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The Bank of N.T. Butterfield & Son Limited (NYSE:NTB)
Q3 2019 Earnings Call
Oct 23, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Butterfield's Third Quarter Earnings Conference call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Noah Fields, Butterfield's Head of Investor Relations. Mr. Fields, please go ahead.

Noah Fields -- Head of Investor Relations

Thank you, operator. Good morning, everyone and thank you for joining us. Today, we will be reviewing Butterfield's third quarter 2019 financial results. On the call, I'm joined by Butterfield's Chairman and Chief Executive Officer, Michael Collins; and Chief Financial Officer, Michael Schrum. Following their prepared remarks, we will open the call up for a question-and-answer session. Yesterday afternoon, we issued a press release announcing our third quarter 2019 results. The press releases along with a slide presentation that we will refer to during our remarks in this call are available on the Investor Relations section of our website at www.butterfieldgroup.com.

Before I turn the call over to Michael Collins, I would like to remind everyone that today's discussions will refer to certain non-GAAP measures, which we believe are important in evaluating the Company's performance. For a reconciliation of these measures to US GAAP, please refer to the earnings press release and slide presentation. Today's call and associated materials may also contain certain forward-looking statements, which are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these risks can be found in our SEC filings.

I will now turn the call over to Michael Collins.

Michael Collins -- Chairman and Chief Executive Officer Read more

Thank you, Noah, and thanks to everyone joining the call today. The third quarter of 2019 was notable for solid earnings as well as the early close of the ABN AMRO Channel Islands deal and ongoing integration of that business into our existing Guernsey Bank. As you may be aware, Bermuda was hit by Hurricane Humberto, a Category two storm on, September 18. Thankfully, the island made it through relatively unscathed. While this was a powerful hurricane, the island suffered limited property damage and loss of electricity to approximately 80% of residents.

The bank was only closed for one business day, reopening for normal operations on Friday, September 20. Bermuda's resilient infrastructure and rigorous building code, in combination with Butterfield's effective business continuity planning and recovery processes, allowed us to quickly return to business as usual. This was the third major hurricane to make landfall in Bermuda in the last five years, so we now have a lot of practice fine-tuning all our recovery processes.

Turning now to some highlights on Slide 4 of the earnings deck. During the third quarter, we reported net income of $42 million or $0.79 per share and $49 million or $0.91 per share on a core basis. Butterfield's core return on tangible equity was a healthy 22.5%. Our earnings continue to benefit from stable and growing fee income, expense management and an expanding balance sheet. Deposit cost increased 12 basis points during the quarter to 54 basis points, contributing to an overall NIM of 2.52%. As expected, the larger multicurrency balance sheet that we acquired with the Channel Islands is impacting NIM. However, once the business normalizes, we expect continued growth to long-term profitability from this acquisition.

Our strong results once again allowed the Board to approve a quarterly cash dividend of $0.44 per common share. Before I turn the call over to our CFO, I wanted to acknowledge the appointment of Mark Lynch to Butterfield's Board of Directors. Mark has had a successful career as an institutional investor, most recently at Wellington Management Company. He has been a longtime supporter of Butterfield and a helpful founding Board since the bank's recapitalization in 2010. I look forward to working with Mark and believe the Board and our shareholders will benefit from his deep expertise and perspective.

I'll now turn the call over to Michael Schrum to provide further commentary on the third quarter results.

Michael Schrum -- Group Chief Financial Officer

Thank you, and good morning, everyone. On Slide 6, we provide a summary of net interest income and NIM. The inclusion of ABN AMRO Channel Islands balance sheet has had an immediate benefit to net interest income. Net interest income was up 1.4% in the quarter, while NIM has decreased 66 basis points compared to the last quarter due to the inclusion of the 80-basis-point NIM balance sheet from the ABN AMRO acquisition and lower-yielding US treasuries at the short end. Loan yields were lower due to the lower Fed Funds rates on variable-rate mortgages and the impacts from the lower-yielding loan book from ABN at 2.81%. As we season the deposits over the next two years, we expect the larger balance sheet to become more productive with an expanded securities portfolio.

On Slide 7, we provide an overview of average customer deposits balances by location, currency and contractual nature. As of September 30, 2019, total deposits were $12.7 billion, up $2.8 billion compared to June 30, 2019. As you can see in the chart, customer deposits in the Channel Islands have increased significantly as a result of the acquisition.

Increased euro and sterling deposits have lowered the percentage of US dollars to 67% of the total deposits from 80% last quarter. We continue to expect overall Channel Island deposit levels to reduce over the coming 12 months as we start to price these to market rates. It is important to note that the increase in Butterfield's overall deposit costs, from 42 basis points to 54 basis points, is almost exclusively attributable to the newly acquired deposits, which had a weighted average cost of 99 basis points at the closing date on July 15.

Looking now at Slide 8. Fee income was up 5.4% in the third quarter due to the new fee revenues from the acquisition. Foreign exchange revenue, custody and asset management fees were all up versus the second quarter. Fee income remains a significant contributor to group earnings, representing 35% of earnings. Our sizable fee income earnings component has become an increasingly important earnings stabilizer to help balance revenue from the rate-dependent NII and more stable fee income from banking and trust.

On Slide 9, we provide an overview of core non-interest expense, which have increased during the quarter to $84.0 million from $79.2 million. This is as expected due to the inclusion of the additional expenses from the recent acquisition. Our cost/income ratio was slightly above our 60% target. We continue to view cost controls as an important way to help maintain net income, and we'll seek to improve efficiencies wherever possible. Looking now at Slide 10, we provide a summary of capital levels.

Our priorities remain the same and are balanced between regulatory requirements and shareholder returns. At the closing of the ABN AMRO Channel Islands acquisition, our TCE to TA reduced approximately 5.5%, which is below our target range of 6% to 6.5%. We are now back in our target range and expect to assume share repurchases in the fourth quarter. In addition to our sustainable quarterly common dividend of $0.44 per share, we believe our capital return policy is appropriate to reward shareholders, while also maintaining sufficient funding to invest in and grow the business through the business cycle.

Turning now to Slide 11 and the discussion of the balance sheet. The ABN AMRO acquisition has significantly increased the size of the balance sheet with growth in loan and investment securities balances. We actually invested approximately $138 million in US government currency mortgage-backed securities with an average book yield of 2.74% with an average effective duration of 4.26 years during the quarter. On Slide 12, we continue to emphasize low credit risk in our investment portfolio, with most of our investments in AAA rated US government guaranteed NBFs.

Our loan book is two-third financial mortgages with an average loan-to-value of approximately 50%. Non-accrual loans have decreased slightly with the trend of low net charge-offs continuing in the third quarter. With seasonal transition on the horizon, we've been working to determine how this new reporting framework could impact Butterfield. At this point, we expect the CECL could increase the collective allowance for credit losses in the range of 20% to 35% as a transitional adjustment on January 1, 2020. This is within the expected range of our accounts being communicated by US banks.

On Slide 13, we discuss the average cash and securities balance sheet with a summary interest rate sensitivity analysis. While Butterfield remains asset sensitive, this has moderated this quarter due to the multicurrency deposits acquired and the addition of fixed-rate securities. We also expect that higher deposit cost in the Channel Islands from the recent acquisitions should decrease in the coming quarters. Additionally, we're gradually increasing the duration of our securities portfolio, which should offset some of the interest rate sensitivity and improve yields.

I will now turn the call back to Michael Collins to provide an update on the ABN AMRO Channel Islands acquisition.

Michael Collins -- Chairman and Chief Executive Officer Read more

Thank you, Michael. Butterfield's operations are based in highly regarded financial jurisdictions with strong regulatory regimes, underpinned by well-established common law principles. Our growing presence in the Channel Islands diversified our credit concentration, solicited revenue and deposit base, while positioning us for organic growth in Guernsey and Jersey where we currently have relatively small market shares. I am very pleased that we were able to close this significant deal ahead of schedule and at a better dollar price than originally anticipated. Staffing levels are coming in lower and ahead of expectations, which will result in lower-than-expected redundancy cost associated with the deal.

This benefit, together with the other significant expense initiatives across the platform, can already be seen in our core expense run rates. Deposit attrition has been in line with what we anticipated, and we are working closely with clients to determine the most appropriate and mutually beneficial banking options. The loan book has exceeded our expectations and does not require the full model 3% credit mark. We now expect the operational integration to be completed in the second quarter of 2020 rather than the second half of next year. We are also expecting the tangible book value per share dilution to be better than expected. Otherwise, the expected pro forma financials are coming through as we anticipated.

Our current business development and M&A focus is on the ABN AMRO integration. However, we continue to reach out to potential targets. With that said, I would not anticipate any significant deals until this latest acquisition is operationally integrated over the next year. We are very excited about our prospects for growth and profitability in the Channel Island and across all of our current operating locations. While we cannot control the interest rate environment, we can improve efficiency, target strategic and high-value low-cost acquisitions and manage our capital without taking significant additional credit risk, while maintaining our regular dividend and an active share repurchase program. The profitability of the bank will be impacted negatively if interest rates continue to fall. However, we believe that our results should continue to outpace US peers with a return on tangible common equity in the high teens or low 20s. In the meantime, we're focused on controlling expenses, managing capital and ensuring the successful integration of the ABN AMRO deal.

Thank you. And with that, we'd be happy to take your questions. Operator?

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Alex Twerdahl with Sandler O'Neill. Please go ahead.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Hey. Good morning, guys.

Michael Collins -- Chairman and Chief Executive Officer Read more

Good morning, Alex.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Can you give us -- just maybe a little bit more color on the plan deposit attrition from the ABN deal that you're seeing in the quarter. I appreciate that the, the weighted average cost of those deposits for the whole thing was 99 basis points, but the deposits that are running off, are those higher costing deposits?

Michael Schrum -- Group Chief Financial Officer

Yeah. Maybe I'll start. So I think we obviously put the model together in April as part of the due diligence. And as previously mentioned, we expected quite a significant attrition in the Europe book, in particular, as we don't have any way, really, to activate those deposits through lending. So that's a marked difference, I think, from the franchise that was previously there.

As we saw the three year, $3.5 billion deposits come on, on the 15th of July, we sort of ended the quarter with a spot balance of around 2.9. A big part of that was euros, but also some normal commercial movements in the other currencies. On a spot basis, we already saw an improvement in the deposit cost from the $0.99 of approximately 13 basis points as at 30 September, and we'll obviously continue that trend. It's a bit early days to find a landing spot. It's probably going to be a range, but I think we feel that the model is actually pretty well constructed at the time. So all other things being equal, we should land at around 2.5 there.

Michael Collins -- Chairman and Chief Executive Officer Read more

And Alex, I think one thing, we're pretty pleased about is, we're retaining the client base. We're not really losing clients. There is going to be volatility in the existing deposits with the existing client base, but so far so good in terms of retaining clients.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Got it. And then maybe you can just help us kind of translate that to some of that attrition to how we should be thinking about the margin going into the fourth quarter and into early next year. Obviously, we have a lot of compression, putting the two balance sheets together, which was mostly expected, but with some of this higher cost deposits coming down kind of weighted against another potential rate cut next week. How should we be thinking about the margin from here? You think there is a little bit more compression to go, or do you think we're kind of, as a point where maybe actually sort of reached the bottom?

Michael Schrum -- Group Chief Financial Officer

Yeah. Thanks, Alex. As you know, there's a few moving bits. And on NIM, as you said, the expected reduction did occur this quarter. Though, of course, very importantly, NII increased as that was immediately accretive on the deposits. The 80-basis-point NIM balance sheet on the 15th of July, obviously, was merged together with the existing bulk and that was the majority of the impact on NIM. If you think about this sort of loans -- loan assets there, obviously, they continue to be unfavorably impacted by reductions in US rates were particularly the Cayman Islands, US prime reference loan book reprices pretty immediately. The Bermuda mortgage book, as you know, has a 90-day lag, so the September price adjustment should impact in Q1 next year.

The Central London loans are not affected by US Fed Funds, obviously, as they are tied to the Bank of England base rate. And on the security side, we continue to roll over maturities to maintain the IRR profile of the bank. And we expect very modest impact of lower long-term rates as current conventionals are pricing in the sort of 2.60% to 2.80% level, which compares sort of roughly with our current running book yield there. Obviously, the short end is already reset to lower rates this quarter and the outlook will depend on, obviously, the actions of the Fed. Although the currency mix here will help somewhat offset the full beta impact on the -- at the short end.

And to some extent, the flatness of the forward curve, the rate of attrition of the ABN book, as we just discussed, as well as the rate of deployment of the seasoned deposits once we get to that. So, essentially, our current forecast is obviously probably due to the timing of the ABN, we get a full quarter of lower NIM in Q4 and then we get a sort of repricing on Cayman loans. But then we should start to see the improved pricing on the book coming through sort of into next year. As I said, that's 13 basis point on the spot basis. So we'll see how that lands into next year. And it will, to some extent, depend on what the Fed does, as you know. It is important that our asset sensitivity is moderated a little bit this quarter, partly because of new deployments. And then as we season in at the -- longer curated assets have a steeper pickup to them, then obviously that will start to help. I don't know -- that was a lot of words, I don't know if that helps you a little bit with some of the drivers, at least.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Yeah. It certainly helps a little bit. So I guess based on what you're saying, it's fair to expect the margin to compress a little bit more in the fourth quarter just due to the full quarter's impact of the ABN deal and obviously, the rate environment to then as some of these things reprice and we get some rebound into the beginning of next year, is that fair to say?

Michael Schrum -- Group Chief Financial Officer

Yeah. And as I said on the call here as well the -- It's important to note that it's not the Bermuda demand deposits, so the Cayman demand deposit costs that are increasing and we're already seeing that cresting in the term on CD rates from roll overs of CD into lower rates. So that should help stabilize and maybe turn the corner there as well.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Great. Thanks for taking my questions.

Michael Schrum -- Group Chief Financial Officer

Sure.

Operator

The next question comes from Timur Braziler with Wells Fargo Securities. Please go ahead.

Timur Braziler -- Wells Fargo -- Analyst

Hi. Good morning.

Michael Collins -- Chairman and Chief Executive Officer Read more

Good morning.

Timur Braziler -- Wells Fargo -- Analyst

Just circling back again on deposits. Do you guys have any added visibility to the timing of the remaining attrition? Or is it still kind of working out customer by customer, seeing what balances or what denominations of loan could we let go?

Michael Collins -- Chairman and Chief Executive Officer Read more

I would say it's very much early days, conversations with customers. You can appreciate, we have two banks in Guernsey, one was very much larger than our existing bank. We had some customers that were banked in both banks. So we're getting together the RMs' teams and looking at client strategies around the total client value, really, to the bank, both in terms of deposits, custody fees, banking fees, other currency deposits. And then we're starting communicating and allocating those portfolios to RMs and starting to communicate around particularly around the euros, obviously.

And as we previously sort of talked about the -- we do anticipate some of that euros may be economic value as they transition to somebody else. And so we do expect some attrition on the sterling and the dollar book. And then there's the normal commercial movements as we learn to -- learn about the customers' behaviors. There's a number of fund families in there, financial intermediaries, so they have risk on/risk off. They have period-end volatility around them, and we'll certainly continue to update on that. But it's kind of a couple of months in, there's still quite a bit of work to do on that. So I think that in terms of getting to a spot estimate, actually, the model wasn't too far off in terms of what we're seeing now over a 4-quarter period. But in reality, it's going to be a range, obviously.

Yeah. And as we talked about earlier, the most important thing to us is obviously to retain the client relationships. I think we'll see those clients that just had euro balances. I think those deposits would go pretty quickly, but most of the clients have multi-currency deposits in US, sterling and euro. And those are the ones that are a bit more of [Indecipherable] so you have to take time to really figure out what other things they can do with the bank. What are the fee opportunities we have. And so we're somewhat hesitant to run off those euro balances because there is a much broader relationships, so it just takes time, but we're pretty much where we thought we would be.

Timur Braziler -- Wells Fargo -- Analyst

Okay. And then looking how longer term, the initial expectation for attrition still holds or as you're going through this exercise and seeing the customers have multiple relationships of the bank is the expectation now that the attrition numbers are probably a little bit too conservative that are originally provided?

Michael Schrum -- Group Chief Financial Officer

I think I would stick with where the original guidance was -- we've seen -- we are beginning a process. And obviously, we have seen some of that impact already. Obviously, we're also pricing for lower rates just because market rates are down. And so that's probably offset by slightly better performance on the loan book from a full review there. So I would -- we're still thinking that's probably the best estimate at this point.

Timur Braziler -- Wells Fargo -- Analyst

Okay. And then looking at organic deposit trends in the third quarter. Any color you can provide on the linked quarter decline in non-interest bearing deposits or any color at all on the organic growth this quarter?

Michael Schrum -- Group Chief Financial Officer

Yeah. So Bermuda and Cayman just saw some normal commercial movements. We saw about 100 coming off both to Bermuda balance sheet and the Cayman balance sheet, just not really -- not any feedback from relationship managers in terms of any unusual movements there. It was just normal sort of premiums and claims movements from captive insurance companies, hedge funds moving subscription and redemptions through Cayman. So nothing really to point out there.

Timur Braziler -- Wells Fargo -- Analyst

Okay. And then just with the commentary that the loans -- the loan book looks significantly better than anticipated. Should we start seeing some accretion roll through the top line beginning in the fourth quarter and if so, kind of what's the expectation for accretion income?

Michael Schrum -- Group Chief Financial Officer

Yeah. So we -- I mean you'll note in the Note 22 of the financial statements, we have sort of set out the provisional results of the fair value review that we've undertaken this quarter. There's still a bit of work to do. Essentially, it's a fully allocated acquisition, i.e., we do not anticipate any material goodwill to arise. The PCR exercise was completed with -- as you know, the model had sort of a 3% credit mark, which was almost a $20 million mark on the book. The provisional disclosures there have set at $2 million to $3 million mark. We're still sort of landing that, but there's not going to be material accretion coming through NII as we sort of NPV that into the fair value, if you will.

Timur Braziler -- Wells Fargo -- Analyst

Okay. And then just one last one for me. Cost saves from the dealer, is that generally embedded in the third quarter number and if not, what's the remaining cost saves that we should expect to see?

Michael Schrum -- Group Chief Financial Officer

Yeah. Sort of those -- I don't know, I think we've talked a little bit about it at the announcement day. There's kind of two buckets there. One, was the original closing of the deal, which they had a number of Dutch second dies at a very senior, highly compensated level in The Netherlands. It's part of the agreement that they exited the organization on day one. So that was one bucket that came through and that obviously has led to some of the cost saves coming through already this quarter.

Then there was the second bucket, which was really related to more the operational integration. So because we're running two banks, two IT systems into Q2 next year, and that's really related to reducing the operational risk profile of this by upgrading our existing systems so the client journeys are coherent for all the clients in the Guernsey location. We would expect, obviously, for that to start to come through in terms of both voluntary exits and some redundancies in the mid-part of next year.

There has obviously been an impact already in the run rate. Although, I would say, usually, we -- I think we talked about last quarter, the 86 to 87 level on the quarterly -- core run rate basis. The voluntary turnover has been a bit more elevated, and so that should mean that we should have less redundancy, which is a positive, as part of this. But I would also expect a few more quarters, some bumpy -- a little bit of bumpiness, $1 million to $2 million buffer there in the expense run rate.

Michael Collins -- Chairman and Chief Executive Officer Read more

And the management team is in place, it's a really good combination of the two organizations. So a lot of the senior ABN people are on our Executive Committee there. And as Michael said, I think the discussions with the ABN employees in terms of who is staying and going have gone well. They've -- we've done a good job focusing on retaining the client relationship managers, which is obviously the most important thing, so I think we've gotten through it pretty quickly.

Timur Braziler -- Wells Fargo -- Analyst

Great. Thank you.

[Operator Instructions] The next question comes from Michael Perito with KBW. Please go ahead.

Michael Perito -- KBW -- Analyst

Hey, guys. Thanks for taking my question.

Michael Collins -- Chairman and Chief Executive Officer Read more

Hi, Mike.

Michael Perito -- KBW -- Analyst

I wanted to start, I know we're probably talking about small numbers here, but can you give us the update on Channel Islands, just the loan growth opportunity? I mean if there's been any kind of new thoughts around that and what you guys are doing, trying to maybe take advantage of some of that. I know it's not huge numbers, it seems like every dollar that you could probably translate out of cash would be helpful. So I'm just trying to get a better sense of where that updated opportunity stands.

Michael Collins -- Chairman and Chief Executive Officer Read more

Yeah. So I mean, we're -- I think our story has been pretty consistent across the board that we're not a loan growth story. I mean, I think group wide, we're up to $4.7 billion in loans, still 65% of that is residential, so it's really residential focused. But even with $4.7 billion on the new deposit base, that's still only 30% lend. So that's about where we're going to give [Indecipherable]. We talked a lot about the Channel Islands in terms of the deposit situation and how we're going to deploy those deposits. And at this point, our focus has been really funding our London mortgage portfolio, which has slowed down somewhat with all the Brexit uncertainty, but it's still a really solid growing portfolio. So that those deposits have been used to fund that.

We do talk about whether there's residential mortgage opportunities in the Channel Islands at some point. It would be very difficult to grow that organically. I think we would probably have to purchase something domestically. So we're considering it. But at this point, the sterling deposits are used to fund the London mortgage growth, and that's worked quite well. And those mortgages are on both Jersey and Guernsey's balance sheets, so the funding situation works here. But we'll keep considering if there's residential, sort of high end residential mortgage opportunities, but nothing at this point.

Michael Perito -- KBW -- Analyst

Okay. And then on the capital side, it seems -- it sounds like you guys expect to be back in the market, buying back stock on the fourth quarter. The tangible common ratio was a little stronger than you guys had initially thought. But can you give us maybe a little bit of a longer-term update? It seems like you guys are committed to the quarterly dividend as is, but just some updated thoughts. I mean it would seem like your payout ratio is going to naturally drift up a little here with rates coming down. I mean are you guys comfortable with that? Is there any parameter around that we should be thinking about? And just any general longer-term thoughts around capital would be helpful.

Michael Schrum -- Group Chief Financial Officer

Yeah, Mike. It's Michael Schrum. So I'll kick-off. So as you know, we're not -- we're currently going through our planning process for next year and we look at our retained earnings profile and profitability. And obviously, we stress the dividend rate to ensure that, that's sustainable through the cycle, and obviously, we very much believe it is at the current payout ratio, its just around the 50% mark. We still want to support organic growth where we can.

Obviously, we're focused on return on risk-weighted assets, but also both organic and inorganic growth, which is -- has historically been sort of relatively modest part of the capital allocation. Obviously, buybacks for us are attractive at the current price levels, so that should be part of our thinking there as well. And then finally, there's limited opportunities in the near term for any further acquisitions. We'll start to message that in terms of how else we get the excess capital generation back to shareholders, either in the form of a special dividend.

But I think at this point, we should expect certainly the outlook to be stable where we are. I think the buyback provides us with a good opportunity to deploy excess capital as we're going through this integration. We'll obviously keep looking for additional M&A opportunities. There's still a good slate of candidates out there that we're looking at. So as and when we've completed the on-boarding and the full integration there of ABN, we should be ready to look at others again. So nothing's really changed that much. I think, longer-term, we're still conservatively positioned vis-a-vis the dividend coverage. We still want to allocate and return capital to shareholders, so I think that there's no change, really, there.

Michael Perito -- KBW -- Analyst

Got it. And then just lastly for me. On the kind of the levering of the AMRO deposits as they season, I mean I know there's like excuse me, quantitative factors, such as time, for example, to see how these deposits behave. But can you give us any more qualitative views on kind of what you're looking for that will give you guys some more comfort and to start levering this over time? Is it just having more conversations with these clients as you guys progress through the next year or so, or are there other less tangible items that you guys will be moderating? Just interested if there's any more color you can provide there.

Michael Schrum -- Group Chief Financial Officer

Yeah. No, absolutely. So as you know, when we did the HSBC acquisition of the private banks here in Bermuda in 2016, we went through the same process. One other thing is obviously, the client base is slightly more in the financial intermediary rather than retail space. The bank is much larger than the existing bank that we had there, so we kind of really doubled dip on the reserves that we're selling for cash and liquidity in the existing bank, although, we can backstop part of that from Bermuda.

In the current environment, it -- the yield curve and actually all the currencies there is pretty flat. So even though you would end up with a marginal pickup, we'd like to sort of land the deposit level, stabilize the deposit level, run some back testing on the VAs and inflows and outflows, get our retention levels on liquidity built out into sort of a three month ladder, making sure we meet all the funding and liquidity requirements in Guernsey and then sort of start to ladder in initially. I would suggest, probably, an AFS book sort of in the medium term and that will have some yield pick up. Sterling, we would just do UK T-bills and dollars, obviously, would just continue to ladder into the existing both HDM and AFS portfolios.

And euros is where we're sort of looking at, obviously, zero risk weighted assets, but maybe looking at sort of supras [Phonetic] those types of things just to see if there was a 20 basis point -- 20 basis point, 30 basis point pickup from the cost of those over the next year. So I would say, four quarters in, you got 200 days of analysis to look at. You should start to see us laddering in initially into AFS, but a modest pickup, and then we'll start to reduce the asset sensitivity from the behaviorized deposits into both HDM and AFS over probably a three year period in quarterly tranches, just like we did from the HSBC acquisition in Bermuda.

Michael Perito -- KBW -- Analyst

Helpful, Michael. Thank you and thank you guys for taking all my questions. Appreciate it.

Michael Collins -- Chairman and Chief Executive Officer Read more

Thanks, Mike.

Michael Schrum -- Group Chief Financial Officer

Thanks, Mike.

Operator

The next question is a follow-up from Alex Twerdahl with Sandler O'Neill. Please go ahead.

Alex Twerdahl -- Sandler O'Neill -- Analyst

I just want to make sure I understood the expense guidance right. It sounded to me, Michael, like you said, $86 million to $87 million is kind of the sort of the base run rate for expenses up until the second tranche of those cost saves come through. Is that correct?

Michael Schrum -- Group Chief Financial Officer

Yeah. I would expect an $85 million to $86 million. So we've seen a bit more voluntary turnover on the ABN staffing level, so again, I think part of it is, we closed -- we only unbundled the staff in the 15th of July, so obviously there's a timing thing there. The $84 million is a little low for the next couple of quarters, but then we should start to see, obviously, the cost benefits of, so I would say, $85 million to $86 million for the next couple of quarters and then kind of trend it down.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Okay. And then you can you remind me -- if I remember correctly, there's a large contract of some sort that you guys that have -- that comes due at the end of next year that could reduce I think technology expense. Is that right?

Michael Schrum -- Group Chief Financial Officer

Yeah. So there is a couple of things happening next year in technology, and that's obviously what we're working through in the part of the planning process. Most of our IT infrastructures is effectively outsourced to DXC or Hewlett-Packard, which is now DXC, which is a fairly large burn rate. It does provide us with some business continuity benefits. As we saw during the hurricane, we can just switch over to a different location and work remotely. But it is also a very expensive contract and we're trying to kind of modernize that contract a bit through that process.

And the second element is, obviously, the amortization on the existing one Butterfield platform that we implemented in 2010, starts to run-off in Q2 next year. We're not going to see -- we don't at the moment have any significant asset investments or builds to do these couple of version upgrades of some of the corporate Internet banking platforms, etc,, but those are relatively minor compared to the $8 million or so annual amortization benefit that we start to fully get in 2021. So that certainly should be an overall improvement there from next year.

And as far as the DXC relationship goes, it's a strategic relationship for us. But obviously, we're always looking to see if we can improve that. And as technology modernizes with cloud computing environments, we're trying to get away from the old racks and a bit more modern so that we'll change the nature of that contract going forward.

Michael Collins -- Chairman and Chief Executive Officer Read more

And our support centers in Halifax for Bermuda and Cayman and [Indecipherable] the Channel Island are continuing to be built out. So again, we're slowly, gradually moving operational functions and compliance functions to Halifax. So the team is really being built there, and so you will see, as we said in the past, we'll continue to see sort of gradual cost savings over time. We reduced positions in Bermuda and Cayman and the Channel Islands, add positions in the support centers. They're obviously less expensive, so it will be a gradual improvement in expenses, but that's the plan and it's still being executed.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Okay. And then it looked to me like you had a little bit of loan growth beyond just what you acquired this quarter, obviously, very small in Bermuda. Is that just bridge financing or is that more permanent loan growth that will stick around for longer?

Michael Collins -- Chairman and Chief Executive Officer Read more

Yeah. I mean obvious that most of the increase, about 4 to 4.7, is obviously ABN, but we did have -- we do have some sovereign exposure increases in Bermuda at this point, and that was basically a $200 million relatively short-term bridge facility to the Bermuda government that we partnered with HSBC to provide. And that will be taken out pretty much within a year from a government sovereign bond issue that will be upcoming so. And loan balances are holding up, so we have significant attrition and run-off because we have a pretty short-term structure, but we're keeping track, particularly in the residential side to keep up. So again, the story is pretty flat with some quarterly increases here and there. But the government exposure will come on and then come off within a year.

Michael Schrum -- Group Chief Financial Officer

Yeah. Alex, we've also talked about St. George's Hotel. Obviously, they're starting now to draw down on that loan. That's been -- that's almost more than half built now, so that's a good well structured loan. So that those units would come online as well. So there's some modest growth in the Bermuda book. I think we're trying to find, but we're not stretching on the underwriting side to make that happen.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Okay. And then just a final question, just a follow-up on the buyback. Is the plan to -- I think, last year, you had a plan to do about 4% of the buyback per year. And then that was put on hold up to the ABN deal as capital rebuilds. Now you're kind of above the 6% threshold and that should grow even more next quarter. So is the plan just to kind of keep capital between the 6% and 6.5% TCE, but maybe to accelerate some of that buyback in the near term to do a little bit of catch up for the months that you weren't buying back stock, especially given that the stock seems to be at a level where that's particularly attractive?

Michael Schrum -- Group Chief Financial Officer

Yeah. So as you know, under the current authorization we've had, we have about just shy of 800,000 shares left in that authorization. The Board, we had good discussions with the Board around this, very supportive of any initiatives there, definitely sees the value in terms of the regression line as well. And as we finalize our plan, that will be part of that discussion around capital allocation, which is normally happening in the fourth quarter. So I would expect to see us being active in the market.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Okay. Thanks for taking my follow-ups.

Michael Collins -- Chairman and Chief Executive Officer Read more

Thanks, Alex.

Michael Schrum -- Group Chief Financial Officer

Thanks, Alex.

Operator

The next question is from Adam Hurwich with Ulysses. Please go ahead.

Adam Hurwich -- Ulysses -- Analyst

Hi. A longer term strategic question. How do we think of the link between earnings growth and asset expansion on the balance sheet?

Michael Schrum -- Group Chief Financial Officer

So maybe I'll kick off and Michael can talk a bit about the inorganic. If you look at a five year CAGR for the bank, pretty much, Bermuda and Cayman are relatively saturated markets in terms of our market participation. And so in Cayman, both on the deposit and the loan side, we have about 25% to 35% market share. In Bermuda, it's more like 40% to 45%. And so those books really will both on the deposit and loan side, should grow in line with GDP, roughly. And so the -- where we're excited about organic growth is really in the Jersey and Guernsey market where we have relatively smaller market shares.

There's also finite markets both on the deposit on the asset side and are relatively slow growing market, but we should be able to take some market share there. The Jersey market, for example, is a much larger deposit market than any of the other three markets where there's about GBP120 billion of customer deposits in that market. Now a lot of that will be retail and not our chosen market segments in finance and intermediary banking. But if we could get to a meaningful, say, 2% or 3%, that sets a meaningful uplift in terms of the size of the balance sheet.

In terms of the productivity of the balance sheet, we've previously communicated and continue to communicate, we're not a big loan growth story. And part of that is because we want to lend in our home markets, but not become innocent capacity in wholesale lending because we're a small bank in -- operating in islands that have no lender plus resort or Central Bank, and so we need to be very conservative both on liquidity, funding and credit. That leads, just by the nature of the market, for us to have more of an asset sensitive balance sheet because our assets to deposits, our ADE ratio, is up 40.

But if you look at our risk density, it's very low at a sub-40 level as well, and that's probably because we've mostly focused on residential mortgages because we don't need to book a 100% risk weighted commercial mortgages in order to get deposits because the markets we're in are driven by capital formation and not by trade. So as you think about the growth and the size of the balance sheet, you would say a 2% to 3% organic. And then overlaying the capital allocation to M&A, you would end up, if you look back over six to seven years, you would end up with a sort of 8% CAGR growth on the size of the balance sheet.

And the profitability of the balance sheet will depend on whether it is allocated. So in the case of Channel Islands, those are more like European banks, and that's because the currency mix of those balance sheets is less productive than the available dollar balance sheets that we could put on in Bermuda and Cayman. But there's limited opportunity for us to put those on in Bermuda and Cayman because we're fairly saturated in terms of our market participation. So you might put on a 10% ROE business in the Channel Islands. But if you can get it at a relatively modest premium to tangible book, that ends up being very accretive even at a very high current ROE.

So I don't know if that gives you a sense of sort of the direction and how we're thinking about the relative growth in the balance sheet versus the productivity of those balance sheets. The last thing I would just say, we're still looking at fee businesses. We like private trust businesses in particular. And one of our acquisition criteria is it has to have two-thirds private trust fees in order for us to consider a fee based business. The fee based businesses are very capital efficient for us. We're recognized as a global leader in the private trust fiduciary space and they're very stable and help moderate some of the earnings risk that arises from a natural rate environment.

Michael Collins -- Chairman and Chief Executive Officer Read more

Yeah. So I think there are two things that make us different from a US Bank is, as Michael was just saying number one is fees will represent about one-third, 35%, 40% of our revenue. So that's a bit unique and that's across FX and trust and banking fees. And the second part, as Michael was describing, is we're in jurisdictions where we're always going to have huge amounts of excess capital, excess deposits because capital, whether it's reinsurance or high net worth families, flows through Bermuda, Cayman, Channel Islands.

And we're always going to be, probably, as far as we're concerned, probably about 35% to 40% loan to deposits because all the excess deposits will go into US government agencies, at least on the US dollar side. And that model still produces throughout the cycle mid-teens to mid-20% core ROEs without stretching for credit risk. So one thing we know about the model is, given these excess deposits and the flows to Bermuda and Cayman, we have to be very careful on the credit side. So we really don't do any out of market lending and won't stretch for credit.

Adam Hurwich -- Ulysses -- Analyst

And then just to understand how you approach this. In other words, over time, that 35% fees to overall net revenue is really the target ratio, it's not as if it keeps on rising over time.

Michael Collins -- Chairman and Chief Executive Officer Read more

That's right. I mean, obviously, it depends on the interest rate cycle. So where we are now, as those rates go down, that will go up a bit. And on the opposite side of the cycle, it would go the other way. But essentially, yeah, the trust business, in particular, which we've been in for 70 years is very slow growing. You will lose 1% or 2% trust a year, and you maybe gain that organically. So that's really an acquisition strategy. The only way to really grow the trust business is through acquisitions in our existing jurisdictions. But beyond trust, as I said, we've got a good FX business, and ABN provides more FX fees, and we've got good trust custody fees and also banking fees. So fees are a big part of our organization and we'll continue to focus on that.

Adam Hurwich -- Ulysses -- Analyst

Thank you very much.

Michael Schrum -- Group Chief Financial Officer

Thank you.

Operator

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

Noah Fields -- Head of Investor Relations

Thank you, Anita, and thank you to everyone for dialing in today. We look forward to speaking with you next quarter. Have a great day.

Operator

[Operator Closing Remarks]

Duration: 49 minutes

Call participants:

Noah Fields -- Head of Investor Relations

Michael Collins -- Chairman and Chief Executive Officer Read more

Michael Schrum -- Group Chief Financial Officer

Alex Twerdahl -- Sandler O'Neill -- Analyst

Timur Braziler -- Wells Fargo -- Analyst

Michael Perito -- KBW -- Analyst

Adam Hurwich -- Ulysses -- Analyst

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