The Bank of N.T. Butterfield & Son Limited 65 Front Street, Hamilton, Bermuda w w w. b a n k o f b u t t e r f i e l d . c o m A N N U A L R E P O R T | 2 0 0 3 Performance Highlights For the year ending 31 December 2003* Net Income $76.5 million up from $66.7 million in 2002 Return on Equity 20.9% up from 20.5% in 2002 Earnings Per Share $3.73 up from $3.19 in 2002 Increase in Shareholder Value 65.2%# *compared with the same (unaudited) 12-month period in 2002, excluding discontinued operations and gain on sale of subsidiaries in 2002. #measured in terms of stock price appreciation and reinvestment of dividends. Acquisitions: The Bahamas Thorand Bank & Trust Limited August 2003 Leopold Joseph (Bahamas) Limited September 2003 Barbados The Mutual Bank of the Caribbean Inc. December 2003 Awards: Standard & Poor’s Performance Awards 2003 • Overall Group of Butterfield Funds: First place in the world for the five-year performance of the Butterfield Funds (Offshore Funds, Smaller Groups Category) • Butterfield Capital Appreciation Bond Fund: First place in the world for five- year performance (Offshore Funds, Fixed Income, Global Sector) Contents Financial & Statistical Summary Corporate Profile Our Corporate Values in Action Chairman’s Letter to the Shareholders President & Chief Executive Officer’s Report Management’s Analysis of Financial Condition & Review of Operations Financial Overview Selected Quarterly Results of Operations Financial Summary Management’s Financial Reporting Responsibility Auditors’ Report to the Shareholders Consolidated Balance Sheet Consolidated Statement of Income Consolidated Statement of Changes in Shareholders’ Equity Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements Principal Group Companies Management Board of Directors & Principal Board Committees Directors’ Code of Practice Directors’ and Executive Officers’ Share Interests and Directors’ Service Contracts Shareholder Information Principal Offices & Subsidiaries 2 3 4 6 7 8 20 24 25 26 27 28 29 30 31 32 55 55 56 56 56 57 58 Bank of the Year 2003 Awarded by The Banker magazine to The Bank of N.T. Butterfield & Son Limited in Bermuda, September 2003. Financial & Statistical Summary (In $ thousands except share data) 31 December 2003 Year ended 31 December 2002 (unaudited) Year ended 30 June 2002 30 June 2001 Net income from continuing operations Profit (loss) from discontinued operations Net income Net income per share Including discontinued operations Excluding discontinued operations At Year End Total assets Cash and deposits with banks Investments Loans Deposits from customers Deposits from banks Repurchase agreements Subordinated debt capital Shareholders’ equity Net book value per share Market value per share Number of shares (in thousands)* Number of shareholders Number of employees Financial Ratios Return on assets** Return on equity** Total capital funds to total assets ratio Risk weighted capital ratio 76,494 - 76,494 $3.73 $3.73 7,679,872 3,035,944 2,503,337 1,935,764 6,583,271 481,837 - 125,000 394,929 $19.13 $44.00 20,643 3,581 1,381 1.2% 20.9% 7.5% 13.0% 83,743 184 83,927 $4.01 $4.00 6,007,874 1,989,159 2,073,112 1,767,088 5,156,111 360,105 - 75,000 338,799 $16.56 $30.50 18,603 3,322 1,200 1.2% 20.5% 6.9% 13.1% 81,416 873 82,289 $3.88 $3.85 5,738,044 2,027,225 1,831,142 1,696,775 4,787,228 429,138 30,179 75,000 335,167 $15.83 $33.00 19,247 3,364 1,229 1.2% 21.2% 7.0% 13.8% 66,732 (5,990) 60,742 $2.85 $3.13 5,197,804 1,691,423 1,882,479 1,451,773 4,464,379 236,344 55,360 75,000 286,525 $13.50 $31.50 17,571 3,619 1,162 1.2% 22.7% 7.2% 14.8% * Excludes shares purchased by the Bank for the Stock Option Trust. **Excludes discontinued operations and gain on sale of subsidiaries. Comparative share data has been restated to reflect the 1 for 10 stock dividends in August 2003 and August 2001. All percentages here and in the report that follows are based on actual rather than rounded numbers. 76.5 64.4 66.7 60.7 40.3 3.73 3.13 3.05 3.19 22.7 21.2 20.5 20.9 2.50 16.4 Jun 00 Jun 01 Jun 02 Dec 02 (unaudited) Dec 03 Jun 00 Jun 01 Jun 02 Dec 02 (unaudited) Dec 03 Jun 00 Jun 01 Jun 02 Dec 02 (unaudited) Dec 03 for 12 months to 30 June Net Income ($m)** for 12 months to 31 December for 12 months to 30 June for 12 months to 31 December Earnings per Share ($m)** for 12 months to 30 June for 12 months to 31 December Return on Equity (%)** 2 Corporate Profile Bank of Butterfield is a full service community bank and a provider of specialised offshore financial services. Our headquarters and largest operation are in Bermuda, where we were established in 1858 as the island’s first bank and continue to play an important role in the local economy. With additional operations located in The Bahamas, Barbados, the Cayman Islands, Guernsey and the United Kingdom, we have $7.7 billion in assets and $60 billion of client assets under management and administration. We provide institutional and Our performance is the direct individual customers with a result of the efforts of a dedi- full range of Community cated team of employees who Banking services in Bermuda, work together to deliver quali- Barbados and the Cayman ty financial services, build Islands, encompassing retail business and enhance share- and corporate banking and holder value. At 31 December treasury activities. As a specialist 2003 we had a total of 1,381 offshore financial services employees, 742 in Bermuda group, we also provide Private and 639 overseas. We are Banking, Wealth Management committed to effective employ- & Fiduciary Services and ee training, development and Investment & Pension Fund communication to benefit Administration from Bermuda our team through increased and our offices in the Cayman job satisfaction, our customers Islands, Guernsey, The through improved service, Bahamas and the United and our shareholder value Kingdom. Our success is built through long-term improve- on a set of fundamental ments in results. strengths: sound corporate values, a stable customer base, Involvement in the community strong capital and liquidity is a key priority for the Bank. positions and solid core We support a variety of businesses. projects and organisations that invest in and support Our home country regulator areas such as youth develop- is the Bermuda Monetary ment, healthcare, social causes, Authority, which operates in sports, heritage and the arts. accordance with Basel princi- Our educational scholarships ples and maintains close and bursaries help young peo- contacts with regulators in ple fulfill their potential and the other jurisdictions where achieve their dreams. We take we have offices. Bank of an active role in community Butterfield common stock is events and salute the efforts listed on The Bermuda Stock of the many Bank employees Exchange and the Cayman who give their own time and Islands Stock Exchange. We energy to a multitude of chari- have over 3,500 shareholders table causes. Collectively and with 22.3 million shares individually, we take action to outstanding. make our communities better. 3 Our Corporate Values in Action Across the Group Shareholder Value We believe in providing Pursuit of Excellence We strive to maintain the highest value to our shareholders standards of quality when deal- by achieving sustainable ing with customers, employees, profitability and building shareholders and communities. on our existing strengths. In Guernsey this year, our With a return on equity above investment management team 20% for the past three years, demonstrated an ability to we have proven that our business construct innovative, market- strategy meets the expectations leading investment solutions of our shareholders. In 2003 the with the development of a Bank granted a one-for-ten Gold Linked Note. This three- dividend to shareholders and year note offered capital pro- increased the fourth quarter tection of 95% of clients’ dividend by 3 cents per share. initial investment and allowed The increase in shareholder clients to participate in 92% value in 2003, measured in terms of the rise in the price of of appreciation in the Bank’s gold over the three years. stock price and dividends rein- The product is proving to be vested, was 65.2%. a successful yet well protected Customer Focus We value and respect our external and internal investment opportunity. Integrity We commit that our actions customers and aim to meet are honest, ethical and fair. and exceed their expectations. We comply with the laws and To add value to our services, regulations that govern our we offer opportunities for activities in jurisdictions where customers to learn more about we do business. Both individually financial topics. In Bermuda, and as an organisation, we are for example, a series of student accountable for our decisions seminars offered eligible and conduct. participants valuable advice Integrity is what drives the and their first pre-approved Know Your Customer principle credit cards; ongoing in-branch that is implemented throughout demonstrations explained the our businesses. In 2003, as the basics of Internet banking and a regulatory environment evolved special community presentation worldwide and corporate answered parents’ questions on governance practices continued to the financial aspects of sending undergo scrutiny, we maintained a child to study overseas. our focus on ethical and effective structures and procedures that are consistent with international best practice. From the development of a corporate strategy to our daily interactions with customers, we are guided by a set of inherent values. Throughout our operations, as teams and individuals, we seek to exemplify these principles each day. Here are just a few examples of our values in action across the Group. 4 and artistic pursuits and offer scholarships. In 2003, we ‘adopted’ a public space in Grand Cayman (Quincentennial Roundabout) to help beautify the environment and we received considerable local recognition for our initiative. Teamwork We work together to achieve our common goals. We know that every team member contributes to our performance. In our UK office, the introduction of a new pension product required effective teamwork among all departments: marketing and sales identified the opportunity and came up with a competitive design; finance developed the pricing; compliance and operations established streamlined processes; risk management ensured the Bank’s position was protected and the lending department delivered the service. The collective efforts of the entire team contributed to the effectiveness of the launch and built a foundation for the product’s continued success. Rewarding and Developing Employees Our success would not be possible without dedicated, skilled employees who are rewarded for achieving their potential. In one of several new initiatives last year, we identified an opportunity for formal credit training, researched available options and offered 70 employees in Bermuda an intensive credit certificate course from a respected inter- national training firm. This programme helped us raise our standards for corporate and consumer lending, in terms of both service quality and risk management. By devel- oping our employees we aim to improve job satisfaction and enhance individual, departmental and Bank performance. Community Involvement We recognise our responsibility to participate fully in the com- munities in which we operate. This means making carefully considered financial donations as well as contributing our time, expertise and energy to benefit the overall health of our communities. With our donations and active community involvement in the Cayman Islands, for example, we have established ourselves in the rewarding role of corporate citizen. We sponsor charity sporting events, support educational Our success would not be possible without dedicated, skilled employees who are rewarded for achieving their potential. 5 Chairman’s Letter to the Shareholders As we navigate this dynamic and competitive environment, the Bank maintains a clearly defined strategy and direction across all our business lines. On behalf of the Board of Directors, I am pleased to report that Bank of Butterfield has again performed well under economic conditions that continue to challenge corporations worldwide. The year ended 31 December 2003 was a period of accomplishment, both strategic and financial. As we navigate this dynamic and competitive environment, the Bank maintains a clearly defined strategy and direction across all our business lines. This strategy, developed by senior management and confirmed in regular reviews by the Board, has produced consistently strong financial results and continues to enhance shareholder value. Taking into account the current challenges and opportunities, along with our strengths, priorities and potential growth areas, we are confident that the current business model is sound. Reflecting the Bank’s ongoing strong earnings performance and our commitment to enhancing shareholder value, in June 2003 the Board approved a one-for-ten bonus share issue. This bonus equates to a 10% stock dividend and, combined with the 12-month cash dividend of $1.43 per share, gives shareholders an impressive return on their investment. This year we bid farewell to a valued and respected colleague. Christopher (Kit) Astwood retired from the Board of Directors in January 2004, having reached the mandatory retirement age. Mr. Astwood was elected to the Board in 1969 and contributed significantly to the progress of the Bank for more than three decades. On behalf of the Board I would like to thank him for his dedication and vision over the years. I am also pleased to welcome two new Directors. We are fortunate to have the opportunity to work with Bob Steinhoff, elected in January 2004 and Vince Ingham, elected in April 2003. I would like to thank Bank of Butterfield’s dedicated management team and employees, whose expertise and hard work make it possible for us to achieve strong results. To our shareholders and customers, I express sincere gratitude for your support. You are essential to our success and we aim to continue to earn your loyalty as we move forward. James A.C. King, MD, FRCS(C), FACS, JP Chairman of the Board 6 President & Chief Executive Officer’s Report Bank of Butterfield achieved a number of strategic milestones in 2003. As we continue to implement a well proven strategy, Bank of Butterfield has once again delivered solid financial results in a demanding and ever-changing environment. Our net income for 2003 was $76.5 million. Excluding discontinued operations and a one-time gain on the sale of our Hong Kong subsidiary in 2002, income for the year increased by $9.8 million or 14.6% from last year. Once again the return on shareholders’ equity exceeded 20%, at 20.9%. This performance can be attributed to the underlying strength of our core businesses and the commitment and skill of our employees. Bank of Butterfield achieved a number of strategic milestones in 2003. Internationally, we acquired two Bahamas-based financial companies and a community bank in Barbados. We are pleased with the quality of these operations and have made excellent progress as we integrate them into Bank of Butterfield. We also purchased 25% of Island Heritage Insurance Company, Ltd., a growing and regionally diversified property insurance company based in the Cayman Islands. These acquisitions are consistent with our overall goal to expand into selected markets where we can deliver our core products and services effectively. I am confident that our businesses are well positioned and that we are investing in the infrastructure needed for future growth. We are focusing on training and developing our employees to help them meet customers’ evolving needs. During 2003 we conducted an extensive review of our information technology resources and have embarked on a programme to reinforce and improve the systems, data and IT infrastructure that enable us to deliver innovative, efficient products and services. We are also investing in premises to help us maintain our high level of customer service. Our community activities remain a priority as we recognise our responsibility to give back to the jurisdictions in which we operate. In 2003 we supported a wide range of causes with the active involvement of our employees. In Bermuda, for example, the Butterfield Employee Shared Trust (BEST) invested in community projects as directed by employees, whose donations in BEST are matched by the Bank. On behalf of management, I would like to express appreciation to the Board of Directors for their vision, advice and leadership. I also thank our employees, shareholders, customers and partners, all of whom help to make Bank of Butterfield a strong and respected business. Alan R. Thompson President & Chief Executive Officer 7 Management’s Analysis of Financial Condition & Review of Operations From left to right: Graham C. Brooks Executive Vice President, International & Trust Peter J.M. Rodger Senior Vice President & Group Legal Adviser, Secretary to the Board C. Wendell Emery Executive Vice President, Operations & Information Technology Richard J. Ferrett Executive Vice President & Chief Financial Officer Results of operations for the 31 December 2003. This repre- $17.0 million gain on the sale 12-month period ended 31 sents a 14.6% increase in net of subsidiaries in 2002. December 2003 compared with income over the same period the (unaudited) 12-month period last year when excluding discon- Against a continued challenging ended 31 December 2002 tinued operations and the $17.0 economic background, we million gain on the sale of our achieved financial success in With effect from 1 January subsidiaries in Hong Kong in many of our core businesses. 2003, we adopted calendar 2002. Our strong core business We experienced an increase of year reporting in place of our results remain pleasing given $3.5 million, or 11.1% to $35.1 previous fiscal year ended 30 the challenges of sustained million in the profitability of June. As a result we produced low interest rates. audited financial statements our Community Banking busi- ness in Bermuda, reflecting an for the six-month period The period under review saw a 11.1% increase in interest-earn- ending 31 December 2002. further 0.25% cut in US interest ing assets. In the Cayman rates in June 2003 and cuts in Islands, despite the impact of a In order to present a meaning- UK interest rates of 0.25% in further US interest rate cut, net ful comparison with the 2003 February and July respectively, income increased by 26.2% or calendar year results, manage- offset by a 0.25% increase in $5.0 million, to $24.3 million ment has presented results for November 2003, and relatively compared with last year. Of par- the calendar year 2002 in the flat yield curves for both cur- ticular note, our Cayman busi- following analysis and review. rencies. Nevertheless net inter- nesses experienced an 18.4% The restatement of the Bank’s est income before provisions increase in operating revenues results for the calendar year was up 13.8% year on year to compared with only a 6.7% 2002 has not been audited $114.6 million, reflecting strong increase in operating expenses. and, accordingly, the 2002 increases in customer deposits In our Guernsey operations, net results discussed in this report in our Community Banking income was down $0.5 million, are marked ‘unaudited’. businesses in Bermuda and or 16.0%, to $2.8 million prima- Cayman. Also very significant rily due to interest rate declines The Bank of N. T. Butterfield was the growth in non-interest and the weakness of the US & Son Limited achieved net income, which increased year dollar. We recorded a 12.7% income of $76.5 million for on year by 9.7% to $126.0 increase in operating revenues the 12-month period ending million, when excluding the in Guernsey, while operating 8 From left to right: Michael A. McWatt Senior Vice President, Credit Risk Management William P. Aston Senior Vice President & Chief Information Officer Donna E. Harvey Maybury Senior Vice President, Human Resources expenses increased by 18.3%, in improved value for our share- recovery of the other. As at 31 part due to expenses incurred holders through strong growth December 2003 the General relating to a move to new in net income, and thereby Provision for loan losses of $19.5 premises in 2004. A loss of $0.9 earnings per share. We look to million was equivalent to 1.0% million was recorded by our achieve balanced growth and of total loans. In addition, there United Kingdom operations, in will continue to seek further is a specific provision of $4.0 line with expectations. Our pres- diversification of revenue million held for possible short- ence in the UK is of long-term streams across our chosen mar- falls in the security held for strategic importance and we kets. At the same time, we focus non-performing loans. In total, look to grow this business sub- on improving efficiencies in our therefore, loan provisions were stantially in the coming year. operations, particularly through $23.5 million, or 1.2% of the investment in technology. In loan portfolio. The Group made three acquisi- 2003 we expanded our Internet tions in 2003, two in The banking delivery platforms to Approximately one third of our Bahamas in August and Guernsey and the United assets are held in investments, September and one in Barbados Kingdom. in December. These businesses predominantly high quality investment grade securities, the performed in line with expecta- Our asset quality improved sig- purpose of which is to enhance tions during the short time they nificantly in 2003. Non perform- both the Bank’s liquidity and have been part of the Group. ing loans reduced $7.6 million, the yield over that available in Bank of Butterfield (Bahamas) or 30.3%, to $17.4 million, rep- the inter-bank deposit market. Limited reported net income of resenting 0.9% of total loans, Standard & Poor’s, the world $0.3 million on revenues of $1.4 down from 1.4% a year ago. renowned credit agency, has million and The Mutual Bank of The Bermuda and Cayman been engaged to monitor and the Caribbean Inc. made net tourism markets continue to be rate the Bank’s own securities income of $0.2 million on adversely affected by economic portfolios, which constitute revenues of $0.8 million. conditions. However, of the some 79.6% of total invest- The solid performance of the the last report, we received full continue to receive investment Group reflects our strategy of payment of both principal and grade ratings. three hotel loans mentioned in ments. All of these portfolios concentrating on core business- interest of two loans in 2003 es and strengths and delivering and have had substantial 9 Management’s Analysis of Financial Condition & Review of Operations From left to right: Michael O’Mahoney Senior Vice President, Treasury Ronald E. Simmons Senior Vice President & Chief Accountant James R. Stewart Senior Vice President, Enterprise Risk Management The year end saw a significant The net interest margin and gain on sale of subsidiaries). For increase in customer deposits, interest rate spread both the year ended 31 December which were up $1.4 billion year increased by 0.1% year on year 2003, Bank of Butterfield on year to $6.6 billion. The to 1.9% and 1.6% respectively, achieved an efficiency ratio of acquisition of The Mutual Bank reflecting both our asset/liability 64.8%, an improvement com- of the Caribbean Inc. increased management strategies and an pared with 66.4% a year ago. customer deposits by $127 mil- 11.2% increase in average inter- lion. In addition both Bermuda est-earning assets to $6.1 During the year 378,994 shares and Cayman saw substantial billion. The return on assets, were repurchased and can- inflows of short-term customer at 1.2%, was in line with that celled, at an average cost of deposits over the year end, in 2002 when excluding the $34.77 per share. The total divi- particularly from collective gain on sale of subsidiaries. dend for the year was $1.43 per investment funds which are The Bank’s net book value share, an increase of 6 cents or administered by the Bank. per share increased year on 4.4% over the same period last year by 15.5% to $19.13. year, and represents a 39.0% Performance Indicators The Bank’s overall strength and Loan portfolio growth reflects period. In addition, a one for payout on net income for the performance are indicated by our ability to meet new demand ten bonus share issue was made certain key measures. Our for lending products, particularly in August 2003, which equates return on shareholders’ equity in our Community Banking busi- to a 10% share dividend. remains in excess of 20%, at ness in Bermuda, where loans 20.9% for the period, and grew by $88.4 million or 6.5%, reached a high of 22.4% in the and in the Cayman Islands, second quarter. Earnings per where growth was $12.7 share were $3.73, up 54 cents, million or 5.0%. An important or 16.9% compared with $3.19 productivity indicator is the last year when excluding the efficiency ratio, which is operat- $0.81 gain on the sale of ing expenses (excluding corpo- subsidiaries in 2002. ration tax and amortisation of intangible assets) expressed as a percentage of operating income (excluding credit provisions and 10 From left to right: Lloyd O. Wiggan Senior Vice President, Retail Banking Fred H. Tesch Senior Vice President, Group Internal Audit Bob W. Wilson Senior Vice President, Corporate Banking Outlook We expect 2004 to present continued challenges with increased competition in the Bermuda banking market and lingering geo-political tensions. We will maintain a low-risk conservative approach and continue to focus on our core business lines. This strategy has served us well over the past several years. Summary of Group’s Debt Securities Monitored and Rated by Standard & Poor’s as at 31 December 2003 Portfolio Location Carrying % of Total S&P Credit S&P Volatility Value ($m) Investments Rating Rating Rated by S&P Fixed Income Floating Rate Notes Floating Rate Notes Floating Rate Notes Bermuda Bermuda Cayman Guernsey 243.0 1138.2 344.3 267.6 12.2 57.1 17.3 13.4 AAf Af Af Af S1 S1 S1 S1 11 Bermuda From left to right: Sheila M. Brown Managing Director, Butterfield Trust (Bermuda) Limited Andrew R. Collins Managing Director, Butterfield Fund Services (Bermuda) Limited Ian M. Coulman Managing Director, Butterfield Asset Management Limited Bermuda Bermuda is home to Bank of Butterfield’s headquarters and largest operation. As the lead- Keeping up with international Letter of Credit portfolios both Know Your Customer standards, experienced considerable we also embarked on a project growth, as the Bank’s quality to confirm and document exist- products and effective relation- ing community bank, we have a ing customer information. ship management again proved long history of meeting the financial needs of businesses and individuals in Bermuda and offshore. Our services include Community & Private Banking, Wealth Management & Fiduciary Services and to be an ideal fit for both local In Bermuda our total income and international clients. While increased by 3.3% over 2002 to increasing the lending portfolio $157.1 million, reflecting record we remain vigilant in our levels of net interest income, up approach to loan quality. 14.5% to $78.1 million and non- interest income, up 16.2% to We also expanded our Private Investment & Pension Fund $79.0 million. Administration. Banking business in Bermuda during 2003, dedicating quality In 2003 Bank of Butterfield’s performance was again recog- nised by The Banker magazine, which presented us with the Community Banking resources to acquiring new Our Corporate Banking, Retail business and building strong Banking, Private Banking and relationships with our high Treasury businesses in Bermuda net worth private clients. continue to perform well. Management plans to further annual ‘Bank of the Year’ award Demonstrating an ability to develop Private Banking in for Bermuda for the second consecutive year. During the year under review we initiated several projects to help us con- tinue to grow and succeed. An extensive upgrade of our IT infrastructure, data and core banking system will support effective operations, product innovation and customer service; and an investment in premises will help maintain our level of security, efficiency and service. retain and attract business Bermuda during 2004. in a competitive market, our Community Banking business Our Consumer Credit business in in Bermuda achieved an 11.1% Bermuda recorded strong results year on year increase in net in 2003, with both mortgage income, from $31.6 million in lending and consumer loans 2002 to $35.1 million in 2003. increasing in volume. During the Total assets in Community year we strengthened existing Banking were $3.9 billion on business relationships to facilitate 31 December 2003 compared referrals and invested in training with $3.2 billion last year. to improve customer service and cross selling, while ensuring that The corporate lending and our products remained profitable. 12 Part of our commitment to cus- Providing portfolio manage- Butterfield Select Fund of Funds tomer service is the continuous ment, advisory and brokerage recorded growth of 72.0% in improvement of products and services to institutional and 2003. Butterfield Select invests delivery channels. In 2003 we private clients, Butterfield Asset in a wide range of quality became the first lending Management Limited manages mutual funds in three classes: institution in Bermuda to offer six of the award-winning family the traditional investments of Creditor Life and Disability of eight Butterfield Funds equity and fixed income as well Insurance on residential mort- (two of which are managed as alternative investments. In gages and consumer loans. in the Cayman Islands), as 2003 International Asset We also enhanced our Internet well as the Bank's own Management (IAM), a specialist Banking product, Butterfield investment portfolios. in alternative investment man- Direct, to provide even more agement, was appointed as the convenience and value. Butterfield Asset Management sub-adviser to the Butterfield Several offices began renova- reported 2003 net income of Select Fund, Alternative Class. tion projects that will result in $11.1 million, an increase of improved efficiencies and a 24.4% over 2002. Client assets better banking experience invested in Butterfield Funds for our customers. managed in Bermuda rose 13.3% year on year to $4.6 As a community bank, we billion at 31 December 2003. provide service to our customers The total client assets under in both good times and bad. management by Butterfield When Bermuda was hit by the Asset Management grew from powerful Hurricane Fabian in $6.2 billion at the end of 2002, September 2003, we offered to $7.1 billion at 31 December special credit terms to customers 2003, an increase of 14.4%. who needed funds to repair the resulting damages. In 2003 the Butterfield Funds 7,100 5,900 6,200 5,152 4,332 Jun 00 Jun 01 Jun 02 Dec 02 Dec 03 Assets Under Management by Butterfield Asset Management ($m) Butterfield Funds 2,369 3,061 3,749 4,123 4,561 Discretionary 1,963 2,091 2,151 2,077 2,539 Total 4,332 5,152 5,900 6,200 7,100 Wealth Management & Fiduciary Services Wealth Management & won performance awards from Standard & Poor’s for the sixth consecutive year. The overall Butterfield Trust (Bermuda) group of Butterfield Funds Limited provides a comprehen- Fiduciary Services in Bermuda earned first place for five-year sive range of trust, estate, comprise the businesses of performance in the Offshore company management and Butterfield Asset Management Funds, Smaller Groups Category. custody services to local and Limited and Butterfield Trust Butterfield Capital Appreciation international clients, both (Bermuda) Limited. These busi- Bond Fund received first place corporate and individual. nesses produced net income of in the world for five-year During the year under review, $15.6 million in 2003, up $3.3 performance in the Offshore client assets under custody million or 27.2% year on year. Funds, Fixed Income, Global increased by $3.7 billion to $16.8 Sector Category. billion, up 28.2% from 2002. 13 Overseas Subsidiaries Robert Lotmore Managing Director, Bank of Butterfield (Bahamas) Limited Assets under custody for hedge by 22.6% from $7.8 billion in At 31 December 2003 the Bank’s funds grew strongly as a result 2002 to $9.6 billion as at 31 total assets in The Bahamas of new business from existing December 2003. We significantly were $19.2 million and during clients and new clients. Our per- increased our client base and its first four months as a sub- sonal trust business continues continued to provide person- sidiary of Bank of Butterfield, to expand, as wealthy families alised, professional service to the business achieved net recognise the importance of the a variety of investment and income of $0.3 million. flexibility and independence we pension funds. provide when managing their Private Banking international financial affairs In 2003 customers of Butterfield Bank of Butterfield is well posi- in this heightened regulatory Fund Services again provided tioned for growth in this area environment. Net income for substantial business to other of the business in The Bahamas Butterfield Trust, at $4.4 million, areas of the group, including with the addition of lending increased by 34.8% from 2002. treasury, credit and Butterfield products and an anticipated Asset Management. increase in customer deposits. Positioning ourselves for growth, we strengthened our senior management team and The Bahamas Bank of Butterfield (Bahamas) Wealth Management & Fiduciary Services improved customer service. Limited was established in 2003 The core activities of Wealth Investment & Pension Fund Administration Butterfield Fund Services (Bermuda) Limited offers by the acquisition of two highly Management & Fiduciary regarded financial institutions, Services generate a significant Thorand Bank & Trust and portion of The Bahamas total Leopold Joseph (Bahamas) income. At 31 December 2003 Limited. This business is strategi- client assets under management accounting, corporate and cally important for Bank of were $1.3 billion. In 2003 we shareholder services to offshore Butterfield, as we can now expanded our services to offer hedge funds and mutual funds, provide several core products Butterfield Funds. as well as corporate pension and services from an additional administration services to reputable and well regulated insurance companies and international financial centre. international pension funds. In The Bahamas we offer Private For the year ended 31 December Banking, Wealth Management 2003, net income was $4.0 mil- & Fiduciary Services and lion compared with $2.9 million Investment Fund Administration. for the previous year. Net assets under administration, excluding the Butterfield Funds, increased 14 Clenell H. Goodman General Manager & Director, The Mutual Bank of the Caribbean Inc. Conor J. O’Dea Managing Director, Bank of Butterfield International (Cayman) Ltd. Investment Fund Administration Community Banking and commercial banking In The Bahamas we provide full Headquartered in Bridgetown services to private and administration services to off- with three additional branches, corporate customers and shore hedge funds and mutual the bank offers a range of retail provide Wealth Management funds. We anticipate growth services including personal and & Fiduciary Services and and development in this area, commercial lending, savings and Investment & Pension Fund with an increase in manage- chequing accounts, overdraft Administration Services. ment focus in 2004. facilities, fixed deposits, 24-hour Barbados In December 2003 Bank of ATM facilities, credit cards and In 2003 we accomplished foreign exchange. We look for- a strategic goal with a 25% ward to continuing to integrate investment in Island Heritage Butterfield acquired The Mutual this business and enhance its Insurance Company, Ltd., Bank of the Caribbean Inc., services with the resources of a growing and regionally a Barbados community bank. Bank of Butterfield. It is a well diversified property insurance This acquisition is consistent run operation with potential company. Additionally, the with the strategy to expand for a growing contribution to Bank obtained an insurance into markets where we can the Group. successfully deliver our core products and services. Barbados Wealth Management is a location known for its solid A separate operation, agent’s license to provide property insurance to mortgage customers. infrastructure and good Butterfield (Barbados) Limited We acted as adviser to the business environment. continues to act as a representa- Cayman Islands Government tive for the services of in respect of its first bond The Mutual Bank, to be Butterfield Asset Management offering of US $163.2 million. renamed Bank of Butterfield Limited, meeting the offshore We also invested in facilities (Barbados) Limited in the first corporate investment needs of and employee development quarter of 2004, was established organisations such as captive with the opening of an in March 1993 as the first insurance companies, interna- Operations Centre and indigenous private sector bank tional businesses and trusts. Learning Facility. During in Barbados. At 31 December 2003 The Mutual Bank had assets of $156.1 million and, in Cayman Islands A leading financial institution the year we completed a retrospective customer due diligence review, bringing its first month as part of the in the Cayman Islands, Bank our customer information Group, the bank achieved net of Butterfield International into compliance with the new, income of $0.2 million. (Cayman) Ltd. provides a higher regulatory standards comprehensive range of services in the Cayman Islands, as well to the local and international as international best practice. markets. We offer community 15 Overseas Subsidiaries Cayman net income for 2003, Electronic delivery of service at $24.3 million, is an increase now accounts for over 38% of 26.2% from 2002. Our total of all transactions processed assets continue to increase, for customers in the Cayman at $2.0 billion compared with Islands, with corporate $1.3 billion the previous year, customers using Butterfield as a result of ongoing growth Online extensively. in customer deposits. Community & Private Banking Wealth Management & Fiduciary Services Wealth Management & With five locations, seven ATMs Fiduciary Services offered in Robert S. Moore Managing Director, Bank of Butterfield International (Guernsey) Limited Guernsey Bank of Butterfield International (Guernsey) Limited provides services in two core business activities: Private Client Services, comprising Wealth Management & Fiduciary Services and Related Banking Services; and Institutional Administration, comprising Investment & Pension Fund Administration and including a drive-through, a the Cayman Islands include Administered Banking Services. web site, online banking and investment management, debit and credit cards allied custody, trust and company to a comprehensive range of administration, as well as credit facilities, we are a leader related banking services. in Community Banking opera- During 2003 we continued to tions in the Cayman Islands. attract new business as client Our personal and corporate assets under management banking business is aided by increased to $325 million at 31 our strong reputation for good December 2003 compared with customer service and innovative $282 million a year ago, an delivery channels. increase of 15.4%. As a result of continued strong Investment & Pension demand for credit, we increased Fund Administration our lending portfolio, while Operating under the banner maintaining a prudent of Butterfield Fund Services, approach to loan quality. we provide third party adminis- Corporate Banking in particular tration services to offshore experienced good growth, hedge funds, mutual funds and primarily resulting from captive pension funds. This business insurance clients. experienced strong growth rates during the year under Technology continues to benefit review, resulting in assets under customers through increased administration increasing by convenience and the Bank 29.6% to $17.4 billion. through efficiency and accuracy. In 2003 the Bank recorded net income of $2.8 million in Guernsey, a 16.0% decrease compared with $3.3 million in 2002, due mainly to the ongoing low interest rate envi- ronment. However, revenues were stable and assets under management for Guernsey clients rose to $690 million at 31 December 2003, up 62.0% from $426 million the previous year. During the year, we introduced an online banking facility, Butterfield Online, and imple- mented new systems in our fund services operation. We achieved the internationally recognised Investors in People accreditation, which demonstrates our commit- ment to the development of employees through training opportunities linked to the Bank’s business goals. 16 Private Banking Investment & Pension During the year under review Fund Administration we continued to cultivate In 2003 we achieved sizeable quality client relationships, growth in Investment & Pension offering a full range of multi- Fund Administration, providing currency deposits, loans and full administration services to foreign exchange dealing. offshore hedge funds, mutual Butterfield Online, launched funds and pension funds. With in September 2003, provides $6.2 billion in assets under added value and convenience administration, of which $1.6 for both private clients and billion are in assets held as their professional advisers. custodian trustee by the Bank, Butterfield Fund Managers Wealth Management & (Guernsey) Limited is now Fiduciary Services ranked as Guernsey’s fourth We provide discretionary portfolio largest fund administrator and is management to a range of the jurisdiction’s largest special- corporate and high net worth ist in administration of Cayman individuals and families. During and other non-Guernsey funds. 2003 we continued to offer Additionally, the Bank provides innovative and effective wealth custodian services for funds management solutions, including that are not administered by a three-year gold linked note. Butterfield Fund Managers. Paul A. Turtle Managing Director, Bank of Butterfield (UK) plc United Kingdom In 2003 Bank of Butterfield (UK) plc, branded Butterfield Private Bank, concentrated on the adoption and implementation of a strategic plan to focus on the provision of private banking services to high net worth individuals in the UK. The Bank’s team of marketing and sales pro- fessionals researched and devel- oped proposition and distribution strategies to expand the business. During the year under review we recorded a loss of $0.9 million, reflecting the cost of implementing our strategic plan, which required initial investments in operations, marketing and the develop- ment of products and services. The Guernsey team is also These assets under administration Private Banking responsible for the management totalled $0.5 billion at 31 of the Butterfield International December 2003. Balanced Fund, Sterling Class. Fiduciary services offered by Administered Banking Services Butterfield Trust (Guernsey) We are the market leader for Limited include tailored and the provision of Administered sophisticated trust and company Banking Services in Guernsey. administration services for We provide customer services, During 2003 we formulated the market positioning and brand proposition of Butterfield Private Bank and launched the new brand, together with a suite of deposit and lending services for high net worth indi- viduals, their pension plans and wealthy families and institutions. operations, accounting, compli- corporate structures. ance and corporate secretarial services for leading financial institutions from the UK, North America and Europe. Distribution began primarily via financial intermediaries such as independent financial advisers, accountants, solicitors, stockbro- kers and pension advisers. 17 Overseas Subsidiaries We enhanced the convenience Group or other investment houses. of our products and services The announcement of proposed with the introduction of an regulatory changes for UK financial Internet banking platform. advisers will give greater impetus to our plans to provide a full We also introduced a Self range of private banking services. Invested Personal Pension Plan, Having built a robust infrastruc- which combines cash deposits ture and viable business proposi- and commercial property financing tion during 2003, Butterfield services provided by Butterfield Private Bank is increasing the Private Bank together with sales team in order to enhance investment services, which can revenues and asset growth. be managed by the Butterfield Mission Statement Bank of Butterfield will provide consistent and superior returns to our shareholders, offer security and opportunities to our employees, and be recognised as making a valuable contribution to the communities in which we operate by a customer focused, efficient and ethical delivery of banking and other selected financial services. 18 A N N U A L R E P O R T | 2 0 0 3 Financial Report Financial Overview Selected Quarterly Results of Operations Financial Summary Management’s Financial Reporting Responsibility Auditors’ Report to the Shareholders Consolidated Balance Sheet Consolidated Statement of Income Consolidated Statement of Changes in Shareholders’ Equity Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements 20 24 25 26 27 28 29 30 31 32 19 Financial Overview Income Total income for the group after provisions was $238.2 million for the 12-month period ended 31 December 2003, up $25.9 million, or 12.2% from $212.3 million for the same period a year ago, when excluding a $17.0 million gain on the sale of subsidiaries in 2002. Net interest income before provisions for credit losses increased by 13.8% to $114.6 million, despite the challenge of declining US and UK interest rates during the year under review. The increase reflects growth in average interest earning assets and successful asset/liability management strategies. As a result we were able to increase the net interest margin by 0.1% to 1.9%. We continue to be appropriately reserved with total provisions of $23.5 million. Non-accrual loans totalled $17.4 million as at 31 December 2003, down from $24.9 million a year ago, and represent 0.9% of the total loan portfolio. Provisions in respect of credit losses charged to income were $2.4 million, compared to $3.2 million last year. In addition, the Bank wrote down its venture capital investment in Promisant Holdings Ltd. (PHL) by $4.6 million in the first quarter on acquisition of Promisant (Technology) Ltd. for $2.0 million. This write-down was charged to investment income. In addition, a $0.7 million working capital loan to PHL was charged off against general provisions. Non-interest income grew by 9.7% to $126.0 million when excluding the gain on sale of subsidiaries in 2002, reflecting growth in asset management, up 15.3%, investment and pension fund administration, up 10.7%, banking services, up 6.9%, and foreign exchange, up 5.4%. Changes in Net Interest Income For the year ended 31 December (In $ thousands) Assets Cash and deposits with banks Investments Loans Earning assets Other assets Total Assets Liabilities Deposits Repurchase agreements Subordinated debt Interest bearing liabilities Non interest bearing current accounts Other liabilities Total Liabilities Shareholders’ Equity Total Liabilities and Shareholders’ Equity Spread Net Interest Margin 2003 Interest 41,049 51,438 102,749 195,236 - 195,236 80,490 - 2,523 83,013 - - 83,013 Average Balance 2,020,828 2,238,746 1,794,253 6,053,827 183,395 6,237,222 4,753,899 - 117,308 4,871,207 921,321 79,209 5,871,737 365,485 6,237,222 2002 (unaudited) Interest 47,201 48,476 99,250 194,927 - 194,927 95,078 232 2,115 97,425 - - 97,425 Average Balance 1,869,567 1,871,916 1,699,501 5,440,984 175,365 5,616,349 4,518,230 12,671 75,000 4,605,901 607,450 76,869 5,290,220 326,129 5,616,349 Rate 2.0% 2.3% 5.7% 3.3% - 3.1% 1.7% - 2.2% 1.7% - - 1.4% 1.6% 1.9% Rate 2.5% 2.6% 5.8% 3.6% - 3.5% 2.1% 1.8% 2.8% 2.1% - - 1.8% 1.5% 1.8% Note: Underlying assets and liabilities are comprised of various currencies. 20 A N N U A L R E P O R T | 2 0 0 3 Expenses Operating expenses were $161.2 million during the year under review, up 10.0% from $146.5 million last year, compared with a 12.2% growth in operating revenues. The increase primarily reflects the expanding size of the Group with salaries and employee benefits up 10.4% to $97.8 million, accounting for 60.7% of total Group expenses compared with 60.5% last year. In addition increases of 12.6% and 23.6% respectively were seen in property and systems and communications costs, reflecting continued spending on infrastructure development as we build and improve our businesses further. At 31 December 2003 we had 742 employees in Bermuda, up from 724 a year ago, reflecting business growth. Overseas, the total headcount increased by 163 to 639 primarily due to the acquisitions in The Bahamas (37) and Barbados (115). We remain committed to the prudent management of the expense base and continually seek opportunities to improve our efficiency. The efficiency ratio improved from 66.4% in 2002 to 64.8% for the year under review. Other Expenses 9.4% Non-Corporation Taxes 5.4% Stationery & Supplies 1.2% Marketing 1.7% Systems & Communications 10.8% Property 10.8% Hong Kong 0.1% Barbados 0.4% The Bahamas 0.7% UK 3.3% Guernsey 15.6% Cayman 15.5% Salaries & Other Employee Benefits 60.7% Distribution of 2003 Total Expenses Bermuda 64.4% Distribution of 2003 Expenses by Location Balance Sheet Total assets increased by 27.8% to $7.7 billion, up from $6.0 billion a year ago. This increase reflects the substantial rise in the customer deposit base, up year on year by $1.4 billion, or 27.7%, to $6.6 billion. This was largely due to a significant level of short-term customer deposits in Bermuda and Cayman over year-end from insurance and mutual fund clients. The increased liquidity was primarily employed in our investment and short-term bank deposit portfolios, up year on year by 20.8% and 55.5% respectively to $2.5 billion and $3.0 billion. The balance sheet remains highly liquid with a loans to customer deposits ratio of 29.4%. Other 2.2% BBB 0.7% A 36.3% AAA 28.9% AA 31.9% Investment Portfolio by Long-Term Debt Rating 21 Financial Overview Barbados 3.2% UK 2.9% Guernsey 5.8% Cayman 13.7% Business and Government 41.3% Personal and Credit Cards 10.5% Bermuda 74.4% Mortgages 48.2% Lending by Location Bermuda Loans by Type Taxes For the year under review corporation tax totalled $0.5 million, compared to a $0.9 million credit for the same period a year ago, which was due to the effect of the change in the financial year end on our Guernsey operations’ tax computation. We also paid $8.6 million in non profits taxes across the Group, up from $7.4 million in the previous year reflecting increased banking licence fees in Bermuda and the Cayman Islands. Capital and Liquidity The Group continues to maintain a strong capital base that ensures stability and allows us to take advantage of opportunities for growth. At 31 December 2003 the risk weighted total capital ratio was 13.0%, well in excess of the 10.0% minimum requirement of the Bermuda Monetary Authority. Of the total, the Tier 1 ratio was 9.1%. Shareholders’ equity increased by $56.1 million, or 16.6% over a year ago, reflecting the increase in retained earnings less share buy-backs. Weighted risk assets rose year on year by 21.1% to $3.7 billion, primarily due to growth in the loan and letters of credit portfolios and deposits with banks. The loan to the Stock Option Trust is in respect of potential obligations under the Bank’s Stock Option Plan and is deducted from shareholders’ equity. The loan declined by $5.4 million, or 14.8%, to $31.1 million, reflecting repayment from cash received on the exercise of stock options by directors and employees. In May 2003 the Bank successfully issued US $125 million of subordinated lower tier II capital notes by way of a private placement with US institutional investors, our first such transaction in the US private placement market. The US $75 million issue of subordinated notes issued in June 1998 was repaid in July 2003. During the period under review, the Bank issued 234,027 shares under the Dividend Re-investment Programme, which represents a cash savings of $8.1 million, or 29.4% of the total dividend declared. As a result of the one-for-ten stock dividend in August 2003 2,037,470 new shares were also issued. Under the Share Buy-Back Plan, the Bank purchased 378,994 shares, at a cost of $13.2 million, as part of our strategy to enhance shareholder value. 22 A N N U A L R E P O R T | 2 0 0 3 Capital Composition (In $ thousands) For the year ended Tier 1 Capital Tier 2 Capital Total Capital Weighted Risk Assets (In $ thousands) Cash and inter-bank placements Investments Loans Other assets Off-balance sheet items Total Weighted Risk Assets Capital Ratios Tier 1 Tier 2 Total Managing Risk 31 December 2003 31 December 2002 341,247 144,504 485,751 309,706 94,985 404,691 618,535 1,025,146 1,394,310 155,047 548,298 3,741,336 391,368 816,273 1,265,705 145,571 469,633 3,088,550 9.1% 3.9% 13.0% 10.0% 3.1% 13.1% Risk is inherent in virtually all of the Bank’s daily activities. In fact, managing risk is a cornerstone of our business. We have established risk management structures, policies and procedures to identify, prioritise and manage risks across the Group in order to develop our businesses with an appropriate balance between risk and reward. Credit risk, market risk and liquidity risk are managed through appropriate controls and reporting systems. The Asset and Liability Management Committee (ALCO) and the Risk Policy Committee of the Board of Directors play an integral role in identifying, reviewing and managing financial and operational risk. Operational risk refers to the risk of loss caused by internal or external events such as procedural failures, errors or fraud. We mitigate this risk through the application of properly risk-adjusted internal controls, sound business processes, good decision-making, effective project execution and risk transfer techniques. The Bank has established an Enterprise Risk Management (ERM) function to identify, report and manage all types of risk by business line or process. Through ERM, we identify and assign ownership for market, credit and operational risks, develop risk priorities, approve appropriate mitigation strategies, and examine the cause-and-effect relationships between individual product risks. We also ensure that adequate and comprehensive risk data are available to support decision-making and that risk reporting is effective, reliable and timely. The Risk Review Committee, chaired by the Chief Financial Officer, also reviews and monitors business/event risks, insurance coverage, transactions and operational controls, operating losses and frauds, business continuity, potential regulatory changes, legal risks and compliance with financial and business conduct regulations. The Board’s Audit and Compliance Committee reviews internal audit, compliance and litigation reports. The Group Internal Audit function is independent from the Group's day-to-day operations, and has access to all activities conducted by the Group, including those of its branches and subsidiaries. Group Internal Audit is accountable only to the Board and the Group's Chief Executive Officer. 23 Financial Overview Selected Quarterly Results of Operations (Unaudited, in $ thousands except share data and ratios) 2003 Quarter ending 31/12/03 30/9/03 30/6/03 31/3/03 Net interest income after provision for credit losses Total fees and other income Total income Total expenses Net income for the quarter Earnings per share ($) * Return on shareholders’ equity (%) 31,263 33,811 65,074 45,084 19,990 0.97 20.5 28,803 31,435 60,238 40,009 20,229 0.99 21.6 28,164 30,946 59,110 39,231 19,879 0.97 22.4 23,993 29,822 53,815 37,419 16,396 0.80 19.3 Quarter ending 31/12/02 30/9/02 30/6/02 31/3/02 2002 Net interest income after provision for credit losses Total fees and other income Gain on sale of subsidiaries Total income Total expenses Net income from continuing operations Profit (loss) from discontinued operations Net income for the quarter Earnings per share ($) * Including discontinued operations Excluding discontinued operations Return on shareholders’ equity (%)# 27,944 29,656 - 57,600 37,239 20,361 (380) 19,981 0.98 1.00 23.6 23,702 29,698 - 53,400 35,949 17,451 - 17,451 0.83 0.83 20.6 23,337 27,936 17,013 68,286 37,926 30,360 531 30,891 1.46 1.43 17.4 22,520 27,542 - 50,062 34,491 15,571 33 15,604 0.74 0.74 20.8 * Earnings per share data has been restated to reflect the 1 for 10 stock dividend in August 2003. # Excludes gain on sale of subsidiaries and discontinued operations. 24 A N N U A L R E P O R T | 2 0 0 3 Financial Summary (In $ thousands except share data) At Year End Cash and deposits with banks Investments Loans Land, buildings and equipment Total assets Total deposits Subordinated debt capital Shareholders' equity For the Year Net interest income after provision for credit losses Fee and other income Gain on sale of subsidiaries Salaries and other employee benefits Other non-interest expenses Net income from continuing operations Net income Dividends declared Financial Ratios Return on assets ** Return on shareholders' equity ** Dividend payout ratio Total capital funds to total assets ratio Risk weighted capital ratio Efficiency ratio Per share ($) # Net income from continuing operations Net income Dividends Net book value Number of Employees Bermuda Overseas Total Shareholder Data Number of shareholders Number of shares (000)* Year ended 31 December 2003 2002 2002 Year ended 30 June 2001 3,035,944 2,503,337 1,935,764 100,486 7,679,872 7,065,108 125,000 394,929 1,989,159 2,073,112 1,767,088 96,419 6,007,874 5,516,216 75,000 338,799 (unaudited) 2,027,225 1,831,142 1,696,775 98,536 5,738,044 5,216,366 75,000 335,167 1,691,423 1,882,479 1,451,773 97,690 5,197,804 4,700,723 75,000 286,525 112,223 126,014 - 97,840 63,903 76,494 76,494 27,471 1.2% 20.9% 35.9% 7.5% 13.0% 64.8% 3.73 3.73 1.43 19.13 742 639 1,381 97,503 114,832 17,013 88,612 56,993 83,743 83,927 25,769 1.2% 20.5% 30.7% 6.9% 13.1% 66.4% 4.00 4.01 1.37 16.56 724 476 1,200 97,237 109,322 17,013 88,623 53,533 81,416 82,289 24,681 1.2% 21.2% 30.0% 7.0% 13.8% 61.9% 3.85 3.88 1.31 15.83 749 480 1,229 100,213 91,775 - 72,024 53,232 66,732 60,742 20,525 1.2% 22.7% 33.8% 7.2% 14.8% 61.8% 3.13 2.85 1.05 13.50 744 418 1,162 2000 1,514,813 1,831,303 1,284,223 96,557 4,794,012 4,337,782 75,000 250,197 97,487 83,368 - 75,520 50,448 54,887 40,347 13,730 0.9% 16.4% 34.0% 7.0% 13.2% 67.1% 2.50 1.83 0.68 11.68 762 351 1,113 3,581 20,643 3,322 18,603 3,364 19,247 3,619 17,571 3,602 17,705 * The number of shares excludes shares purchased by the Bank for the Stock Option Trust. Per share data, with the exception of dividends, has been restated to reflect the 1 for 10 stock dividends in August 2003 and August 2001. The number of shares in 2003 and 2002 increased primarily due to the issue of stock dividends. ** Exclusive of discontinued operations and gain on sale of subsidiaries. # Inclusive of gain on sale of subsidiaries. 25 Management’s Financial Reporting Responsibility The Management of The Bank of N.T. Butterfield & Son Limited is responsible for the preparation of the consolidated financial statements contained in this Report, which covers all of the interests of the Bank. Management has fully disclosed its income, assets, liabilities and off balance sheet commitments. These financial statements have been prepared in accordance with accounting principles generally accepted in Bermuda and Canada and, where appropriate, are based on the best estimates and judgment of management. Management has established and maintains a system of financial reporting and internal controls to provide reasonable assurance that transactions are properly authorised and recorded, assets are protected against unauthorised use or disposition and liabilities are recognised. These procedures include the careful selection and training of qualified staff, the establishment of organisational structures providing an appropriate and well-defined division of responsibilities, and the communication of policies and standards of business conduct throughout the Bank. The system of internal controls is further supported by a professional staff of internal auditors who conduct periodic inspections of all aspects of the Bank’s operations. In addition, the Bank’s Head of Group Internal Audit has full and free access to the Audit & Compliance Committee of the Board of Directors. The Audit & Compliance Committee, composed entirely of directors who are not employees of the Bank, reviews the financial statements before such statements are approved by the Board of Directors and submitted to the Bank’s shareholders. Under the provisions of the Bermuda Monetary Authority Act 1969, the Bermuda Monetary Authority is charged with the supervision of the Bank. Such supervision is in line with international practices and combines a comprehensive system of statistical returns, providing a detailed breakdown of the balance sheet and statement of income accounts of the Bank, and regular meetings with the senior management of the Bank. Such regular reviews are intended to satisfy the Authority that the safety and interests of the depositors, creditors and shareholders of the Bank are being duly observed and that the Bank is in a sound financial condition. PricewaterhouseCoopers, the shareholders’ independent auditors, have examined the consolidated financial statements of the Bank in accordance with auditing standards generally accepted in Bermuda and Canada and have expressed their opinion in their report to the shareholders. The auditors have unrestricted access to, and meet periodically with, the Audit & Compliance Committee to review their findings regarding internal controls over the financial reporting process, auditing matters and financial reporting issues. Alan R. Thompson President & Chief Executive Officer 13 February 2004 Richard J. Ferrett Executive Vice President & Chief Financial Officer 13 February 2004 26 Auditors’ Report to the Shareholders A N N U A L R E P O R T | 2 0 0 3 27 Financials Consolidated Balance Sheet As at 31 December 2003 (In $ thousands) Assets Cash and demand deposits with banks Term deposits with banks Total cash and deposits with banks (note 2) Investments (notes 1(d) and 4) Loans (notes 1(e) and 5) Land, buildings and equipment (notes 1(g) and 6) Accrued interest Intangible assets (notes 1(b) and 7) Other assets Total Assets Liabilities Deposits Customers Banks Total deposits (note 8) Dividend payable Accrued interest Other liabilities Total other liabilities Subordinated debt capital (note 17) Total Liabilities Shareholders' Equity Share capital Share premium General reserve Retained earnings Less: loan to stock option trust (notes 1(j) and 18) Total Shareholders' Equity Total Liabilities and Shareholders' Equity The accompanying notes are an integral part of these consolidated financial statements. 2003 2002 40,896 2,995,048 3,035,944 2,503,337 1,935,764 100,486 22,915 42,860 38,566 7,679,872 6,583,271 481,837 7,065,108 7,817 7,218 79,800 94,835 125,000 7,284,943 22,335 120,086 100,000 183,566 (31,058) 394,929 7,679,872 63,103 1,926,056 1,989,159 2,073,112 1,767,088 96,419 21,313 27,322 33,461 6,007,874 5,156,111 360,105 5,516,216 7,155 7,998 62,706 77,859 75,000 5,669,075 20,443 56,543 100,000 198,262 (36,449) 338,799 6,007,874 James A.C. King, MD, FRCS(C), FACS, JP Chairman of the Board Robert J. Stewart, FCIS, LL.B Vice Chairman Alan R. Thompson President & Chief Executive Officer 28 A N N U A L R E P O R T | 2 0 0 3 Consolidated Statement of Income (In $ thousands, except per share data) Year Ended 31 December 2003 Six Months Ended 31 December 2002 Year Ended 30 June 2002 Interest Income Loans Investments Deposits with banks Interest income Interest Expense Deposits and other Subordinated debt capital Interest expense Net interest income Provision for credit losses Net Interest Income after Provision for Credit Losses Trust and investment services Asset management Investment and pension fund administration Banking services Foreign exchange revenue Other income Gain on sale of subsidiaries Total Fees and Other Income Total Income Expenses Salaries and other employee benefits Property Systems and communications Marketing Stationery and supplies Non-corporation taxes Other expenses Total Expenses Net Income from Continuing Operations before Corporation Tax Corporation Tax Net Income from Continuing Operations after Corporation Tax Profit (loss) from discontinued operations (note 19) Net Income for the Year Earnings per Share (note 1(l)) Including discontinued operations Excluding discontinued operations The accompanying notes are an integral part of these consolidated financial statements. Earnings per share comparative figures have been restated for the 1 for 10 stock dividend in August 2003. 105,162 51,438 41,049 197,649 80,490 2,523 83,013 114,636 (2,413) 112,223 20,388 21,859 22,937 33,646 18,908 8,276 - 126,014 238,237 97,840 17,400 17,480 2,749 1,888 8,652 15,220 161,229 77,008 (514) 76,494 - 76,494 $3.73 $3.73 52,589 26,299 23,812 102,700 48,081 1,041 49,122 53,578 (1,932) 51,646 9,456 10,175 9,614 16,771 9,447 3,891 - 59,354 111,000 44,028 7,836 7,294 1,394 977 3,741 7,848 73,118 37,882 (70) 37,812 (380) 37,432 $1.81 $1.83 103,327 57,925 55,350 216,602 114,568 2,638 117,206 99,396 (2,159) 97,237 21,590 19,301 16,884 31,521 16,273 3,753 17,013 126,335 223,572 88,623 15,229 12,947 2,463 1,971 6,942 13,999 142,174 81,398 18 81,416 873 82,289 $3.88 $3.85 29 Financials Consolidated Statement of Changes in Shareholders' Equity For the year ended 31 December 2003 (In $ thousands) Year Ended 31 December 2003 Six Months Ended 31 December 2002 Year Ended 30 June 2002 Share Capital Authorised: 70,000,000 shares (2002: 70,000,000 shares) of par value $1.00 each Issued: Balance at Beginning of Year (January 2003: 20,443,030 shares; July 2002: 21,309,750 shares; July 2001: 19,435,655 shares) Dividend re-investment plan (December 2003: 234,027 shares; December 2002: 123,580 shares; June 2002: 219,431 shares) Stock dividend (December 2003: 2,037,470 shares; December 2002: Nil; June 2002: 1,942,185 shares) - (note 22) Share redemptions (December 2003: 378,994 shares; 70,000 20,443 234 2,037 December 2002: 990,300 shares; June 2002: 287,521 shares) - (note 20) (379) Balance at End of Year 70,000 21,310 124 - (991) 70,000 19,436 219 1,942 (287) (December 2003: 22,335,533 shares; December 2002: 20,443,030 shares; June 2002: 21,309,750 shares) 22,335 20,443 21,310 Share Premium Balance at Beginning of Year Dividend re-investment plan Stock dividend - (note 22) Share redemptions - (note 20) Balance at End of Year General Reserve Balance at Beginning of Year Balance at End of Year Retained Earnings Balance at Beginning of Year Net income for the year Dividends declared Stock dividend Unrealised gain on translation of investment in foreign operations Balance at End of Year 56,543 7,854 68,500 (12,811) 120,086 100,000 100,000 198,262 76,494 274,756 (27,471) (70,537) 6,818 183,566 83,045 3,761 - (30,263) 56,543 100,000 100,000 170,828 37,432 208,260 (13,486) - 3,488 198,262 22,186 6,824 62,878 (8,843) 83,045 100,000 100,000 176,273 82,289 258,562 (24,681) (64,820) 1,767 170,828 Loan to Stock Option Trust - (notes 1(j) and 18) Balance at Beginning of Year (January 2003: 1,839,743 shares; July 2002: 2,062,745 shares; July 2001: 1,864,547 shares) Loan repaid (advanced) during year Balance at End of Year (December 2003: 1,692,698 shares; December 2002: 1,839,743 shares; June 2002: 2,062,745 shares) Total Shareholders' Equity (36,449) (40,016) (31,370) 5,391 3,567 (8,646) (31,058) 394,929 (36,449) 338,799 (40,016) 335,167 The accompanying notes are an integral part of these consolidated financial statements. 30 A N N U A L R E P O R T | 2 0 0 3 Consolidated Statement of Cash Flows For the year ended 31 December 2003 (In $ thousands) Year Ended 31 December 2003 Six Months Ended 31 December 2002 Year Ended 30 June 2002 Cash Flows From Operating Activities Net income for the year Adjustments for: Depreciation and amortisation Provision for credit losses Writedown of investments (net) Gain on disposal of subsidiaries Decrease (increase) in accrued interest receivable Decrease (increase) in other assets Decrease in accrued interest payable Increase in other liabilities Cash flows from operations Cash Flows From Investing Activities Term deposits with banks Net sale (purchase) of investments Net increase in loans Purchase of subsidiaries Net proceeds on disposal of subsidiaries Purchase of land, buildings and equipment Cash flows used in investing activities Cash Flows From Financing Activities Net increase in demand and term deposits Securities sold under agreements to repurchase Issuance of subordinated debt capital (note 17) Dividends paid Proceeds from dividend re-investment plan Stock option trust loan Redemption of shares Cash flows from financing activities Effect of exchange rates on cash and demand deposits with banks 76,494 15,226 2,413 4,145 - (1,126) (1,547) (1,426) 13,757 107,936 (1,018,280) (393,469) (108,864) (31,063) - (11,501) (1,563,177) 1,409,379 - 50,000 (26,808) 8,088 5,391 (13,190) 1,432,860 37,432 6,612 1,932 2,124 - (311) 1,501 (1,519) 1,350 49,121 58,913 (244,094) (72,245) - - (3,415) (260,841) 299,850 (30,179) - (13,150) 3,885 3,567 (31,253) 232,720 82,289 12,667 2,159 2,616 (17,013) 10,533 (957) (2,863) 179 89,610 (9,021) 51,860 (208,260) (36,069) 17,116 (11,100) (195,474) 119,403 (25,181) - (24,081) 7,043 (8,646) (9,130) 59,408 174 (153) 1,020 Increase (decrease) in cash and demand deposits with banks (22,207) 20,847 (45,436) Cash and demand deposits with banks: - Beginning of Year - End of Year Interest Paid Corporation Taxes Paid (Received) 63,103 40,896 83,793 1,078 42,256 63,103 50,641 (1,180) 87,692 42,256 120,069 (372) The accompanying notes are an integral part of these consolidated financial statements. 31 Financials Notes to Consolidated Financial Statements For the year ended 31 December 2003 (All amounts are expressed in thousands of Bermuda dollars unless otherwise stated.) NOTE 1: Significant Accounting Policies These consolidated financial statements are prepared in accordance with accounting principles generally accepted in Bermuda and Canada. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as at the date of the financial statements. Estimates also affect the reported amounts of income and expenses for the reporting period. Actual results could differ from those estimates. The significant accounting policies followed in the preparation of these consolidated financial statements are summarised below: (a) Basis of Consolidation: The consolidated financial statements include the assets, liabilities and results of operations of the Bank and all of its subsidiaries. Subsidiaries are companies which the Bank controls and are normally those in which the Bank owns directly or indirectly more than 50% of the voting shares. Effective 1 July 2001 the Bank adopted the revised recommendations of the Canadian Institute of Chartered Accountants (CICA) on accounting for business combinations. The standard requires the use of the purchase method to account for all business combinations and requires the recognition of certain other intangible assets acquired in a business combination apart from goodwill. On transition, for business combinations completed before 1 July 2001, where the carrying amount of acquired intangible assets does not meet the criteria for separate recognition, the assets were reclassified to goodwill while items which met the definition of intangibles but were originally recorded as goodwill were reclassified and accounted for as intangible assets. The difference between the acquisition cost of an investment and the fair value of the net assets (including certain intangible assets) acquired represents goodwill. The Bank’s interest in joint ventures is recognised using the proportionate consolidation method. Under this approach the Bank’s share of the joint venture’s assets, liabilities, revenues and expenses is reported on a line-by-line basis. (b) Goodwill and Other Intangible Assets: Effective 1 July 2001 the Bank adopted the revised recommendations of the CICA on accounting for goodwill and other intangible assets. Under the standard, goodwill is no longer amortised but is subject to a revised annual impairment test to identify any potential goodwill impairment. A goodwill impairment loss will be recognised if the fair value of the goodwill of a reporting unit is less than its carrying amount. The Bank continues to amortise to income intangible assets other than goodwill with a definite life over their estimated useful lives on a straight-line method, not to exceed 20 years, as provided for in the standard. An impairment test is carried out if certain indicators are identified. (c) Translation of Foreign Currencies: Assets, liabilities, revenues and expenses denominated in US dollars are translated into Bermuda dollars at par. Assets and liabilities arising from other foreign currency transactions are translated into Bermuda dollars at the rates of exchange prevailing at the balance sheet date while associated revenues and expenses are translated into Bermuda dollars at the average rates of exchange prevailing throughout the period. Resulting gains or losses are included as foreign exchange income in the Consolidated Statement of Income. Assets and liabilities of the Bank’s foreign operations are translated into Bermuda dollars at the rates of exchange prevailing at the balance sheet date while associated revenues and expenses are translated into Bermuda dollars at the average rates of exchange prevailing throughout the period. Exchange gains and losses arising from the translation of net investment positions and from the results of hedging these positions are reported in retained earnings. (d) Investments: Investment portfolio securities are debt securities where the Bank’s original intention is to hold to maturity and equity securities where the Bank’s original intention is to hold for the long term. They are carried at cost or amortised cost, adjusted to recognise other than temporary impairment in the underlying value, except for money market mutual funds which are carried at market value, which approximates cost plus accrued and reinvested interest since acquisition. Investments held in the trading portfolio are intended to be held for a short period of time and are carried at market value and any adjustments to market value of these investments are included in the Consolidated Statement of Income. Venture capital investments are equity or debt investments whereby the Bank's original intention is to dispose of the investment in the medium term. Venture capital investments are recorded at fair value with adjustments to fair value being recognised in investment income. In assessing fair value, management reviews meaningful third party transactions in the private market and the results of applying acceptable valuation methodologies to current and projected cash flows. In the absence of persuasive evidence to the contrary, management generally considers cost to be the best indicator of fair value. Due to the dynamic nature of assumptions used in establishing fair values, the values reflected in the consolidated financial statements may differ significantly from the values that would be determined by negotiations held between parties in a sales transaction and those differences could be material. 32 A N N U A L R E P O R T | 2 0 0 3 Dividend and interest income on all securities, including amortisation of premiums and discounts on debt securities held for investment, are included in investment income in the Consolidated Statement of Income. (e) Loans: Loans are stated net of any unearned income and of an allowance for credit losses. Interest income is accounted for on the accrual basis for all loans other than impaired loans. A loan is classified as non-accrual when, in management’s opinion, there has been a deterioration in credit quality to the extent that there is no longer reasonable assurance of timely collection of all amounts due under the contractual terms of the loan. If an interest payment on a loan becomes contractually 90 days in arrears, the loan will be classified as non-accrual, if not already classified as such, unless the loan is fully secured, and any collection efforts are reasonably expected to result in repayment of all amounts due under the contractual terms of the loan. All non-accrual loans are considered impaired loans. When a loan is classified as non-accrual, recognition of interest ceases. Interest received on non-accrual loans is credited to the carrying value of the loan. Loans are generally returned to accrual status when the collection of all amounts due under the contractual terms of the loan is reasonably assured and all delinquent principal and interest payments are brought current. Credit card loans that are contractually 180 days in arrears and personal loans with an outstanding balance under $100,000 that are contractually 180 days in arrears are automatically written off. (f) Allowance for Credit Losses: The Bank maintains an allowance for credit losses, which in management’s opinion is adequate to absorb all credit-related losses in its portfolio relating to on and off balance sheet financial instruments. The allowance for credit losses consists of specific provisions and a general provision, each of which is reviewed on a regular basis. The allowance for credit losses is included as a reduction of the related asset category. Specific provisions are determined on an item-by-item basis and reflect the associated estimated credit loss. In the case of loans, the specific provision is the amount that is required to reduce the carrying value of an impaired loan to its estimated realisable amount. Generally, the estimated realisable amount is measured by discounting the expected future cash flows at the effective interest rate inherent in the loan at the date of non- accrual. The change in the present value attributable to the passage of time on the expected future cash flows is reported as a reduction of the provision for credit losses in the Consolidated Statement of Income. When the amounts and timing of future cash flows cannot be measured with reasonable reliability, either the fair value of any security underlying the loan, net of expected costs of realisation and any amounts legally required to be paid to the borrower, or the observable market price for the loan is used to measure the estimated realisable amount. A general provision is established in respect of the Bank’s core business lines where a prudent assessment by the Bank of past experience and existing economic and portfolio conditions indicate that losses have occurred, but where such losses cannot be determined on an item-by-item basis. The general provision is determined by using historical trends in loss experience, weighted to emphasise recent periods, and the current portfolio profile together with management’s evaluation of other conditions existing at the balance sheet date which are not reflected in historical trends. As the general provision principally relates to loans it is deducted from loans in the Consolidated Balance Sheet. (g) Land, Buildings and Equipment: Land is carried at cost. Buildings, equipment and leasehold improvements are carried at cost less accumulated depreciation and/or amortisation. Depreciation and amortisation are calculated using the straight-line method over the estimated useful lives of the related assets, which are up to 50 years for buildings, up to 10 years for furniture, up to 5 years for computers and equipment and, in the case of leasehold improvements, the term of the lease. Gains and losses on disposal are reported in other income in the Consolidated Statement of Income. (h) Employee Future Benefits: The Bank maintains trusteed pension plans for substantially all employees including non-contributory defined benefit and a number of 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. The Bank also provides post-retirement medical benefits for substantially all retired Bermuda based employees. 33 Financials Effective 1 July 2000, the Bank adopted the revised recommendations of the CICA on accounting for pension benefits and on accounting for employees’ future benefits. This standard requires the use of current market interest rates to estimate the present value of the liability and the use of current market prices for valuing defined benefit pension plan assets, whereas in previous years, an estimated long-term interest rate was used to determine the present value of the defined benefit pension and medical benefits obligation. The change in accounting policy for employees’ future benefits has been adopted prospectively such that the change in the net pension asset and the medical benefits liability at 1 July 2000, arising from adoption of the standard are being amortised over the relevant remaining service life of the employees covered by the defined benefit pension plans and the post-retirement medical benefits plan. Expense for the defined benefit pension plans and the post-retirement medical benefits plan is comprised of (a) the actuarially determined benefits for the current year’s service, (b) imputed interest on the actuarially determined liability of the plan, (c) in the case of the defined benefit pension plan, the expected investment return on the market value of plan assets and (d) amortisation of certain items over the expected average remaining service life of employees, in the case of the defined benefit pension plans, and the expected average remaining service life to full eligibility age of employees covered by the plan, in the case of the post-retirement medical benefits plan. The items amortised are amounts arising as a result of experience gains and losses, changes in assumptions, plan amendments and the change in the net pension asset or post-retirement medical benefits liability arising on adoption of the revised accounting standard on 1 July 2000. For the defined benefit pension plans the cumulative difference between the funding contributions and the expense is reported in other assets. For the post-retirement medical benefits plan, the liability recognised for accounting purposes is reported in other liabilities. The defined contribution pension plans provide for an annual contribution based on each participating employee’s pensionable earnings. Amounts paid are expensed in the period. (i) Derivatives: Derivatives are used for asset/liability management and proprietary trading purposes and also to provide clients with the ability to manage their own market risk exposures. The most frequently used derivative products are foreign exchange contracts and interest rate swaps. Asset/liability management derivatives are used to hedge the Bank’s own exposure to interest rate and foreign exchange risks which arise from the Bank’s balance sheet positions. Income and expense on these derivatives are recognised over the life of the related position primarily as an adjustment to net interest income. Gains or losses on effective hedges are deferred and amortised over the remaining life of the related positions. Accrued income and expense and deferred gains and losses are included in other assets and other liabilities, as appropriate in the Consolidated Balance Sheet. Unrealised gains and losses are not recognised. Proprietary trading derivatives are marked to market and realised and unrealised gains and losses are included in other income. Effective 1 July 2002, the Bank early adopted Accounting Guideline 13 (AcG13), "Hedging Relationships" which requires the Bank to identify, document and demonstrate the effectiveness of all hedging relationships for which derivative instruments are used as cash flow or fair value hedges. Positions hedged with derivative instruments meeting AcG13 requirements will continue to be accounted for using accrual accounting provided they are effective hedges. If designated hedges are no longer effective the derivative investment is reclassified as trading and subsequently marked to market with realised and unrealised gains and losses being included in other income. (j) Loan to Stock Option Trust: The loan made to finance the acquisition of shares by the Stock Option Trust is shown as a deduction from shareholders’ equity. Dividends paid on the acquired shares are deducted in arriving at dividends paid reflected in the Statements of Changes in Shareholders’ Equity and Cash Flows. The weighted average number of shares outstanding used in the calculation of earnings per share is calculated after deducting the shares held by the Stock Option Trust during the period. 34 A N N U A L R E P O R T | 2 0 0 3 (k) Stock-based Compensation: The Bank has a Stock Option Plan for all eligible employees. The Bank follows the intrinsic value method of accounting for stock options. Since the exercise price is set at an amount equal to the closing price on the day prior to the grant of the stock options, no compensation expense is recognised on the day of the grant. When options are exercised the proceeds received are credited to the loan to Stock Option Trust. Effective 1 July 2002, the Bank adopted CICA handbook section 3870, "Stock-based Compensation" which requires the use of a fair value based method to account for certain stock-based compensation arrangements. Options granted by the Bank to employees and directors are not required under the new standard to be accounted for using a fair value based method. However, pro-forma fair value based income and earnings per share disclosures are required under the new standard. (l) Earnings Per Share: Earnings per share has been calculated using the weighted average number of shares outstanding during the year adjusted as described in 1(j) above and adjusted for the stock dividends declared during the year ended 31 December 2003 and 30 June 2002 (see also Note 22). Fully diluted earnings per share, calculated after giving effect to the potential dilution arising from the existence of stock options, is not materially different from the earnings per share disclosed in the Consolidated Statement of Income. Effective 1 July 2001 the Bank adopted the revised recommendations of the CICA on accounting for earnings per share. The standard requires the use of the treasury stock method, whereby the proceeds received from the exercise of stock options are assumed to be used to repurchase shares. (m) Future Accounting Policies: Impairment or Disposal of Long-lived Assets The CICA has issued a new accounting standard for the impairment and disposal of non-monetary long-lived assets. This standard requires an impairment loss to be recognised when the carrying amount of a long-lived asset to be held and used exceeds the sum of the undiscounted cash flows expected from its use and disposal. The impairment recognised should be measured as the amount by which the carrying amount of the asset exceeds its fair value. Long-lived assets that are to be disposed of other than by sale should be classified and accounted for as held-for-use until the date of disposal or abandonment. Assets that meet certain criteria are classified as held-for-sale and are measured at the lower of their carrying amounts or fair value, less costs to sell. In addition, under this standard, the definition of discontinued operations has been broadened to include any disposals of a component of an entity, which comprises operations and cash flows that can be clearly distinguished. This standard is effective for the Bank for fiscal 2004, except for the change in presentation of discontinued operations which is effective for disposals committed to on or after 1 April 2003. These new accounting requirements could require the Bank to consolidate certain Venture Capital Investments. Consolidation of Variable Interest Entities (VIE’S) In June 2003, the CICA issued a new accounting guideline which requires the consolidation of VIE’s by the primary beneficiary. A VIE is an entity where (a) its equity investment at risk is insufficient to permit the entity to finance its activities without additional subordinated support from others and/or (b) where certain essential characteristics of a controlling financial interest are not met. The primary beneficiary is the enterprise that will absorb or receive the majority of the VIE’s expected losses, expected residual returns, or both. The guideline is effective for the Bank’s interim financial statements commencing 1 January 2005. The Bank is currently performing an assessment of the existence of VIE’s and the potential impact on the financial position and results of operations. (n) Certain prior year comparative amounts have been reclassified to conform to the current year presentation. 35 Financials NOTE 2: Cash and Deposits with Banks Summary of cash and deposits with banks as at: Cash and demand deposits Term deposits maturing within six months Term deposits maturing within six to twelve months Term deposits maturing after twelve months Total 31 December 2003 40,896 2,839,945 130,678 24,425 3,035,944 31 December 2002 63,103 1,847,746 78,310 - 1,989,159 NOTE 3: Significant Acquisitions and Significant Disposals On 26 July 2001, the Bank's Guernsey subsidiaries, Bank of Butterfield International (Guernsey) Limited and Butterfield Fund Managers (Guernsey) Limited, acquired all of the outstanding common shares of CIBC Bank and Trust Company (Channel Islands) Limited, Canadian Imperial Bank of Commerce Trust Company (Channel Islands) Limited and CIBC Fund Managers (Guernsey) Limited (collectively referred to as CIBC's Guernsey operations). The total consideration in respect of this purchase was paid in cash. The acquisition was accounted for by the purchase method and the results of CIBC's Guernsey operations have been included in the Consolidated Statement of Income from the date of acquisition. The principal activities of the CIBC Guernsey operations include: (a) private client business comprising the administration of private companies and trusts, the provision of multi-currency deposits, foreign exchange, credit facilities, securities trading and portfolio management services for high net worth individuals, and (b) institutional business comprising administered banking, managed trust companies, institutional custody and fund administration services. On 6 June 2002, the Bank sold its controlling interest in its Hong Kong subsidiaries to Dexia Banque Internationale à Luxembourg (Dexia BIL) for cash and realised a gain of $17.0 million. Net income up to the date of sale totalled $1.4 million and is included in the Consolidated Income Statement. The Bank’s Hong Kong subsidiaries, established in 1986, consisted of Butterfield Trust (Hong Kong) Limited and Butterfield Corporate Services (Hong Kong) Limited. Dexia BIL acquired a majority interest in the Trust and Corporate Services operations and took over the business of the Bank’s restricted licence branch after regulatory approval was received in April 2003. On 4 March 2003, the Bank acquired Promisant (Technology) Ltd (PTL) and certain tangible fixed assets of Promisant Holdings Ltd (PHL) for $2 million. PTL is a Bermuda based provider of multi-currency payment processing services to Bermudian and international merchants and was a wholly-owned subsidiary of PHL, a company in which the Bank had a venture capital equity investment. PHL was wound down and the Bank wrote-off its remaining investment of $4.63 million which was a charge to investment income. In addition the Bank charged off a $0.7 million working capital loan to PHL against general provisions in 2003. PTL has been consolidated as a wholly owned subsidiary of the Bank with $2 million of tangible assets included in land, buildings and equipment in the Consolidated Balance Sheet at year-end. On 22 August 2003, the Bank acquired all the outstanding common shares of Thorand Bank and Trust Limited, and on 3 September 2003, the Bank acquired all the outstanding common shares of Leopold Joseph (Bahamas) Limited. The total consideration in respect of these acquisitions was paid in cash and have been accounted for by the purchase method. Subsequent to the acquisitions, the Bank has merged the operations of the two companies into Bank of Butterfield (Bahamas) Limited and these results are included in the Consolidated Statement of Income from the date of acquisitions. The principal activities of the acquired companies is private client business comprising primarily trust and related services to high net worth individuals. On 4 December 2003, the Bank acquired all the outstanding common shares of The Mutual Bank of the Caribbean Inc., a Barbados community bank, from its majority shareholder, Sagicor Financial Corporation, and its minority shareholders. The total consideration in respect of this acquisition was paid in cash and has been accounted for by the purchase method. The bank will be renamed Bank of Butterfield (Barbados) Limited in 2004. 36 A N N U A L R E P O R T | 2 0 0 3 Fair value of assets acquired Total cash and deposits with banks Investments Loans Land, buildings and equipment Intangible assets - customer list Intangible assets - goodwill Other assets Total Fair value of liabilities assumed Deposits Other liabilities Total Fair value of identifiable net assets acquired Total purchase consideration NOTE 4: Investments (a) Maturity: Summary of investments 31 December 2003 31 December 2002 50,712 42,901 62,225 3,486 11,446 5,404 5,029 181,203 139,513 10,627 150,140 31,063 31,063 - - - - - - - - - - - - - 30 June 2002 372,217 3,139 38,901 515 21,401 - - 436,173 396,240 3,864 400,104 36,069 36,069 31 December 2003 Marketable Securities US Government and agencies Other OECD Governments Financial institution debt Corporate and asset backed debt Non OECD Governments Mutual fund/equity investments* Total 31 December 2002 Marketable Securities US Government and agencies Other OECD Governments Financial institution debt Corporate and asset backed debt Non OECD Governments Mutual fund/equity investments* Total Within 1 Year 25 5,899 580,095 74,562 26,559 - 687,140 Within 1 Year 2,800 - 323,802 34,866 237 - 361,705 1 to 3 Years 3 to 5 Years 5 to 10 Years Over 10 Years 40,479 10,251 650,020 107,252 18,243 - 826,245 1 to 3 Years 40,783 5,963 668,940 149,351 1,833 - 866,870 157 - 388,140 134,686 10,895 - 533,878 3 to 5 Years 10,001 10,374 360,004 159,117 3,267 - 542,763 7,976 - 1,104 83,760 19,077 - 111,917 5 to 10 Years 61,400 5,188 3,224 9,266 10,766 - 89,844 5,714 - 45,337 244,199 6,000 42,907 344,157 Over 10 Years 9,000 - - 158,315 212 44,403 211,930 Total 54,351 16,150 1,664,696 644,459 80,774 42,907 2,503,337 Total 123,984 21,525 1,355,970 510,915 16,315 44,403 2,073,112 * Mutual funds and equity investments have no specific maturity date and are listed as Over 10 Years. All of the above amounts are held in the investment portfolio and are carried at amortised cost with the exception of the trading portfolio which amounts to $15,419 ($15,771 at 31 December 2002), venture capital investments which amount to $5,079 ($18,956 at 31 December 2002), and certain other equity investments aggregating $22,409 ($8,547 at 31 December 2002). Actual maturities may differ from the stated maturities reflected above because certain investments may have call or prepayment features and asset backed securities are shown at their legal final maturity and not their weighted average life, which will normally be under five years. 37 Financials (b) Fair Value Summary 31 December 2003 Marketable Securities US Government and agencies Other OECD Governments Financial institution debt Corporate and asset backed debt Non OECD Governments Mutual fund/equity investments Total 31 December 2002 Marketable Securities US Government and agencies Other OECD Governments Financial institution debt Corporate and asset backed debt Non OECD Governments Mutual fund/equity investments Total Carrying Value Unrealised Gain Unrealised (Loss) Fair Value 54,351 16,150 1,664,696 644,459 80,774 42,907 2,503,337 1,366 690 3,381 4,505 533 160 10,635 - - (427) (7,386) - - (7,813) 55,717 16,840 1,667,650 641,578 81,307 43,067 2,506,159 Carrying Value Unrealised Gain Unrealised (Loss) Fair Value 123,984 21,525 1,355,970 510,915 16,315 44,403 2,073,112 2,271 1,376 3,622 3,828 261 - 11,358 - - (1,250) (3,935) - - (5,185) 126,255 22,901 1,358,342 510,808 16,576 44,403 2,079,285 Marketable Securities, excluding mutual funds and equity investments include $538,457 ($243,953 at 31 December 2002) of fixed rate instruments and $1,921,973 ($1,784,871 at 31 December 2002) of floating rate instruments. The approximate yield on the floating rate securities at 31 December 2003 was 1.79% (2.14% at 31 December 2002), while the approximate yield on the fixed rate securities was 4.53% (4.55% at 31 December 2002). During the year ended 31 December 2003 the Bank reduced the carrying value of certain venture capital investments by $4,627 ($966 for the six months ended 31 December 2002; $726 for the year ended 30 June 2002) and corporate and asset backed investments by $Nil ($1,158 for the six months ended 31 December 2002; $1,890 for the year ended 30 June 2002). NOTE 5: Loans (a) Loans outstanding The Bank’s loans net of unearned income and the allowance for credit losses in respect of loans are as follows: Residential mortgages Personal and credit cards Business and government Sub-total loans Allowance for credit losses Net loans 31 December 2003 832,656 262,105 864,460 1,959,221 (23,457) 1,935,764 31 December 2002 710,463 292,213 788,699 1,791,375 (24,287) 1,767,088 The principal means of securing residential mortgages, personal, credit card and business loans are charges over assets and guarantees. Mortgage loans are generally repayable over twenty years and personal, credit card, business and government loans are generally repayable over terms not exceeding five years. The effective yield on total loans as at 31 December 2003 is 5.88% (5.9% at 31 December 2002). 38 A N N U A L R E P O R T | 2 0 0 3 (b) Impaired Loans By loan type: Residential mortgages Personal and credit cards Business Sub-total before general provisions General provisions Total impaired loans By geography: Bermuda Cayman Barbados Guernsey Sub-total before general provisions General provisions Total impaired loans (c) Allowance for Credit Losses Beginning of year New acquisitions Write-offs Recoveries/transfers Provisions this year Other, including exchange movement Carried forward Gross 5,287 3,327 8,752 17,366 - 17,366 8,235 4,751 3,900 480 17,366 - 17,366 31 December 2003 31 December 2002 Specific Provisions General Provisions Net Net (175) (583) (3,194) (3,952) - (3,952) (2,436) (445) (1,009) (62) (3,952) - (3,952) - - - - (19,505) (19,505) - - - - - (19,505) (19,505) 5,112 2,744 5,558 13,414 (19,505) (6,091) 5,799 4,306 2,891 418 13,414 (19,505) (6,091) 6,255 1,409 12,954 20,618 (19,985) 633 12,701 7,912 - 5 20,618 (19,985) 633 31 December 2003 31 December 2002 Specific Provisions General Provisions Net Net 4,302 1,009 (5,180) 3,821 - - 3,952 19,985 123 (48) (2,968) 2,413 - 19,505 24,287 1,132 (5,228) 853 2,413 - 23,457 24,455 - (2,271) 62 1,932 109 24,287 39 Financials (d) Credit Exposure The following table summarises the credit exposure* of the Bank: 31 December 2003 31 December 2002 Primary industry and manufacturing Commercial and merchandising Real estate Transport and communication Banks and financial services Governments Individuals Sub-total General provisions Total 59,148 574,868 832,656 34,218 1,027,401 11,525 530,885 3,070,701 (19,505) 3,051,196 30,241 553,672 710,463 53,715 826,772 30,907 459,844 2,665,614 (19,985) 2,645,629 * Credit exposures include loans, guarantees and acceptances, letters of credit and commitments for undrawn lines of credit. NOTE 6: Land, Buildings and Equipment Summary of land, buildings and equipment Net Book Value Accumulated 31 December 2003 Cost Depreciation Net Book Value 31 December 2002 12,345 89,415 103,977 205,737 - (28,284) (76,967) (105,251) 12,345 61,131 27,010 100,486 12,989 59,841 23,589 96,419 Land Buildings Equipment Total Depreciation charged to operating expenses for the year ended 31 December 2003 was $12,920 ($5,532 for the six months ended 31 December 2002; $10,769 for the year ended 30 June 2002). The Bank has outstanding capital commitments of approximately $32 million as at 31 December 2003 ($Nil at December 2002) in respect of building refurbishments and systems improvements. NOTE 7: Intangible Assets Intangible assets Customer list Goodwill Total Net Book Value Accumulated 31 December 2003 Cost Amortisation Net Book Value 31 December 2002 43,271 5,404 48,675 (5,815) - (5,815) 37,456 5,404 42,860 27,322 - 27,322 The aggregate amortisation expense for the year ended 31 December 2003 was $2,306 ($1,080 for the six months ended 31 December 2002; $1,898 for the year ended 30 June 2002). These intangible assets are amortised over their defined useful lives of 15 years as determined by the Bank using the straight-line method. 40 A N N U A L R E P O R T | 2 0 0 3 31 December 2003 31 December 2002 4,212,898 2,501,691 101,311 249,208 7,065,108 2,402,601 2,784,129 134,478 195,008 5,516,216 NOTE 8: Deposits An analysis of deposits (a) By Maturity Demand deposits Term deposits maturing within six months Term deposits maturing within six to twelve months Term deposits maturing after twelve months Total (b) By Type and Location Payable On Demand A Fixed Date Payable on 31 December 2003 31 December 2002 Bermuda: Customers Banks Cayman: Customers Banks Guernsey: Customers Banks Other International: Customers Banks Total 2,095,137 186,411 1,450,585 - 3,545,722 186,411 2,949,390 152,260 1,308,133 66,213 362,405 85,555 1,670,538 151,768 380,847 - 497,464 - 878,311 - 995,236 144,578 842,888 2,041 167,519 8,638 4,212,898 321,181 135,020 2,852,210 488,700 143,658 7,065,108 368,597 61,226 5,516,216 The effective yield on deposits at 31 December 2003 was 1.5% (1.7% at 31 December 2002). NOTE 9: Employee Future Benefits The Bank maintains trusteed pension plans including non-contributory defined benefit plans and a number of defined contribution plans, and provides post-retirement medical benefits to its 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 plans are non-contributory and the funding required is provided by the Bank, based upon the advice of an independent actuary. Effective 1 September 2000, the Bank implemented a defined contribution pension plan for its Bermuda based employees. Funding of the plan is determined based upon the provisions of the plan and is shared with the employees. All employees under age 45 were transferred into this plan. All Bermuda based employees joining the Bank after this date will automatically join this defined contribution plan. Substantially all of the pension assets are invested in equity, fixed income and other marketable securities. 41 Financials The following table presents the financial position of the Bank’s defined benefit pension plans and the Bank’s post-retirement medical benefit plan: Pension Plans 31 December 2003 31 December 2002 Post-Retirement Medical Benefit Plan 31 December 2002 31 December 2003 Change in benefit obligation Benefit obligation at beginning of year New acquisitions Effect of change in accounting policy Benefit obligation at beginning of year as adjusted Service cost Interest cost Benefits paid Actuarial losses Benefit obligation at end of year Change in plan assets Fair value of plan assets at beginning of year New acquisitions Actual return on plan assets Employer contribution Benefits paid Fair value of plan assets at end of year Funded status Deficit of plan assets over benefit obligation at end of year Unamortised transitional asset Unamortised net actuarial loss Unamortised past service cost Accrued benefit asset (liability), included in other assets (liabilities) Annual benefit expense Service cost Interest cost Expected return on plan assets Amortisation of past service cost Amortisation of actuarial loss Amortisation of transitional asset Defined benefit expense Defined contribution expense Total benefit expense 67,187 1,249 17 68,453 3,900 4,241 (3,098) 1,893 75,389 58,204 994 9,193 1,521 (3,098) 66,814 (8,575) (8,724) 23,221 963 6,885 3,900 4,241 (4,650) 113 1,838 (1,026) 4,416 2,508 6,924 61,549 - - 61,549 1,407 2,119 (1,774) 3,886 67,187 59,847 - (1,407) 2,675 (1,774) 59,341 (7,846) (9,750) 21,759 1,076 5,239 1,407 2,119 (2,257) 57 608 (513) 1,421 1,258 2,679 30,551 - - 30,551 900 1,973 (1,919) 44,316 75,821 - - - - - - (75,821) (8,566) 50,713 - (33,674) 900 1,973 - - 375 (553) 2,695 - 2,695 27,363 - - 27,363 385 965 (978) 2,816 30,551 - - - - - - (30,551) (9,119) 6,772 - (32,898) 385 965 - - 33 (276) 1,107 - 1,107 Pension Plans 31 December 2003 31 December 2002 Post-Retirement Medical Benefit Plan 31 December 2002 31 December 2003 Actuarial assumptions Year-end discount rate for benefit obligation Expense discount rate Long-term rate of return on plan assets Rate of compensation increases, excluding merit increases Annual increase in the per capita cost of post-retirement benefits 6.00% 6.50% 7.00% 4.00% - 6.50% 7.00% 7.75% 4.50% - 6.25% 6.50% - 4.00% 6.50% 7.00% - 4.50% 12% to 5% over 7 years 7% to 5% over 2 years 42 A N N U A L R E P O R T | 2 0 0 3 NOTE 10: Assets Under Administration Securities and properties (other than cash deposits directly with the Bank and its subsidiaries) held in a trust, agency or fiduciary capacity for customers, including mutual funds, are not included in the Consolidated Balance Sheet as they are not the property of the Bank or its subsidiaries. The value of assets under administration at 31 December 2003 was estimated to be $59.8 billion ($46.3 billion at 31 December 2002). NOTE 11: Guarantees, Commitments and Contingent Liabilities In February 2003, the CICA issued an accounting guideline on the disclosure of guarantees, which broadens the definition of guarantees and requires substantially expanded disclosure. This new guideline was effective for the Bank this year. As this guideline requires disclosure only, there was no impact on the Consolidated Statement of Income and Consolidated Balance Sheet. A guarantee is a contract that contingently requires the guarantor to make payments to a third party based on (i) changes in an underlying interest rate, foreign exchange rate or other variable, including the occurrence or non-occurrence of an event, that is related to an asset, liability or equity security held by the guaranteed party, (ii) an indemnification provided to the third party with the characteristics listed above, (iii) another entity's failure to perform under an obligating agreement, or (iv) another entity’s failure to perform related to its indebtedness. As at 31 December 2003, the Bank was contingently liable for letters of credit, guarantees and other contracts amounting to $639,971 ($537,789 at 31 December 2002) of which $637,545 was fully collateralised ($527,494 at 31 December 2002). The Bank’s commitment for undrawn lines of credit amounted to $475,461 at 31 December 2003 ($340,752 at 31 December 2002). The carrying value of these amounts on the 31 December, 2003 Consolidated Balance Sheet are $Nil. Standby letters of credit and letters of guarantee are issued at the request of a Bank customer in order to secure the customer’s payment or performance obligations to a third party. These guarantees represent an irrevocable obligation of the Bank 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 customer. Generally, the term of the standby letters of credit does not exceed one year, while the term of the guarantees does not exceed four years. The types and amounts of collateral security held by the Bank for these standby letters of credit and guarantees is generally the same as for loans, which is a charge over assets. There are a number of actions and legal proceedings pending against the Bank and its subsidiaries which arose in the normal course of its business. Management, after reviewing all actions proceeding, pending against or involving the Bank and its subsidiaries, considers that the resolution of these matters would not be material to the consolidated financial position of the Bank. NOTE 12: Segmented Information (a) Operating Segments: For management reporting purposes, the operations of the Bank are grouped into the following nine business segments based upon the geographic location of the Bank’s operations: Bermuda (which is further sub-divided based on products and services into Community Banking, Wealth Management & Fiduciary Services and Investment & Pension Fund Administration and Real Estate), Barbados, Cayman, Guernsey, The Bahamas, the United Kingdom, and Hong Kong. Accounting policies of the reportable segments are the same as those described in Note 1. The Bermuda Community Banking segment provides a full range of retail and corporate services. Retail services are offered to individuals and small to medium sized businesses through five branch locations and through telephone banking, Internet banking, Automated Teller Machines (ATMs) and debit cards. Retail services include deposit services, consumer and mortgage lending, credit cards and personal insurance products. Corporate services include commercial lending and mortgages, cash management, payroll services, remote banking, and letters of credit. Community Banking also includes private banking, treasury operations, Promisant (Technology) Ltd. and the Bank’s proportionate share of the assets, liabilities, income and expenses of its joint venture, ProServe Bermuda Limited. 43 Financials The Bermuda Wealth Management & Fiduciary Services and Investment & Pension Fund Administration segment consists of two main business lines. They are: - Wealth Management & Fiduciary Services which includes Investment Management, Custody, Trust, and Company Administration and related Banking services. Investment & Pension Fund Administration which includes provision of third party administration and accounting services to collective investment and pension schemes. The Barbados segment provides a range of community and commercial banking services through four branch locations, Automated Teller Machines and debit cards. Services include deposit services, consumer and mortgage lending, credit cards and personal insurance products. The Cayman segment provides a comprehensive range of community and commercial banking services to private and corporate customers through four branches and through telephone banking, internet banking, Automated Teller Machines and debit cards. They also provide Wealth Management & Fiduciary Services and Investment & Pension Fund Administration Services. The Guernsey segment provides a broad range of services to private clients and financial institutions including, general banking and treasury services, internet banking, administered bank services, Wealth Management & Fiduciary Services and Investment & Pension Fund Administration Services. The Bahamas segment provides institutional, corporate and private clients with a wide range of Wealth Management & Fiduciary Services and Investment Fund Administration Services. The United Kingdom segment provides personalised banking services and internet banking to high net worth individuals and privately owned businesses. The Hong Kong segment provided Investment & Pension Fund Administration and custody services and includes a 20% share in the net income of Dexia Holding (Hong Kong) Limited. The restricted branch license in Hong Kong was taken over by Dexia in April 2003. Operating segment information follows: Total Assets 31 December 2003 31 December 2002 30 June 2002 Community Banking Wealth Management & Fiduciary Services and Investment & Pension Fund Administration Real Estate 3,943,163 3,208,530 2,997,077 28,889 52,137 20,496 57,517 20,140 57,500 4,024,189 3,286,543 3,074,717 156,171 1,966,954 975,095 19,202 536,281 1,980 - 1,260,027 934,916 - 389,761 136,627 - 1,204,894 952,586 - 357,000 148,847 7,679,872 6,007,874 5,738,044 Total Bermuda Barbados Cayman Guernsey The Bahamas United Kingdom Hong Kong Total 44 A N N U A L R E P O R T | 2 0 0 3 Business Area Analysis for the year ended 31 December 2003 Net Interest Income Provisions for Fees and Total Other Depreciation & Total Net Customer Intersegment Loan Losses Other Income Income Expenses Amortisation Expenses Income Community Banking Wealth Management & Fiduciary Services and Investment & Pension Fund Administration Real Estate Total Bermuda Barbados Cayman Guernsey The Bahamas United Kingdom Hong Kong 82,887 (2,251) (1,730) 34,485 113,391 72,067 6,188 78,255 35,136 - - 331 (1,157) - - 42,055 2,444 42,386 1,287 22,257 4,770 574 1,548 22,831 6,318 19,555 (5,031) 82,887 (3,077) (1,730) 78,984 157,064 99,094 8,310 107,404 49,660 408 21,646 5,590 90 3,991 24 - 2,218 1,569 - (709) (1) 6 366 (982) 27,199 21,503 137 1,329 - 1,170 149 582 7 780 50,081 28,799 1,419 4,601 612 500 23,459 21,713 1,064 5,434 372 85 2,366 4,307 69 88 1 585 25,825 26,020 1,133 5,522 373 195 24,256 2,779 286 (921) 239 Total Overseas 31,749 3,077 (683) 52,149 86,292 52,542 6,916 59,458 26,834 Total Income 114,636 - (2,413) 131,133 243,356 151,636 15,226 166,862 76,494 less: Inter-segment eliminations (principally rent and management fees) Total - 114,636 - - - (5,119) (2,413) 126,014 238,237 146,517 (5,119) (5,119) - (5,119) 15,226 161,743 - 76,494 Business Area Analysis for the six months ended 31 December 2002 Net Interest Income Provisions for Fees and Total Other Depreciation & Total Net Customer Intersegment Loan Losses Other Income Income Expenses Amortisation Expenses Income Community Banking Wealth Management & Fiduciary Services and Investment & Pension Fund Administration Real Estate Total Bermuda Cayman Guernsey United Kingdom Hong Kong Total Overseas Sale of subsidiaries 39,600 (1,869) (1,382) 17,904 54,253 31,107 2,659 33,766 20,487 - - 117 (602) - - 18,663 2,517 18,780 1,915 12,179 2,507 278 768 12,457 3,275 6,323 (1,360) 39,600 (2,354) (1,382) 39,084 74,948 45,793 3,705 49,498 25,450 9,613 2,305 1,770 290 13,978 - 1,050 1,470 (181) 15 2,354 - (450) (94) (6) - 11,910 9,717 461 204 22,123 13,398 2,044 509 10,166 10,115 2,104 420 1,136 1,751 16 4 11,302 11,866 2,120 424 10,821 1,532 (76) 85 (550) - 22,292 - 38,074 - 22,805 - 2,907 - 25,712 - 12,362 - Total Income 53,578 - (1,932) 61,376 113,022 68,598 6,612 75,210 37,812 less: Inter-segment eliminations (principally rent and management fees) Sub-total Discontinued Operations Total - 53,578 118 53,696 - - - - - (1,932) (2,022) (2,022) 59,354 111,000 (2,022) 66,576 - 6,612 (2,022) 73,188 - 37,812 - - 118 498 - 498 (380) (1,932) 59,354 111,118 67,074 6,612 73,686 37,432 45 Financials Business Area Analysis for the year ended 30 June 2002 Net Interest Income Provisions for Fees and Total Other Depreciation & Total Net Customer Intersegment Loan Losses Other Income Income Expenses Amortisation Expenses Income Community Banking Wealth Management & Fiduciary Services and Investment & Pension Fund Administration Real Estate Total Bermuda Cayman Guernsey United Kingdom Hong Kong 72,939 (2,531) (1,784) 31,119 99,743 65,414 5,241 70,655 29,088 - - 185 (1,231) - - 37,308 8,656 37,493 7,425 26,596 4,829 510 1,627 27,106 6,456 10,387 969 72,939 (3,577) (1,784) 77,083 144,661 96,839 7,378 104,217 40,444 17,932 4,331 3,556 638 1,204 2,951 (608) 30 (200) (174) - (1) 21,193 18,124 834 6,223 40,129 25,232 3,782 6,890 19,953 17,994 3,599 5,239 2,236 2,820 29 204 22,189 20,814 3,628 5,443 17,940 4,418 154 1,447 Total Overseas Sale of subsidiaries 26,457 - 3,577 - (375) - 46,374 17,013 76,033 17,013 46,785 - 5,289 - 52,074 - 23,959 17,013 Total Income 99,396 - (2,159) 140,470 237,707 143,624 12,667 156,291 81,416 less: Inter-segment eliminations (principally rent and management fees) Sub-total Discontinued Operations Total - 99,396 422 99,818 - - - - - (14,135) (14,135) (2,159) 126,335 223,572 129,489 (14,135) - 12,667 (14,135) 142,156 - 81,416 - 1,155 1,577 704 - 704 873 (2,159) 127,490 225,149 130,193 12,667 142,860 82,289 For the year ended 31 December 2003, included within other expenses are the following income tax expense/(refund) amounts: Guernsey, $908, UK $(435) and Barbados $22. The respective amounts for the six months ended 31 December 2002 were: Guernsey $(1,183) and UK $3. Transactions between operating segments principally include interbank deposits and rent which are recorded based upon market rates, and management fees, which are recorded based on the cost of the services provided. (b) Revenues by Products and Services: The principal sources of revenues by products and services are disclosed separately in the Consolidated Statement of Income. NOTE 13: Derivative Financial Instruments (a) Derivative Products used by the Bank: The Bank’s derivative contracts principally involve over-the-counter transactions that are privately negotiated between the Bank and the counterparty to the contract. The Bank uses various off-balance sheet derivative contracts in the management of its asset and liability positions, for trading purposes and as a market maker for its clients’ needs. The Bank enters into foreign exchange contracts for both asset/liability management and as a market maker for its clients’ needs. Interest rate contracts are used for trading and asset/liability management purposes. Purchased option contracts on interest rates are used for asset/liability management purposes. These contracts are financial instruments, the value of which is derived from underlying assets or interest and exchange rates. Such financial instruments used by the Bank include: 46 A N N U A L R E P O R T | 2 0 0 3 Interest Rate Swaps Interest rate swaps are financial transactions in which two counterparties exchange fixed or floating interest cash flows over a period of time based on rates applied to defined notional principal amounts. Foreign Exchange Contracts Foreign exchange forward contracts are transactions in which an amount of one currency is purchased or sold in exchange for the delivery of another amount of a second currency, at a specified future date or range of dates. Spot transactions are similar to forward contracts except that settlement takes place within two business days. Forward Rate Agreements A forward rate agreement is a contract under which two counterparties agree on the interest to be paid on a notional deposit of a specified maturity at a specific future settlement date. There is no exchange of principal. (b) Notional Amounts: The following table provides the aggregate notional amounts of derivative contracts outstanding listed by type and divided between those used for trading and those used in managing the exposure to risk inherent in the Bank’s asset/liability risk management (ALM) positions. Trading involves managing market risk positions with the expectation of profiting from favourable movements in prices, rates or indices. ALM activities may include the use of interest rate swaps and forward rate agreements to adjust exposure to interest rate risk by modifying the repricing or maturity characteristics of existing assets and liabilities. The notional amounts are not recorded as assets or liabilities on the Consolidated Balance Sheet as they represent the face amount of the contract to which a rate or price is applied to determine the amount of cash flows to be exchanged. Notional amounts represent the volume of outstanding transactions and do not represent the potential gain or loss associated with market risk or credit risk of such instruments. Interest Rate Contracts Over-the-Counter Traded Interest rate swaps Forward rate agreements Purchased options Total Foreign Exchange Contracts Spot and forwards Total Total Notional Amount of Financial Derivatives Outstanding Trading ALM 31 December 2003 Total Value Trading ALM 31 December 2002 Total Value 171,000 - 33,000 204,000 635,982 - - 635,982 806,982 - 33,000 839,982 - - - - 1,241,367 1,241,367 1,770 1,770 1,243,137 1,243,137 656,387 656,387 381,503 150,000 - 531,503 29,831 29,831 381,503 150,000 - 531,503 686,218 686,218 1,445,367 637,752 2,083,119 656,387 561,334 1,217,721 (c) Fair Value: Derivative instruments, in the absence of any compensating upfront cash payments, generally have no market value at inception. They obtain value, positive or negative, as relevant interest rates, exchange rates, equity or commodity prices or indices change, such that the terms of previously contracted derivative transactions have become more or less favourable than what can be negotiated under current market conditions for contracts with the same remaining period to maturity. The potential for derivatives to increase or decrease in value as a result of the foregoing factors is generally referred to as market risk. Market risk is managed within clearly defined parameters as prescribed by senior management of the Bank. 47 Financials The following table shows the marked to market fair value of all derivative contracts outstanding. This is defined as the profit (loss) associated with replacing the derivative contracts at prevailing market prices. Positive Negative 31 December 2003 Net Positive Negative 31 December 2002 Net Derivative Financial Instruments Interest rate swaps Purchased options Spot and forward foreign exchange Forward rate agreements Total 13,376 592 19,694 - 33,662 3,898 479 19,153 - 23,530 9,478 113 541 - 10,132 19,261 - - 10,673 29,934 2,365 - 93 10,759 13,217 16,896 - (93) (86) 16,717 (d) Remaining Maturity: The following table summarises the remaining term to maturity of the notional amounts of the Bank’s derivative instruments by type: 31 December 2003 Interest Rate Contracts Interest rate swaps Purchased options Sub-total Foreign Exchange Contracts Spot and forwards Sub-total Total by Remaining Maturity 31 December 2002 Interest Rate Contracts Interest rate swaps Forward rate agreements Sub-total Foreign Exchange Contracts Spot and forwards Sub-total Total by Remaining Maturity 0-6 mths 6-12 mths 1-3 years 3-5 years 5-10 years Total 167,980 - 167,980 1,140,298 1,140,298 1,308,278 93,571 - 93,571 92,610 92,610 186,181 371,156 - 371,156 10,229 10,229 381,385 154,667 33,000 187,667 - - 187,667 19,608 - 19,608 - - 19,608 806,982 33,000 839,982 1,243,137 1,243,137 2,083,119 0-6 mths 6-12 mths 1-3 years 3-5 years 5-10 years Total 18,473 150,000 168,473 641,571 641,571 810,044 28,900 - 28,900 44,616 44,616 73,516 233,502 - 233,502 31 31 233,533 89,222 - 89,222 - - 89,222 11,406 - 11,406 - - 11,406 381,503 150,000 531,503 686,218 686,218 1,217,721 (e) Replacement: The following table reflects the replacement cost of all derivative contracts outstanding. This is defined as the cost of replacing, at current market rates, all contracts which have a positive fair value before factoring in the impact of master netting agreements. The replacement cost of an instrument is dependent upon its terms relative to prevailing market prices and will fluctuate as market prices change and as the derivative approaches its scheduled maturity. Interest Rate Contracts Interest rate swaps Purchased options Sub-total Foreign Exchange Contracts Spot and forwards Total Replacement Cost Trading ALM - 592 592 19,694 20,286 13,376 - 13,376 - 13,376 31 December 2003 Total Value Trading ALM 31 December 2002 Total Value 13,376 592 13,968 19,694 33,662 - - - 10,667 10,667 19,261 - 19,261 6 19,267 19,261 - 19,261 10,673 29,934 48 A N N U A L R E P O R T | 2 0 0 3 (f) Credit Risk: As with on-balance sheet assets, derivative instruments are subject to credit risk. Credit risk arises from the possibility that counterparties may default on their obligations to the Bank. However, whereas the credit risk of on-balance sheet assets is represented by the principal amount net of any applicable allowance for credit losses, the credit risk associated with derivatives is normally a small fraction of the notional amount of the derivative instrument. Derivative contracts expose the Bank to credit loss only if changes in market rates affect a counterparty’s position unfavourably and the counterparty defaults on payment. Accordingly, credit risk of derivatives is represented by the replacement value of the instrument. Negotiated over-the-counter derivatives often present greater credit exposure than exchange-traded contracts. The net change in value of the exchange-traded contracts is normally settled daily in cash with the exchange. Holders of these contracts look to the exchange for performance under the contract. The Bank strives to limit credit risk by dealing with counterparties that it believes are creditworthy, and manages its credit risk for derivatives through the same credit risk process applied to on-balance sheet assets. The Bank pursues opportunities to reduce its exposure to credit losses on derivative instruments. These opportunities include entering into master netting arrangements with counterparties. The Bank negotiates master netting arrangements with counterparties with which it has significant credit risk through derivatives activities. Such agreements provide for the simultaneous close out and netting of all transactions with a counterparty in an event of default. An increasing number of these agreements also provide for the exchange of collateral between parties in the event that the marked to market value of outstanding transactions between the parties exceeds an agreed threshold. Such agreements are used to accommodate business with less creditworthy counterparties, as well as to help contain the build up of credit exposure resulting from multiple deals with more active counterparties. NOTE 14: Fair Value of Financial Instruments The following table shows the fair value of the Bank’s financial instruments: Assets Cash and deposits with banks Investments Loans Accrued interest Liabilities Deposits Accrued interest Subordinated debt capital Derivative Financial Instruments Interest rate swaps Options Forward rate agreements Spot and forwards Book Value Fair Value 31 December 2003 Favourable (Unfavourable) 31 December 2002 Favourable Value (Unfavourable) Fair Book Value 3,035,944 2,503,337 1,935,764 22,352 3,035,944 2,506,159 1,938,592 22,352 - 2,822 2,828 - 1,989,159 2,073,112 1,767,088 21,313 1,989,159 2,079,285 1,772,578 21,313 - 6,173 5,490 - 7,065,108 7,218 125,000 7,075,159 7,218 121,750 (10,051) - 3,250 5,516,216 7,998 75,000 5,526,625 7,998 74,777 (10,409) - 223 1,410 113 - 541 9,478 113 - 541 8,068 - - - 2,133 - - (86) 16,896 - (93) (86) 14,763 - (93) - Fair value amounts represent estimates of the consideration that would currently be agreed upon between knowledgeable, willing parties who are under no compulsion to act and is best evidenced by a quoted market price, if one exists. Some of the Bank’s financial instruments lack an available trading market. Therefore, these instruments have been valued using present value or other valuation techniques and may not necessarily be indicative of the amounts realisable in an immediate settlement of the instruments. In addition, the calculation of estimated fair value is based on market conditions at a specific point in time and may not be reflective of future fair values. 49 Financials The book value of financial assets and financial liabilities held for purposes other than trading may exceed their fair value due primarily to changes in interest rates. In such instances, the Bank does not reduce the book value of these financial assets and financial liabilities to their fair values as it is the Bank’s intention to hold them until maturity. The fair values disclosed exclude premises and equipment and certain other assets and liabilities as these are not financial instruments. The following methods and assumptions were used in the determination of the fair value of financial instruments: Cash and Deposits with Banks: The fair value of cash and deposits with banks, being short term in nature, is deemed to equate to the carrying value. Investments: The fair values of investments are based upon quoted market prices where available. Loans: The majority of loans are variable rate and reprice in response to changes in market rates and hence the fair value has been estimated as the carrying value. For fixed rate loans, the fair value has been estimated by performing a discounted cash flow calculation using market rates for similar loans made at the balance sheet date. Accrued Interest: The carrying values of accrued interest receivable and payable are assumed to approximate their fair values given their short-term nature. Deposits: The fair value of fixed rate deposits has been estimated by discounting the contractual cash flows, using market interest rates offered at the balance sheet date for deposits of similar terms. The fair value of deposits with no stated maturity date is deemed to equate to the carrying value. Securities Sold Under Agreements to Repurchase: The fair value of obligations relating to securities sold under repurchase agreements is considered to be equal to the carrying value given their short-term nature. Subordinated Debt Capital: The fair value of the subordinated debt capital is based on current market pricing. Derivatives: Fair value of exchange traded derivatives is based on quoted market prices. Fair value of over-the-counter derivatives is calculated as the net present value of contractual cash flows using prevailing market rates. The aggregate of the estimated fair value of amounts presented does not represent management’s estimate of the underlying value of the Bank. NOTE 15: Interest Rate Risk The following table sets out the assets, liabilities and off-balance sheet instruments on the date of the earlier of contractual maturity or repricing date. Use of this table to derive information about the Bank’s interest rate risk position is limited by the fact that customers may choose to terminate their financial instruments at a date earlier than 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 and certain investments which have call or pre-payment features. 50 A N N U A L R E P O R T | 2 0 0 3 After 3 mths but After 1 year but Within within within within 3 mths After 6 mths but 6 mths 1 year 5 years 5 years Non- interest After bearing funds 2,585 2,129 1,806 - - 6,520 - 5,393 - - 5,393 (545) 582 582 271 31 6 - - 308 - 251 - - 251 (5) 52 634 131 42 19 - - 192 - 101 - - 101 54 145 779 24 210 74 - - 308 - 249 - - 249 - 74 17 - - 91 - - - 125 125 25 17 14 101 104 261 395 1,071 95 - 1,561 516 575 1,354 (20) (54) 1,300 - (1,300) - Total 3,036 2,503 1,936 101 104 7,680 395 7,065 95 125 7,680 - - - At 31 December 2003 (In $ millions) Assets Cash and deposits with banks Investments Loans Land, buildings and equipment Other assets Total Assets Liabilities Shareholders’ equity Deposits Other liabilities Subordinated debt capital Total Liabilities Off-balance sheet items Interest rate sensitivity gap Cumulative interest rate sensitivity gap NOTE 16: Concentrations of Credit Risk Concentrations of credit risk exist where clients are engaged in similar activities, are located in the same geographic region or have some other form of commonality such that their ability to meet their contractual obligations would be similarly affected by changes in economic, political or other conditions. Of the total interest earning assets of $7.48 billion at 31 December 2003 ($5.79 billion at 31 December 2002, 14% (16.6% at 31 December 2002) relates to the Bermuda market, 3.8% (3.1% at 31 December 2002) relates to the Canadian market, 4.7% relates to the Australian market, 16.1% (21.3% at 31 December 2002) relates to the United Kingdom market and 46.9% (40.0% at 31 December 2002) relates to the United States market. No other country accounts for more than 5% of interest earning assets. Of the total loan book which amounted to $1.94 billion at 31 December 2003 ($1.77 billion at 31 December 2002) 74.4% (76.5% at 31 December 2002) of the lending was from Bermuda, 8.7% (9.2% at 31 December 2002) from Europe, and 13.7% (14.3% at 31 December 2002) from Cayman. NOTE 17: Subordinated Debt Capital On 27 May 2003 the Bank issued US$125 million of Subordinated Lower Tier II capital notes. The notes were issued in two tranches, namely US$78 million in Series A notes due 2013 and US$47 million in Series B notes due 2018. The issuance was by way of private placement with US institutional investors. The Notes are listed on The Bermuda Stock Exchange in the specialist debt securities category. Part proceeds of the issue was used to repay the entire amount of the US$75 million outstanding subordinated notes which were redeemed in July 2003. The notes issued under Series A pay a fixed coupon of 3.94%, payable semi-annually in arrears, until 27 May 2008 when they become redeemable in whole at the option of the Bank. The Series B notes pay a fixed coupon of 5.15%, payable semi-annually in arrears, until 27 May 2013 when they also become redeemable in whole at the Bank’s option. The Series A notes were priced at a spread of 1.25% over the 5-year US Treasury yield and the Series B notes were priced at a spread of 1.35% over the 10-year US Treasury yield. 51 Financials NOTE 18: Stock Option Plan At the Annual General Meeting of Shareholders held on 29 October 1997, the directors were granted authority to implement a Stock Option Plan for directors and employees. Under the Bank’s 1997 Stock Option Plan (the 1997 Plan), options to purchase common shares of the Bank may be granted to employees and directors of the Bank that entitle the holder to purchase one common share at a subscription price related to the market value prior to the effective date of the grant. Subscription prices are stated and payable at a price related to the market value prior to the effective date of the grant. Subscription prices are stated and payable in Bermuda dollars for the options. Generally, grants vest 25 percent at the end of each year for four years. The committee that administers the 1997 Plan has the discretion to vary the period during which the holder has the right to exercise options and, in certain circumstances, may accelerate the right of the holder to exercise options, but in no case shall the exercise period exceed ten years. The Bank has established a Stock Option Trust to meet its potential obligations under the 1997 Plan by the purchase on the open market of common shares. The Stock Option Trust is funded by a loan from the Bank. As at 31 December 2003 the Stock Option Trust held 1,692,698 shares (at 31 December 2002: 1,839,743 shares) that will be used to satisfy the Bank’s obligations with respect to the Stock Option Plan. The current maximum number of common shares reserved for issuance by the Board of Directors of the Company under the 1997 Plan is 2,200,000. Directors’ and Executive Officers’ Stock Option Plan 30 June 2002 Weighted Average Exercise Price ($) 14.91 24.10 - 13.49 16.73 15.85 31 December 2003 Weighted Average Exercise Price ($) Number of Stock Options 31 December 2002 Weighted Average Exercise Price ($) Number of Stock Options Number of Stock Options Outstanding at beginning of year Granted Stock dividend granted Exercised Outstanding at end of year Vested and exercisable at end of year 323,689 69,443 35,800 43,461 385,471 217,931 20.63 29.18 22.35 15.04 22.96 18.96 306,390 88,345 - 71,046 323,689 194,369 16.73 29.35 - 14.67 20.63 17.15 236,846 91,841 24,840 47,137 306,390 218,890 Characteristics of Options Granted to Directors and Executive Officers as at 31 December 2003 Exercise Price Range 9.80 - 14.54 14.55 - 19.29 24.05 - 28.78 28.79 - 33.50 33.51 - 38.25 38.26 - 43.00 Total Outstanding Weighted Average Life Remaining Weighted Average Exercise Price ($) 5.8 4.5 9.0 7.3 4.8 5.0 7.2 13.47 14.79 26.48 30.21 35.05 40.55 22.96 Exercisable Weighted Average Exercise Price ($) 13.47 14.79 25.69 30.17 - - 18.96 Number of shares 94,407 36,300 68,507 18,717 - - 217,931 Number of shares 103,482 36,300 142,193 99,113 3,300 1,083 385,471 52 Employees Stock Option Plan 31 December 2003 Weighted Average Exercise Price ($) Number of Stock Options Outstanding at beginning of year Granted Stock dividend granted Exercised Forfeited/Cancelled Outstanding at end of year Vested and exercisable at end of year 1,061,111 159,305 110,396 274,143 72,030 984,639 421,316 22.09 27.82 23.41 16.93 26.43 24.28 20.96 Number of Stock Options 900,737 336,368 - 151,988 24,006 1,061,111 378,644 Characteristics of Options Granted to Employees as at 31 December 2003 Exercise Price Range 9.80 - 14.54 14.55 - 19.29 24.05 - 28.78 28.79 - 33.50 33.51 - 38.25 38.26 - 43.00 Total Outstanding Weighted Average Life Remaining Weighted Average Exercise Price ($) 6.2 4.5 8.7 4.0 - - 6.5 13.52 14.79 26.48 30.18 - - 24.28 Number of shares 224,728 35,292 410,723 313,897 - - 984,640 A N N U A L R E P O R T | 2 0 0 3 30 June 2002 Weighted Average Exercise Price ($) 14.94 25.66 - 13.51 18.22 17.85 14.51 31 December 2002 Weighted Average Exercise Price ($) Number of Stock Options 17.85 30.17 - 14.68 23.55 22.09 16.94 1,001,513 366,674 96,774 440,148 124,076 900,737 300,020 Exercisable Weighted Average Exercise Price ($) 13.53 14.79 25.62 30.18 - - 20.96 Number of shares 167,361 35,292 121,112 97,551 - - 421,316 The weighted average fair value of stock options granted in the year ended 31 December 2003 was $3.91 per share, using the Black-Scholes option-pricing model with the following weighted average assumptions: Dividend yield Risk free interest rate Historical volatility Expected lives Year Ended 31 December 2003 4.57% 3.71% 21% 9.43 years Had compensation cost been determined based on the fair value of the stock option awards at the date of grant, net income and earnings per share would have been reduced to the pro-forma amounts shown below: (In BD$ thousands, except per share data) Year Ended 31 December 2003 Net income as reported Net income – pro-forma Earnings per share – as reported (basic) Earnings per share – pro-forma (basic) 76,494 74,139 3.73 3.61 The amount credited to the loan to the Stock Option Trust for the period is $5,391. 53 Financials NOTE 19: Discontinued Operations In 1997 the Bank adopted a formal plan to cease operations at its London Branch, and to exit the trade finance business in the United Kingdom. The negative earnings for the six months ended 31 December 2002 reflects an increase in the provision in respect of the Bank's leasehold obligations, which expire in September 2005, net of recoveries of loans previously written off. NOTE 20: Share Buy-Back Plan In 2000 the Bank recommenced its initiative under the Share Buy-Back Plan. During the year under review, 378,994 shares (990,300 shares for the six months ended 31 December 2002; 287,521 shares for the year ended 30 June 2002) were purchased and cancelled at a cost of $13,190 ($31,254 for the six months ended 31 December 2002; $9,130 for the year ended 30 June 2002). The Board of Directors of the Bank has the present intention to repurchase over the twelve month period commencing 1 July 2003 up to 2 million of its ordinary shares of par value $1 each pursuant to its share repurchase programme authorised by shareholders on 29 October 1997. As at 31 December 2003, 1,785,879 shares could be repurchased under the current intention, representing 8% of the total issued shares of the Bank. The Directors consider that share repurchase is an excellent means of enhancing shareholder value while increasing earnings per share. This intention is subject to appropriate market conditions and repurchases will only be made in the best interests of the Bank. From time to time the Bank’s associates, insiders, and insiders’ associates as defined in The Bermuda Stock Exchange (BSX) Regulations may sell shares which may result in such shares being repurchased pursuant to the programme, but under BSX Regulations such trades must not be pre-arranged and all repurchases must be made in the open market. Prices paid by the Bank must not, according to BSX Regulations, be higher than the last independent trade. The Bank advises the BSX monthly of shares repurchased and cancelled. NOTE 21: Dividend Re-investment and Common Stock Purchase Plans The Bank’s dividend re-investment and common stock direct purchase plans permit participants to purchase, at fair market value, shares of the Bank’s common stock by re-investment of dividends and/or optional cash payments, subject to the terms of each plan. NOTE 22: Stock Dividends In August 2003 and August 2001 the Bank distributed 10% stock dividends to shareholders of record on 5 August 2003 and 14 August 2001 respectively. All prior period per share amounts have been restated to reflect those stock dividends. NOTE 23: Subsequent Events On 30 January 2004, the Bank acquired the entire issued share capital of Deerfield Fund Services Limited of The Bahamas. The company provides a full range of valuation, accounting, corporate and shareholder services to offshore hedge funds and mutual funds. The acquisition was accounted for using the purchase method and total consideration was paid in cash. The name of the company is to be changed to Butterfield Fund Services (Bahamas) Limited in 2004. On 5 February 2004, the Bank announced that Bank of Butterfield (UK) plc has made a cash offer for the entire and to be issued share capital of Leopold Joseph Holdings plc. subject to Leopold Joseph shareholder and appropriate regulatory approvals. The cash offer is £9.50 in cash per Leopold Joseph share, valuing the existing issued share capital of Leopold Joseph at approximately £51.5 million ($94.5 million ). The offer price, which has the unanimous recommendation of the directors of Leopold Joseph Holdings plc, represents a premium of 11.1% to the closing price of £8.55 per share on 4 February 2004, being the last business day prior to the announcement of the offer. As an alternative to some or all of the cash consideration under the offer Leopold Joseph shareholders, other than restricted non-United Kingdom persons, who accept the offer may elect to receive loan notes to be issued by Bank of Butterfield (UK) plc and guaranteed by the Bank on the basis of £1.00 nominal per loan note for every £1.00 of cash consideration. The loan notes have a maximum term of five years, pay interest at 3 month LIBOR less 0.5% on a quarterly basis and may be redeemed at par together with accrued interest on 30 June 2005 and on any subsequent interest payment date thereafter. Leopold Joseph was founded in 1919 and is headquartered in London with wholly owned subsidiary operations based in the United Kingdom and Guernsey. Leopold Joseph offers banking, treasury, investment management, offshore company administration and trust services to companies and high net worth individuals and families. At 31 August 2003, the company had 121 full time equivalent employees and at its last financial year-end, 31 March 2003, it had £503 million in total assets ($923 million). 54 Directory PRINCIPAL GROUP COMPANIES This list does not include all companies in the Group. It includes all companies that materially contribute to the profit or loss or assets of the Group. The Bank of N.T. Butterfield & Son Limited Bermuda Holding company, banking, credit and treasury services Butterfield Asset Management Limited Bermuda Investment management and capital market services Butterfield Fund Services (Bermuda) Limited Bermuda Investment & pension fund administration services Butterfield Trust (Bermuda) Limited Bermuda Trust & private banking services MANAGEMENT Alan R. Thompson President & Chief Executive Officer Graham C. Brooks, ACIB Executive Vice President, International & Trust C. Wendell Emery, MBE, JP Executive Vice President, Operations & Information Technology Richard J. Ferrett, ACIB, MCT Executive Vice President & Chief Financial Officer William P. Aston Senior Vice President & Chief Information Officer Donna E. Harvey Maybury Senior Vice President, Human Resources Butterfield Vencap Limited Bermuda Investment holding Field Real Estate Holdings Limited Bermuda Real estate holding Promisant (Technology) Ltd. Bermuda Multi-currency payment processing Bank of Butterfield (Bahamas) Limited The Bahamas Private banking, treasury, wealth manage- ment & fiduciary services and investment fund administration services The Mutual Bank of the Caribbean Inc. to be renamed Bank of Butterfield (Barbados) Limited Barbados Banking, credit and treasury services Bank of Butterfield International (Cayman) Ltd. Cayman Islands Banking, credit, treasury, wealth manage- ment & fiduciary services and investment & pension fund administration services Bank of Butterfield International (Guernsey) Limited Guernsey Private banking, treasury and wealth management Butterfield Fund Managers (Guernsey) Limited Guernsey Investment & pension fund administration services Butterfield Trust (Guernsey) Limited Guernsey Fiduciary services Bank of Butterfield (UK) plc United Kingdom Banking, credit and treasury services Fred H. Tesch, CPA, CFE, CCP, CFSA Senior Vice President, Group Internal Audit Lloyd O. Wiggan Senior Vice President, Retail Banking Bob W. Wilson, ACIB Senior Vice President, Corporate Banking Michael A. McWatt Senior Vice President, Credit Risk Management Michael O’Mahoney Senior Vice President, Treasury Peter J. M. Rodger Senior Vice President & Group Legal Adviser, Secretary to the Board Ronald E. Simmons, CPA Senior Vice President & Chief Accountant James R. Stewart, CPA Senior Vice President, Enterprise Risk Management 55 Directory BOARD OF DIRECTORS & PRINCIPAL BOARD COMMITTEES 2 James A. C. King, MD, FRCS(C), FACS, JP, Chairman Chairman, KeyTech Ltd. Chairman, Argus Insurance Co. Ltd. 1, 2 Roderick A. Ferguson III, JP Chairman, Gorham’s Ltd. Chairman, Purvis Ltd. Director, KeyTech Ltd. 3,4 Alan R. Thompson* President & Chief Executive Officer, The Bank of N. T. Butterfield & Son Limited 1, 3 Robert J. Stewart, FCIS, LL.B, Vice Chairman Chairman, Island Circle Limited, Bermuda Director, Shell Trust (Bermuda) Limited J. Christopher Astwood, OBE, JP Chairman, J.B. Astwood & Son Ltd. Deputy Chairman, Argus Insurance Co. Ltd. Retired from the Board 15 January 2004 3 Geoffrey R. Bell, QC, FCIArb. Senior Counsel, Appleby, Spurling & Kempe 2, 4 Arlene Brock, LL.B, LL.M Lawyer / Mediator Director, BELCO Holdings Limited Director, Bermuda Electric Light Co. Ltd. 2, 5 Brian Duperreault Chairman & Chief Executive Officer, ACE Limited 5 A.L. Vincent Ingham, JP, P.Eng. Executive Vice President & Chief Operating Officer, BELCO Holdings Limited Director, BELCO Holdings Limited Elected to the Board 8 April 2003 3, 5 Sheila G. Manderson Chief Executive Officer, KeyTech Ltd. 1, 2 Robert A. Mulderig Chairman, Woodmont Management Ltd. Chairman, Woodmont Trust Company Ltd. 1 Robert Steinhoff, FCA Retired Senior Partner, KPMG, Chartered Accountants Chairman, Insurance Advisory Committee Elected to the Board 16 January 2004 4,5 Glenn M. Titterton, ACII Chartered Insurer President & Chief Executive Officer BF&M Insurance Group 1,4 Harry Wilken, CA* President, Jardine Matheson International Services Limited John R. Wright, FIB, FCIOBS* Retired Bank Chief Executive * Directors are Bermudian except where marked Principal Board Committees 1 Audit & Compliance Committee 2 Risk Policy Committee 3 Corporate Governance Committee 4 Scholarship Committee 5 Human Resources Committee Directors’ Code of Practice The Directors have adopted a Code of Best Practice based upon United Kingdom recommended principles of corporate governance. In implementing the code, the Board meets regularly, retains full effective control over the Bank, and monitors executive management. Directors’ and Executive Officers’ Share Interests and Directors’ Service Contracts Pursuant to Regulation 6.8(3) of section IIA of the Bermuda Stock Exchange Listing Regulations, the total interests of all Directors and Executive Officers of the Bank in the shares of the Bank as at 31 December 2003 were 632,604 shares. With the exception of those participating in the Shareholders’ Dividend Reinvestment Plan or the Stock Option Plan, no rights to subscribe for shares in the Bank have been granted to or exercised by any Director or Officer. None of the Directors or Executive Officers had any interest in any debt securities issued by the Bank or its subsidiaries. There are no service contracts with Directors, except for Alan R. Thompson, President & Chief Executive Officer, whose contract expires on 28 January 2006. Bermudian 71.0% Non-Bermudian 29.0% 1 - 999 Shares 2.8% 1,000 - 4,999 Shares 8.1% 5,000 - 9,999 Shares 5.9% 100,000 and above Shares 49.3% 10,000 - 49,000 Shares 23.8% 50,000 - 99,999 Shares 10.1% Split of Share Ownership Bermudian/Non-Bermudian Distribution of Shares by Number Held 56 SHAREHOLDER INFORMATION Dividend Payment Payment of dividends is quarterly, occurring in November, February, May and August. Exchange Listing The Bank’s shares are listed on The Bermuda Stock Exchange (BSX) and the Cayman Islands Stock Exchange (CSX), located at: Bermuda (Primary Listing) Phase 1 – 3rd Floor, Washington Mall, Church Street, Hamilton HM 11, Bermuda Telephone: (441) 292-7212 or 292-7213 Fax: (441) 292-7619 www.bsx.com Cayman Islands (Secondary Listing) Elizabethan Square, 4th Floor, P.O. Box 2408 GT, Grand Cayman, Cayman Islands Telephone: (345) 945-6060 Fax: (345) 945-6061 Share Dealing Service Butterfield Securities (Bermuda) Limited 65 Front Street Hamilton, Bermuda Telephone: (441) 299-3972 Fax: (441) 296-8867 Share Price Published daily in The Royal Gazette in Bermuda and available on Bloomberg Financial Markets (symbol: NTB BH). Also available on the BSX web site (www.bsx.com). Dividend Reinvestment Plan Details are available from Butterfield Fund Services (Bermuda) Limited. Certain restrictions apply. Registrar and Transfer Agent Butterfield Fund Services (Bermuda) Limited Rosebank Centre 11 Bermudiana Road Pembroke, Bermuda Telephone: (441) 298-6464 Fax: (441) 295-6759 E-mail: contact@bntb.bm Head Office The Bank of N. T. Butterfield & Son Limited 65 Front Street Hamilton, Bermuda Telephone: (441) 295-1111 Fax: (441) 292-4365 E-mail: contact@bntb.bm Mailing Address P. O. Box HM 195 Hamilton HM AX, Bermuda www.bankofbutterfield.com Media Relations/ Publication Requests Marketing & Communications Telephone: (441) 299-3886 E-mail: contact@bntb.bm Investor Relations Chief Financial Officer Telephone: (441) 299-1643 E-mail: richardferrett@bntb.bm Written Notice of Share Repurchase Programme BSX Regulation 6.38 The Board of Directors of the Bank announced the intention to repurchase over the 12 month period commencing 1 July 2003, up to 2,000,000 of its ordinary shares of par value $1 each pursuant to its share repurchase programme authorised by shareholders on 29 October, 1997. As at 31 December, 2003, 1,785,879 shares could be repurchased under this intention, which represents 8.0% of total issued shares of the Bank. This intention is subject to appropriate market conditions and repurchases will only be made in the best interests of the Bank. The Directors consider that share repurchase is an excellent means of enhancing shareholder value while increasing earnings per share. Shares repurchased and cancelled in the 12 months to 31 December 2003 totalled 378,994 at an average price of $34.77 and aggregate cost of $13.2 million. From time to time the Bank’s associates, insiders, and insiders’ associates as defined in the BSX Regulations may sell shares which may result in being repurchased pursuant to the programme, but under BSX Regulations such trades must not be pre-arranged and all repurchases must be made in the open market. Prices paid by the Bank must not, according to BSX Regulations, be higher than the last independent trade. The Bank will continue to advise the BSX monthly of shares repurchased and cancelled. Large Shareholders The following professional nominees at 31 December 2003 were registered holders of 5% or more of the issued share capital: Harcourt & Co. (16.2%) and Murdoch & Co. (5.3%). Known beneficial holdings of 5% or more of issued share capital, at that date, were: the Bank’s Stock Option Trust (7.6%); Jardine Strategic Holdings Limited (6.3%); and Bermuda Life Insurance Company Limited (6.3%). Market Price per Share 1 January 2003 to 31 December 2003 ($) Market Value & Net Book Value per Share ($) 50.00 45.00 40.00 35.00 30.00 25.00 20.00 50 40 30 20 10 J F M A M J J A S O N D June 00 June 01 June 02 Dec 02 Dec 03 Market Value 15.20 31.50 33.00 30.50 44.00 Book Value 11.68 13.50 15.83 16.56 19.13 2000-2002 Values Restated for Stock Dividends 57 Principal Offices & Subsidiaries PRINCIPAL BERMUDA OFFICES & SUBSIDIARIES PRINCIPAL OVERSEAS OFFICES & SUBSIDIARIES HEAD OFFICE The Bank of N.T. Butterfield & Son Limited President & CEO: Alan R. Thompson 65 Front Street, Hamilton HM 12, Bermuda Tel: (441) 295-1111 Fax: (441) 292-4365 S.W.I.F.T.: BNTB BM HM E-mail: contact@bntb.bm www.bankofbutterfield.com THE BAHAMAS Bank of Butterfield (Bahamas) Limited Managing Director: Robert V. Lotmore Montague Sterling Centre East Bay Street P.O. Box N-3242 Nassau, Bahamas Tel: (242) 393-8622 Fax: (242) 393-3772 E-mail: info@bankofbutterfield.bs MAILING ADDRESS P.O. Box HM 195 Hamilton HM AX Bermuda DOMESTIC SUBSIDIARIES Butterfield Asset Management Limited Managing Director: Ian M. Coulman 65 Front Street, Hamilton HM 12, Bermuda Tel: (441) 299-3817 Fax: (441) 292-9947 E-mail: contact@bntb.bm www.bam.bm Butterfield Fund Services (Bermuda) Limited Managing Director: Andrew R. Collins Rosebank Centre 11 Bermudiana Road, Pembroke, Bermuda Tel: (441) 298-6464 Fax: (441) 295-6759 E-mail: contact@bntb.bm Butterfield Trust (Bermuda) Limited Managing Director: Sheila M. Brown 65 Front Street, Hamilton HM 12, Bermuda Tel: (441) 299-3980 Fax: (441) 292-1258 E-mail: contact@bntb.bm Promisant (Technology) Ltd. Managing Director: Michael J. Preuss Park Place, 55 Par-La-Ville Rd. Hamilton HM 11, Bermuda Tel: (441) 299-1341 Fax: (441) 296-6562 E-mail: corporate@promisant.com www.promisant.com BARBADOS The Mutual Bank of the Caribbean Inc.* General Manager & Director: Clenell H. Goodman The Mutual Building 1 Beckwith Place, Lower Broad Street Bridgetown, Barbados Tel: (246) 431-4500 Fax: (246) 430-0222 E-mail: contact@bankofbutterfield.bb *to be renamed Bank of Butterfield (Barbados) Limited Butterfield (Barbados) Limited Vice President: Caroline J. Prow Belleville Corporate Centre 38 Pine Road, Belleville St. Michael, Barbados Tel: (246) 430-1650 Fax: (246) 436-7999 E-mail: carolineprow@butterfield.bb CAYMAN ISLANDS Bank of Butterfield International (Cayman) Ltd. Managing Director: Conor J. O’Dea Butterfield House, 68 Fort Street P.O. Box 705 GT George Town, Grand Cayman Cayman Islands Tel: (345) 949-7055 Fax: (345) 949-7004 E-mail: info@bankofbutterfield.ky www.bankofbutterfield.ky GUERNSEY Bank of Butterfield International (Guernsey) Limited Managing Director: Robert S. Moore P. O. Box 25 Roseneath The Grange, St. Peter Port Guernsey GY1 3AP Channel Islands Tel: (01481) 711521 Fax: (01481) 714533 E-mail: info@butterfield.gg www.bankofbutterfield.gg Butterfield Fund Managers (Guernsey) Limited Managing Director: Patrick A.S. Firth P. O. Box 211 La Tonnelle House, Les Banques Stv Sampsons Guernsey GY2 4BF Channel Islands Tel: (01481) 720321 Fax: (01481) 716117 E-mail: info@butterfield.gg www.bankofbutterfield.gg Butterfield Trust (Guernsey) Limited Managing Director: Paul D.H. Hodgson P. O. Box 25 Roseneath The Grange, St. Peter Port Guernsey GY1 3AP Channel Islands Tel: (01481) 711521 Fax: (01481) 714533 E-mail: info@butterfield.gg www.bankofbutterfield.gg UNITED KINGDOM Bank of Butterfield (UK) plc Managing Director: Paul A. Turtle St Helen’s 1 Undershaft, London EC3A 8JX United Kingdom Tel: 020 7816 8300 Fax: 020 7816 8306 E-mail: info@bankofbutterfield.co.uk www.bankofbutterfield.co.uk 58