrowers or market counterparties failing to meet their obligations to repay. Credit risk is managed through the jurisdictional CRM departments. CRM provides a system of checks and balances for our diverse credit-related activities by establishing and monitoring all credit-related policies and practices throughout the Group and assuring their uniform application. These activities are designed to diversify credit exposure on an industry and client basis, thus lessening overall credit risk. These credit management activities also apply to our use of derivative financial instruments, including foreign exchange contracts and interest rate risk management instruments, which are used primarily to facilitate client transactions.
Individual credit authority for commercial and other loans is limited to specified amounts and maturities. Credit decisions involving commitment exposure in excess of the specified individual limits are submitted to CRM and then to the GCC, which provides a forum for ongoing executive review of loan activity, establishing our credit guidelines and policies and approving selected credit transactions in accordance with our business objectives. The committee reviews large credit exposures, establishes and reviews credit strategy and policy and approves selected credit transactions. The FIC manages counterparty risk in respect of third party bank counterparties which do not have commercial credit relationships within the Group and also approves country exposure limits.
As part of our ongoing credit granting process, internal ratings are assigned to commercial clients before credit is extended, based on an assessment of creditworthiness. At least annually, a review of all significant credit exposures is undertaken to identify, at an early stage, clients who might be facing financial difficulties. Internal borrower risk ratings are also reviewed during this process, allowing identification of adverse individual borrower and sector trends, and accurate application of internal borrower risk ratings which incorporates but is not limited to an assessment of climate risk impacting borrower risk ratings.
An integral part of the CRM function is to formally review past due and potential problem loans to determine which credits, if any, need to be placed on non-accrual status or charged off. The allowance for loan losses is reviewed quarterly to determine the amount necessary to maintain an adequate provision for current expected credit losses.
Another way credit risk is managed is by requiring collateral. Management's assessment of the borrower's creditworthiness determines whether collateral is obtained. The amount and type of collateral held varies but may include deposits held in financial institutions, mutual funds, US Treasury securities, other marketable securities, income-producing commercial properties, accounts receivable, residential real estate, property, plant and equipment, and inventory. Values of variable collateral are monitored on a regular basis to ensure that they are maintained at an appropriate level, which includes an assessment of the climate risk impact on the value of the collateral.
Credit Risk — Retail and Private Banking
Retail and private lending activity is split between residential mortgages, personal loans, credit cards and authorized overdrafts. Retail credit risks are managed in accordance with limits and processes set out in the credit risk policies and guidelines approved by GCC and GRCC (and approved by the Board). The policies set out where specialist underwriting may be needed.
For residential mortgages, a combination of lending policy criteria, lending guidelines and underwriting are used to make a decision on applications for credit. The primary factors considered are affordability, residential status, residential history, credit history, employment history, nature of income and LTV of the residential property. In addition, confirmation of a borrower's identity is obtained and an assessment of the value of the collateral is carried out prior to granting a credit facility. When considering applications, the primary focus is placed on the willingness and ability to repay.
LTV ratios are derived based on third-party valuations as part of the original underwriting or when increased borrowing has been requested. Updated valuations are not otherwise obtained unless the loan reaches non-accrual status. Non-accrual loans which are collateral-dependent on real estate must be supported by a third-party valuation no older than 12 months. Costs of sale for commercial properties are calculated based on individual circumstances, whereas the haircuts for residential real estate are prescribed in lending guidelines by geographic location and are never less than 15% of the valuation amount.
As valuations are conducted throughout the year, the rolling average age of the valuations are closer to 6 months than 12 months. To further ensure that valuations within the 12-month revaluation period remain appropriate measures for input into the CECL model, we: (1) compare renewal valuations to the prior valuation to track market movement; (2) back-test all sales to compare net carrying value versus any additional gain/loss at the time of sale; (3) segregate the tests described in (1) and (2) by geographic area and, where required, amend provision factors accordingly; and (4) perform a review of new valuations to ascertain such valuations' reasonableness and determine if any change in value may impact similar properties or locations where valuations are more stale-dated and require an adjustment to the CECL model.
The Bank performs an annual assessment of group residential LTV ranges as part of its stress-testing exercise for regulatory and capital-adequacy purposes. Real estate indices are not available in the Bank's primary markets and LTV values are based on standard reductions in value over time, based on observed market activity.
Generally, maximum LTV for new residential and commercial loans is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Bermuda | | Cayman Islands | | UK—London | | Channel Islands |
Residential | | | | | | | | |
Owner-occupied freehold | | 70 | % | | 85 | % | | 65 | % | | 80 | % |
Owner-occupied leasehold condominium | | 70 | % | | 85 | % | | 65 | % | | 80 | % |
Investment (not owner-occupied) | | 65 | % | | 75 | % | | 65 | % | | 80 | % |
Raw land | | 50 | % | | 80 | % | | N/A | | N/A |
Commercial Real Estate | | 65 | % | | 65 | % | | N/A | | 65 | % |
For other retail lending products, similar lending policy criteria are used, and each of these products has its own policy and underwriting guidelines to enable decisions on applications for credit and to manage accounts. The factors used are attuned to the lending product in question, although affordability and credit history are considered in all
cases. Ongoing monitoring of all retail and private banking credit is undertaken by the business unit concerned as well as by CRM. In addition, the GCC reviews reports on a weekly basis. In the event that particular exposures show adverse features such as arrears, the Bank's specialist recovery teams generally work with borrowers to resolve the situation.
Unlike the United States where the FCRA is designed to help ensure that credit bureaus furnish correct and complete information when evaluating loan applications, the markets in which we operate do not have systemic credit bureau reports. Therefore, we manually review each loan and we use a formally governed tiered credit approval process that is administered through and governed by our Risk Management framework.
Credit Risk — Commercial Banking
Commercial credit risks are managed in accordance with limits and asset quality measures set out in the credit risk policies and guidelines approved by the GCC (and ratified by the Board).
In respect of Commercial Banking, there is a level of delegated sanctioning authority to underwrite certain credit risks based upon an evaluation of the borrower's experience, track record, financial strength, ability to repay, transaction structure and security characteristics. Lending decisions for large or high risk exposures are based upon a thorough credit risk analysis and the assignment of an internal borrower risk rating, and are subject to further approval by the assigned officers in CRM or the GCC.
Consideration is also given to risk mitigation measures which will provide the Group with protection, such as third-party guarantees, supporting collateral and security, legal documentation and financial covenants. Commercial portfolio asset quality monitoring is based upon a number of measures, including the monitoring of financial covenants, cash flows, pricing movements and variable collateral. In the event that particular exposures begin to show adverse features such as payment arrears, covenant breaches or business trading losses, a full risk reassessment is undertaken. Where appropriate, a specialist recovery team will work with the borrower to resolve the situation. If this proves unsuccessful, the case will be subject to intensive monitoring and management procedures designed to maximize debt recovery.
Credit Risk — Treasury
Treasury credit risks are managed in accordance with limits, asset quality measures and criteria set out within the policy approved by the GCC and ratified by the Board. The policy also sets out powers which require higher levels of authorization according to the size of the transaction or the nature of the associated risk. The FIC identifies, assesses, prioritizes and manages our risks associated with counterparty exposure to other financial institutions, as well as country-specific exposures.
Exposures to financial institutions arise within the Group's investment portfolio and treasury operations. The Group has treasury operations in all of its banking locations. Treasury exposures primarily take the form of deposits with banks and foreign exchange positions. Exposures to financial institutions in the investment portfolio can take the form of bonds, floating rate notes and/or certificates of deposit.
Diversification and avoidance of concentration is emphasized. The Group establishes limits for countries and each financial institution where there is an expected exposure. Ongoing asset quality monitoring is undertaken by Treasury and CRM and reports are sent to the FIC, GCC and GRCC on a monthly basis. Exception reporting takes place against a range of asset quality triggers. Treasury uses a number of risk mitigation techniques including netting and collateralization agreements. Other methods (such as margining and derivatives) are used periodically to mitigate the risk associated with particular transactions or groups of transactions.
For its exposure to Treasury credit risk, the Group uses external credit assessment institutions as permitted under Basel III for sovereign, financial institutions, asset-backed securities, covered bonds and corporate risks. With regard to financial institutions and corporates, the Group's preference for a long-term rating is the senior unsecured rating. However, counterparty ratings and/or short-term deposit or commercial paper ratings are used if this is unavailable. For asset-backed securities, the issue or tranche rating is used.
Exposures
The following tables analyze the Group's regulatory credit risk exposures as at December 31, 2022 and December 31, 2021. Exposures are allocated to specific standardized exposure portfolios determined by the BMA's Revised Framework for Regulatory Capital Assessment and it is these portfolios that determine the risk weights used. These exposures include both on- and off-balance sheet exposures, with the latter shown separately after credit conversion factors have been applied.
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Analysis of exposures class (in millions of $) | | Average Exposure 2022 | | Position as at December 31, 2022 | | Average Exposure 2021 | | Position as at December 31, 2021 |
Cash | | 69.4 | | | 73.9 | | | 70.2 | | | 66.5 | |
Claims on Sovereigns | | 2,758.6 | | | 2,933.5 | | | 2,539.2 | | | 3,091.5 | |
Claims on Public Sector Entities | | 42.8 | | | 6.4 | | | 88.2 | | | 68.2 | |
Claims on Corporates | | 595.5 | | | 477.0 | | | 666.0 | | | 559.0 | |
Claims on Banks and Securities Firms | | 1,458.6 | | | 1,346.9 | | | 1,804.6 | | | 1,527.6 | |
Securitizations | | 4,896.0 | | | 4,646.7 | | | 5,194.9 | | | 5,134.3 | |
Retail Loans | | 202.8 | | | 211.8 | | | 226.6 | | | 222.3 | |
Residential Mortgages | | 3,499.3 | | | 3,544.8 | | | 3,444.3 | | | 3,582.8 | |
Commercial Mortgages | | 644.2 | | | 619.5 | | | 703.5 | | | 675.7 | |
Past Due Loans | | 64.6 | | | 68.6 | | | 72.4 | | | 63.3 | |
Other Balance Sheet Exposures | | 260.1 | | | 282.6 | | | 268.5 | | | 246.6 | |
Non‑Market Related Off-Balance Sheet Credit Exposures | | 535.5 | | | 482.8 | | | 628.7 | | | 608.7 | |
Market Related Off‑Balance Sheet Credit Exposures | | 60.4 | | | 51.1 | | | 58.0 | | | 54.8 | |
Total | | 15,087.9 | | | 14,745.6 | | | 15,765.2 | | | 15,901.3 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Geographic segment distribution of exposures class as at December 31, 2022 (in millions of $) | | Bermuda | | Cayman Islands | | Channel Islands & UK | | Other | | Total |
Cash | | 38.8 | | | 35.1 | | | — | | | — | | | 73.9 | |
Claims on Sovereigns | | 912.4 | | | 722.2 | | | 1,298.9 | | | — | | | 2,933.5 | |
Claims on Public Sector Entities | | 6.4 | | | — | | | — | | | — | | | 6.4 | |
Claims on Corporates | | 313.0 | | | 42.1 | | | 121.9 | | | — | | | 477.0 | |
Claims on Banks and Securities Firms | | 503.9 | | | 417.2 | | | 415.2 | | | 10.6 | | | 1,346.9 | |
Securitizations | | 1,811.1 | | | 2,165.3 | | | 670.3 | | | — | | | 4,646.7 | |
Retail Loans | | 100.3 | | | 72.5 | | | 39.0 | | | — | | | 211.8 | |
Residential Mortgages | | 997.5 | | | 815.0 | | | 1,732.3 | | | — | | | 3,544.8 | |
Commercial Mortgages | | 457.7 | | | 79.9 | | | 81.9 | | | — | | | 619.5 | |
Past Due Loans | | 48.1 | | | 0.7 | | | 19.8 | | | — | | | 68.6 | |
Other Balance Sheet Exposures | | 161.1 | | | 55.7 | | | 53.3 | | | 12.5 | | | 282.6 | |
Non‑Market Related Off-Balance Sheet Credit exposures | | 170.7 | | | 180.4 | | | 131.7 | | | — | | | 482.8 | |
Market Related Off-Balance Sheet Credit Exposures | | 24.5 | | | 1.5 | | | 25.1 | | | — | | | 51.1 | |
Total | | 5,545.5 | | | 4,587.6 | | | 4,589.4 | | | 23.1 | | | 14,745.6 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Residual maturity breakdown of exposures class as at December 31, 2022 (in millions of $) | | Up to 12 months | | 1 ‑ 5 years | | More than 5 years | | No specific maturity | | Total |
Cash | | 73.9 | | | — | | | — | | | — | | | 73.9 | |
Claims on Sovereigns | | 1,736.6 | | | 763.7 | | | 433.2 | | | — | | | 2,933.5 | |
Claims on Public Sector Entities | | — | | | — | | | 6.4 | | | — | | | 6.4 | |
Claims on Corporates | | 215.9 | | | 178.9 | | | 82.2 | | | — | | | 477.0 | |
Claims on Banks and Securities Firms | | 1,346.9 | | | — | | | — | | | — | | | 1,346.9 | |
Securitizations | | — | | | 18.0 | | | 4,628.7 | | | — | | | 4,646.7 | |
Retail Loans | | 157.5 | | | 40.3 | | | 14.0 | | | — | | | 211.8 | |
Residential Mortgages | | 410.7 | | | 1,156.9 | | | 1,977.2 | | | — | | | 3,544.8 | |
Commercial Mortgages | | 28.5 | | | 107.7 | | | 483.3 | | | — | | | 619.5 | |
Past Due Loans | | 36.4 | | | 5.9 | | | 26.3 | | | — | | | 68.6 | |
Other Balance Sheet Exposures | | — | | | — | | | — | | | 282.6 | | | 282.6 | |
Non‑Market Related Off-Balance Sheet Credit exposures | | 482.8 | | | — | | | — | | | — | | | 482.8 | |
Market Related Off-Balance Sheet Credit Exposures | | 51.1 | | | — | | | — | | | — | | | 51.1 | |
| | 4,540.3 | | | 2,271.4 | | | 7,651.3 | | | 282.6 | | | 14,745.6 | |
Impairment Provisions
Credit Risk Concentrations
Concentration risk is defined as: any single exposure or group of exposures with the potential to produce losses large enough (relative to the Group's capital, total assets or overall risk level) to threaten the Group's health or ability to maintain core operations. The management of concentration risk is addressed in the first instance by the Group's large exposure policy and related credit guidelines, which require that credit facilities to entities that are affiliated through common ownership or management are aggregated for adjudication and reporting purposes. The policy also defines what constitutes a large exposure and the related reporting requirements. The CRM function also undertakes monitoring and assessment of our exposure to concentration risk, reporting the results of these analyses to the GCC, GRCC and RPCC.
The factors taken into consideration when assessing concentration risk are as follows:
•single or linked counterparty;
•industry or economic sector (e.g., hospitality, property development, commercial office building investment);
•geographic region;
•product type;
•collateral type; and
•maturity date (whether of the facility or of interest rate fixes).
Counterparty Concentrations
Counterparty concentrations is the risk associated with assuming a high level of exposure to a single counterparty, the failure of which could have an adverse impact on the Group.
Large exposures are reviewed quarterly by the GRCC and RPCC for the loan portfolio and the treasury/investment portfolios. Group Market Risk and Treasury work closely together on daily treasury positions and exceptions.
All large exposures and concentrations in the portfolio are reviewed and agreed by the FIC on a quarterly basis and are reported to the Board and the BMA as a part of this process. The review of large exposures considers:
•facility total;
•any link with other facilities;
•total linked facility being within guidelines;
•borrower risk rating;
•security value on the facility; and
•loan-to-value percentage against minimum security covenants.
Industry Concentration
Industry concentration encompasses the scenario that a risk factor inherent within an industry is tied to an entire portfolio of accounts or investments; e.g., a portfolio made up of a large number of small individual loans where all the counterparties are hotel operators. We believe that due to the nature of the Group's client base our exposure to the property, insurance and fund sectors could be classified as industry concentration, although we believe geographic and product concentration are the more appropriate risks to measure.
Geographic Concentration
Geographic concentration of the book is monitored as follows: Reports are generated which provide details of all the property loan exposure of the Group. Through this, loans are subdivided into regional exposure. From this, the percentage breakdown per region of the Group's property exposure is analyzed and reported to the GRCC and RPCC. Assessment of the exposure allows the committees to decide whether the Group should decline further lending in any area in which it is becoming over-weighted.
Product Concentration
Product concentration is defined in the context of credit risk, as an over-weighting in the portfolio to a given product type, making the Group vulnerable to the impact of a variety of external factors that could either reduce demand for the product itself or lead to an increase in the level of default rates experienced. We operate as a full service bank in Bermuda and the Cayman Islands and aim to satisfy the requirements of our customers in these communities through the range of products and services we offer. Accordingly, there is no dependence or concentration on a single product in these markets outside of the residential mortgage portfolios, which comprised 69.7% of the Group's loan book as at December 31, 2022 (compared to 68.8% as at December 31, 2021); in Bermuda, residential mortgage lending made up 55.0% of the Bermuda loan book as at December 31, 2022 (compared to 53.1% as at December 31, 2021), and loans for many purposes (education, business support, family requirements) were made in the form of residential mortgages. Product category analysis confirms that the total lending portfolio is concentrated in the property market; this has been addressed by performing stress testing.
Collateral Concentration
Collateral concentration considers whether the Group's loan book is secured by a limited number of collateral types. An example of this would be when a large value of loans to a diversified group of borrowers is all secured by shares in the same company or by the shares of various companies within the same industry sector. Any decline in the value of these shares or in the performance of the sector as a whole could have an adverse impact on the Group's security position across all affected borrowers. The most relevant example of collateral concentration is the Group's exposure to real estate property values. Ignoring cash-backed facilities, the largest collateral concentrations within the portfolio are to residential and commercial property. The greatest risk with collateral concentration is that the value of the security could be severely reduced. To simulate this, the Group's stress testing process incorporates a scenario in which all real estate collateral is devalued by factors as high as 30%.
Credit Risk Mitigation
The Group uses a wide range of techniques to reduce the credit risk of its lending. The most basic of these is performing an assessment of the ability of a borrower to service the proposed level of borrowing without distress. However, the risk can be further mitigated by obtaining security for the funds advanced.
Residential Mortgages
Residential property is the Group's main source of collateral and means of mitigating credit risk inherent in the residential mortgage portfolio. All mortgage lending activities are supported by underlying assumptions and estimated values received by independent third parties. All residential property must be insured to cover property risks through a third party.
Commercial
Commercial property is one of the Group's primary sources of collateral and means of mitigating credit risk inherent in its commercial portfolios. Collateral for the majority of commercial loans comprises first legal charges over freehold or long leasehold property but the following may also be taken as security: life insurance policies; credit balances assignments; shares; guarantees; equitable charges; debentures; chattel mortgages and charges over residential property.
For property-based lending, supporting information such as professional valuations are an important tool to help determine the suitability of the property offered as security and, in the case of investment lending, generating the cash to cover interest and principal payments. All standard documentation is subject to in-house legal review and sign-off in order to ensure that the Group's legal documentation is robust and enforceable. Documentation for large advances may be specifically prepared by independent solicitors. Insurance requirements are always fully considered as part of the application process and the Group ensures that appropriate insurance is taken out to protect the property against an insurable event.
Treasury
Collateral held as security for treasury assets, including investments, is determined by the nature of the instrument. Loans, debt securities, treasury and other eligible bills are generally unsecured with the exception of asset-backed securities and similar instruments, which are secured by pools of financial assets. The ISDA master agreement is the Group's preferred method of documenting derivative activity. It is common in such cases for a Credit Support Annex to be executed in conjunction with the ISDA master agreement in order to mitigate credit risk on the derivatives portfolio. Valuations are performed, agreed with the relevant counterparties, and collateral is exchanged to bring the credit exposure within agreed tolerances. The EAD value to the counterparty is measured under the standardised approach for measuring counterparty credit risk exposures method and is derived by adding the gross positive fair value of the contract (replacement cost) to the contract's potential future credit exposure, which is derived by applying a multiple base on the contracts residual maturity to the notional value of the contract, and applying an alpha of 1.4 to the sum of these components.
The following table shows the exposures to counterparty credit risk for derivative contracts as at December 31, 2022 and December 31, 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(in millions of $) | | Gross Positive Fair Value of Contracts as at December 31, 2022 | | Potential Future Credit Exposure as at December 31, 2022 | | Alpha as at December 31, 2022 | | EAD Value as at December 31, 2022 | | Gross Positive Fair Value of Contracts as at December 31, 2021 | | Potential Future Credit Exposure as at December 31, 2021 | | Alpha as at December 31, 2021 | | EAD Value as at December 31, 2021 |
Spot and forward foreign exchange and currency swap contracts | | 13.2 | | | 23.3 | | | 1.4 | | | 51.1 | | | 18.0 | | | 21.2 | | | 1.4 | | | 54.9 | |
Securitizations
The Bank has not, to date, securitized assets that it has originated. The Bank's total exposure to purchased securitization positions as at December 31, 2022 was $4.6 billion by market value (compared to $5.1 billion as at December 31, 2021), with US government and federal agencies accounting for the majority of this exposure.
The following table provides an analysis of the Bank's investments in securitization positions by exposure type as at December 31, 2022 and December 31, 2021:
| | | | | | | | | | | | | | |
Underlying asset type (in millions of $) | | Exposure Value as at December 31, 2022 | | Exposure Value as at December 31, 2021 |
US government and federal agencies | | 4,611.9 | | 5,083.2 |
| | | | |
Mortgage backed securities — Retail | | 19.0 | | 27.3 |
Asset-backed securities — Student loans | | 5.6 | | 13.2 |
Total | | 4,636.5 | | 5,123.7 | |
Operational Risk
In providing our services, we are exposed to operational risk. This is the risk of loss from inadequate or failed internal processes and systems, actions or inactions of people, or from external events. Operational risk is inherent in our activities and can manifest itself in various ways including fraudulent acts, business interruptions, inappropriate behavior of employees, unintentional failure to comply with applicable laws and regulations, cybersecurity incidents and privacy breaches or failure of vendors to perform in accordance with their arrangements. These events could result in financial losses, litigation and regulatory fines, as well as other damage to us. Our risk management goal is to keep operational risk at appropriate levels consistent with our risk appetite, financial strength, the characteristics of our businesses, the markets in which we operate and the competitive and regulatory environment to which we are subject.
As we continue to expand our use of technology, we are exposed to various forms of cyber-attacks. We devote significant resources to maintain and regularly upgrade our systems and networks and review the ever changing threat landscape in order to mitigate our exposure to cyber risks. In addition to the policy reviews, we continue to look to implement technology solutions that enhance preventive and detection capabilities and our ability to recover quickly should a successful cyber-attack occur. We assess our third-party vendor controls and have a developed business continuity plan that addresses potential cyber risks. We also maintain insurance coverage that may, subject to policy terms and conditions, cover certain aspects of cyber risks. However, such insurance may be insufficient to cover all losses.
Operational risk is mitigated through internal controls embedded in our business activities and our risk management practices, which are designed to continuously reassess the effectiveness of these controls in order to keep the risk we assume at levels appropriate to our risk appetite as approved by the Board. Data on operational losses and any significant control failures incurred are captured through an incident reporting process. These events are reported to both the GRCC and RPCC, which assess the sufficiency of the corrective actions taken by management to prevent recurrence. Both committees also receive regular reporting on actual performance against established risk tolerance metrics.
Russian Invasion of Ukraine
Butterfield adopts a conservative risk posture and maintains robust preventative and detective controls that have meant that the identified exposure to targets of sanctions has, to date, been minimal. Our business generally contains very few clients with Russian, Belarusian or Ukrainian ties and we therefore do not expect the current geopolitical conflict and related sanctions to present significant reputational or financial exposure for the Bank. The Bank's Group Compliance function continues to monitor for new sanctions, review our client base and ensure our control environment remains appropriately calibrated to manage our reputational and compliance risk as events continue to unfold.
Interest Rate Benchmark Reform
On March 5, 2021, the FCA and ICE Benchmark Administration, the authorized and regulated administrator of LIBOR, announced that all the GBP, CHF, JPY and EUR LIBOR settings and the one-week and two-month USD LIBOR settings will cease after December 31, 2021, and the remaining USD LIBOR settings will cease after June 30, 2023. It was subsequently announced that one-, three- and six-month GBP and JPY LIBOR settings would continue for the duration of 2022, albeit on a synthetic basis.
These reforms have the potential to impact various risk areas for the Bank, including but not limited to: operational risk (potential adverse impacts to the business, customers and technology); market risk (potential adverse impacts to the business and customers if markets are disrupted); and accounting risk (potential adverse impacts to the statement of operations if issues with hedge accounting/effectiveness arise). The Bank, however, does not expect any material change to its risk management frameworks and controls as a result of the reforms.
The Bank has established a LIBOR transition working group, consisting of senior members of management, with significant representation from the Legal and Risk departments. The working group reports directly to the GRCC which feeds into the RPCC of the Board. The working group has set up a detailed project plan which includes: transition planning; financial exposure measurement and risk assessment; operational preparedness and controls; legal contract preparedness/modification; communication; and training and oversight.
As at December 31, 2022, the Bank had 72 loans totaling $290.8 million linked to LIBOR (December 31, 2021: 121 loans totaling $563.5 million). This excludes one-week and two-month USD LIBOR which have already transitioned. The Bank is engaging with impacted customers to ensure adequate fallback provisions are included in contracts, where not already provided for.
There were no derivative positions maturing after the relevant transition dates.
Capital Adequacy Management
Effective January 1, 2015, the BMA adopted capital and liquidity requirements consistent with Basel III. These requirements are contained within the BMA's "Basel III for Bermuda Banks November 2017 Rule Update" and can be found on its website.
The Group manages its capital both on a total Group basis and, where appropriate, on a legal entity basis. The finance department has the responsibility for measuring, monitoring and reporting capital levels within guidelines and limits established by the RPCC. The management of capital will also involve regional management to ensure compliance with local regulation. In establishing the guidelines and limits for capital, a variety of factors are taken into consideration, including the overall risk of the business in stressed scenarios, regulatory requirements, capital levels relative to our peers, and the impact on our credit ratings.
Capital Assessment and Risk Profiling
Under the requirements of the Basel II Accord as implemented by the BMA, the Group undertakes a CARP process, which is an internal assessment of all material risks to determine our capital needs. This internal assessment takes account of the minimum capital requirement and other risks not covered by the minimum capital requirement (Pillar II). Where capital is deemed as not being able to mitigate a particular risk, alternative management actions are identified and described within the CARP. The CARP is presented to the RPCC before being presented to the Board for challenge and approval and then submission to the BMA. The CARP process is performed annually or more frequently should the need arise.
A SREP is then undertaken biannually by the BMA, which is designed to assess the Group's risk profile as documented in the CARP. This assessment is used to determine and set the Individual Capital Guidance which is the minimum level of capital the Group will be required to hold until the next SREP review is conducted.
B.Liquidity and Capital Resources
Liquidity
We define liquidity as our ability to maintain cash flow that is adequate to fund operations and meet present and future financial obligations through either the sale or maturity of existing assets or by obtaining additional funding through liability management.
Sources and Uses of Cash
Our primary sources of cash are (i) cash obtained from deposits, (ii) long-term debt, and (iii) cash from operations. Our primary uses are (i) the payment of our operating expenses, (ii) payment of dividends on our common shares, (iii) repayment of certain maturing liabilities, (iv) repurchase of our common shares, and (v) extraordinary requirements for cash, such as acquisitions. We had $2.1 billion of cash and cash equivalents as at December 31, 2022 and $2.2 billion as at December 31, 2021, as well as $6.7 billion and $7.5 billion, respectively, of liquid securities, the balance of which could be sold to meet liquidity requirements. In our opinion, the Bank’s working capital is sufficient for the Bank’s present requirements.
Liquidity Risk
Our liquidity risk is managed through a comprehensive framework of policies and limits overseen by GALCO. We consider the effective and prudent management of liquidity to be fundamental to our health and strength. Our objective is to manage our cash flow and liquidity reserves so that they are adequate to fund our obligations and other commitments on a timely basis and at a reasonable cost.
We continuously monitor and make adjustments to our liquidity position by adjusting the balance between sources and uses of funds as we deem appropriate. Our primary measures of liquidity include monthly cash flow analysis under ordinary business activities and conditions and under situations simulating a severe run on the Bank. The Bank strives to use a balanced liquidity risk appetite with internal quantitative liquidity risk tolerances more stringent than regulatory requirements. Specifically the Bank manages liquidity against internal limits established by the market risk management policy and its related liquidity risk standard and quarterly stress testing methodology. The results of these measures and analysis are incorporated into our liquidity contingency plan, which provides the basis for the identification of our liquidity needs. For more information, see Item 11 "Operating Results - Liquidity Risk".
Capital Resources
We have financed our operations, growth and cash needs primarily through income from operations and issuances of debt and equity securities. We believe that our cash on hand and cash flows from operations will be sufficient to repay our outstanding debt as it matures. In the future, we may need to incur additional debt or issue additional equity securities, which we may be unable to do or which may be on less favorable terms.
We manage our capital both on a consolidated basis and, where appropriate, on a legal entity basis. The group finance team has the responsibility for measuring, monitoring and reporting capital levels within guidelines and limits established by the RPCC. The management of capital will also involve jurisdictional management to ensure compliance with local regulations. In establishing the guidelines and limits for capital, a variety of factors are taken into consideration, including the overall risk of the business in stressed scenarios, regulatory requirements, capital levels relative to our peers, and the impact on our credit ratings.
Effective January 1, 2015, the BMA implemented the capital reforms proposed by the BCBS and referred to as the Basel III regulatory framework. Basel III aims to raise the quality, consistency and transparency of the capital base, limit the build-up of excess leverage and increase capital requirements for the banking sector. We are now subject to the following requirements:
•CET1 ratio of at least 7.0% of RWA, inclusive of a minimum CET1 ratio of 4.5% and the new capital conservation buffer of 2.5%, but excluding the Domestic Systematically Important Bank ("D-SIB") surcharge described below;
•Tier 1 capital of at least 8.5% of RWA, inclusive of a minimum Tier 1 ratio of 6% and the new capital conservation buffer of 2.5%, but excluding the D-SIB surcharge described below;
•Total capital of at least 10.5% of RWA, inclusive of a minimum total capital ratio of 8% and the new capital conservation buffer of 2.5%, but excluding the D-SIB surcharge described below;
•We are considered to be a D-SIB and are subject to a 3% surcharge composed of CET1-eligible capital implemented by the BMA effective September 30, 2015. This is based upon our assessment of the extent to which we (individually and collectively with the other Bermuda banks) pose a degree of material systemic risk to the economy of Bermuda due to our role in deposit taking, corporate lending, payment systems and other core economic functions;
•Counter-cyclical buffer of up to 2.5% composed of CET1-eligible capital may be implemented by the BMA when macroeconomic indicators provide an assessment of excessive credit or other pressures building in the banking sector, potentially increasing the CET1, Tier 1 and total capital ratios by up to 2.5%. No counter-cyclical buffer has been implemented to date;
•Leverage ratio must be at 5.0% or higher;
•LCR with a minimum requirement of 100%; and
•NSFR with a minimum requirement of 100%.
The minimum capital ratio requirements set forth above do not reflect additional Pillar II add-on requirements that the BMA may impose upon us as a prudential measure from time to time. Our capital requirements remain under continuous review by the BMA pursuant to its prudential supervision and we cannot guarantee that the BMA will not seek higher total capital ratio requirements at any time.
In December 2017, the BCBS published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as "Basel IV"). Among other things, these standards revise the BCBS's standardized approach for credit risk (including by recalibrating risk weights and introducing new segmentations for exposures) and provides a new standardized approach for operational risk capital. Under the BCBS framework, these standards will generally be effective on January 1, 20232, with an aggregate output floor phasing in through January 1, 2028. The BMA issued consultation papers in 2022 which set out the Authority’s proposed adoption of the BCBS's revised standardized approach for operational and credit risk with implementation dates of January 1, 2023 and January 1, 2024, respectively.
The following table sets forth our capital adequacy as at December 31, 2022 and 2021 in accordance with the Basel III framework:
| | | | | | | | | | | | |
| As at December 31 | |
(in millions of $) | 2022 | | 2021 | |
Capital | | | | |
Common Equity Tier 1 | 983.3 | | | 896.3 | | |
Tier 1 capital | 983.3 | | | 896.3 | | |
Tier 2 capital | 183.6 | | | 184.0 | | |
Total capital | 1,167.0 | | | 1,080.3 | | |
Risk Weighted Assets | | | | |
Cash and cash equivalents and investments | 1,023.4 | | | 1,141.4 | | |
Loans | 2,507.3 | | | 2,606.0 | | |
Other assets | 288.6 | | | 255.3 | | |
Off-balance sheet items | 173.5 | | | 230.9 | | |
Operational risk charge | 850.5 | | | 867.9 | | |
Total risk-weighted assets | 4,843.4 | | | 5,101.5 | | |
Capital Ratios (%) | | | | |
Common Equity Tier 1 | 20.3 | % | | 17.6 | % | |
Tier 1 total | 20.3 | % | | 17.6 | % | |
Total capital | 24.1 | % | | 21.2 | % | |
Leverage ratio | 6.7 | % | | 5.6 | % | |
Overall, capital ratios have increased, driven primarily by a decrease in RWAs and earnings accretion and partially offset by dividend payments and share repurchases. The decrease in RWA is driven primarily by decreased depositor funding. As at December 31, 2022, we were in compliance with the minimum LCR of 100% as well as the minimum NSFR of 100%.
Share Repurchase Program
The Bank repurchases its common shares through share repurchase programs from time to time as a means to improve shareholder liquidity and facilitate growth in share value. In accordance with applicable laws, regulations and listing standards, each program was approved by the Board and repurchases of shares pursuant to each program are subject to the approval of the BMA. In addition, the BSX is advised monthly of shares purchased pursuant to each program.
On December 6, 2018, following the completion of the initial 2018 share repurchase program, the Board approved the 2019 share repurchase program, authorizing the purchase of up to 2.5 million common shares through February 29, 2020.
On December 2, 2019, the Board approved, with effect from the completion of the previous program on December 20, 2019 through February 28, 2021, a common share repurchase program, authorizing the purchase of up to 3.5 million common shares or $125 million.
On February 10, 2021, the Board approved a new common share repurchase program, authorizing the purchase of up to 2.0 million common shares through February 2022.
2 In March 2020, in response to the pandemic, the BCBS deferred the implementation timeline from January 1, 2022 to January 1, 2023 and the output floor phasing in from January 1, 2027 to January 1, 2028.
On February 14, 2022, the Board approved, with effect from the completion of the previous program, a new common share repurchase program, authorizing the purchase of up to 2.0 million common shares through February 28, 2023.
On February 13, 2023, the Board approved, with effect from the completion of the previous program, a new common share repurchase program, authorizing the purchase of up to 3.0 million common shares through February 29, 2024. The timing and amount of repurchase transactions under the new program will be based on market conditions, share price, legal requirements and other factors. No assurances can be given as to the amount of common shares that may actually be repurchased.
Total common share repurchases for the years ending December 31, 2022, 2021 and 2020 are as follows:
| | | | | | | | | | | | | | |
| For the year ending December 31 |
| 2022 | 2021 | 2020 | | | |
Acquired number of shares (to the nearest share) | 102,000 | | 534,828 | | 3,452,000 | | | | |
Average cost per common share (in $) | 38.21 | | 36.93 | | 25.10 | | | | |
Total cost (in $) | 3,897,268 | | 19,753,336 | | 86,639,889 | | | | |
From time to time, our associates, insiders and insiders' associates as defined by the BSX regulations may sell shares which may result in such shares being repurchased pursuant to each program, provided no more than any such person's pro-rata share of the listed securities is repurchased. Pursuant to the BSX regulations, all repurchases made by any issuer pursuant to a securities repurchase program must be made: (1) in the open market and not by private agreement; and (2) for a price not higher than the last independent trade for a round lot of the relevant class of securities.
Dividends
During the year ended December 31, 2022, we paid cash dividends totaling $87.3 million or $1.76 (2021: $87.3 million or $1.76; 2020: $88.9 million or $1.76) for each common share on record as of the related record dates. The Board declared these dividends as a quarterly dividend of $0.44 per common share for each quarter of 2022, 2021 and 2020.
For more information, see Item 3.D. "Risk Factors – Risks Relating to the Common Shares".
Cash Flows
2022 vs. 2021
Cash and cash equivalents was $2.1 billion as at December 31, 2022, compared to $2.2 billion as at December 31, 2021. The decrease is described below by category of operating, investing and financing activities.
For the year ended December 31, 2022, net cash provided by operating activities totaled $219.3 million (2021: $251.3 million). Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. Cash provided by operating activities decreased by $32.1 million from 2021 to 2022, due primarily to movements in other assets and liabilities, reduced depreciation and amortization and partially offset by an increase in net income.
Net cash provided by investing activities for the year ended December 31, 2022 totaled $292.0 million, compared to cash used in investing activities of $1,905.7 million in 2021. The $2,197.7 million increase in cash provided by investing activities in 2022 was mainly attributable to the reduced purchases of investments in securities due to reduced depositor funding.
Net cash used in financing activities totaled $506.8 million in 2022, compared to net cash provided by financing activities of $535.8 million in 2021. The $1,042.6 million decrease is mainly due to reduced deposit liabilities partially offset by common share repurchases.
2021 vs. 2020
Cash and cash equivalents was $2.2 billion as at December 31, 2021, compared to $3.3 billion as at December 31, 2020. The decrease is described below by category of operating, investing and financing activities.
For the year ended December 31, 2021, net cash provided by operating activities totaled $251.3 million (2020: $188.2 million). Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. Cash provided by operating activities increased by $63.2 million from 2020 to 2021, due primarily to an increase in net income as well as movements in other liabilities.
Net cash used in investing activities for the year ended December 31, 2021 totaled $1,905.7 million, compared to cash used in investing activities of $41.7 million in 2020. The $1,864.0 million increase in cash used in investing activities in 2021 was mainly attributable to the purchases of investments in securities which was driven by both increased depositor funding as well as the redeployment of funds from cash and cash equivalents.
Net cash provided by financing activities totaled $535.8 million in 2021, compared to net cash provided by financing activities of $546.4 million in 2020. The $10.7 million decrease is mainly due to a decreases in common share repurchases during the year and partially offset by a reduced increase in deposit liabilities and the issuance of subordinated debt in 2020.
Contractual Obligations
Credit-Related Arrangements
See "Note 12: Credit related arrangements, repurchase agreements and commitments" to our audited consolidated financial statements as at December 31, 2022 for additional information.
Contractual Obligations
The following table presents our outstanding contractual obligations as at December 31, 2022:
| | | | | | | | | | | | | | | | | | |
(in millions of $) | Total | Less than 1 year | 1 to 3 years | 3 to 5 years | After 5 years | |
Long term debt(1) | 175.0 | | — | | — | | 175.0 | | — | | |
Sourcing arrangements(2) | 42.9 | | 12.6 | | 21.7 | | 8.6 | | — | | |
Term deposits | 3,107.2 | | 3,020.1 | | 87.2 | | — | | — | | |
Other obligations | 25.5 | | 12.9 | | 9.1 | | 2.2 | | 1.4 | | |
Total outstanding contractual obligations | 3,350.7 | | 3,045.6 | | 117.9 | | 185.7 | | 1.4 | | |
______________________________
(1)Long-term debt excludes interest and unamortized debt issuance costs.
(2)We have an outstanding contractual obligation relating to a five-year agreement entered into in November 2021 with DXC to supply technology infrastructure and application development management, information security and technical support for our locations in Bermuda and the Cayman Islands. Under our agreement with DXC, server management and maintenance, technology field support, application support and development and help desk functions are managed by DXC.
See "Note 12: Credit related arrangements, repurchase agreements and commitments" to our audited consolidated financial statements as at December 31, 2022 for additional information.
Interest expense on our contractual obligations relates primarily to deposit liabilities and our long-term debt. Interest expense on customer deposits was $45.2 million for the year-ended December 31, 2022, compared to $15.5 million and $25.1 million for the years ended December 31, 2021 and 2020, respectively. Movements in interest expense on deposit liabilities are due primarily to market interest rate movements, with yearly average deposits liabilities of $13.3 billion, $13.7 billion and $12.1 billion for 2022, 2021 and 2020, respectively. The increase in the expense is related primarily to a rapid increase in market interest rates during the year and partially offset by lower average deposit volumes.
Capital Commitments
In 2021, the Bank embarked on a significant information technology project intended to modernize and upgrade its technology applications and infrastructure. It is a three-year programme that will improve the efficiency and stability of the Bank's technology estate and enhance the Bank's ability to provide broader and better digital solutions to its clients. The project is anticipated to be completed towards the end of 2023.
The Bank is expected to spend between $30 million to $40 million over the three year project horizon, which will be funded by existing cash resources.
The Bank has established a project management steering committee and program office. The steering committee consists of senior and executive members of management and reports directly to the Board.
For more information, see Item 3.D. "Risk Factors - Risks Relating to Risk Oversight and Internal Controls - Our operations are reliant on effective implementation and use of technology and require us to adapt to new technologies, and a breach, interruption or failure of our technology services or the inability to effectively integrate new technologies could have an adverse effect on our business, financial condition or results of operations."
See also "Note 12: Credit related arrangements, repurchase agreements and commitments" to our audited consolidated financial statements as at December 31, 2022 for additional information.
C.Research and Development, Patents and Licenses, etc.
Not applicable.
D.Trend Information
See discussion in Item 5.A. "Operating Results" for a description of the trend information relevant to us.
E. Critical Accounting Estimates
The Bank's significant accounting policies conform to GAAP and are described in Note 2 of our audited consolidated financial statements. Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Given the sensitivity of our consolidated financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. Details of certain critical policies and estimates that affect our business results are summarized below:
Allowance for Credit Losses
Accounting for Financial instruments - Credit losses
On January 1, 2020, the Bank adopted Accounting Standards Update (“ASU”) 2016-13 Financial Instruments – Credit Losses (Topic 326). Accordingly, from the date of adoption, the Bank uses a current expected credit loss model ("CECL") which is based on expected losses. The model used by the Bank up to December 31, 2019 to estimate credit losses was based on incurred losses. The CECL model is applied by the Bank to the measurement of credit losses on financial instruments at amortized cost, including loan receivables and HTM debt securities. The Bank also applies the CECL model to certain off-balance sheet credit exposures such as undrawn loan commitments, standby letters of credit, financial guarantees, and other similar instruments. In line with Topic 326, the Bank will present credit losses on AFS securities as a valuation allowance rather than as a direct write-down. Changes in expected credit losses are recorded through the respective credit loss allowances on the consolidated balance sheets as well as in the provision for credit losses (recoveries) in the consolidated statements of operations.
The Bank's purchased credit-impaired (“PCI”) loans outstanding as at January 1, 2020 were classified as purchased credit deteriorated (“PCD”) loans and both the amortized cost and an allowance for expected credit losses are disclosed and included with other non-PCD loans figures. The Bank will continue to recognize the amortization of the noncredit discount, if any, as interest income based on the yield of such assets.
The Bank has not restated comparative information previously accounted for under the incurred loss and the PCI models. The total adjustment resulting from the adoption of this methodology on the opening balance of the Bank’s accumulated deficit as at January 1, 2020 was a negative adjustment of $7.8 million relating to the Bank's loan portfolio.
Under the CECL model, the Bank collects and maintains attributes as they relate to its financial instruments that are within the scope of CECL including fair value of collateral, expected performance over the lifetime of the instruments and reasonable and supportable assumptions about future economic conditions. The Bank's measurement of expected losses takes into account historical loss information and is primarily based on the product of the respective instrument’s probability of default (“PD”), loss given default (“LGD”) and exposure at default (“EAD”). For AFS securities, any allowance for credit losses is based on an impairment assessment.
The Bank made the accounting policy election to write off accrued interest receivable on loans that are placed on non-accrual status by reversing the then accrued interest balance against interest income revenue.
The Bank maintains an allowance for credit losses, which in management’s opinion is adequate to absorb all estimated credit-related losses that are expected in its lending and off-balance sheet credit-related arrangements at the balance sheet date.
Management measures expected credit losses on HTM and AFS debt securities on a collective basis by major security type when similar risk characteristics exist, or failing that, on an individual basis.
For AFS debt securities in an unrealized loss position, the Bank first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For AFS debt securities that do not meet the aforementioned criteria, the Bank evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.
Losses are charged against the allowance when management believes the uncollectibility of an AFS debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met.
The allowance for credit losses on loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries typically do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
Management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts as well as the Bank's internal risk rating framework. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in the current-loan specific risk characteristics such as differences in underwriting practices, vintage, portfolio mix, delinquency level and term as well as changes in environmental conditions, such as changes in macroeconomic factors and collateral values.
The allowance for credit losses is measured on a collective pool basis when similar risk characteristics exist. In each of its jurisdictions, the Bank has identified the following portfolio segments: residential mortgages, consumer loans (including overdrafts), commercial loans, commercial overdrafts, commercial real estate loans and credit cards. For loans and overdrafts, management uses a PD and LGD model to estimate the allowance for credit losses. Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the collective evaluation. For credit cards, management uses a loss rate to estimate expected credit losses.
Expected credit losses are estimated over the contractual term of the loans. The contractual term excludes potential extensions, renewals and modifications unless management has a reasonable expectation at the reporting date that the extension or renewal options included in the original contract will occur or that a troubled debt restructuring will be executed. Credit card receivables do not have stated maturities, therefore establishing a contractual term is performed by using an analytical approximation of behavior.
Fair Value of financial instruments
We define fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We determine the fair values of assets and liabilities based on the fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The relevant accounting standard describes three levels of inputs that may be used to measure fair value. Equity securities and debt instruments classified as AFS, and derivative assets and liabilities are recognized in the consolidated balance sheet at fair value.
Fair value inputs are considered Level 1 when based on unadjusted quoted prices in active markets for identical assets.
We determine fair value based on quoted market prices, where available. If quoted prices are not available, fair value is estimated based upon other observable inputs, and may include valuation techniques such as present value cash flow models or other conventional valuation methods. In addition, when estimating the fair value of assets, we may use the quoted price of similar assets, if available.
We use unobservable inputs when observable inputs are not available. These inputs are based upon our judgments and assumptions, which represent our assessment of the assumptions market participants would use in pricing the asset or liability, which may include assumptions about risk, counterparty credit quality and liquidity and are developed based on the best information available. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Bank's results of operations.
Significant assets measured at fair value on a recurring basis include our US government and federal agencies investments, non-US government debt securities, and residential mortgage-backed securities. The fair values of these instruments are generally sourced from an external pricing service and are classified as Level 2 within the fair value hierarchy. The service's pricing models use predominantly observable valuation inputs to measure the fair value of these securities under both the market and income approaches.
Fair value is also used on a nonrecurring basis to evaluate certain assets for impairment or for disclosure purposes. Examples of nonrecurring uses of fair value include OREO, loan impairments for certain loans and goodwill.
We review and update the fair value hierarchy classifications on a quarterly basis. We also verify the accuracy of the pricing provided by our primary external pricing service on a quarterly basis.
During the year ended December 31, 2022, there were no transfers between Level 1 and Level 2 and there was a transfer out of Level 3 and into Level 2 due to increased price observability. There were no transfers between Level 1 and Level 2 or Level 2 and Level 3 during the year ended December 31, 2021.
Refer to "Note 17: Fair value measurements" of the audited consolidated financial statements for further detail on the judgments made in classifying instruments in the fair value hierarchy.
Impairment of Goodwill
We account for acquisitions using the acquisition method of accounting, under which the acquired company's net assets are recorded at fair value at the date of the acquisition and the difference between the fair value of consideration and fair value of the net assets acquired is recorded as goodwill, if positive, and as a bargain purchase gain, if negative.
Goodwill is tested annually in the third quarter for impairment at the reporting unit level, or more frequently if events or circumstances indicate there may be impairment. The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing each reporting unit's fair value to its carrying value including goodwill. If the fair value of a reporting unit exceeds its carrying value, applicable goodwill is deemed to be not impaired. If the carrying value exceeds fair value, there is an indication of impairment and the second step is performed to measure the amount of impairment.
The second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated impairment. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, which is the excess of the fair value of the reporting unit, as determined in the first step, over the aggregate fair values of the individual assets, liabilities and identifiable intangible assets as if the reporting unit were being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss recognized cannot exceed the amount of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted.
We rely on several assumptions when estimating the fair value of our reporting units using the discounted cash flow method. These assumptions include the estimated future cash flows from operations, required discount rate, as well as projected loan losses, an estimate of terminal value and other inputs. Our estimated future cash flows are largely based on our historical actual cash flows and industry and economic trends, among other considerations. Although management has used the estimates and assumptions it believes to be most appropriate in the circumstances, it should be noted that even relatively minor changes in certain valuation assumptions used in management's calculation would result in significant differences in the results of the impairment test.
The valuation of goodwill is dependent on forward-looking expectations related to nationwide and local economic conditions and our associated financial performance. In the future, if our acquisitions do not yield expected returns or there are changes in discount rates, we may be required to take additional charges to our earnings based on the impairment assessment process, which could harm our business, financial condition, results of operations and prospects. We had $22.9 million of goodwill as of December 31, 2022 and $25.4 million as of December 31, 2021, and the results of the impairment analysis for both annual periods resulted in no impairment being required.
Employee Benefit Plans
We maintain trusteed pension plans for substantially all employees as either non-contributory defined benefit plans or defined contribution plans. Benefits under the defined benefit plans are primarily based on the employee's years of credited service and average annual salary during the final years of employment as defined in the plans. We also provide post-retirement medical benefits for certain qualifying active and retired Bermuda-based employees.
The calculations of the amounts recorded require the use of various actuarial assumptions, such as discount rates, assumed rates of return on plan assets, compensation increases, and turnover rates. We review our actuarial assumptions on an annual basis and make modifications to the assumptions based on current rates and trends when appropriate. We believe that the assumptions used in recording our defined benefit plan obligations are reasonable based on our experience and advice from our actuaries.
The post-retirement medical benefits obligation is determined using our assumptions regarding health care cost trend rates. The health care trend rates are developed based on historical cost data, the near-term outlook on health care trends and the likely long-term trends.
In accordance with GAAP, actual results that differ from these assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expenses and the recorded obligation of future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect the defined benefit obligations and future expense.
See "Note 11: Employee benefit plans" to our audited consolidated financial statements as at December 31, 2022 for more information on our pension plans and post-retirement medical benefit plan, along with the key actuarial assumptions.
Share-based Compensation
We engage in equity settled share-based payment transactions in respect of services received from eligible employees. The fair value of the services received is measured by reference to the fair value of the shares or share options granted on the date of the grant. The cost of the employee services received in respect of the shares or share options granted is recognized in the consolidated statements of operations over the shorter of the vesting or service period.
The fair value of the options granted is determined using option pricing models, which take into account the exercise price of the option, the current share price, the risk-free interest rate, expected dividend rate, the expected volatility of the share price over the life of the option and other relevant factors. The fair value of unvested share awards is deemed to be the closing price of the publicly traded Bank shares on the grant date. The fair value of time vesting conditions are taken into account by adjusting the number of shares or share options included in the measurement of the cost of employee services so that ultimately, the amount recognized in the consolidated statements of operations reflects the number of vested shares or share options. The Bank recognizes compensation cost for awards with performance conditions if and when the Bank concludes that it is probable that the performance condition will be achieved, net of an estimate of pre-vesting forfeitures (e.g., due to termination of employment prior to vesting).
See "Note 21: Share-based payments" to our audited consolidated financial statements as at December 31, 2022 for more information on share-based compensation.