Bank of N.T. Butterfield & Son Ltd
Annual Report 2004

Plain-text annual report

T h e B a n k o f N . T. B u t t e r f i e l d & S o n L i m i t e d 65 Fr on t Street , Ha mil ton, Berm uda w w w. b u t t e r f i e l d b a n k . c o m A N N U A L R E P O R T | 2 0 0 4 B E R M U D A | B A H A M A S | B A R B A D O S | C A Y M A N I S L A N D S | G U E R N S E Y | U N I T E D K I N G D O M B U T T E R F I E L D B A N K A N N U A L R E P O R T 2 0 0 4 Performance Highlights For the year ended 31 December 2004 Net income $90.5 million Up from $70.8 million in 2003 Return on Equity 21.2% Up from 17.9% in 2003 Diluted Earnings Per Share $3.86 Up from $3.07 in 2003 Acquisitions: The Bahamas Deerfield Fund Services Limited February 2004 Bermuda Grosvenor Trust Company Limited October 2004 UK & Guernsey Leopold Joseph Holdings plc April 2004 Awards: Bank of the Year 2004 Awarded by The Banker magazine to Butterfield Bank in Bermuda and the Cayman Islands, September 2004 Contents Financial & Statistical Summary Corporate Profile Chairman’s Letter to the Shareholders President & Chief Executive Officer’s Report Management’s Discussion and Analysis of Results of Operations and Financial Condition Financial Overview 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 and Comprehensive Income Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements Board of Directors & Principal Board Committees Directors’ Code of Practice and Group Code of Conduct Directors’ and Executive Officers’ Share Interests and Directors’ Service Contracts Management Principal Group Companies Shareholder Information Principal Offices & Subsidiaries 2 3 4 5 6 18 23 24 25 26 27 28 29 30 61 61 61 62 62 63 64 Financial & Statistical Summary 2 (In $ thousands except share data) 31 December 2004 31 December 2003 31 December 2002 (unaudited) 30 June 2002 Year ended Year ended Net income from continuing operations Profit (Loss) from discontinued operations Net income Net income per share (Diluted) Including discontinued operations Excluding discontinued operations At Year End Total assets Cash and deposits with banks Investments Loans Deposits from customers Deposits from banks Subordinated capital and senior debt 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 90,466 - 90,466 $3.86 $3.86 8,630,383 2,396,724 3,266,400 2,645,331 7,404,855 502,595 142,333 428,030 $18.84 $40.50 22,714 3,778 1,552 1.1% 21.2% 6.6% 70,838 - 70,838 $3.07 $3.07 7,733,806 2,912,383 2,638,253 1,954,716 6,612,303 510,274 122,871 382,095 $16.83 $40.00 20,643 3,581 1,381 1.0% 17.9% 6.5% 83,743 184 83,927 $3.26 $3.26 6,007,874 1,989,159 2,073,112 1,767,088 5,156,111 360,105 75,000 338,799 $15.05 $27.73 18,603 3,322 1,200 1.2% 20.5% 6.9% * Excludes shares purchased by the Bank for the Stock Option Trust. ** Excludes discontinued operations and gain on sale of subsidiaries. Comparative per share data has been restated to reflect the 1 for 10 stock dividends in August 2004, 2003 and 2001. Data for 2004 and 2003 is shown under US GAAP and for 2002 under Canadian GAAP. All percentages here and in the report that follows are based on actual rather than rounded numbers. 81,416 873 82,289 $3.44 $3.40 5,738,044 2,027,225 1,831,142 1,696,775 4,787,228 429,138 75,000 335,167 $14.39 $30.00 19,247 3,364 1,229 1.2% 21.2% 7.0% Jun 01Jun 02Dec 02(unaudited)Dec 03Dec 0460.764.466.770.890.5for 12 months to 30 Junefor 12 months to 31 DecemberNet Income ($m)**Jun 01Jun 02Dec 02(unaudited)Dec 03Dec 042.753.403.263.073.86for 12 months to 30 Junefor 12 months to 31 DecemberJun 01Jun 02Dec 02(unaudited)Dec 03Dec 04for 12 months to 30 Junefor 12 months to 31 DecemberEarnings Per Share ($) (Diluted)**22.721.220.517.921.2Return on Equity (%)**Corporate Profile 3 The Butterfield Bank Group is a full service community bank and a provider of specialised offshore financial services. Our headquarters and largest operations 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 $9.5 billion of assets under management and over $80 billion of client assets under management and administration. We provide a full range of Our performance is a direct result community banking services of the efforts of our dedicated for institutional and individual employees who work together to customers in Barbados, Bermuda deliver quality financial services, and the Cayman Islands, encompassing retail and build business and enhance shareholder value. At 31 corporate banking and treasury December 2004 we had a total activities. As a specialist offshore of 1,552 employees, 786 in financial services group, we also Bermuda and 766 overseas. provide private banking, wealth We believe that a positive work management and fiduciary environment, with effective services, and institutional and employee training, development pension fund administration in and communication, benefits The Bahamas, Bermuda, the our customers through quality Cayman Islands, Guernsey and service and our shareholders the United Kingdom. Our success through long-term improvements is built on a set of fundamental in results. strengths: sound corporate values, a stable customer base, strong liquidity position and solid core businesses. Involvement in the communities in which we operate is important to the Butterfield Bank Group. We support a variety of projects Our home country regulator is and organisations that invest in the Bermuda Monetary Authority, areas such as youth development, which operates in accordance healthcare, social causes, sports, with Basel principles and maintains close contacts heritage and the arts. Our educational scholarships and with regulators in the other bursaries help young people jurisdictions where we have fulfil their potential and achieve offices. Our common stock is their dreams. We take an active listed on The Bermuda Stock role in community events and Exchange and the Cayman encourage the efforts of the many Islands Stock Exchange. We have employees who give their own over 3,700 shareholders with time and energy to a multitude 24.3 million shares outstanding. of charitable causes. Collectively and individually, we take action to make our communities better. Chairman’s Letter to the Shareholders 4 On behalf of the Board of Directors, it is my pleasure to report that the Butterfield Bank Group has again performed well under economic conditions that continue to challenge the global market. The year ended 31 December 2004 was a period of growth and accomplishment, both strategically and financially. The Group has maintained its course with a clearly defined strategy across all our business lines. This strategy, developed by executive management, has produced consistently strong financial results and continues to enhance shareholder value. The current business model is proven to be sound, as these results attest. We have expanded our geographic diversification with key acquisitions in Bermuda, Guernsey, the United Kingdom and The Bahamas. This growth speaks to our increasing strength and stability, as well as our commitment to continue building and expanding core businesses. Reflecting our ongoing strong earnings performance and our commitment to enhancing shareholder value, in July 2004 the Board approved a one-for-ten bonus share issue, as it had the prior year. This bonus equates to a 10% stock dividend and, combined with the 12-month cash dividend of $1.55 per share, gave shareholders an impressive return on their investment. This year we bade farewell to a valued and respected colleague. Geoffrey Bell retired from the Board in January 2005, following his appointment as a Puisne judge of the Bermuda Supreme Court. Mr. Bell was elected to the Board in 1987 and made a number of significant contributions, most recently as Chair of the Corporate Governance Committee. On behalf of the Board, I would like to thank him for his 17 years of service and wish him well on his move to the Bench. I would like to express sincere thanks to the Group’s dedicated management team and employees whose expertise and dedication has made it possible for us to continue to achieve strong results. I also thank our shareholders and customers for their steadfast support, amid a climate of change within our industry. You are essential to our success and we will work to continue to earn your loyalty as we move forward. James A.C. King, JP Chairman of the Board President & Chief Executive Officer’s Report 5 The year 2004 was one of growth and change for the Butterfield Bank Group, as our tested strategy has again delivered solid financial results in a highly competitive environment. Our net income for 2004 was $90.5 million, increasing by 27.7% from last year and we experienced a good return on shareholders’ equity at 21.2%. This performance can be attributed to the overall strength of our core businesses and the commitment and skill of our employees. We made significant acquisitions in 2004, acquiring Leopold Joseph Holdings plc, with operations in Guernsey and the United Kingdom, Deerfield Fund Services Limited in The Bahamas, and Grosvenor Trust Company Limited in Bermuda. The transition of these acquisitions into the Butterfield Bank Group is progressing well with promising growth potential. In 2004 the Group re-branded across all jurisdictions. This re-branding to the name Butterfield Bank is a positive initiative for the Group and will contribute to a consistent, group-wide identity as we continue to expand internationally. A cornerstone of our business is value added customer service. In Bermuda we entered into a partnership with MasterCard and American Airlines and launched the Butterfield / AAdvantage® MasterCard®, a popular credit card. We will continue to seek other innovative products and services that meet the needs of our customers. Our resiliency and strength was underscored after Hurricane Ivan severely damaged the infrastructure of our Cayman operations. Other offices in the Group immediately went to the aid of colleagues, assisting them in re-establishing their operations within several days. Additionally, we made a substantial contribution to the entire community to help with their recovery efforts. 2004 also saw the launch of a Service Initiative training programme in Bermuda for all Bank employees, which will enable them to better serve each other and our customers. We see this internal training as a key element to achieving our overall goals. Our community activities remain a priority as we recognise our responsibility to give back to the jurisdictions in which we operate. In 2004 we supported a wide variety of causes in our communities, with the active involvement of our employees. On behalf of management, I would like to express appreciation to the Board of Directors for their support, advice and oversight. I also thank our employees, shareholders, customers and partners, all of whom contribute to the Butterfield Bank Group’s reputation as a respected business and strong community partner. Alan R. Thompson President & Chief Executive Officer Management’s Discussion and Analysis of Results of Operations and Financial Condition 6 Richard J. Ferrett Executive Vice President & Chief Financial Officer C. Wendell Emery Executive Vice President, Operations & Information Technology Graham C. Brooks Executive Vice President, International Peter J.M. Rodger Senior Vice President & Group Legal Adviser, Secretary to the Board From left to right: All references to the Butterfield Bank Group or “the Group” refer to The Bank of N.T. Butterfield & Son Limited and its subsidiaries on a consolidated basis. Management’s discussion and The Bahamas in February 2004 analysis of results of operations and Grosvenor Trust Company and financial condition should Limited was acquired in be read in conjunction with the Bermuda in October 2004. Group’s Consolidated Financial These businesses performed Statements, beginning on page in line with expectations during 26, and the notes to those the period of time that they financial statements, which have been part of the Butterfield begin on page 30. These Bank Group. statements and notes have been prepared in accordance with Results of operations for the generally accepted accounting year ended 31 December 2004 principles in the United States compared with the year ended of America (US GAAP). The 31 December 2003. Group changed its accounting convention from Canadian GAAP The Butterfield Bank Group in 2004; as a result, 2003 achieved net income of $90.5 comparatives have been million for the year ended restated under US GAAP. 31 December 2004, representing During 2004, three acquisitions over the same period last year. a 27.7% increase in net income were made which impacted results. Leopold Joseph Holdings plc was acquired in April 2004 and integrated with the Group’s United Kingdom and Guernsey operations; Deerfield Fund Services Limited was acquired in From left to right: Michael A. McWatt Senior Vice President, Credit Risk Management Sheila M. Brown Senior Vice President, Investment Services Lloyd O. Wiggan Senior Vice President, Retail Banking 7 Net interest income, before credit The Group’s balance sheet remains Asset quality remained a strength related provisions, at $151.0 highly liquid. Deposits with banks across the Group. Non performing million, was a record and is up and investments increased year on loans totalled $20.5 million at year on year by $32.9 million, or year by 2.1% to $5.7 billion and year-end 2004, representing 0.8% 27.9%, reflecting balance sheet represents 65.6% of total assets, of total loans, down from 0.9% a growth, an increase in the loan compared to 71.8% a year earlier. year ago. As at 31 December 2004 portfolio and a benefit from the The loan to assets ratio at year the General Provision for loan rise in US and UK interest rates. end 2004 stood at 30.7%, up from losses of $21.9 million was The period under review saw 25.3% a year earlier. Loans equivalent to 0.8% of total loans. increases in both US and UK increased by $690.6 million, or In addition, there is a specific interest rates, with five increases 35.3%, year on year. This increase provision of $1.9 million held for in US interest rates and four reflects the ability across the possible shortfalls in the security increases in UK interest rates, Group to meet new demand for held for non-performing loans. all of 0.25%. lending products, particularly in In total, therefore, loan provisions the community banking business were $23.8 million, or 0.9% of the Also significant was the growth in Bermuda, which produced loan loan portfolio. Delinquency and in non-interest income, which growth of $252.6 million, up 17.4%, charge-off ratios continued to be increased year on year by and in the Cayman Islands, where well below industry average. $33.5 million, or 27.3%, to growth was $38.2 million, up $156.5 million. This reflects strong 14.2%. The acquisition of Leopold growth across all revenue lines, Joseph’s businesses was the notably from our fund primary reason for the growth in administration businesses the loan portfolios in Guernsey (+52.7%), asset management and the UK, which increased by (+38.4%), trust and investment $72.6 million, or 64.1% and $328.7 services (+29.8%) and banking million, or 575.0% respectively. services (+16.0%). Management’s Discussion and Analysis of Results of Operations and Financial Condition 8 Bob W. Wilson Senior Vice President, Corporate Banking Fred H. Tesch Senior Vice President, Group Internal Audit Graham M. Jack Managing Director, Butterfield Trust (Bermuda) Limited Ian M. Coulman Managing Director, Butterfield Asset Management Limited From left to right: The year saw a significant fourth quarter the Board share increased year on year by increase in customer deposits, approved a dividend increase of 11.9% to $18.84. which were up $0.8 billion, 3 cents. or 12.0%, year on year to $7.4 An important productivity billion, again primarily due to Performance Indicators indicator is the efficiency ratio, the acquisition of Leopold Joseph. Substantial inflows of short-term customer deposits continued over the year from clients whose third party investment funds are administered by the Group in Cayman. During the year 459,232 shares were repurchased and cancelled, at an average cost of $42.19 per share. The total dividend for the period was $1.55 per share, an increase of 12 cents or 8.4% over the same period last year, and represents a 37.2% payout on net income for the period. In addition, for the second consecutive year, a one-for-ten bonus share issue was made in August 2004, which equates to a 10% share dividend, and for the The Group’s overall strength and performance are indicated by certain key measures. Return on shareholders’ equity was 21.2% for the period, up from 17.9% in 2003. Diluted earnings per share were $3.86, up 79 cents, or 25.7%, compared with $3.07 last year. The net interest margin and interest rate spread both remained unchanged year on year at 1.9% and 1.6% respectively. Average interest- earning assets increased year on year by 30.6% to $7.9 billion. The increase in the return on assets, up 0.1% on 2003 to 1.1%, reflected the strong earnings growth achieved in 2004. The Group’s net book value per which is operating expenses (excluding corporation tax and amortisation of intangible assets) expressed as a percentage of operating income (excluding credit provisions). For the year ended 31 December 2004, the Group’s efficiency ratio was 69.1%, up from 67.7% a year ago. The increase was due to a higher year on year growth rate for non interest expense, up 36.6%, than for total revenue, which grew by 32.9%. This reflects the acquisition and integration costs associated with the purchase of Leopold Joseph, together with increased expenses in Cayman relating to Hurricane Ivan. From left to right: Donna E. Harvey Maybury Senior Vice President, Human Resources James R. Stewart Senior Vice President, Enterprise Risk Management Michael O’Mahoney Senior Vice President, Treasury 9 Outlook The Group re-branding, which was launched in 2004, has made ‘Butterfield’ an increasingly recognised brand wherever the Group operates, particularly in the markets entered over the past two years. Whilst 2005 is expected to present the continued challenge of increased competition, the Group’s business model is expected to continue effectively to generate enhanced shareholder value as long as the economies in which the Group operates remain robust. Recently-acquired companies are anticipated to perform in line with expectations in 2005. The Group will therefore continue with the strategy that has returned a strong performance over the past several years, namely to maintain a conservative approach and continue to focus on core business lines. Bermuda 10 W. Aaron M. Spencer Senior Vice President, Operations D. John Charlick Senior Vice President, Strategic Projects Andrew R. Collins Managing Director, Butterfield Fund Services (Bermuda) Limited From left to right: The Butterfield Bank Group has its headquarters and largest operation in Bermuda. Home to over half the Group’s employees, Bermuda-based businesses provide community banking, wealth management, fiduciary services and investment and pension fund administration services. These are offered through The Bank of N.T. Butterfield & Son Limited, under the brand name of Butterfield Bank, and its wholly-owned subsidiaries: Butterfield Asset Management Limited, Butterfield Trust (Bermuda) Limited, Butterfield Fund Services (Bermuda) Limited and Promisant (Technology) Limited. In 2004, the Group’s Bermuda operations thrived in a fast-paced, changing market. For the third consecutive year, Butterfield Bank was named ‘Bank of the Year’ in Bermuda by The Banker magazine, recognising its impressive performance in the jurisdiction. While the competitive environment in Bermuda intensified with the acquisition of a local competitor by a global bank, the continued focus on the Group’s core strategy successfully attracted and retained customers, producing impressive results for all businesses on the island. With quality customer service a cornerstone of the Group’s strategy, Bermuda operations focused on operational efficiency, product innovation and enhancing the all- round customer experience, through continued investment in premises, people, IT infrastructure, data and systems. During the period under review in Bermuda, total income increased year on year by 24.2% to $192.0 million, reflecting record levels of both net interest and non-interest income. Included in non-interest income was a $5.8 million realised gain from the sale of a venture capital investment. Assets under administration in Bermuda were up 26.1% to $33.3 billion. Butterfield Bank Corporate, private and retail banking and treasury businesses in Bermuda comprise Butterfield Bank’s Community Banking operations and all have maintained strong performances in 2004. Demonstrating the Bank’s strength in retaining and attracting business in an increasingly competitive market, a 48.1% year on year increase in net income was achieved, up from $31.8 million in 2003 to $47.1 million in 2004, reflecting increased net interest income as a result of strong loan growth and a 12 basis point increase in the net interest margin. Average interest earning assets were $3.8 billion in 2004 compared with $3.5 billion last year. Corporate Lending experienced significant growth, as its quality products and effective relationship management proved an ideal fit for both local and international customers. The corporate loan portfolio increased year on year by 26.0% to $0.8 billion, reflecting strength in the local economy. Corporate Lending continues to remain vigilant in its approach to loan quality. Letters of Credit income was ahead of expectations although volume grew at a slower rate than in previous years. Private Banking expanded during 2004, by dedicating quality resources to acquiring new business and continuing to build strong relationships with high net worth private clients. This area is viewed as a growth opportunity. Retail Banking experienced another year of growth and cemented its position as Bermuda’s premier provider of community banking services in July 2004 with the launch of the only credit card in Bermuda offering access to the internationally recognised AAdvantage® miles programme. A significant number of new customers have been attracted to the Group by the Butterfield / AAdvantage® MasterCard® and, following its launch, 88% of new credit card applications in 2004 were for this particular card. 11 Consumer Credit yet again recorded strong growth in 2004, with mortgage and consumer loan balances increasing by 10.0% to $0.9 billion. A focused and pro-active marketing strategy attracted significant new business, strengthened existing relationships and expanded referral arrangements. Specialised Consumer Credit training, meanwhile, ensured a continued focus on technical skills, quality customer service and cross-selling capabilities. Improvements to products, delivery channels and fraud protection technology kept the Group in line with global standards. With a focus on electronic services, in the fourth quarter of 2004 the Group began upgrading the ATM network in Bermuda, offering newer technology and greater security. Having exceeded 1 million transactions since its launch in 2001, in 2004 Butterfield Direct Internet Banking continued to show strong growth in both numbers of users and transactions. The Group is committed to ongoing technology investments in this delivery channel to provide enhanced functionality and security. Work continued on the physical infrastructure in Bermuda with renovations on-going in the Rosebank building in Hamilton. Additionally, an extensive refurbishment of the St. George’s branch was completed and work will begin on the Somerset branch in 2005. Butterfield Asset Management Providing investment management, advisory and brokerage services to institutional and private clients, Butterfield Asset Management Limited (BAM) manages the family of eight Butterfield Funds, as well as Butterfield Bank Group’s own investment portfolios. BAM reported 2004 net income of $13.5 million, an increase of 20.8% over 2003. Client assets invested in Butterfield Funds managed in Bermuda rose 9.3% year on year to $5.0 billion at 31 December 2004, while total client assets under management grew from $7.1 billion at the end of 2003, to $7.5 billion at year end, an increase of 6.3%. Considerable growth was achieved in BAM’s Fund of Funds product, Butterfield Select, which grew by 61.5%. Also displaying strong growth were the Butterfield US Dollar Bond, which grew by 32.1%, and the Butterfield Money Market Funds which, in dollar terms, attracted well over half of all BAM’s new client assets. BAM’s strong performance was powered by consistent marketing to prospective and existing clients. It actively marketed wealth management services, implementing a pro-active strategy to attract trust companies and intermediaries. BAM also continued to develop its relationship with the insurance industry by attending the major insurance conferences in Bermuda and abroad, including RIMS. Additionally, BAM conducted a series of presentations during the year, which successfully attracted new investors to the funds. Butterfield Trust (Bermuda) Providing a comprehensive range of trust, estate, company management and custody services, Butterfield Trust (Bermuda) Limited (BTB) focuses on local and international clients, both corporate and individual. During the year under review client assets under custody increased by $0.7 billion to $17.5 billion, up 4.2% from 2003. BTB experienced significant growth in hedge fund business and attracted new business from existing clients. Personal trust business continued to expand, as wealthy families recognised the importance of the flexibility and independence BTB provides when managing their international financial affairs in an increasingly more regulated environment. The net income for BTB, at $6.8 million, increased by 53.2% from 2003. In the last quarter of the year, Grosvenor Trust Company Limited, a Jun 01Jun 02Dec 02Butterfield Funds3,061 3,749 4,123 4,551 4,976Discretionary2,091 2,151 2,077, 2,508 2,531Total5,152 5,900 6,200 7,059 7,507Dec 03Dec 045,1525,9006,2007,0597,507Assets Under Management by Butterfield Asset Management ($m)Overseas Subsidiaries 12 specialist trust company in Bermuda, was acquired and now operates as a wholly-owned subsidiary of BTB. With a well-established and select group of clients, Grosvenor Trust is complementary to BTB’s existing trust business. Its acquisition is consistent with the Group’s ongoing strategy of growth in core products and services. Positioned well for further growth, BTB continued in 2004 to strengthen its senior management team, improve customer service and cost efficiencies and enhance operational effectiveness. Butterfield Fund Services (Bermuda) Providing valuation, accounting, corporate and shareholder services to offshore hedge funds and mutual funds, Butterfield Fund Services (Bermuda) Limited (BFS) also offers corporate pension administration services to insurance companies and international pension funds. For the year ended 31 December 2004 net income was $7.2 million, up 78.6% compared with $4.0 million the previous year. Net assets under administration, excluding the Butterfield Funds, increased by 74.0% from $9.6 billion in 2003 to $16.7 billion as at 31 December 2004. Yet again this year, BFS significantly increased its client base and continued to provide personalised, professional service to a variety of investment and pension funds. In 2004 customers of BFS again provided substantial business to other areas of the Group in Bermuda, including Treasury, Credit and Butterfield Asset Management. The Bahamas Robert V. Lotmore Managing Director, Butterfield Bank (Bahamas) Limited Butterfield Bank (Bahamas) Limited was established in 2003 through the acquisition of Thorand Bank & Trust and Leopold Joseph (Bahamas) Limited and provides private banking, wealth management and fiduciary services. Butterfield Fund Services (Bahamas) Limited was established in February 2004 through the acquisition of Deerfield Fund Services Limited and provides fund administration services. At 31 December 2004 the Group’s total assets in The Bahamas were $63.4 million, up from $18.4 million the previous year, and net income was $0.7 million. Client assets under administration were $4.4 billion, up 248.9% from $1.3 billion in 2003, reflecting the acquisition. Butterfield Bank (Bahamas) Butterfield Bank (Bahamas) Limited focuses on providing a premier service, creating tailored solutions for international, high net worth clients with wealth management needs. Areas of expertise include private banking, trust administration and custody. With The Bahamas attracting high net worth individuals looking to buy real estate, Butterfield Bank (Bahamas) launched a new US Dollar mortgage programme in October 2004 aimed to service this niche market and create opportunities to cross-sell other products and services. Already receiving strong interest, this product is expected to be an area of growth in 2005. By 31 December 2004, the total lending portfolio in The Bahamas was $2.9 million, compared to $26,000 the previous year. Butterfield Fund Services (Bahamas) The acquisition of Deerfield Fund Services Limited, a Bahamas-based fund administrator, was consistent with the Group’s strategy of growth in its core businesses and complemented existing operations in The Bahamas. Re-named Butterfield Fund Services (Bahamas) Limited, the business provides fund administration services for offshore hedge funds, mutual funds and pension funds, and grew overall assets under administration for the year to $2.9 billion. Barbados Mariano R. Browne Managing Director, Butterfield Bank (Barbados) Limited The Group’s principal business in Barbados is a comprehensive banking service to the local community offered through Butterfield Bank (Barbados) Limited, which was formed in December 2003 through the acquisition of The Mutual Bank of The Caribbean Inc. A separate entity, Butterfield Asset Management (Barbados) Limited, acts as a representative office for investment business. The priority in 13 Barbados for 2004 was to complete a re-branding process, which was successfully achieved by the end of the first quarter of 2004. At 31 December 2004, total assets were $173.3 million, up 11.6% from the previous year. Net income for 2004 was $0.3 million. Butterfield Bank (Barbados) Headquartered in Bridgetown with three additional branches, Butterfield Bank (Barbados) Limited’s range of community banking services includes personal and commercial loans and overdrafts; savings, chequing and fixed deposit accounts; 24-hour ATM facilities; credit cards; and foreign exchange. Ensuring existing customers received a consistent level of service with the newly-branded bank was key in establishing a solid performance in 2004. Butterfield Bank (Barbados) moved swiftly to build its reputation as a dedicated community banker with the launch of the “Butterfieldninetyfive” mortgage in the second quarter of 2004. “Butterfieldninetyfive” provides 95% financing and has the lowest fixed rate for mortgages in Barbados. This product spear-headed an encouraging first year for the mortgage portfolio in 2004. Butterfield Asset Management (Barbados) A separate operation from the community bank, Butterfield Asset Management (Barbados) Limited acts as a representative office for the services of Butterfield Asset Management Limited, meeting the corporate investment needs of organisations such as captive insurance companies, international businesses and trusts. CAYMAN ISLANDS Conor J. O’Dea Managing Director, Butterfield Bank (Cayman) Limited A comprehensive range of services is offered in Cayman to the local and international market. Services are offered through Butterfield Bank (Cayman) Limited, Butterfield Asset Management (Cayman) Ltd. and Butterfield Fund Services (Cayman) Limited. They provide community and commercial banking services, investment management, custody, trust and company administration and investment and pension fund administration services. In 2004, Butterfield Bank (Cayman) was named ‘Bank of the Year’ in Cayman by The Banker magazine, in recognition of the strength of its service and its position as the premier community bank in the jurisdiction. Customer service remained a key focus, resulting in another year of strong growth in all business areas. Success was achieved despite the impact of Hurricane Ivan, the Category 5 storm which devastated the Cayman Islands on 12 September 2004 and affected all businesses in the jurisdiction. With solid business continuity plans in place, however, disruption to clients was minimised with the Butterfield Bank Group supporting its Cayman Islands operations from other locations for a short period of time. Open within four days for limited services, the Cayman Islands operations were able to offer a full service to customers on and off island within a week of the storm’s passing. Butterfield Bank (Cayman) took on a lead role in helping to rebuild the community, and made the first donation to the Cayman Islands National Recovery Fund with US$1 million. To support employees whose commitment saw them back at work within days of the hurricane, various initiatives were offered, ranging from counselling to clothing and day-care for their children. Net income for the Cayman Islands in 2004 was $24.7 million, representing an increase of 6.4% over 2003. A loss of $1.9 million was recorded for the year in respect of a minority shareholding in Island Heritage Insurance Company Limited. Nevertheless, total income increased year on year by 14.7% to $56.3 million and the Return on Equity for the year was 22.2%. Total assets increased year on year by 17.7% to $2.3 billion, reflecting continued growth in customer deposits. Butterfield Bank (Cayman) Butterfield Bank (Cayman) Limited’s community banking business experienced another strong year of growth in the Cayman Islands, Overseas Subsidiaries 14 increasing market share and further reinforcing its position as a leading provider of banking services to individuals and businesses in the jurisdiction. With five locations, seven ATMs including a drive-through, a web site, online banking and debit and credit cards allied to a wide range of credit facilities, the Bank’s comprehensive delivery channels are supported by a strong reputation for excellent customer service. Strong demand for credit continued during the year, with the lending portfolio growing by $38.1 million, from $268.4 million the previous year to $306.5 million, an increase of 14.2%. Following Hurricane Ivan, Butterfield Bank (Cayman) has been actively managing its loan portfolio and remains confident that the quality of lending decisions, allied to good administration of the portfolio, will minimise losses. In common with other banks in Cayman, a repayment moratorium was granted on residential mortgages and personal loans until January 2005, but continued to accrue interest payable in appropriate cases. Following a review of the loan portfolio post-Hurricane Ivan, credit provisions were increased by $3 million. Focusing on increasing convenience for customers and improving efficiency for the Bank, a firm commitment to investment in technology has been maintained. Cayman’s highly successful internet banking service, Butterfield Online, was enhanced both in terms of functionality and network infrastructure with security features upgraded to ensure the integrity of the system. Butterfield Asset Management (Cayman) Butterfield Asset Management (Cayman) Limited’s wealth management team experienced a successful year, reporting steady growth of institutional and private client assets under management. Total client assets under management at 31 December 2004, increased 3.7% to $726 million. Butterfield Fund Services (Cayman) Providing full administration services to hedge funds, mutual funds and pension funds, Butterfield Fund Services (Cayman) Limited experienced strong growth during 2004, driven by effective business development allied to a strong commitment to client servicing. Assets under administration in the Cayman Islands increased by 44.3% to $25.0 billion. GUERNSEY Robert S. Moore Managing Director, Butterfield Bank (Guernsey) Limited Services offered in Guernsey comprise private banking, wealth management and fiduciary services, administered banking services, and investment and pension fund administration services. They are offered through Butterfield Bank (Guernsey) Limited, Butterfield Trust (Guernsey) Limited and Butterfield Fund Services (Guernsey) Limited. In October 2004 the operations of Leopold Joseph & Sons (Guernsey) Limited were amalgamated with the Group’s existing private banking business, following Leopold Joseph’s acquisition, in April 2004. Both as a result of this acquisition and growth in existing business, total client deposits at 31 December 2004 increased by 47.1% to $1.3 billion, up from $0.9 billion the previous year. Overall in 2004, post tax net income of $2.6 million was achieved, up 11.1% compared to 2003. Revenue growth of 20.3%, to $35.0 million, was off-set by a rise in expenses of 21.1% from $26.8 million to $32.5 million, which included a $1.1 million provision in respect of leasehold premises vacated following a move to new premises in St. Peter Port. A tax credit of $0.4 million was recognised, primarily reflecting the amalgamation of the Guernsey-based businesses of Leopold Joseph. The Guernsey operations have $17 billion in assets under administration, of which $0.6 billion are also administered elsewhere in the Group. Butterfield Bank (Guernsey) During the year under review Butterfield Bank (Guernsey) Limited continued to cultivate quality client relationships, offering a full range of multi-currency deposits, loans and foreign exchange dealing. Enhancements to Butterfield Online, the Group’s internet banking service offered in Guernsey, were introduced to provide additional flexibility for professional financial intermediaries. 15 15 Butterfield Bank (Guernsey) provides discretionary portfolio management to a range of corporate and high net worth individuals and families. Assets under management for Guernsey clients increased to $854 million at 31 December 2004, up 23.8% from $690 million the previous year. Serving institutions from the UK, North America and Europe, the Group is also Guernsey’s market leader for administered banking services, providing customer services, operation, accounting, compliance and corporate secretarial services for leading financial institutions seeking outsourced solutions. This business experienced an 8% year on year increase in assets under administration. Butterfield Trust (Guernsey) Fiduciary services offered by Butterfield Trust (Guernsey) Limited include tailored and sophisticated trust and company administration services for wealthy families and institutions. Butterfield Fund Services (Guernsey) Butterfield Fund Services (Guernsey) Limited provides a full range of administration services to offshore funds of hedge funds, property funds and other specialist investment funds. As the jurisdiction’s largest specialist in administration of Cayman and other non-Guernsey funds, Butterfield Fund Services (Guernsey) has $6.3 billion assets under administration, of which $1.1 billion represent assets held as custodian by Butterfield Bank (Guernsey). The Group in Guernsey also provides custodian services for institutional clients which are not administered by Butterfield Fund Services (Guernsey) and provides custodian services to corporate and high net worth individuals, resulting in total assets held as custodian of $2.5 billion. UNITED KINGDOM Paul A. Turtle Managing Director, Butterfield Bank (UK) Limited A private banking service is offered from London by Butterfield Bank (UK) Limited, under the brand of Butterfield Private Bank. Butterfield Private Bank In April 2004 the purchase of Leopold Joseph Holdings plc, a company first established in London in 1919, was concluded and by the year-end full integration had been successfully completed of its operations in London and Guernsey with those of the Group. The acquisition of Leopold Joseph supports the Group’s strategy of growth in its core private banking business in the UK. The acquisition also enables the Group to expand its service offering through Leopold Joseph’s comprehensive investment management service, a service not previously offered in London. The combined businesses in the UK operate from 99 Gresham Street in the City, adjacent to the Bank of England, with over 100 employees. The efforts of the management team enabled the two banks to operate as one entity within six months of the acquisition. All clients have been retained and there have also been healthy increases in deposit and lending balances during 2004, as new client relationships have been won. The loan portfolio in the UK has increased year on year by $328.7 million to $385.9 million, reflecting the acquisition, and similarly customer deposits increased year on year by $413.9 million to $803.1 million. The year saw a $14.9 million increase in total income, to $19.3 million, though a post tax loss of $7.2 million was recorded in 2004, reflecting exceptional charge-offs of $5.0 million taken in respect of a lease on premises vacated at the year-end and redundancy costs. Butterfield Private Bank is well placed to execute its strategic plan to focus on the provision of private banking and wealth management services to high net worth clients. Total assets at 2004 year-end were $1.1 billion compared to $0.5 billion at the same stage a year earlier. Client assets under management in the UK now total $738 million, directly as a result of the acquisition. Well-positioned to meet the financial service requirements of high net worth individuals and their families, Butterfield Private Bank provides a Family Office Banking service. The Bank is also a provider of self-invested Overseas Subsidiaries 16 pension plans. Legislation due to take effect from April 2006 should encourage high earners to make greater contributions to their pensions and to self manage their investments. Butterfield Private Bank has therefore entered into a number of joint venture arrangements with pension practitioners, providing deposit banking, investment management services and lending to permit gearing within the pension to purchase certain classes of property. Butterfield Private Bank’s strategy remains unchanged, essentially to focus on the provision of private banking services to high net worth individuals in the UK. These services are primarily distributed through financial intermediaries who advise high net worth individuals, and efforts have continued this year to build the brand awareness of Butterfield Private Bank. Outstanding customer service remains a critical part of Butterfield Private Bank’s service offering in the UK and which differentiates it from competitors. M i s s i o n S t a t e m e n t Butterfield Bank 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 focused, efficient and ethical delivery of banking and other selected financial services. Financial Report 17 Financial Overview 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 and Comprehensive Income Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements 18 23 24 25 26 27 28 29 30 Financial Overview 18 Income Total income for the Group after provisions was $311.2 million for the year ended 31 December 2004, up $77.1 million, or 32.9% from $234.1 million for the same period a year ago. Net interest income before provisions for credit losses increased by 27.9% to $151.0 million. The increase reflects growth in average interest earning assets and successful asset/liability management strategies. We continue to be appropriately reserved with total provisions of $23.8 million. Non-accrual loans totalled $20.5 million as at 31 December 2004 up from $17.4 million a year ago reflecting loan growth, and represent 0.8% of the total loan portfolio, compared to 0.9% a year ago. Provisions in respect of credit losses charged to income were $2.9 million, compared to $3.0 million last year. Non-interest income grew by 27.3% to $156.5 million, reflecting growth across all revenue lines, notably from Investment & Pension Fund Administration (+52.7%), Asset Management (+38.4%), Foreign Exchange (+34.6%), Trust & Investment Services (+29.8%) and Banking Services (+16.0%). 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 Subordinated capital and senior debt Interest bearing liabilities Non interest bearing current accounts Other liabilities Total Liabilities Shareholders’ Equity Total Liabilities and Shareholders’ Equity Spread Net Interest Margin Average Balance 2,654,554 2,952,326 2,300,024 7,906,904 275,191 8,182,095 6,444,827 132,602 6,577,429 1,070,187 129,247 7,776,863 405,232 2004 Interest 46,275 89,553 130,743 266,571 - 266,571 115,249 3,247 118,496 - - 118,496 - 8,182,095 - 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 2003 Interest 36,165 60,791 101,598 198,554 - 198,554 80,965 2,523 83,488 - - 83,488 - 6,237,222 - Rate 1.7% 3.0% 5.7% 3.4% - 3.3% 1.8% 2.4% 1.8% - - 1.5% - - 1.6% 1.9% Rate 1.8% 2.7% 5.7% 3.3% - 3.2% 1.7% 2.2% 1.7% - - 1.4% - - 1.6% 1.9% Note: Underlying assets and liabilities are comprised of various currencies. 19 Expenses Operating expenses were $222.4 million during the period under review, up 36.6% from $162.8 million last year, compared to a 32.9% growth in operating revenues. The increase primarily reflects the expanding size of the Group through acquisitions with salaries and employee benefits up 27.3% to $127.5 million. In addition, an increase of 60.1% was seen in property and systems costs, reflecting continued spending on infrastructure development as we build and improve our businesses. At 31 December 2004 we had 786 employees in Bermuda, up from 734 a year ago, reflecting business growth, particularly in our Wealth Management & Investment Services and Investment & Pension Fund Administration businesses, where the headcount increased year on year by 21 and 19 respectively. Overseas, the total headcount increased by 119 to 766 primarily due to the acquisition in the UK (78) and growth in our Cayman business (16). We remain committed to the prudent management of the expense base and continually seek opportunities to improve our efficiency. Whilst the efficiency ratio of 69.1% in 2004 was up from 67.7% in 2003, the increase was primarily due to costs associated with the Leopold Joseph acquisition and ‘one-off’ expenses in Cayman as a result of Hurricane Ivan. Distribution of 2004 Total ExpensesSalaries & Other Employee Benefits 57.3%Other Expenses 14.7%Non-Corporation Taxes 4.9%Marketing 2.2%Systems & Communications 8.8%Property12.1%Distribution of 2004 Expenses by LocationBermuda 54.2%Barbados 3.6%The Bahamas 2.3%UK 11.7%Guernsey 14.3%Cayman 13.9%Financial Overview 20 Balance Sheet Total assets increased by 11.6% to $8.6 billion, up from $7.7 billion a year ago. This increase reflects the substantial rise in the customer deposit base, up year on year by $0.8 billion, or 12.0%, to $7.4 billion, primarily due to the acquisition of Leopold Joseph. The increase in the customer deposit base was primarily employed in our investment and loan portfolios, up year on year by 23.8% and 35.3% respectively to $3.3 billion and $2.6 billion. The balance sheet remains highly liquid with a loans to customer deposits ratio of 35.7%. and loans to total assets ratio of 30.7%. Bermuda 63.8%Barbados 3.2%UK 14.8%Guernsey 6.9%Cayman 11.3%Lending by LocationAAA 30.7%AA 43.0%Other 1.1%BBB 2.3%A 22.9%Investment Portfolio by Long-Term Debt Rating21 Taxes For the period under review the net corporation tax of the Group was a credit of $1.7 million compared to an expense of $0.4 million for the same period a year ago. Tax credits of $1.6 million in the UK and $0.4 million in Guernsey were offset by a corporation tax expense of $0.2 million in Barbados. We also paid $10.8 million in non profits taxes across the Group, up from $8.6 million the previous year reflecting increased employee and ‘value added’ taxes in the UK due to the acquisition. Capital The Group’s strategy is to maintain a strong capital base that ensures stability and allows us to take advantage of opportunities for growth. At 31 December 2004 the risk weighted total capital ratio was 10.7%, compared to the 10.0% minimum requirement of the Bermuda Monetary Authority. Of the total, the Tier 1 ratio was 7.2%, compared to a 5% minimum requirement. Shareholders’ equity increased by $45.9 million, or 12.0%, over a year ago, reflecting the increase in retained earnings less share buy-backs. Weighted risk assets rose year on year by 18.2% to $4.4 billion, primarily due to growth in the loan, investments and letters of credit portfolios. The loan to the Stock Option Trust (reflected as Treasury Stock in the financial statements) is in respect of potential obligations under the Group’s Stock Option Plan and is deducted from shareholders’ equity. The loan declined by $5.6 million, or 18.0%, to $25.5 million, reflecting repayment from cash received on the exercise of stock options by directors and employees. The acquisition of Leopold Joseph increased the amount of lower tier 2 subordinated capital notes in issuance by $9.6 million (£5 million). The notes issued by Leopold Joseph are redeemable in 2012. During the period under review, the Group issued 207,109 shares under the Dividend Re-investment Programme, which represents a cash savings of $8.9 million, or 26.6% of the total dividend declared. As a result of the one-for-ten stock dividend in August 2004 2,217,927 new shares were also issued. Under the Share Buy-Back Plan, the Group purchased and cancelled 459,232 shares, at a cost of $19.4 million, as part of our strategy to enhance shareholder value. Commerical Real Estate 19.0%Commercial and Industrial 18.6%Other Consumer Loans 13.2%Mortgages 34.1%Credit card 1.9%Financial Institutions & Government 13.2%Bermuda Loans by TypeFinancial Overview 22 Managing Risk Risk is inherent in virtually all of the Group’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 Group 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 via the Audit and Compliance Committee and the Group's Chief Executive Officer. 23 Financial Summary (In $ thousands except share data) At Year End Cash and deposits with banks Investments Loans, less allowance for credit losses Premises, equipment and computer software Total assets Total deposits Subordinated capital and senior debt Shareholders' equity For the Year Net interest income, after provision for credit losses Non-interest 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 (Diluted) Net income (Diluted) Dividends Net book value Number of Employees Bermuda Overseas Total Shareholder Data Number of shareholders Number of shares (000)* Year ended 31 December 2004 31 December 2003 31 December 2002 2,396,724 3,266,400 2,645,331 126,031 8,630,383 7,907,450 142,333 428,030 148,075 156,487 - 127,459 94,962 90,466 90,466 33,635 1.1% 21.2% 37.2% 6.6% 10.7% 69.1% 3.86 3.86 1.55 18.84 786 766 1,552 2,912,383 2,638,253 1,954,716 99,979 7,733,806 7,122,577 122,871 382,095 115,066 122,950 - 100,104 62,729 70,838 70,838 27,471 1.0% 17.9% 38.8% 6.5% 13.0% 67.7% 3.07 3.07 1.43 16.83 734 647 1,381 1,989,159 2,073,112 1,767,088 96,419 6,007,874 5,516,216 75,000 338,799 (unaudited) 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% 3.26 3.26 1.37 15.05 724 476 1,200 Year ended 30 June 2002 2,027,225 1,831,142 1,696,775 98,536 5,738,044 5,216,366 75,000 335,167 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% 3.40 3.44 1.31 14.39 749 480 1,229 3,778 22,714 3,581 20,643 3,322 18,603 3,364 19,247 * 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 2004, 2003 and 2001. The number of shares in 2004 increased primarily due to the issue of the stock dividend. ** Exclusive of discontinued operations and gain on sale of subsidiaries. # Inclusive of gain on sale of subsidiaries. Data for 2004 and 2003 is shown under US GAAP and for 2002 and 2001 under Canadian GAAP. 30 June 2001 1,691,423 1,882,479 1,451,773 97,690 5,197,804 4,700,723 75,000 286,525 100,213 91,775 - 72,024 53,232 66,732 60,742 20,525 1.2% 22.7% 33.8% 7.2% 14.8% 61.8% 2.75 2.51 1.05 12.27 744 418 1,162 3,619 17,571 24 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 the United States of America and, where appropriate, are based on the best estimates and judgement 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. The Committee meets and consults regularly with Management, the internal auditors and the independent accountants to review the scope and results of their work. 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. The accounting firm of PricewaterhouseCoopers, the shareholders’ independent auditors, has examined the consolidated financial statements of the Bank in accordance with auditing standards generally accepted in the United States of America 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. Management has made available to PricewaterhouseCoopers all of the Bank’s financial records and related data as well as the minutes of shareholders’ and directors’ meetings. Alan R. Thompson President & Chief Executive Officer 4 March 2005 Richard J. Ferrett Executive Vice President & Chief Financial Officer 4 March 2005 25 Auditors’ Report to the Shareholders To the Shareholders of The Bank of N.T. Butterfield & Son Limited In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in shareholders’ equity and comprehensive income, and of cash flows present fairly, in all material respects, the financial position of The Bank of N.T. Butterfield & Son Limited at December 31, 2004 and December 31, 2003, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion. Financials 26 Consolidated Balance Sheet As at 31 December (In $ thousands) Assets Cash and demand deposits with banks Term deposits with banks Total cash and deposits with banks Investments Held to maturity Available for sale Trading Total investments Loans, less allowance for credit losses Premises, equipment and computer software Accrued interest Goodwill and other intangible assets Other assets Total assets Liabilities Deposits Non-interest bearing Interest bearing Customers Banks Total deposits Accrued interest Dividend payable Other liabilities Total other liabilities Subordinated capital and senior debt Total liabilities Shareholders' equity Share capital ($1.00 par: Authorised shares 70,000,000) Additional paid in capital Retained earnings Less: treasury stock Accumulated other comprehensive income Total shareholders' equity Total liabilities and shareholders' equity The accompanying notes are an integral part of these consolidated financial statements. 2004 2003 164,431 2,232,293 2,396,724 2,592,824 29,681 643,895 3,266,400 2,645,331 126,031 30,843 106,043 59,011 8,630,383 111,702 2,800,681 2,912,383 2,450,887 27,815 159,551 2,638,253 1,954,716 99,979 22,828 48,154 57,493 7,733,806 999,826 1,140,548 6,405,029 502,595 7,907,450 9,120 9,235 134,215 152,570 142,333 8,202,353 24,301 229,495 188,674 (25,471) 11,031 428,030 8,630,383 5,471,755 510,274 7,122,577 7,632 7,817 90,814 106,263 122,871 7,351,711 22,335 149,454 224,002 (31,058) 17,362 382,095 7,733,806 James A.C. King, JP Chairman of the Board Robert J. Stewart, JP Vice Chairman Alan R. Thompson President & Chief Executive Officer Consolidated Statement of Income For the year ended 31 December (In $ thousands, except per share data) Non-interest income Trust and investment services Asset management Investment and pension fund administration Banking services Foreign exchange revenue Other non-interest income Total non-interest income Interest income Deposits with banks Loans Investments Total interest income Interest expense Deposits and other Subordinated capital and senior debt Total interest expense Net interest income before provision for credit losses Provision for credit losses Net interest income, after provision for credit losses Other income (loss) Gain on sale of affiliate Realised / unrealized gains on trading securities Realised gains on available for sale securities Total revenue Non-interest expense Salaries and other employee benefits Property Systems and communications Marketing Other expenses Total non-interest expense Income before taxes Income taxes Income after taxes Net income Earnings per share Basic Diluted 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 2004. 27 2004 2003 28,690 28,706 34,339 36,396 25,488 2,868 156,487 46,275 133,637 89,553 269,465 115,249 3,247 118,496 150,969 (2,894) 148,075 (156) 5,750 647 362 311,165 127,459 26,970 19,589 4,836 43,567 222,421 88,744 1,722 90,466 90,466 3.98 3.86 22,109 20,741 22,570 31,385 18,943 7,202 122,950 36,165 104,584 60,791 201,540 80,965 2,523 83,488 118,052 (2,986) 115,066 (4,254) - 233 56 234,051 100,104 16,843 17,275 2,709 25,902 162,833 71,218 (380) 70,838 70,838 3.14 3.07 Financials 28 Consolidated Statement of Changes in Shareholders' Equity and Comprehensive Income For the year ended 31 December (In $ thousands) Share capital Authorised: 70,000,000 shares (2003: 70,000,000 shares) of par value $1.00 each Issued Issued and outstanding at beginning of year (January 2004: 22,335,533 shares; January 2003: 20,443,030 shares) Dividend reinvestment (December 2004: 207,109 shares; December 2003: 234,027 shares) Stock dividend (December 2004: 2,217,927 shares; December 2003: 2,037,470 shares) Shares repurchased and cancelled (December 2004: 459,232 shares; December 2003: 378,994 shares) Issued and outstanding at end of year (December 2004: 24,301,337 shares; December 2003: 22,335,533 shares) Additional paid in capital Balance at beginning of year Dividend reinvestment Stock dividend Issued under executive and employee share plans Shares repurchased and cancelled Balance at end of year Retained earnings Balance at beginning of year Net income for year Cash divided on common shares Stock dividend Balance at end of year 2004 2003 22,335 20,443 207 2,218 (459) 234 2,037 (379) 24,301 22,335 149,454 8,659 89,941 413 (18,972) 229,495 124,002 90,466 214,468 (33,635) (92,159) 88,674 84,692 7,854 68,500 1,219 (12,811) 149,454 151,172 70,838 222,010 (27,471) (70,537) 124,002 Appropriate retained earnings – general reserve 100,000 100,000 Accumulated other comprehensive income Net unrealised gains on translation of net investment in foreign operations Net unrealised gains on available for sale securities Net unrealised losses on cash flow hedges Balance at end of year Treasury stock Balance at beginning of year (January 2004:1,692,698 shares; January 2003: 1,839,743 shares) Purchases and forfeitures Balance at end of year (December 2004: 1,556,476 shares; December 2003: 1,692,698 shares) Total shareholders' equity Comprehensive income Net income Other comprehensive income (loss) Total comprehensive income The accompanying notes are an integral part of these consolidated financial statements. 17,362 4,455 201 (10,987) 11,031 (31,058) 5,587 (25,471) 11,432 8,915 63 (3,048) 17,362 (36,449) 5,391 (31,058) 428,030 382,095 90,466 (6,331) 84,135 70,838 5,930 76,768 Consolidated Statement of Cash Flows For the year ended 31 December (In $thousands) Cash Flows From Operating Activities Net income for the year Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortisation Change in carrying value of investment in affiliate Gain on sale of affiliate Provision for loan losses Increase in accrued interest receivable Increase in other assets Decrease (increase) in accrued interest payable Increase in other liabilities Net change in trading account securities Cash provided by operating activities Cash Flows From Investing Activities Term deposits with banks Additions to premises, equipment and computer software Net change in loans Held to maturity securities: proceeds from maturities Purchases Available for sale securities: purchases Net proceeds on sale of affiliate Net purchase of subsidiaries Cash used in investing activities Cash Flow From Financing Activities Increase in demand and term deposit liabilities Issuance of subordinated capital and senior debt Proceeds from dividend re-investment plan Redemption of shares Treasury stock Cash dividends Cash (used in) / from financing activities Effect of exchange rates on cash and from demand deposits with banks Net increase in cash and demand deposits with banks Cash and demand deposits with banks: beginning of year Cash and demand deposits with banks: end of year Supplemental disclosure of cash flow information Amount of interest paid in the year Amount of income tax paid in the year The accompanying notes are an integral part of these consolidated financial statements. 29 2004 2003 90,466 70,838 18,390 1,543 (5,750) 2,894 (8,015) (6,549) 1,488 23,473 117,940 13,561 131,501 647,946 (34,732) (432,538) 623,860 (765,797) (2,008) 8,250 (116,626) (71,645) 19,718 10,000 8,866 (19,431) 5,587 (32,217) (7,477) 350 52,729 111,702 164,431 14,880 2,032 - 2,986 (1,515) (11,777) (366) 14,475 91,553 (61,407) 30,146 (823,913) (13,100) (131,092) 400,593 (863,215) (6,414) - (31,063) (1,468,204) 1,463,003 50,000 8,088 (13,190) 5,391 (26,809) 1,486,483 174 48,599 63,103 111,702 117,008 1,649 83,854 1,078 Financials 30 Notes to Consolidated Financial Statements For the year ended 31 December 2004 (All amounts are expressed in thousands of Bermuda dollars unless otherwise stated) NOTE 1: Significant Accounting Policies (a) Basis of Presentation The accounting and financial reporting policies of The Bank of N.T. Butterfield & Son Limited (The Bank) and its subsidiaries conform to Generally Accepted Accounting Principles in the United States of America (GAAP). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Such estimates are subject to change in the future as additional information becomes available or previously existing circumstances are modified. (b) Basis of Consolidation The Bank consolidates subsidiaries where it holds, directly or indirectly, more than 50% of the voting rights or where it exercises control. Entities where the Bank holds 20% to 50% of the voting rights and/or has the ability to exercise significant influence, other than investments of designated venture interest entities (VIEs), are accounted for under the equity method, and the pro rata share of their income (loss) is included in other income. The Bank consolidates entities deemed to be variable interest entities when the Bank is determined to be the primary beneficiary under SFAS Interpretation No. 46 Consolidation of Variable Interest Entities (FIN 46). (c) Foreign Currency Translation Assets, liabilities, revenues and expenses denominated in US dollars are translated to 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 transaction date. The resulting gains or losses are included in foreign exchange revenue in the Consolidated Statement of Income. The assets and liabilities of foreign currency based subsidiaries are translated at the rate of exchange prevailing on the balance sheet date while associated revenues and expenses are translated to Bermuda dollars at the average rates of exchange prevailing throughout the period. Unrealised translation gains or losses on investments in foreign currency based subsidiaries are recorded as a separate component of shareholders' equity within accumulated other comprehensive income. Such gains and losses are recorded in the Consolidated Statement of Income only when realised. (d) Assets Held in Trust or Custody Securities and properties (other than cash and deposits held with the Bank and its subsidiaries) held in trust, custody, agency or fiduciary capacity for customers are not included in the Consolidated Balance Sheet since the Bank is not the beneficiary of these assets. (e) Investments Investments include debt and equity securities. Debt securities include bonds, notes, redeemable preferred stock, as well as certain loan or asset backed and structured securities subject to prepayment risk. Equity securities include common and non-redeemable preferred stocks. Debt securities classified as "held to maturity" represent securities that the Bank has both the ability and the intent to hold until maturity and are carried at amortised cost adjusted to recognise other than temporary impairment, except for money market mutual funds which are carried at market value, which approximates cost plus accrued and reinvested interest since acquisition. Debt securities and marketable equity securities classified as "available for sale" are carried at fair value, with unrealised gains and losses reported in Other Comprehensive Income. Debt and equity securities classified as "trading" securities are carried at fair value, with the unrealised gains and losses included in the Consolidated Statement of Income as gains and losses on trading. Fair value is determined based on the quoted market price when available or, if quoted market prices are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment. In respect of held to maturity or available for sale securities, declines in fair value that are determined to be other than temporary are charged to earnings. Accrual of income is suspended in respect of debt securities that are in default, or on which it is unlikely that future interest payments will be made as scheduled. Realised gains and losses on sales of investments are included in earnings on a specific identified cost basis. 31 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 materially from the values that would be determined by negotiations held between parties in a sales transaction. (f) Loans Loans are reported at the principal amount outstanding, net of allowance for credit losses, unearned income and net deferred loan fees. Interest income is recognised over the term of the loan using the interest method, or on a basis approximating a level rate of return over the term of the loan, except for loans classified as non-accrual. Non-accrual loans are those on which the accrual of interest is discontinued. Loans are placed on non-accrual status immediately if, in the opinion of management, full payment of principal or interest is in doubt or when principal or interest is 90 days past due, 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. Interest accrued but not collected at the date a loan is placed on non-accrual status is reversed against interest income. In addition, the amortisation of net deferred loan fees is suspended. Interest income on non-accrual loans is recognised only to the extent it is received in cash. However, where there is doubt regarding the ultimate collectivity of the loan principal, all cash thereafter received is applied to reduce the carrying value of the loan. Loans are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured. Credit card loans that are contractually 180 days past due and consumer loans with an outstanding balance under $100,000 that are contractually 180 days past due are automatically written off. The Bank accounts for and discloses non-accrual commercial loans as impaired loans, and recognises their interest income as previously discussed for non-accrual loans. Accordingly, interest income on these loans is recognised after the entire recorded investment is recovered, and interest is actually received. In addition, the amortisation of net deferred loan fees is suspended. (g) Allowance for Credit Losses The Bank maintains an allowance for credit losses, which in management’s opinion is adequate to absorb all incurred 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. (h) Specific Provisions Specific provisions are determined on an item by item basis and reflect the associated estimated credit loss. The specific provision for loan loss is computed as the difference between the recorded investment in the loan and present value of expected future cash flows from the loan. The effective rate of return on the loan is used for discounting the cash flows. However, when foreclosure of a collateral-dependent loan is probable, the Bank measures impairment based on the fair value of the collateral. The Bank considers estimated costs to sell, on a discounted basis, in the measurement of impairment if those costs are expected to reduce the cash flows available to repay or otherwise satisfy the loan. If the measurement of an impaired loan is less than the recorded investment in the loan, then the Bank recognises impairment by creating a valuation allowance with a corresponding charge to bad debt expense. (i) General Provisions The allowance for credit losses attributed to the remaining portfolio is established through a process that estimates the probable loss inherent in the portfolio based upon various analyses. These analyses consider historical and projected default rates and loss severities, internal risk ratings, and geographic, industry, and other environmental factors. Management also considers overall portfolio indicators including trends in internally risk rated exposures, cash-basis loans, historical and forecasted write-offs, and a review of industry, geographic and portfolio concentrations, including current developments within those segments. In addition, management considers the current business strategy and credit process, including limit setting and compliance, credit approvals, loan underwriting criteria and loan workout procedures. Each portfolio of smaller balance, homogeneous loans, including consumer mortgage, installment, revolving credit, and most other consumer loans, is collectively evaluated for impairment. The allowance for credit losses attributed to these loans is established via a process that estimates the probable losses inherent in the portfolio, based upon various analyses. Management considers overall portfolio indicators including historical credit losses; delinquent, non-performing, and classified loans; trends in volumes and terms of loans; an evaluation of overall credit quality; the credit process, including lending policies and procedures; and economic, geographical, product, and other environmental factors. Financials 32 (j) Business Combinations, Goodwill and Intangible Assets All business combinations are accounted for using the purchase method. Identifiable intangible assets (mostly customer relationships) are recognised separately from goodwill and are initially valued using discounted cash flow calculations and other recognised valuation techniques. Goodwill represents the excess of the price paid for the acquisition of a business over the fair value of the net assets acquired. Goodwill is not amortised but is tested at least annually for impairment at the reporting unit level, if events or circumstances such as adverse changes in the business climate indicate there may be impairment. If the carrying amount of a reporting unit, including the allocated goodwill, exceeds its fair value, goodwill impairment is measured as the excess of the carrying amount of the reporting unit's allocated goodwill over the implied fair value of the goodwill. Other acquired intangible assets with finite lives are amortised on a straight line basis over their estimated useful lives, not exceeding 15 years. An impairment test is carried out if certain indicators of impairment exist. (k) Premises, Equipment and Computer Software Premises, equipment and software, including leasehold improvements, are carried at cost less accumulated depreciation. The Bank generally computes depreciation using the straight-line method over the estimated useful life of an asset, which is 50 years for premises, and 3 to 10 years for other equipment. For leasehold improvements the Bank uses the straight-line method over the lesser of the remaining term of the leased facility or the estimated economic life of the improvement. The Bank capitalises certain costs associated with the acquisition or development of internal use software. Once the software is ready for its intended use, these costs are amortised on a straight-line basis over the software's expected useful life, which is 5 years. If deemed significant the Bank will capitalise interest cost in accordance with SFAS No. 34 Capitalisation of Interest Cost. (l) Derivatives In accordance with SFAS No. 133, all derivatives are recognised on the Consolidated Balance Sheet at their fair value. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138 and No. 149, establishes accounting and reporting standards for financial derivatives, including certain financial derivatives embedded in other contracts and hedging activities. On the date that the Bank enters into a derivative contract, it designates the derivative as either: a hedge of the fair value of a recognised asset or liability (a fair value hedge); a hedge of a forecasted transaction or the variability of cash flows that are to be received or paid in connection with a recognised asset or liability (a cash flow hedge), or an instrument that is held for trading or non-hedging purposes (a trading or non-hedging instrument). Changes in the fair value of a derivative that is highly effective, and that is designated and qualifies as a fair value hedge, along with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk, are recorded in current period earnings. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash flow hedge, to the extent that the hedge is effective, are recorded in other comprehensive income, until earnings are affected by the variability of cash flows of the hedged transaction. Any hedge ineffectiveness is recorded in current period earnings. Changes in the fair value of a derivative that is highly effective as and that is designated and qualifies as a foreign currency hedge is recorded in either current period earnings or other comprehensive income, depending on whether the hedging relationship satisfies the criteria for a fair value or cash flow hedge. If, however, a derivative is used as a hedge of a net investment in a foreign operation, the changes in the derivative’s fair value, to the extent that the derivative is effective as a hedge, are recorded in the cumulative translation adjustment account within other comprehensive income. Changes in the fair value of derivative trading and non-hedging instruments are reported in current period earnings. The Bank formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair value, cash flow, or foreign currency hedges to specific assets and liabilities on the consolidated balance sheet or specific firm commitments or forecasted transactions. The Bank also formally assesses whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative has ceased to be highly effective as a hedge, the Bank discontinues hedge accounting prospectively. For those hedge relationships that are terminated, hedge designations that are removed, or forecasted transactions that are no longer expected to occur, the hedge accounting treatment described in the paragraphs above is no longer applied and the end-user derivative is terminated or transferred to the trading account. For fair value hedges, any changes to the hedged item remain as part of the basis of the asset or liability and are ultimately reflected as an element of the yield. For cash flow hedges, any changes in fair value of the end-user derivative remain in other comprehensive income and are included in retained earnings of future periods when earnings are also affected by the variability of the hedged cash flows. If the forecasted transaction is no longer likely to occur, any changes in fair value of the end-user derivatives are immediately reflected in other income. 33 (m) Employee Future Benefits The Bank maintains trusteed pension plans for substantially all employees including non-contributory defined benefit plans 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. The Bank’s defined benefit pension plans are accounted for with SFAS 87 and SFAS 88. It’s postretirement medical and life insurance plans are accounted for in accordance with SFAS 106. 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. 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 an annual contribution based on each participating employee's pensionable earnings. Amounts paid are expensed in the period. (n) 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. (o) Revenue Recognition Trust and investment services fees include fees for private and institutional trust, executorship, and custody services. These fees are recognised as revenue when the Bank has rendered all services to the clients and is entitled to collect the fee from the client, as long as there are no other contingencies associated with the fee. Asset management fees include fees for investment management, investment advice and brokerage services. Investment management fees are recognised over the period in which the related service is provided, on a net asset value basis. Investment advice and brokerage services fees are recognised in the period in which the related service is provided. Investment and pension fund administration fees include fees for pension fund administration, institutional fund administration, registration and transfer agent and corporate services. Pension and institutional fund administration fees are recognised as revenue when the Bank has rendered all services to the clients and is entitled to collect the fee from the client, as long as there are no other contingencies associated with the fee. All other fees are recognised as revenue over the period of the relationship. Banking services fees primarily include fees for certain loan origination, letters of credit, other financial guarantees, compensating balances and other financial services related products. Certain loan origination fees are primarily overdraft and other revolving lines of credit fees. These fees are recognised as revenue over the period of the underlying facilities. Letters of credit fees are recognised as revenue over the period in which the related service is provided. All other fees are recognised as revenue in the period in which the service is provided. Loan interest income includes the amortisation of non-refundable loan origination and commitment fees. These fees are deferred (except for certain retrospectively determined fees meeting specified criteria) and recognised as an adjustment of yield over the life of the related loan. In accordance with SFAS No. 91 Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, these loan origination and commitment fees are offset by their related direct cost and only the net amounts are deferred and amortised into interest income. 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. Financials 34 (p) Fair Value of Financial Instruments The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The accounting for an asset or liability may differ based on the type of instrument and / or its use in a trading or investing strategy. Generally, the measurement framework recorded in financial statements is based on of the following: – At fair value on the Consolidated Balance Sheet, with changes in fair value recorded each period in the Consolidated Statement of Income. – At fair value on the Consolidated Balance Sheet, with changes in fair value recorded each period as a separate component of shareholders' equity and as part of other comprehensive income. – At cost (less other than temporary impairments), with changes in fair value not recorded in the financial statements but disclosed in the notes. – At the lower of cost or fair value. 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. 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: i) 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 is based upon quoted market prices where available. ii) iii) Loans: The majority of loans are variable rate and re-priced 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. iv) Accrued interest: The carrying values of accrued interest receivable and payable are assumed to approximate their fair values given their short-term nature. v) 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. vi) Subordinated capital: The fair value of the subordinated capital is based on current market pricing. vii) 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. (q) Credit Related Arrangements In the normal course of business, the Bank enters into various commitments to meet the credit requirements of its customers. Such commitments, which are not included in the Consolidated Balance Sheets, include: i) ii) Commitments to extend credit which represent undertakings to make credit available in the form of loans or other financing for specific amounts and maturities, subject to certain conditions. Standby letters of credit, which represent irrevocable obligations to make payments to third parties in the event that the customer is unable to meet its financial obligations. iii) Documentary and commercial letters of credit, primarily related to the import of goods into Bermuda by customers, which represent agreements to honor drafts presented by third parties upon completion of specific activities. These credit arrangements are subject to the Bank's normal credit standards and collateral is obtained where appropriate. The contractual amounts for these commitments set out in the table in Note 11 represent the maximum payments the Bank would have to make should the contracts be fully drawn, the counterparty default, and any collateral held prove to be of no value. As many of these arrangements will expire or 35 terminate without being drawn upon or fully collateralised, the contractual amounts do not necessarily represent future cash requirements. The Bank does not carry any liability for these obligations. (r) Income Taxes The Bank uses the asset and liability method whereby income taxes reflect the expected future tax consequences of temporary differences between the financial statements carrying amounts of assets and liabilities and their respective tax bases. Accordingly, a deferred income tax asset or liability is determined for each temporary difference based on the enacted tax rates to be in effect on the expected reversal date of the temporary difference. Income taxes on the Consolidated Statement of Income include the current and deferred portions of the income taxes. Income taxes applicable to items charged or credited directly to shareholders’ equity are included in such items. Net deferred income taxes assets or liabilities accumulated as a result of temporary differences are included in other assets or other liabilities, respectively. A valuation allowance is established to reduce deferred income tax assets to the amount more likely than not to be realised. (s) Consolidated Statement of Cash Flows For the purposes of the Consolidated Statement of Cash Flows, cash and demand deposits with banks include cash and demand deposits; vault cash and cash in transit where the Bank holds the related assets. (t) Earnings Per Share Earnings per share has been calculated using the weighted average number of shares outstanding during the year and adjusted for the stock dividends declared during the year ended 31 December 2004 and 2003 (see also Note 18). The dilutive effect of stock options was calculated using the treasury stock method, whereby the proceeds received from the exercise of stock options are assumed to be used to repurchase outstanding shares, using the quarterly average market price of the Bank’s shares for the period. (u) Consolidation of Variable Interest Entities In December 2003 the FASB issued interpretation No. 46(R), Consolidation of Variable Interest Entities. This interpretation addresses consolidation by a business enterprise of a VIE. FIN 46(R) requires a variable interest holder to consolidate the VIE if that party will absorb a majority of the expected losses of the VIE, receive a majority of residual returns of the VIE, or both. This party is considered the primary beneficiary of the entity. The determination of whether a firm meets the criteria to be considered the primary beneficiary of a VIE requires an evaluation of all transaction (such as investments, loans and fee arrangements) with the entity. The foundation of this evaluation is an expected-loss calculation prescribed by FIN 46(R) (note 23). (v) Impairment or Disposal of Long-Lived Assets An impairment loss is 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 is 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 are 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 of sale. NOTE 2: Significant Acquisitions On 2 February 2004, the Bank acquired all the outstanding shares of Deerfield Fund Services Limited, a fund administration services provider based in The Bahamas for $4.3 million paid in cash. The company was renamed Butterfield Fund Services (Bahamas) Limited in 2004. On 5 February 2004, the Bank announced that Bank of Butterfield (UK) Limited had made a cash offer for the entire and to be issued share capital of Leopold Joseph Holdings plc. (Leopold Joseph) subject to Leopold Joseph shareholder and appropriate regulatory approvals. The cash offer was £9.50 in cash per Leopold Joseph share, valuing the existing issued share capital of Leopold Joseph at approximately £55.1 million ($103.6 million). The offer price, which had the unanimous recommendation of the directors of Leopold Joseph, represented 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. On 2 April 2004, the Bank announced that it had acquired all the outstanding common shares of Leopold Joseph and that all the conditions of the Bank's offer had been satisfied unconditionally. The principal activities of Leopold Joseph were private banking, treasury, investment management, offshore company administration and trust services to companies and high net worth individuals and families. The company was renamed Butterfield Bank (UK) Limited in 2004. Financials 36 On 8 October 2004, the Bank acquired all outstanding shares of Grosvenor Trust Company Limited (Grosvenor) a specialist trust business based in Bermuda for $8.7 million. The total consideration in respect of this acquisition was paid in cash. On 4 March 2003, the Bank acquired Promisant (Technology) Limited (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. During 2003 PHL was wound down and the Bank wrote-off its remaining investment of $4.6 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. 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 $11.9 million and was paid in cash. Subsequent to the acquisitions, the Bank merged the operations of the two companies into Butterfield Bank (Bahamas) Limited and these results are included in the Consolidated Statement of Income from the dates of their acquisition. 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 $18.1 million and was paid in cash. The company was renamed Butterfield Bank (Barbados) Limited in 2004. The following table summarises the total consideration in respect of significant acquisitions. Fair value of assets acquired Cash and deposits with banks Investments Loans Premises, equipment and computer software Intangible assets – Customer relationships Intangible assets – Goodwill Other assets Total assets Fair value of liabilities assumed Deposits Other liabilities Subordinated capital Total liabilities Fair value of identifiable net assets acquired Total purchase consideration Deerfield 2004 Leopold Joseph Grosvenor Total 205 - - 173 2,700 1,031 290 4,399 - 149 - 149 4,250 4,250 78,957 497,258 260,971 4,126 32,439 13,695 13,466 900,912 765,155 23,229 8,892 797,276 103,636 103,636 396 - - 41 8,337 - 988 9,762 - 1,022 - 1,022 8,740 8,740 79,558 497,258 260,971 4,340 43,476 14,726 14,744 915,073 765,155 24,400 8,892 798,447 116,626 116,626 2003 Total 50,712 42,901 61,517 3,486 11,446 6,112 5,029 181,203 139,513 10,627 - 150,140 31,063 31,063 37 NOTE 3: Cash and Deposits with Banks 31 December Unrestricted Non-interest earning Cash and demand deposits Bermuda Other currencies Total Bermuda Other currencies Total 2004 2003 118,975 25,651 144,626 69,468 24,201 93,669 Interest earning Cash and demand deposits Term deposits maturing within six months Term deposits maturing within six to twelve months Sub-total – Interest earnings 124,688 10,000 - 134,688 160,042 284,730 1,898,352 1,908,352 39,211 2,097,605 2,232,293 39,211 - - - - 92,079 92,079 2,570,321 2,570,321 138,281 2,800,681 2,800,681 138,281 Total unrestricted cash and deposits Affected by drawing restrictions related to minimum reserve and derivative margin requirements Non-interest earning Cash and demand deposits Total cash and deposits with Banks 253,663 2,123,256 2,376,919 69,468 2,824,882 2,894,350 1,535 255,198 18,270 19,805 2,141,526 2,396,724 - 69,468 18,033 18,033 2,842,915 2,912,383 NOTE 4: Investments Trading Trading assets include debt and equity securities held for trading purposes that the Bank owns ("long" positions). Included in trading assets are the reported receivables (unrealised gains) and payables (unrealised losses) related to derivatives. These amounts include the effect of netting as permitted under FASB Interpretation No. 39 Offsetting Amounts Related to Certain Contracts (FIN 39). Trading positions are carried at fair value on the Consolidated Balance Sheet. 31 December Trading revenue Equities (a) Fixed income and other (b) Total (a) Includes equity securities and equity derivatives. (b) Includes bonds and commercial paper, and interest rate and foreign exchange derivatives. Trading assets The following table presents the fair value of trading assets and liabilities for the dates indicated: 31 December Debt and equity instruments Certificates of deposit, bankers acceptances and commercial paper Debt securities issued by non-US governments Corporate securities and other Total net trading The following table presents realised gains and losses from available for sale securities: 31 December Realised gains Realised losses Net realised gains 2004 2003 307 340 647 147 86 233 2004 2003 628,147 12,475 3,273 643,895 153,943 - 5,608 159,551 2004 362 - 362 2003 56 - 56 Financials 38 Available for Sale The amortised cost and estimated fair value of available for sale and held to maturity securities were as follows for the dates indicated: 2004 2003 31 December Available for sale Corporate debt securities Equity securities Other, primarily asset-backed securities Total available for sale Held to maturity US government and federal agencies/corporations Collateralised mortgage obligations Debt securities issued by non-US governments Corporate debt securities Other, primarily asset-backed securities Total held to maturity Gross Amortised unrealised unrealised (losses) Gross gains cost Fair value Gross Gross Amortised unrealised unrealised (losses) gains cost Fair value 26,304 2,890 223 29,417 - 264 - 264 - - - - 26,304 3,154 223 29,681 23,966 3,563 223 27,752 - 63 - 63 - - - - 23,966 3,626 223 27,815 85,421 242,249 364 111 (36) (378) 85,749 241,982 40,480 414,867 57,246 2,023,810 228 3,560 (4) 179,618 57,470 (1,363) 2,026,007 1,739,847 1,343 1,519 1,719 4,956 - (226) 41,823 416,160 181,238 (99) (676) 1,744,127 184,098 2,592,824 335 4,598 (8,452) 175,981 (10,233) 2,587,189 76,075 2,450,887 468 10,005 (6,822) 69,721 (7,823) 2,453,069 Investments include $707,165 (2003: $538,457) of fixed-rate instruments and $2,521,170 (2003: $1,921,973) of floating-rate instruments. The approximate yield on floating rate securities at 31 December 2004 was 2.69% (2003: 1.79%), while the approximate yield on fixed rate securities was 5.31% (2003: 4.53%). The following table presents the maturity of securities by remaining term to maturity: 31 December 2004 Available for sale Corporate debt securities Equity securities Other, primarily asset backed securities Total available for sale Held to maturity US government and federal agencies/corporations Collateralised mortgage obligations Debt securities issued by non-US governments Corporate debt securities Other, primarily asset-backed securities Total held to maturity Remaining term to maturity Within 3 months 3 to 12 months 1 to 5 years Over 5 years No specific maturity Carrying value 24,934 - - 24,934 - - - - - - - - 19,983 - 5,755 379,834 - 405,572 20,191 - 7,935 318,226 - 346,352 - 32,168 35,048 1,300,871 37,617 1,405,704 1,370 - - 1,370 45,248 210,081 18,723 9,984 120,523 404,559 - 3,154 223 3,377 - - 4,667 - 25,970 30,637 26,304 3,154 223 29,681 85,422 242,249 72,128 2,008,915 184,110 2,592,824 39 31 December 2004 Trading Debt and equity instruments Certificates of deposit, bankers acceptances and commercial paper Debt securities issued by non-US governments Corporate securities and other Total debt and equity instruments Remaining term to maturity Within 3 months 3 to 12 months 1 to 5 years Over 5 years No specific maturity Carrying value 513,966 - - 513,966 114,181 747 - 114,928 - 3,376 - 3,376 - 8,353 - 8,353 - - 3,272 3,272 628,147 12,476 3,272 643,895 Total investments 944,472 461,280 1,409,080 414,282 37,286 3,266,400 Total by currency (in US dollars equivalent) Bermuda dollars US dollars Other Total Investments - 339,861 604,611 944,472 - 289,273 172,007 461,280 - 1,326,445 82,635 1,409,080 - 379,236 35,046 414,282 3,154 32,448 1,684 37,286 3,154 2,367,263 895,983 3,266,400 Remaining term to maturity Within 3 months 3 to 12 months 1 to 5 years Over 5 years - - - - - - - - - - - - - 15,004 8,491 285,632 - 309,127 40,479 17,029 162,295 1,065,198 5,587 1,290,588 - 382,787 26,176 - 53,670 462,633 No specific maturity - 3,626 223 3,849 - - - - 16,821 16,821 Carrying value 23,966 3,626 223 27,815 40,479 414,867 196,962 1,722,501 76,078 2,450,887 31 December 2003 Available for sale Corporate debt securities Equity securities Other, primarily asset-backed securities Total available for sale Held to maturity US government and federal agencies/corporations Collateralised mortgage obligations Debt securities issued by non-US governments Corporate debt securities Other, primarily asset-backed securities Total held to maturity Trading Debt and equity instruments Certificates of deposit, bankers acceptances and commercial paper Corporate securities and other Total debt and equity instruments 23,966 - - 23,966 - 47 - 371,671 - 371,718 153,943 - 153,943 - - - - - - - - - - 5,608 5,608 153,943 5,608 159,551 Total investments 549,627 309,127 1,290,588 462,633 26,278 2,638,253 Total by currency (in US dollars equivalent) Bermuda dollars US dollars Other Total investments - 373,375 176,252 549,627 - 285,562 23,565 309,127 - 1,118,268 172,320 1,290,588 - 420,732 41,901 462,633 3,626 21,030 1,622 26,278 3,626 2,218,967 415,660 2,638,253 Financials 40 NOTE 5: Loans The composition of the loan portfolio at each of the indicated dates was as follows: 31 December Commercial loans Commercial and industrial Commercial real estate: Commercial mortgages Construction Financial institutions Government Total commercial loans Less allowance for credit losses on commercial loans Total commercial loans after allowance for credit losses Consumer loans Credit card Automobile financing Mortgages Other consumer Total consumer loans Less allowance for credit losses on consumer loans Total consumer loans after allowance for credit losses Total loans Less allowance for credit losses Net loans 2004 Non- Bermuda Bermuda Total Bermuda 2003 Non- Bermuda Total 375,390 121,765 497,155 314,547 97,845 412,392 61,500 134,839 249,520 24,853 846,102 (10,588) 835,514 34,814 47,099 702,200 73,881 857,994 (5,578) 852,416 1,704,096 (16,166) 1,687,930 306,186 5,164 63,217 13,983 510,315 (3,051) 507,264 16,618 8,102 207,562 222,459 454,741 (4,604) 450,137 965,056 (7,655) 957,401 367,686 140,003 312,737 38,836 1,356,417 (13,639) 1,342,778 51,432 55,201 909,762 296,340 1,312,735 (10,182) 1,302,553 60,964 38,384 245,980 11,500 671,375 (11,010) 660,365 31,596 45,421 631,946 71,125 780,088 (5,929) 774,159 2,669,152 (23,821) 2,645,331 1,451,463 (16,939) 1,434,524 90,104 2,389 36,324 23,703 250,365 (2,676) 247,689 13,701 7,250 171,244 82,579 274,774 (2,271) 272,503 525,139 (4,947) 520,192 151,068 40,773 282,304 35,203 921,740 (13,686) 908,054 45,297 52,671 803,190 153,704 1,054,862 (8,200) 1,046,662 1,976,602 (21,886) 1,954,716 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 periods of up to thirty 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 2004 is 6.32% (2003: 5.88%). During the year loans of $35 million were purchased from other parties at fair value. The premium or discount over book value is amortised over the life of the loan. The table below sets forth information about the Bank's impaired loans: 31 December Commercial loans – Bermuda Commercial loans – Non-Bermuda Consumer loans and credit cards – Bermuda Consumer loans and credit cards – Non-Bermuda Mortgages – Bermuda Mortgages – Non-Bermuda Total Gross 2,557 9,019 1,072 726 1,203 5,895 20,472 2004 Allowance (716) (484) (237) (374) - (107) (1,918) Total 1,841 8,535 835 352 1,203 5,788 18,554 Gross 4,802 4,585 1,393 1,044 1,831 3,711 17,366 2003 Allowance (2,197) (1,030) (233) (308) - (181) (3,949) Total 2,605 3,555 1,160 736 1,831 3,530 13,417 For the year ended 31 December 2004, the amount of gross interest income that would have been recorded had impaired loans been current was $2,666 (2003: $2,933). For the year ended 31 December 2004, the Bank recovered overdue interest of $172 (2003: $59) on impaired loans that were repaid in the year. The average balance of impaired loans during the year ended 31 December 2004 was $18,429 (2003: $20,572). 41 The table below summarises the changes in the allowance for loan losses: 31 December Allowance for loan losses at beginning of year Allowance this year Recoveries Charge-off Other Allowance for loan losses at end of year Specific Provisions 3,949 723 2,215 (5,330) 361 1,918 2004 General Provisions 17,937 2,171 3,204 (1,053) (356) 21,903 Total 21,886 2,894 5,419 (6,383) 5 23,821 Specific Provisions 7,624 (345) 5,163 (9,095) 602 3,949 2003 General Provisions 17,686 3,331 (2,968) (48) (64) 17,937 Total 25,310 2,986 2,195 (9,143) 538 21,886 The table below presents information about loan delinquencies and net charge-offs: 31 December Credit card Automobile financing Other consumer Consumer loans Commercial loans Total loans reported Total 2004 Loans 90 delinquent days or more past due loans Net charge-offs Total 2003 Loans 90 delinquent days or more past due loans 3,812 872 25,882 30,566 12,563 43,129 587 569 12,969 14,125 11,168 25,293 763 554 1,286 2,603 3,780 6,383 2,775 665 21,150 24,590 13,448 38,038 927 167 11,973 13,067 9,559 22,626 Net charge-offs 1,336 161 704 2,201 6,942 9,143 NOTE 6: Credit Risk Concentrations Concentrations of credit risk arise when a number of customers are engaged in similar business activities, are in the same geographic region, or when they have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions. The Bank regularly monitors various segments of its credit risk portfolio to assess potential concentrations of risks and to obtain collateral when deemed necessary. In the Bank's commercial portfolio, risk concentrations are primarily evaluated by industry and also by geographic region. In the consumer portfolio, concentrations are primarily evaluated by products. Credit exposures includes loans, guarantees and acceptances, letters of credit and commitments for undrawn lines of credit. The following table summarises the credit exposure of the Bank by business sector: 31 December Primary industry and manufacturing Commercial and merchandising Real estate Transport and communication Bank and financial services Governments Individuals Sub-total General provisions Total 2004 95,155 572,940 1,340,454 56,322 938,413 38,474 944,747 3,986,505 (21,903) 3,964,602 2003 59,609 570,035 825,864 32,047 1,018,962 35,203 519,944 3,061,664 (17,937) 3,043,727 Financials 42 The following table summarises the credit exposure by the Bank by region: 31 December Bermuda Barbados Cayman Guernsey The Bahamas UK Sub-total General provision Total 2004 2,752,005 84,148 428,962 225,902 2,904 492,584 3,986,505 (21,903) 3,964,602 2003 2,364,581 61,446 408,257 134,348 - 93,032 3,061,664 (17,937) 3,043,727 NOTE 7: Premises, Equipment and Computer Software The following table summarises premises, equipment and computer software: 31 December Land Buildings Equipment Computer software Total 31 December Depreciation Buildings and equipment (included in property expense) Software (included in systems and communication expense) Total depreciation charged to operating expenses 2004 Accumulated Depreciation - 30,633 47,281 39,079 116,993 Net carrying value 12,345 75,274 14,881 23,531 126,031 Cost 12,345 90,183 57,699 45,728 205,955 Cost 12,345 105,907 62,162 62,610 243,024 2003 Accumulated Depreciation - 28,683 45,676 31,617 105,976 Net carrying value 12,345 61,500 12,023 14,111 99,979 2004 2003 6,686 6,334 13,020 5,815 6,707 12,522 The Bank has outstanding capital commitments of approximately $25 million as at 31 December 2004 in respect of building refurbishments and system improvements. During the year the Bank capitalised certain cost associated with the development of software amounting to $16.9 million. These costs are included in computer software costs above. 43 Note 8: Goodwill and Other Intangible Assets The following table presents the goodwill and other intangible assets by business segment: Goodwill Business segment Barbados Guernsey Balance as at 31 December 2002 Goodwill acquired during the year Foreign exchange translation adjustment Balance as at 31 December 2003 Goodwill acquired during the year Foreign exchange translation adjustment Balance as at 31 December 2004 Other Intangibles 31 December Bermuda Barbados Cayman Guernsey The Bahamas UK Customer relationships - 5,220 - 5,220 - - 5,220 Gross carrying amount 8,337 6,681 1,211 50,740 7,790 19,831 94,590 2,720 - 294 3,014 4,758 419 8,191 2004 Accumulated amortisation (139) (482) (27) (10,202) (1,067) (1,268) (13,185) The Bahamas - 892 - 892 1,031 - 1,923 Net carrying amount 8,198 6,199 1,184 40,538 6,723 18,563 81,405 United Kingdom - - - - 8,937 367 9,304 Gross carrying amount - 6,488 - 35,265 5,090 - 46,843 Total 2,720 6,112 294 9,126 14,726 786 24,638 2003 Accumulated amortisation - - - (7,675) (140) - (7,815) Net carrying amount - 6,488 - 27,590 4,950 - 39,028 There have been no impairment losses for the years ended 31 December 2004 and 2003. The estimated aggregate amortisation expense for each of the succeeding years until 31 December 2008 is $6.6 million. Customer relationships are valued based on the present value of net cash flows expected to be derived solely from the recurring customer base existing as at the date of acquisition. Customer relationship intangible assets may or may not arise from contracts. During 2004, the Bank acquired new customer relationships for $44.9 million, the amortisation expenses amounted to $5.4 million. Financials 44 NOTE 9: Customer Deposits and Deposits from Banks (a) By maturity 31 December Customer and bank demand deposits Customer deposits – Current accounts – Non-Interest Bearing Customer deposits – Current accounts – Interest Bearing Sub-total – demand deposits 2004 2003 999,826 3,878,707 4,878,533 1,140,547 3,048,157 4,188,704 2,690,114 105,695 233,108 3,028,917 2,576,235 110,615 247,023 2,933,873 7,907,450 7,122,577 Customer and bank term deposits Term deposits maturing within six months Term deposits maturing within six to twelve months Term deposits maturing after twelve months Sub-total – term deposits Total (b) By Type and Location 31 December Bermuda Customers Banks Cayman Customers Banks Guernsey Customers Banks Other International Customers Banks Total The effective yield on deposits at 31 December 2004 was 2.2% (2003: 1.5%). 2004 2003 Payable On Demand Payable on a fixed date Payable Total On Demand Payable on a fixed date Total 2,098,322 223,951 1,069,535 - 3,167,857 223,951 2,087,514 241,768 1,461,037 - 3,548,551 241,768 1,528,645 - 438,140 184,943 1,966,785 184,943 1,308,029 - 387,237 151,767 1,695,266 151,767 524,102 5,711 756,042 488 1,280,144 6,199 379,574 4,938 474,067 19,891 853,641 24,829 497,802 - 4,878,533 492,267 87,502 3,028,917 990,069 87,502 7,907,450 166,881 - 4,188,704 347,963 91,911 2,933,873 514,844 91,911 7,122,577 45 NOTE 10: 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. The following table presents the financial position of the Bank’s defined benefit pension plans and the Bank’s post-retirement medical benefit plan. The benefit obligations and plan assets are measured as at 31 December. Accumulated benefit obligation at end of year 98,084 - 71,188 - 2004 Pension Plans Post-Retirement Medical Benefit Plan Pension Plans 2003 Post-Retirement Medical Benefit Plan Change in projected benefit obligation Projected benefit obligation at beginning of year New acquisitions Service cost Employee contributions Interest cost Benefits paid Past service cost Actuarial losses Foreign currency exchange rate changes Projected 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 contributions Employee contributions Benefits paid Foreign currency exchange rate changes Fair value of plan assets at end of year Funded status Excess (deficit) of plan assets over projected benefit obligation at end of year Employer contributions during the period from measurement date to fiscal year end Unamortised net actuarial loss Unamortised past service cost Net amount recognised 77,093 21,610 4,443 180 5,278 (3,496) 221 (2,002) 2,188 105,515 66,352 15,524 3,427 2,830 180 (3,496) 1,631 86,448 (19,067) 255 2,138 201 (16,473) 75,821 - 1,472 - 4,755 (560) - 1,036 - 82,524 - - - 560 - (560) - - 64,166 1,237 3,288 4 4,060 (3,268) - 6,114 1,492 77,093 58,203 982 7,767 1,656 4 (3,268) 1,008 66,352 (82,524) (10,741) - 36,874 - (45,650) - 2,544 - (8,197) 50,551 - 1,252 - 3,305 (1,919) - 22,632 - 75,821 - - - 1,919 - (1,919) - - (75,821) - 39,013 - (36,808) Financials 46 Amounts recognised in balance sheet consist of: Accrued benefit asset included in other assets Accrued benefit (liability) included in other liabilities Accumulated other comprehensive (income) Net amount recognised Annual benefit expense Service cost Interest cost Expected return on plan assets Amortisation of past service cost Amortisation of actuarial loss Defined benefit expense Defined contribution expense Total benefit expense 31 December Actuarial assumptions used to determine annual benefit expense Weighted average discount rate Weighted average rate of compensation increases Weighted average expected long-term rate of return on plan assets Weighted average annual medical cost increase rate Actuarial assumptions used to determine benefit obligations at end of year Weighted average discount rate Weighted average rate of compensation increases Weighted average annual medical cost increase rate 2004 Pension Plans Post-Retirement Medical Benefit Plan Pension Plans 2003 Post-Retirement Medical Benefit Plan (16,473) - (16,473) 4,443 5,278 (5,046) 28 21 4,724 3,121 7,845 (45,650) - (45,650) 1,472 4,755 - - 3,175 9,402 - 9,402 (9,013) 816 (8,197) 3,287 4,060 (3,937) - - 3,410 2,508 5,918 (36,808) - (36,808) 1,252 3,305 - - 1,272 5,829 - 5,829 2004 Pension Plans Post-Retirement Medical Benefit Plan Pension Plans 2003 Post-Retirement Medical Benefit Plan 5.75% 4.15% 6.55% N/A 5.60% 3.70% N/A 6.25% N/A N/A 12% to 5% in 2011 6.00% N/A 11% to 5% in 2011 6.35% 3.90% 6.85% N/A 5.85% 3.85% N/A 6.50% N/A N/A 6% to 5% in 2004 6.25% N/A 12% to 5% in 2011 For 2004, the effect of one percentage point increase or decrease in the assumed medical cost increase rate on the aggregate of service and interest costs is a $1.3 million increase and a $0.9 million decrease, respectively, and on the benefit obligation a $14 million increase and a $13 million decrease, respectively. To develop the expected long-term rate of return on assets assumption for each plan, the Bank considered the historical returns and the future expectations for returns for each asset class, as well as the target asset allocations of the funds. 47 The weighted average actual and target asset allocations of the pension plans by asset category, are as follows: 31 December Asset category Equity securities (including equity mutual funds) Equity/debt balanced mutual funds Debt securities (including debt mutual funds) Other Total 2004 2003 Actual Allocation Target Allocation Actual Allocation Target Allocation 46% 17% 31% 6% 100% 51% - 49% - 100% 39% 19% 35% 7% 100% 45% - 55% - 100% At 31 December 2004, 50.8% (2003: 49.9) of the assets of the pension plans were mutual funds and alternative investments managed or administered by wholly-owned subsidiaries of the Bank. On 31 December 1.8% (2003: 1.9%) of these mutual funds assets were invested in common shares of the Bank. The investments of the pension funds are diversified across a range of asset classes and are diversified within each asset class. The assets are generally actively managed with the goal of adding some incremental value through security selection and asset allocation. Estimated 2005 Bank contribution to, and estimated benefit payments for the next 10 years under, the pension and medical benefit plan are as follows: Estimated Bank contributions Estimated benefit payments Estimated benefit payments Estimated benefit payments Estimated benefit payments Estimated benefit payments Estimated benefit payments Year 2005 2005 2006 2007 2008 2009 2010-2014 Pension Plans 6,700 3,400 3,600 3,700 3,900 4,200 25,900 Post-Retirement Medical Benefit Plan 2,700 2,700 3,000 3,300 3,700 3,900 24,200 The projected benefit obligation and fair value of plan assets for pension plans with projected benefit obligations in excess of plan assets were $103 million and $84 million respectively, as at 31 December 2004 ($77 million and $66 million respectively, as at 31 December 2003). NOTE 11: Commitments, Credit Related Arrangements and Contingencies Commitments The Bank was committed to expenditures under contract for software development and construction of $8.7 million and $25 million respectively, as at 31 December 2004. Rental expense for premises leased on a long-term basis for the year ended 31 December 2004 amounted to $8.2 million (2003: $3.3 million). The following table summarises the Bank's commitments for construction, computer software development and long-term leases: Year 2005 2006 2007 2008 2009 2010 & thereafter 8,159 9,192 5,305 4,612 4,515 10,127 Total rental expense was as follows: Year ended 31 December Gross rentals Sub-lease rentals Net rental expense 2004 4,896 - 4,896 2003 2,134 (198) 1,936 Financials 48 Credit Related Arrangements The following table presents the credit related arrangements with contractual amounts representing credit risk as follows: 31 December Commitments to extend credit Commitments to invest Letters of Credit Standby Documentary and commercial Guarantees Securities lending Forward guarantees Total Gross 650,973 2,464 544,587 3,025 15,296 - 2,151 1,218,496 2004 Collateral Net Gross 156,106 2,464 494,867 - 34,221 4,521 515,432 2,599 11,074 - 2,151 689,826 29,155 426 4,222 - - 528,670 514,997 4,036 10,821 - 1,504 570,100 2003 Collateral 34,221 4,521 493,544 3,689 3,276 - 1,154 540,405 Net - - 21,453 347 7,545 - 350 29,695 Collateral is shown at estimated market value less selling cost. Where cash is the collateral, this is shown gross including interest income. 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 note 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. Legal Proceedings 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: Interest Income Loans The following table presents the components of loan interest income: Year ended 31 December Mortgages Other loans Amortisation of loan origination fees (net of amortised costs) Total loan interest income 2004 68,212 63,203 131,415 2,222 133,637 2003 57,025 45,699 102,724 1,860 104,584 Balance of unamortised loan fees as at 31 December 9,195 7,430 49 NOTE 13: 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 and Fiduciary Services and Investment and Pension Fund Administration, and Real Estate), Barbados, Cayman, Guernsey, The Bahamas, 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 treasury operations and Promisant (Technology) Limited. The Bermuda Wealth Management and Fiduciary Services and Investment and Pension Fund Administration segment consists of Butterfield Asset Management Limited, which provides investment management, advisory and brokerage services, Butterfield Trust (Bermuda) Limited which provides trust, estate, company management and custody services, and Butterfield Fund Services (Bermuda) Limited, which provides valuation, accounting, corporate and shareholder services. The Real Estate segment consists of the Bank's investments in real estate and all related costs. This segment also includes rental revenues from third parties. The Barbados segment provides a range of community and commercial banking services through three branch locations, ATMs 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, ATMs and debit cards. Wealth management and fiduciary services and investment and pension fund administration services are also provided. The Guernsey segment provides a broad range of services to private clients and financial institutions including, private banking and treasury services, Internet banking, administered bank services, wealth management and fiduciary services and investment and pension fund administration services. The Bahamas segment provides institutional, corporate and private clients with a range of wealth management & fiduciary services and investment fund administration services. The United Kingdom segment provides a broad range of services including private banking and treasury services, Internet banking and wealth management and fiduciary services to high net worth individuals and privately owned businesses. The Hong Kong segment provides investment and pension fund administration and custody services and represents the Bank's 20% investment in Dexia Holdings (Hong Kong) Limited. The restricted branch license in Hong Kong was taken over by Dexia in April 2003. Operating segment information follows: 31 December 2004 2003 Total Assets Bermuda Community Banking Wealth Management & Fiduciary Services and Investment & Pension Fund Administration Real Estate Total Bermuda Barbados Cayman Guernsey The Bahamas United Kingdom Hong Kong Total 3,435,708 3,991,190 28,952 65,082 3,529,742 173,324 2,322,657 1,442,522 63,433 1,096,629 2,076 8,630,383 28,889 52,137 4,072,216 155,372 1,973,977 974,428 18,429 537,404 1,980 7,733,806 Financials 50 Business Area Analysis 31 December 2004 Customer Intersegment Loan Losses Income Net Interest Income Provisions for Fees and Other Total Net Income Expenses Amortisation Expenses Income Other Depreciation & Total Community Banking Wealth Management & Fiduciary Services and Investment & Pension Fund Administration Real Estate Sub-total Bermuda Barbados Cayman Guernsey The Bahamas United Kingdom Hong Kong Sub-total Overseas 94,275 363 1,437 38,941 135,016 82,479 5,388 87,867 47,149 - - 94,275 5,608 29,037 7,378 131 14,540 - 56,694 249 (1,114) (502) (6) 1,835 1,649 389 (3,365) - 502 - 55,357 55,606 27,531 5,632 - 1,437 96,813 192,023 115,642 1,401 2,515 706 28,237 27,369 1,581 7,213 (5,812) 7,675 123,317 68,706 (721) 3,576 8,457 6,572 (3,582) 28,972 56,262 28,767 - 26,015 35,042 29,273 4,454 5,861 5,369 8,137 19,312 24,081 - 688 (4,331) 72,757 125,622 93,147 (28) - - 688 1,561 324 8,133 2,775 31,542 24,720 3,193 32,466 2,576 668 5,193 2,447 26,528 (7,216) 688 10,715 103,862 21,760 739 - - Total Income 150,969 - (2,894) 169,570 317,645 208,789 18,390 227,179 90,466 less: Inter-segment eliminations (principally rent and management fees) Total 150,969 - (6,480) (2,894) 163,090 311,165 202,309 (6,480) (6,480) - - (6,480) 18,390 220,699 90,466 31 December 2003 Customer Intersegment Loan Losses Income Income Expenses Other Depreciation & Amortisation Total Expenses Net Income Net Interest Income Provisions for Fees and Other Total 83,952 (338) (1,731) 28,884 110,767 73,823 5,107 78,930 31,837 Community Banking Wealth Management & Fiduciary Services and Investment & Pension Fund Administration Real Estate Sub-total Bermuda Barbados Cayman Guernsey The Bahamas United Kingdom Hong Kong Sub-total Overseas - - 83,952 408 24,022 5,528 90 4,028 24 34,100 Total Income 118,052 less: Inter-segment eliminations (principally rent and management fees) Total - 118,052 331 (1,157) (1,164) - 294 1,580 - (709) (1) 1,164 - - - - - (1,731) (741) (858) 325 - 12 7 (1,255) 42,195 42,526 22,257 4,771 1,287 2,444 73,523 154,580 100,851 355 25,593 21,697 1,298 1,056 582 50,581 22 49,051 29,130 1,388 4,387 612 84,590 - 480 23,457 22,513 968 4,811 372 52,601 575 22,832 19,694 (5,031) 6,318 1,547 7,229 108,080 46,500 121 2,366 4,298 181 684 1 7,651 601 (579) 25,823 23,228 2,319 26,811 1,149 239 (1,108) 5,495 239 373 60,252 24,338 (2,986) 124,104 239,170 153,452 14,880 168,332 70,838 - (5,630) (2,986) 118,474 233,540 147,822 (5,630) (5,630) - - (5,630) 14,880 162,702 70,838 51 For the year ended 31 December 2004, included within other expenses are the following income tax expense/(refund) amounts: Guernsey ($376) (2003: $908), UK ($1,551), (2003: $(435)) and Barbados $192 (2003: $22). 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 14: Accounting for Derivative Instruments and Risk Management The Bank uses derivatives in the asset and liability management (ALM) of positions and to assist customers with their risk management objectives. The Bank primarily enters into derivative contracts as part of its overall interest rate risk management strategy to minimise significant unplanned fluctuations in earnings that are caused by interest rate volatility. The Bank’s goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain consolidated balance sheet assets and liabilities so that movements in interest rates do not adversely affect the net interest margin. The Bank’s derivative contracts principally involve over the counter transactions that are privately negotiated between the Bank and the counterparty to the contract. Derivative instruments that are used as part of the Bank’s interest rate risk management strategy include interest rate swaps and option contracts that have indices related to the pricing of specific consolidated balance sheet assets and liabilities. Interest rate swaps generally involve the exchange of fixed and variable-rate interest payments between two parties, based on a common notional principal amount and maturity date. Interest rate options represent contracts that allow the holder of the option to receive cash or purchase, sell, or enter into a financial instrument at a specified price within a specified period. The Bank pursues opportunities to reduce its exposure to credit losses on derivatives by entering into International Swaps and Derivatives Association Master Agreements (ISDAs). Depending on the nature of the derivative transaction, bilateral collateral arrangements may be used as well. When the Bank is engaged in more than one outstanding derivative transaction with the same counterparty, and also has a legally enforceable master netting agreement with that counterparty, the "net" marked to market exposure represents the netting of the positive and negative exposures with that counterparty. When there is a net negative exposure, the Bank regards its credit exposure to the counterparty as being zero. The net marked to market position with a particular counterparty represents a reasonable measure of credit risk when there is a legally enforceable master netting agreement between the Bank and that counterparty. (a) Fair Value Hedges The Bank enters into interest rate swaps to convert its fixed rate long term debt to floating rate debt, and convert fixed rate deposits to floating rate deposits. For the year ended 31 December 2004 the Bank recognised a net loss of $0.2 million (2003: $0.1 million) reported as other income in the Consolidated Statement of Income, which represented the ineffective portion of all fair-value hedges. As of 31 December 2004 the Bank has recorded the fair value of derivative instrument assets of $0.4 million (2003: $0.6 million) in other assets and derivative instrument liabilities of $3.2 million (2003: $3.5 million) other liabilities. (b) Cash Flow Hedges The Bank uses interest rate swaps to convert floating-rate notes to fixed-rate instruments. These swaps, which qualify for hedge accounting, have the pay rate indexed to the rates received on the Bank’s variable-rate assets and the receive rate indexed to rates paid on the Bank’s various deposit liabilities. For cash flow hedges, gains and losses on derivative contracts that are reclassified from accumulated other comprehensive income to current-period earnings are included in the line item in which the hedged item is recorded in the same period the forecasted transaction affects earnings. As at 31 December 2004 and 2003, there was no hedge ineffectiveness related to cash flow hedges. As of 31 December 2004, $1.9 million (2003: $9.0 million) of the deferred net gains on derivative instruments accumulated in other comprehensive income are expected to be reclassified as earnings during the next twelve months. The maximum term over which the Bank is hedging its exposure to the variability of future cash flows is 3 years. As of 31 December 2004, the Bank has recorded the fair value of derivative instrument assets of $2.9 million (2003: $12.5 million) in other assets and $1.4 million (2003: nil) in other liabilities. Financials 52 Notional Amounts: The following table provides the aggregate notional amounts of derivative contracts outstanding listed by type and divided between those used for trading (non-hedging) and those used in hedging activities. 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. 31 December Interest rate contracts Interest rate swaps Interest rate caps Total Foreign exchange contracts Spot and forwards Currency options Total Trading 59,593 66,000 125,593 2,415,658 5,130 2,420,788 2004 ALM 595,320 - 595,320 Total Value Trading 654,913 66,000 720,913 171,000 66,000 237,000 - - - 2,415,658 5,130 2,420,788 1,199,397 - 1,199,397 2003 ALM 637,307 - 637,307 12,599 - 12,599 Total Value 808,307 66,000 874,307 1,211,996 - 1,211,996 Total notional amount of financial derivatives outstanding 2,546,381 595,320 3,141,701 1,436,397 649,906 2,086,303 Included in the notional amounts for cash flow hedges using interest rate swaps for 31 December 2004, are $372.8 million (2003: $444.9 million), pertaining to specific floating rate notes included in the investment portfolio which were classified as held to maturity. Included in the notional amounts for fair value hedges using interest rate swaps for 2004, are $29.8 million (2003: $23.7 million), pertaining to specific loans, $125 million (2003: $125 million), pertaining to subordinated debt, and $24.5 million (2003: $24.5 million), pertaining to deposits. (c) Fair Value Derivative instruments, in the absence of any compensating up-front 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 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. 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 31 December Derivative financial instruments Interest rate swaps Spot and forward foreign exchange Interest rate caps and currency options Total Positive 3,690 26,555 506 30,751 2004 Negative 4,271 23,734 477 28,482 Net Positive (581) 2,821 29 2,269 13,471 18,270 592 32,333 2003 Negative 3,897 17,846 479 22,222 Net 9,574 424 113 10,111 (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 2004 Interest rate contracts Interest rate swaps Interest rate caps Sub-total Foreign exchange contracts Spot and forwards Currency options Sub-total Total by remaining maturity 31 December 2003 Interest Rate Contracts Interest rate swaps Interest rate caps Sub-total Foreign exchange contracts Spot and forwards Total by remaining maturity Within 6 months 6 to 12 months 1 to 3 years 3 to 5 years 97,373 - 97,373 2,280,033 - 2,280,033 2,377,406 111,511 - 111,511 124,496 5,130 129,626 241,137 275,797 66,000 341,797 11,129 - 11,129 352,926 100,659 - 100,659 - - - 100,659 After 5 years 69,573 - 69,573 - - - 69,573 Within 6 months 6 to 12 months 1 to 3 years 3 to 5 years After 5 years 150,118 - 150,118 1,146,079 1,296,197 112,757 - 112,757 55,688 168,445 371,156 - 371,156 10,229 381,385 154,667 66,000 220,667 - 220,667 19,609 - 19,609 - 19,609 1,211,996 2,086,303 53 Total 654,913 66,000 720,913 2,415,658 5,130 2,420,788 3,141,701 Total 808,307 66,000 874,307 (e) Replacement Cost 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 that 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. 31 December Interest rate contracts Interest rate swaps Interest rate caps Sub-total Foreign exchange contracts Spot and forwards Currency options Total replacement cost Trading - 305 305 26,555 201 26,756 2004 ALM 3,690 - 3,690 Total Value Trading 3,690 305 3,995 - 592 592 - - - 26,555 201 26,756 16,351 1,919 18,270 2003 ALM 13,367 - 13,367 - 104 104 Total Value 13,367 592 13,959 16,351 2,023 18,374 Financials 54 NOTE 15: Fair Value of Financial Instruments The following table presents the carrying value and fair value of financial assets and liabilities value under SFAS NO. 107 Disclosures about Fair Value of Financial Instruments. Accordingly, certain amounts which are not considered financial instruments are excluded from the table. For investments with an indicator of impairment management have considered the available evidence, including discussions with rating agencies. Based on this and because the Bank has the ability and the intent to hold such securities to maturity, the Bank believes it will recover the full carrying value of the security. Should specific circumstances dictate that the Bank may not be able to hold such securities to maturity, such as a significant deterioration of credit worthiness of the issuer, the Bank may reassess whether a market value below carrying value represents an other than temporary impairment. 31 December Carrying value Fair value Appreciation / (depreciation) Carrying value Fair value Appreciation / (depreciation) 2004 2003 Financial assets Cash and deposits with banks Investments: Held-to-maturity Available-for-sale Trading Loans: Commercial, net of allowance for credit losses Consumer, net of allowance for credit losses Other assets Total financial assets Financial liabilities Customer deposits: Demand deposits Term deposits Deposits, Financial institution Other liabilities Subordinated capital and senior debt Total financial liabilities 2,396,724 2,396,724 - 2,912,383 2,912,383 - 2,592,824 29,681 643,895 2,587,189 29,681 643,895 1,342,778 1,302,553 321,928 8,630,383 1,343,503 1,304,684 321,928 8,627,604 (5,635) - - 725 2,131 - (2,779) 2,450,887 27,815 159,551 2,453,068 27,815 159,551 908,054 1,046,662 228,454 7,733,806 908,543 1,048,834 228,454 7,738,648 4,663,654 2,771,201 502,595 152,570 142,333 8,202,353 4,633,654 2,762,101 502,595 152,570 142,333 8,193,253 - 9,100 - - - 9,100 3,917,244 2,695,059 510,274 106,263 122,871 7,351,711 3,917,244 2,685,005 510,274 106,263 122,871 7,341,657 2,181 - - 489 2,172 - 4,842 - 10,054 - - - 10,054 55 NOTE 16: 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 the contractual maturity or repricing date. Examples of this include fixed-rate mortgages, which are shown at contractual maturity but which may pre-pay earlier, and certain term deposits, which are shown at contractual maturity but which may be withdrawn before their contractual maturity, and certain investments which have call or pre-payment features. 31 December 2004 (in $millions) Assets Cash and deposits with banks Investments Loans Premises, equipment and computer software Other assets Total Assets Liabilities Shareholders’ equity Deposits Other liabilities Subordinated capital and senior debt (a) Total Liabilities Interest rate sensitivity gap Cumulative interest rate sensitivity gap 31 December 2003 (in $millions) Assets Cash and deposits with banks Investments Loans Premises, equipment and computer software Other assets Total Assets Liabilities Shareholders’ equity Deposits Other liabilities Subordinated capital (a) Total Liabilities Interest rate sensitivity gap Cumulative interest rate sensitivity gap 3 months 6 months but within 1 year but within 6 months 1 year but within 5 years Within 3 months Non- interest bearing funds After 5 years 2,131 945 2,427 - - 5,503 - 6,464 - (2) 6,462 (959) (959) 64 461 12 - - 537 - 138 - - 138 399 38 1,404 11 - - 1,453 - 94 - - 94 1,359 - 408 99 - - 507 - 210 - - 210 297 - 43 87 - - 130 - - - 144 144 164 5 9 126 196 500 428 1,001 153 - 1,582 (14) (1,082) (560) 799 1,096 1,082 - 3 months but within 6 months 6 months but within 1 year 1 year but within 5 years Within 3 months After 5 years 2,647 550 1,765 - - 4,962 - 5,452 - (2) 5,450 (488) (488) 78 309 6 - - 393 - 167 - - 167 226 (262) 75 1,290 35 - - 1,400 - 109 - - 109 1,291 1,029 - 463 88 - - 551 - 254 - - 254 297 - 26 48 - - 74 - - - 125 125 (51) 1,326 1,275 Non- interest bearing funds 112 - 13 100 129 354 382 1,141 106 - 1,629 (1,275) - (a) Includes interest rate swaps with fair value of ($2 million), that are highly effective, designated and quality as fair valve hedges. Total 2,397 3,266 2,645 126 196 8,630 428 7,907 153 142 8,630 - - Total 2,912 2,638 1,955 100 129 7,734 382 7,123 106 123 7,734 - - Financials 56 NOTE 17: Subordinated Capital and Senior Debt On 28 May 2003, the Bank issued US $125 million of Subordinated Lower Tier II capital notes. The notes were issued at par and 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 were used to repay the entire amount of the US $75 million outstanding subordinated notes redeemed in July 2003. The notes issued under Series A will pay a fixed coupon until 27 May 2008 when they become redeemable in whole at the option of the Bank. The Series B notes will pay a fixed coupon 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. On 2 April 2004, in conjunction with the acquisition of Leopold Joseph, the Bank assumed a subordinated debt of £5 million which is included in the balance sheet in the amount of $9 million. The issuance was by way of private placement in the UK and pays a fixed coupon of 9.29% until April 2012 when it becomes redeemable in whole at the option of the Bank and 10.29% thereafter until August 2017. On 5 April 2004, as part of the consideration to the shareholders of Leopold Joseph, the Bank of Butterfield (UK) Limited issued a Senior debt of £5.2 million which is included in the Consolidated Balance Sheet in the amount of $10 million. The issue was exclusively to the shareholders of Leopold Joseph and pays a variable rate of interest of 3 months LIBOR plus 30 basis points until April 2009 when it becomes redeemable in whole at the option of the Bank. The following table presents the contractual maturity and interest payments for subordinated debt issued by the Bank as at 31 December 2004 ($ millions) With in 1 Year 1 to 5 Years After 5 Years Carrying Value 2004 Subordinated debt Parent Company Series A Series B Subsidiaries Senior debt Subsidiaries Other (a) Total Fixed rate Fixed rate Fixed rate Variable rate 3 2 1 1 - 7 12 10 4 2 - 28 89 68 17 - - 174 78 47 9 10 (2) 142 (a) Other includes interest rate swaps with notional amount of $125 million, that are highly effective, designated and qualify as fair value hedges. NOTE 18: Earnings per Share Earnings per share has been calculated using the weighted average number of shares outstanding during the year after deduction of the shares held as Treasury Stock and adjusted for the stock dividends declared during the year ended 31 December 2004 and 2003 (see also Note 24). The dilutive effect of stock options was calculated using the treasury stock method, whereby the proceeds received from the exercise of stock options are assumed to be used to repurchase outstanding shares, using the average market price of the Bank’s shares for the period. 31 December Basic earnings per share Net Income for the year Weighted average number of common shares issued (in thousands) Weighted average number of common shares held as Treasury Stock (in thousands) Adjusted weighted average number of common shares (in thousands) 2004 90,466 24,428 (1,679) 22,749 3.98 2003 70,838 24,647 (2,061) 22,586 3.14 57 Diluted earnings per share Net Income for the year Average number of common shares issued (in thousands) Average number of common shares held as Treasury stock (in thousands) Stock options (Note 1 (q)) Adjusted weighted average number of diluted common shares (in thousands) 2004 90,466 24,428 (1,679) 668 23,417 3.86 2003 70,838 24,647 (2,060) 508 23,095 3.07 NOTE 19: 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 in 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 current maximum number of common shares reserved for issuance by the Board of Directors of the Company under the 1997 Plan is 2,662,000. At 31 December 2004, the Bank held as Treasury Stock 1,556,476 shares (2003: 1,692,698) that will be used to satisfy the Bank’s obligations with respect to the Stock Option Plan. Directors’ and Officers' Stock Option Plan 31 December Outstanding at beginning of year Granted Stock dividend granted Exercised Forfeited / cancelled Outstanding at end of year Vested and exercisable at end of year Number of Stock Options 385,471 117,211 45,616 (28,069) - 520,229 290,888 2004 Weighted Average Exercise Price ($) 20.87 40.18 24.92 22.94 - 25.47 18.66 Number of Stock Options 323,689 69,443 35,800 (43,461) - 385,471 217,931 2003 Weighted Average Exercise Price ($) 18.75 26.53 20.32 13.67 - 20.87 17.24 Characteristics of Options Granted to Directors and Executive Officers as at 31 December 2004 Exercise Price Range 12.03 – 21.68 21.69 – 26.51 26.52 – 31.34 31.35 – 36.17 36.18 – 41.00 Total Outstanding Weighted Average Life Remaining 4 6 6 4 8 6 Number of Shares 151,443 131,610 106,844 2,067 128,265 520,229 Exercisable Weighted Average Exercise Price ($) 12.56 24.20 27.55 32.59 40.15 25.47 Number of Shares 151,443 88,681 49,486 734 544 290,888 Weighted Average Exercise Price ($) 12.56 23.90 27.51 32.50 37.87 18.66 Financials 58 Employees Stock Option Plan Outstanding at beginning of year Granted Stock dividend granted Exercised Forfeited/cancelled Outstanding at end of year Vested and exercisable at end of year 2004 2003 Weighted Number of Stock Options 984,639 424,240 120,965 (231,393) (80,985) 1,217,466 521,134 Average Exercise Price ($) 22.08 40.23 28.26 19.84 32.88 28.72 21.06 Weighted Number of Stock Options 1,061,111 159,305 110,396 (274,143) (72,030) 984,639 421,316 Average Exercise Price ($) 20.08 25.29 21.28 15.39 24.03 22.07 19.05 Characteristics of Options Granted to Employees as at 31 December 2004 Exercise Price Range 12.03 – 21.68 21.69 – 26.51 26.52 – 31.34 31.35 – 36.17 36.18 – 41.00 Total Outstanding Weighted Average Life Remaining 5 7 7 - 9 8 Number of Shares 178,551 345,483 271,818 - 421,614 1,217,466 Exercisable Weighted Average Exercise Price ($) 12.42 24.12 27.44 - 40.23 28.72 Number of Shares 178,551 206,315 130,108 - 6,160 521,134 Weighted Average Exercise Price ($) 12.42 23.94 27.44 - 40.23 21.06 The weighted average fair value of stock options granted in the year ended 31 December 2004, was $6.80 per share (2003: $3.70), using the Black- Scholes option-pricing model with the following weighted average assumptions: 31 December Dividend yield Risk free interest rate Historical volatility Expected lives 2004 3.14% 3.17% 20% 5.0 2003 4.58% 3.09% 20% 5.0 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: 31 December Net income as reported Net income – pro-forma Earnings per share – as reported (basic) Earnings per share – pro-forma (basic) 2004 90,466 89,122 3.98 3.92 2003 70,838 70,156 3.14 3.11 59 NOTE 20: Share Buy-Back Plan During the year under review, 459,232 shares (31 December 2003: 378,994) were purchased and cancelled at a cost of $19,431 (31 December 2003: $13,190). The Board of Directors of the Bank has present intention to repurchase over the twelve month period commencing 1 January 2005 up to 2 million of its ordinary shares of par value $1 each, pursuant to its share repurchase programme authorised by the shareholders on 29 October 1997. The Directors consider that share repurchase is an excellent means of enhancing shareholders value, while increasing earnings per share. This intention is subject to appropriate market conditions and repurchases will only be made in the best interest of the Bank. From time to time the Bank's associates, insiders and insiders' associates as defined by the Bermuda Stock Exchange (BSX) regulations may sell shares which may result in such shares being repurchased pursuant to the programme, but under BSX Regulation 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 Dividend In August 2004 and August 2003 the Bank distributed a 10% stock dividend to shareholders of record on 5 August 2004 and 5 August 2003 respectively. All prior period per share amounts have been restated to reflect the stock dividend. NOTE 23: Variable Interest Entities Effective 1 January 2004 the Bank implemented FIN 46(R). The effect of the adoption of FIN 46(R) was a decrease in the Bank's assets of approximately $0.5 million as at 31 December 2004. The decrease primarily relates to the Bank's venture capital investment (Butterfield Vencap Limited). Butterfield Vencap Limited holds investments in private and listed companies where the nature of the investment relationship is such that the Bank, through Butterfield Vencap Limited may absorb a majority of the expected losses of these companies or receive a majority of the residual returns of these companies. Upon adoption of FIN 46, the assets, liabilities and noncontrolling interest of VIE’s were generally measured at the amounts at which such interest would have been carried had FIN 46(R) been effective when the Bank first met the conditions to be considered the primary beneficiary. In cases where historical information was limited the valuation of VIE’s was based on the fair value. The difference between the net amount added to the balance sheet and the amount of any previously recognised interest in any newly consolidated entity was recognised as cumulative effect of accounting change at December 2003 which resulted in a $0.4 million after tax adjustment to the Bank's consolidated earnings. As at 31 December 2004 the total assets of VIE’s consolidated in the balance sheet is $10.7 million. Financials 60 NOTE 24: Income Taxes The Bank is not subject to any taxes in Bermuda on either income or capital gains under current Bermuda law. The Bank’s income tax expense or benefit for all period presented relates to income from continuing operations and is attributable to subsidiaries and offices in various other jurisdictions that are subject to the relevant taxes in those jurisdictions. 31 December Income taxes in consolidated statement of income Current Deferred Total (credit) /debit Deferred income tax asset Tax loss carried forward General loan provision General bad debt provision Pension liability provision Provision for compensated absence Onerous leases Other (non significant) Total assets Deferred income tax liability Depreciation Net unrealised gain on derivatives Total liability Net deferred income tax asset 2004 (422) (1,300) (1,722) 8,168 - 39 1,186 40 225 214 9,872 2,367 16 2,383 7,489 2003 1,187 (807) 380 4,549 158 36 1,109 39 - 60 5,951 2,944 - 2,944 3,007 NOTE 25: Future Accounting Developments a) Share-based payments In December 2004, the Financial Accounting Standards Board issued a revised version (FAS123R) of the previously issued FAS123 Accounting for Stock- Based Compensation. Under FAS123R, share-based payments classified as equity, such as the Bank’s stock option plan, are measured and recognised in the statement of income at their fair value for all periods beginning after 15 June 2005. Under the original FAS123, the Bank chose the option to present such compensation costs are measured at their fair value as a pro-forma impact which is presented in note 21 to financial statements but not in the income statement. FAS123R is effective for the Bank’s third quarter of fiscal 2005 and management is currently evaluating the effect of adoption which may be material. b) EITF 03-1 The meaning of other-than-temporary impairment and its application to certain investments The Emerging Issues Task Force (EITF) has issued pronouncement EITF 03-1. The meaning of other-than-temporary impairment and its applications to certain investments. As originally proposed, EITF 03-1 would require an investor to treat securities (in the available for sale category and certain other cost-basis investments) whose fair value is below cost as impaired securities. If the entity can establish its intent and ability to hold that security until its value has recovered to cost, then this impairment is considered as temporary. In the absence of such declared intent and/or ability, any reduction in fair value should be treated as "other than temporary" impairment, with reduction in fair value adjusted in the income statement. Further, sale of securities which are declared to be held for a reasonable period of time (until the value has recovered to cost) may be used as a basis for establishing a pattern of non-compliance with the declared intent. The FASB has delayed the original effective date of 30 September 2004, and an extended commencement period is in effect. It is not expected that this pronouncement will have a significant impact on the financial statements of the Bank. Directory 61 BOARD OF DIRECTORS & PRINCIPAL BOARD COMMITTEES 2 James A. C. King, JP, Chairman Chairman, KeyTech Ltd. Chairman, Argus Insurance Co. Ltd. 1, 3 Robert J. Stewart, JP, Vice Chairman Chairman, Island Circle Limited, Bermuda Director, Shell Trust (Bermuda) Limited 3 Geoffrey R. Bell, QC Formerly Senior Counsel, Appleby, Spurling & Hunter Retired from the Board 4 January 2005 2, 4 Arlene Brock Lawyer / Mediator 2, 5 Brian Duperreault Chairman, ACE Limited Director, Tyco International Ltd. 1, 5 Roderick A. Ferguson III, JP Chairman, Gorham’s Ltd. Chairman, Purvis Ltd. Director, KeyTech Ltd. 5 A.L. Vincent Ingham, JP Executive Vice President & Chief Operating Officer, BELCO Holdings Limited Director, BELCO Holdings Limited 3, 5 Sheila G. Manderson Chief Executive Officer, KeyTech Ltd. 1, 2 Robert A. Mulderig Retired Chairman & Chief Executive Officer, Mutual Risk Management Ltd. Chairman, Woodmont Trust Co. Ltd. 1 Robert Steinhoff Retired Senior Partner, KPMG Chairman, Insurance Advisory Committee 3,4 Alan R. Thompson* President & Chief Executive Officer, The Bank of N. T. Butterfield & Son Limited 4,5 Glenn M. Titterton Chairman, BF&M Insurance Group Retired President & Chief Executive Officer, BF&M Insurance Group 1,4 Harry Wilken* President, Jardine Matheson International Services Limited John R. Wright* Retired Bank Chief Executive *Non Bermudian 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 and Group Code of Conduct The Directors have adopted a Code of Best Practice based upon recommended principles of corporate governance. In implementing the Code, the Board meets regularly, retains full effective control over the Bank, and monitors executive management. A Group Code of Conduct applies to directors and employees and imposes the Bank’s principles of business, including ethics and conflicts of interest. Copies of the Codes can be accessed on www.butterfieldbank.bm/web2000/about/shareholder_info.asp 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 2004 were 732,028 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. Non-Bermudian 29.7%Bermudian 70.3%Split of Share Ownership Bermudian/Non-Bermudian100,000 and above Shares 47.0%50,000 – 99,999 Shares 11.5%10,000 – 49,000 Shares 24.5%5,000 – 9,999 Shares 6.2%1,000 - 4,999 Shares 8.1%1-999 Shares 2.7%Distribution of Shares by Number HeldDirectory 62 MANAGEMENT Alan R. Thompson President & Chief Executive Officer Graham C. Brooks Executive Vice President, International C. Wendell Emery, MBE, JP Executive Vice President, Operations & Information Technology Richard J. Ferrett Executive Vice President, Chief Financial Officer Mariano R. Browne Managing Director, Butterfield Bank (Barbados) Limited Sheila M. Brown Senior Vice President, Investment Services D. John Charlick Senior Vice President, Strategic Projects Andrew R. Collins Managing Director, Butterfield Fund Services (Bermuda) Limited 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 and pension fund administration services Butterfield Trust (Bermuda) Limited Bermuda Trust and private banking services Ian M. Coulman Managing Director, Butterfield Asset Management Limited Michael J. Preuss Managing Director, Promisant (Technology) Limited Donna E. Harvey Maybury Senior Vice President, Human Resources Graham M. Jack Managing Director, Butterfield Trust (Bermuda) Limited Robert V. Lotmore Managing Director, Butterfield Bank (Bahamas) Limited Michael A. McWatt Senior Vice President, Credit Risk Management Conor O’Dea Managing Director, Butterfield Bank (Cayman) Limited Michael O’Mahoney Senior Vice President, Treasury Robert S. Moore Managing Director, Butterfield Bank (Guernsey) Limited Peter J.M. Rodger Senior Vice President & Group Legal Adviser, Secretary to the Board W. Aaron M. Spencer Senior Vice President, Operations James R. Stewart Senior Vice President, Enterprise Risk Management Fred H. Tesch Senior Vice President, Group Internal Audit Paul A. Turtle Managing Director, Butterfield Bank (UK) Limited Lloyd O. Wiggan Senior Vice President, Retail Banking Bob W. Wilson Senior Vice President, Corporate Banking Grosvenor Trust Company Limited Bermuda Trust and private banking services Field Real Estate Holdings Limited Bermuda Real estate holding Promisant (Technology) Limited Bermuda Multi-currency payment processing Butterfield Bank (Bahamas) Limited The Bahamas Private banking, treasury, wealth management and fiduciary services, and fund administration services Butterfield Bank (Cayman) Limited Cayman Islands Banking, credit, treasury, wealth management and fiduciary services, and investment and pension fund administration services Butterfield Bank (Guernsey) Limited Guernsey Private banking, treasury and wealth management services Butterfield Fund Managers (Guernsey) Limited Guernsey Investment and pension fund administration services Butterfield Bank (Barbados) Limited Barbados Banking, credit and treasury services Butterfield Trust (Guernsey) Limited Guernsey Fiduciary services Butterfield Bank (UK) Limited United Kingdom Private banking, credit, treasury and investment management services 63 SHAREHOLDER INFORMATION Dividend Payment Payment of dividends is quarterly, normally occurring in November, March, 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: The Bermuda Stock Exchange (Primary Listing) Phase 1 – 3rd Floor, Washington Mall, Church Street, Hamilton HM 11, Bermuda Tel: (441) 292-7212 or (441) 292-7213 Fax: (441) 292-7619 www.bsx.com Cayman Islands Stock Exchange (Secondary Listing) Elizabethan Square, 4th Floor, P.O. Box 2408 GT, Grand Cayman, Cayman Islands Tel: (345) 945-6060 Fax: (345) 945-6061 www.csx.com.ky Share Dealing Service Butterfield Securities (Bermuda) Limited 65 Front Street, Hamilton, Bermuda Tel: (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. 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 Tel: (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 Tel: (441) 295-1111 Fax: (441) 292-4365 E-mail: contact@bntb.bm MAILING ADDRESS P. O. Box HM 195 Hamilton HM AX, Bermuda www.butterfieldbank.com Media Relations / Publication Requests Marketing & Communications Tel: (441) 298-6463 or (441) 298-4682 E-mail: annalowry@bntb.bm or karencabral@bntb.bm Investor Relations Chief Financial Officer Tel: (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 January 2005, 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, 2004, 2,000,000 shares represented 8.2% 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 2004 totalled 459,232 at an average price of $42.19 and aggregate cost of $19.4 million. From time to time the Bank’s associates, insiders, and insiders’ associates as defined in the BSX Regulations may sell shares which may result in being repurchased pursuant to the programme, but under BSX Regulations such trades must not be pre-arranged and all repurchases must be made in the open market. Prices paid by the Bank must not, according to BSX Regulations, be higher than the last independent trade. The Bank will continue to advise the BSX monthly of shares repurchased and cancelled. Large Shareholders The following professional nominees at 31 December 2004 were registered holders of 5% or more of the issued share capital: Harcourt & Co. (16.4%) and Murdoch & Co. (5.2%). Known beneficial holdings of 5% or more of issued share capital, at that date, were: Bermuda Life Insurance Company Limited (6.6%); Jardine Strategic Holdings Limited (6.5%); and the Bank’s Stock Option Trust (6.4%). Jun 01Jun 02Dec 02Dec 03Dec 041.051.311.371.431.55for 12 months to 30 Junefor 12 months to 31 DecemberAnnual Dividend ($)1020304050Dec 02June 02June 01Dec 03Dec 04Market Value & Net Book Value per Share ($)2001-2003 Book Values Restated for Stock DividendsBook Value12.27 14.39 15.05 16.83 18.84Market Value31.50 33.00 30.50 44.00 40.50JFMAMJJASONDMarket Price per Share 1 January 2004 to 31 December 2004 ($)20.0025.0030.0035.0040.0045.0050.00Directory 64 GUERNSEY Butterfield Bank (Guernsey) Limited Managing Director: Robert S. Moore Butterfield Fund Services (Guernsey) Limited Managing Director: Patrick A.S. Firth Butterfield Trust (Guernsey) Limited Managing Director: Paul D.H. Hodgson Regency Court, Glategny Esplanade, St Peter Port, Guernsey GY 3AP, Channel Islands Tel: (01481) 711521 Fax:(01481) 714533 E-mail: info@butterfield.gg www.bankofbutterfield.gg UNITED KINGDOM Butterfield Bank (UK) Limited Managing Director: Paul A. Turtle 99 Gresham Street, London EC2V 7NG Tel: (020) 7776-6700 Fax: (020) 7776-6701 E-mail: info@butterfieldprivatebank.co.uk www.butterfieldprivatebank.co.uk PRINCIPAL BERMUDA OFFICES & SUBSIDIARIES PRINCIPAL OVERSEAS OFFICES & SUBSIDIARIES THE BAHAMAS Butterfield Bank (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@butterfieldbank.bs BARBADOS Butterfield Bank (Barbados) Limited Managing Director: Mariano R. Browne The Mutual Building, 1 Beckwith Place, Lower Broad Street, Bridgetown, Barbados Tel: (246) 431-4500 Fax:(246) 246-0222 E-mail: contact@bankofbutterfield.bb Butterfield Asset Management (Barbados) Limited Vice President: Caroline J. Prow Belleville Corporate Centre, 38 Pine Road, Bellville, St Michael, Barbados Tel: (246) 430-1650 Fax: (246) 436-7999 E-mail: carolineprow@butterfield.bb CAYMAN ISLANDS Butterfield Bank (Cayman) Limited Managing Director: Conor 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@butterfieldbank.ky www. butterfieldbank.ky HEAD OFFICE The Bank of N.T. Butterfield & Son Limited President & CEO: Alan R. Thompson 65 Front Street, Hamilton HM 12 P.O. Box HM 195 Hamilton HM AX Bermuda Tel: (441) 295-1111 Fax: (441) 292-4365 S.W.I.F.T.: BNTB BM HM E-mail: contact@bntb.bm www.butterfieldbank.com BERMUDA 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: Graham M. Jack 65 Front Street, Hamilton HM 12, Bermuda Tel: (441) 299-3286 Fax: (441) 296-8832 E-mail: contact@bntb.bm Promisant (Technology) Ltd. Managing Director: Michael J. Preuss Park Place, 55 Par-La-Ville Road, Hamilton HM 11, Bermuda Tel: (441) 299-1341 Fax: (441) 296-6562 E-mail: contact@bntb.bm www.promisant.bm T h e B a n k o f N . T. B u t t e r f i e l d & S o n L i m i t e d 65 Fr on t Street , Ha mil ton, Berm uda w w w. b u t t e r f i e l d b a n k . c o m A N N U A L R E P O R T | 2 0 0 4 B E R M U D A | B A H A M A S | B A R B A D O S | C A Y M A N I S L A N D S | G U E R N S E Y | U N I T E D K I N G D O M B U T T E R F I E L D B A N K A N N U A L R E P O R T 2 0 0 4 

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