Butterfield: Not Bad, But Not Great Either (NYSE:NTB)

As far as banks go, one of the oldest that you have likely never heard of that still exists today is The Bank of N.T. Butterfield & Son Limited (NYSE:NTB). Although the bank was originally founded in 1858, it actually traces its roots back to 1784 when Nathaniel Butterfield founded his own trading firm. Today, the institution is rather large as far as smaller banks go. It has a market capitalization of $1.54 billion and nearly $12 billion in deposits. Relative to earnings, the institution is attractively priced. But shares are quite pricey relative to book value. The picture is complicated by the fact that a sizable portion of the company’s revenue actually comes from non-interest income. That can help to legitimize such a pricey institution from a book value perspective. In some respects, the bank is doing quite well. But in others, it continues to demonstrate some meaningful weakness. Given this mixed picture, I’ve decided to rate it a ‘hold’ for now.

An interesting bank

As I mentioned already, Butterfield is an institution with a long history. Over time, its status has changed quite a bit. But one thing that has remained unchanged the sense very early in its history is that a large portion of its business is centered around the economy of Bermuda. Over the years, management opened offices elsewhere, including that came in islands. In fact, today, the institution has 10 different international locations, including, but not limited to, Switzerland, Singapore, Canada, and the UK.

Through these locations, the company provides a full range of banking and wealth management services. These include account and deposit services, the origination of residential and commercial mortgages, business deposit services, the issuance of credit and debit cards, cash management services, mobile and Internet banking services, and more. The company also makes itself available to private clients and financial institutions for the purpose of private banking, corporate banking, treasury services, and more. All three of its geographic segments provide wealth management services to high net worth and ultra-high net worth individuals, as well as various types of institutions like family offices. The company also has a trust business line and an asset management line, the latter of which provides portfolio management services to institutional and private clients.

Using data from the 2022 fiscal year, the firm very much is still focused on the economy of Bermuda. About 44% of net revenue that year came from the country. The Cayman Islands was a close second at 32%. The Channel Islands and the UK, combined, Account for roughly 19% of revenue. And that leaves all other miscellaneous operations accounting for the remaining 5% of net revenue.

Over the past few years, Butterfield has done a solid job growing its top and bottom lines. The company went from generating $309.1 million of net interest income in 2020 to generating $341.2 million of net interest income in 2022. In the first nine months of 2023, net interest income climbed further to $277.3 million. That’s up from the $248.2 million generated the same time one year earlier. Over the three-year window from 2020 through 2022, non-interest income also expanded, growing from $183.9 million to $206.6 million. Its growth has also continued through 2023, with the first nine months resulting in a reading of $152.3 million compared to the $151.7 million reported the same time of 2022. Although the company generates non-interest income from activities like asset management services and serving as the custodian of assets, the three main categories from which it derives revenue would be banking, handling foreign exchange, and providing trust services. In the most recent quarter alone, these accounted for 77.3% of the non-interest income of the institution.

Off the top of my head, I don’t believe I have ever seen a bank that did not generate non-interest income. But normally, it is a fairly small portion of overall net revenue. In the case of Butterfield, however, using data from the first nine months of 2023, we see that an impressive 35.5% of sales come from these types of activities. The reason why I said, earlier in the article, that this can help to justify shares trading at a premium to book value is that, in theory, these activities provide a more stable source of income when interest rates might be unstable or bank deposits are on the decline.

As revenue has grown, so too has profitability. Back in 2020, Butterfield generated $147.2 million in net profits. This number rose in each of the subsequent years, eventually hitting $214 million in 2022. For the first nine months of 2022, net profits came in at $150.9 million. Fast forward one year, and profits were $172 million. That represents an increase of 13.9% year over year. Naturally, the growth in net interest income contributed the most to this improvement. After all, that kind of income is high margin in nature.

This kind of growth for the company has only been possible by a growth in the assets on its books. But the growth is not exactly where you might expect. From 2020 through 2022, the value of loans on the company’s books actually declined from $5.19 billion to $5.12 billion. We have seen that metric continued to worsen through 2023. By the third quarter of the year, loans had dropped to $4.78 billion. Now, before we touch on other metrics, some additional details regarding its loan exposure should be touched upon. One area that many investors are worried about at this time is exposure to office assets. Unfortunately, management does not provide a breakdown for how much of its loans are exposed to these types of assets. But we do know that only about 12.6% of its entire loan portfolio involves commercial real estate. So exposure can’t be that significant. Meanwhile, 69.5% of its loan portfolio involves residential mortgages.

For the most part, the value of cash on hand has also been declining. It went from $3.29 billion in 2020 to $2.10 billion by the end of 2022. Cash has largely declined further since then, totaling $1.75 billion as of the end of the third quarter of 2023. The good news is that, even as cash values declined, the amount of debt on the company’s books has also dropped. After hitting $172.3 million in 2022, debt for the institution ended up falling to only $98.4 million by the end of the third quarter of last year.

The only area of growth for Butterfield has been when it comes to securities. But even that picture has changed recently. After rising from $4.86 billion in 2020 to $5.73 billion in 2022, the value of securities has started falling, eventually hitting $5.32 billion by the end of the most recent quarter. If pretty much all of these metrics have been falling, it’s not hard to imagine that the deposit picture for the institution has also been less than ideal. After peaking at $13.87 billion in 2021, the value of deposits at the institution pulled back to $12.99 billion in 2022. By the end of the most recent quarter for which data is available, deposits came in at $11.86 billion.

As the overall financial situation of the institution has worsened, management has also reported mixed results when it comes to book value. As you can see in the chart above, book value per share and tangible book value per share has been quite volatile, especially from 2022 through to the present day. As a whole, we have seen a slight increase since the end of 2022. That in and of itself is positive. But I don’t like to see the kind of volatility that Butterfield brings to the table. As I mentioned earlier in this article, shares are also trading at a premium to book value. They are trading about 83.9% higher than book value and 101.3% above tangible book value. Relative to earnings, however, shares do look rather cheap. If we assume that financial results for the first nine months of 2023 are indicative of how the final quarter will be, then according to my estimate, the institution is trading at a forward price to earnings multiple of 6.3. Using the data from 2022, however, we get a multiple of 7.2. Either way, these numbers are well below the 10.4 average seen for regional banks.

Takeaway

The value investor in me wants to be a fan of Butterfield because I like how cheap shares are relative to earnings. I also like the diverse business model that generates so much of its income from non-interest activities. But when you really take a step back and look at the bigger picture, you see an institution that is struggling in many respects. The primary goal of investing should be to preserve capital. And when you think about it that way, there are certainly better prospects that can be had. Because of this, I have decided to rate Butterfield stock a ‘hold’ for now.