Bank of N.T. Butterfield & Son Ltd
Annual Report 2005

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 6 5 F r o n t S t r e e t , H a m i l t o n H M 1 2 , B e r m u d a w w w. b u t t e r f i e l d b a n k . c 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 5 A N N U A L R E P O R T 2 0 0 5 B A H A M A S | B A R B A D O S | B E R M U D A | C AY 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 Missi on S tat em en t Butt erfield Bank wi ll pro vid e c on sist ent and su perior r et ur ns t o ou r sha r eh ol d er s, offer security and opp ort un it ie s to ou r e mp loy ees, and be reco gn is ed as m a k in g a val u a bl e c o n t r ib ut i o n to t he communiti es i n wh ich we op er a t e by a customer focused, e ffi ci en t a nd eth ic al d el iv ery of bankin g and o th er s ele cte d f in a n c ia l s er v ic es . 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 Jurisdictional Overview Group Business Lines & Support Divisions Financial Overview Financial Summary Management’s Financial Reporting Responsibility Independent 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 10 16 17 23 24 25 26 27 28 29 30 61 61 61 62 62 63 64 1 Awards: Awarded by Global Finance Magazine Best Developed Market Bank in Bermuda April 2005 Bank of the Year 2005 Awarded by The Banker Magazine to Butterfield Bank in Bermuda September 2005 Financial & Statistical Summary (In $ thousands except per share data) 31 December 2005 31 December 2004 31 December 2003 Year ended 31 December 2002 (unaudited) Net income from continuing operations Profit from discontinued operations Net income Diluted earnings per share Including discontinued operations Excluding discontinued operations At year end Total assets Cash and deposits with banks Investments Loans Deposits from customers Deposits from banks 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 shareholders' equity** Total capital funds to total assets ratio 109,351 – 109,351 4.23 4.23 9,197,566 2,849,920 2,916,399 3,085,594 7,948,966 291,143 278,679 495,226 19.48 46.60 25,429 3,878 1,597 1.2% 23.6% 8.4% 90,466 – 90,466 3.51 3.51 8,630,383 2,396,724 3,266,400 2,645,331 7,404,855 502,595 142,333 428,030 17.13 36.82 22,745 3,778 1,552 1.1% 21.2% 6.6% 70,838 – 70,838 2.79 2.79 7,733,806 2,912,383 2,638,253 1,954,716 6,612,303 510,274 122,871 382,095 15.30 36.36 20,643 3,581 1,381 1.0% 17.9% 6.5% 83,743 184 83,927 2.96 2.96 6,007,874 1,989,159 2,073,112 1,767,088 5,156,111 360,105 75,000 338,799 13.68 25.21 18,603 3,322 1,200 1.2% 20.5% 6.9% Excludes shares held by the Bank's 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 2005, 2004 and 2003. Data for 2005, 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. Net Income ($m)** Earnings Per Share ($) (Diluted)** Return on Equity (%)** 109.4 90.5 64.4 66.7 70.8 3.09 2.96 2.79 4.23 3.51 21.2 20.5 23.6 21.2 17.9 Dec 02 Jun 02 for 12 months to 30 June Dec 03 Dec 04 for 12 months to 31 December Dec 05 Dec 02 Jun 02 for 12 months to 30 June Dec 03 Dec 04 for 12 months to 31 December Dec 05 Dec 02 Jun 02 for 12 months to 30 June Dec 03 Dec 04 for 12 months to 31 December Dec 05 2 Corporate Profile 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 $9.4 billion of assets under management and over $102 billion of client assets under administration. We provide a full range of community banking services for institutional and individual customers in Barbados, Bermuda and the Cayman Islands, encompassing retail and corporate banking and treasury activities. As a specialist offshore financial services group, we also provide private banking, wealth management and fiduciary services, and institutional and pension fund administration in The Bahamas, Bermuda, the Cayman Islands, Guernsey and the United Kingdom. Our success is built on a set of fundamental strengths: sound corporate values, a stable customer base, strong liquidity and capital positions, and solid core businesses. Our home country regulator is the Bermuda Monetary Authority, which operates in accordance with Basel principles and maintains close contacts with regulators in the other jurisdictions where we have offices. Our common stock is listed on The Bermuda Stock Exchange and the Cayman Islands Stock Exchange. We have over 3,800 shareholders with 26.9 million shares outstanding. Our performance is a direct result of the efforts of our dedicated employees who work together to deliver quality financial services, build business and enhance shareholder value. At 31 December 2005 we had a total of 1,597 employees, 789 in Bermuda and 808 overseas. We believe that a positive work environment, with effective employee training, development and communication, benefits our customers through quality service, and our shareholders through long- term improvements in results. Involvement in the communities in which we operate is important to the Butterfield Bank Group. We support a variety of projects and organisations that invest in areas such as youth development, healthcare, social causes, sports, heritage and the arts. Our educational scholarships and bursaries help young people fulfil their potential and achieve their dreams. We take an active role in community events and encourage the efforts of the many employees who give their own time and energy to a multitude of charitable causes. Collectively and individually, we take action to make our communities better. 3 Chairman’s Letter to the Shareholders On behalf of the Board of Directors, it gives me great pleasure to report that the Butterfield Bank Group has again delivered impressive results at a time of challenging global economic conditions. The year ended 31 December 2005 saw the Group continue to achieve substantial strategic and financial growth. The Strategic Review approved by the Board in 2003 was updated in 2005 and continues to provide a sound vision for the Group's future: a commitment to building and judiciously expanding our core businesses. The figures for 2005 once again demonstrated the strength of this proven business model in consistently producing solid financial results and continuing to build shareholder value. The acquisitions made by the Group in the United Kingdom, The Bahamas and Bermuda in 2004 have now been successfully assimilated into our core businesses and are beginning to contribute to the Group’s revenues. As we move into 2006 the Group can now focus on building on this strong foundation in line with our strategic plan. The Group is now well positioned to offer first class seamless multi- jurisdictional solutions and products to our increasingly diverse and sophisticated customer base. For the third year running the Board approved a one-for-ten bonus share issue, which was distributed to shareholders in August 2005. This bonus equated to a 10% stock dividend and combined with the 12-month cash dividend of $1.67 per share once again gave shareholders an impressive return on their investment. In closing, I wish to express my sincere gratitude to the Group's management team and employees for their expertise, dedication and commitment which has produced these impressive results. I also thank our shareholders and customers for their continued support. In today's highly competitive environment the Board values your loyalty and pledges to continue working to earn the trust placed in us. James A.C. King, JP Chairman of the Board 4 President & Chief Executive Officer's Report I am pleased to report that in 2005, the Butterfield Bank Group delivered solid financial results. The Group's net income for 2005 was $109.4 million, an increase of 20.9% on last year with a return of 23.6% on shareholders' equity. These results reflect the strength of the Bank's core businesses that underpin our balanced, international business model. We were particularly pleased with the performance of our Cayman operations this year in making a full recovery from the damage inflicted on their infrastructure by Hurricane Ivan in 2004. In addition we continue to be very satisfied with the progress made by our operations in The Bahamas and Barbados. This year marked the first full 12 months of operation with Leopold Joseph Holdings plc, which we acquired in April 2004. We continue to be pleased with the success of the integration of Leopold Joseph into our UK and Guernsey operations and the improved financial performance as well as the quality of service it now enables us to offer our clients. Our financial results in 2005 continue to reflect the balance and soundness of the Group's business model with approximately 70% of our revenues being generated from banking business lines and 30% from fund administration, trust, asset management and related areas. Interest income represents approximately half of our revenue with the balance generated from fees and customer generated foreign exchange earnings. We believe this balance to be one of the Group's fundamental strengths. The increasingly international nature of our business will be reflected in a product line approach for Butterfield Asset Management and Butterfield Fund Services which will leverage our specialist strengths across all the Group's jurisdictions to better serve our customers. Superior customer service is critical in today's competitive banking environment, and continually improving the customer experience remains a priority across the Group. For example, we continued to focus on our Service Initiative Training programme, launched in Bermuda in 2004. We continue to be closely involved in all the communities in which we operate. We consider it our duty and responsibility to support a wide range of local causes, events and organisations both financially and through direct involvement of our employees. On behalf of the management team, I once again wish to express my appreciation to the Board of Directors for their continued support, advice and oversight. I would also like to thank our employees, shareholders, customers and business partners for their valuable contributions to another successful year. Alan R. Thompson President & Chief Executive Officer 5 Management’s Discussion and Analysis of Results of Operations and Financial Condition1 From left to right: Sheila M. Brown Senior Vice President, Investment Services Michael O’Mahoney Senior Vice President, Treasury W. Aaron M. Spencer Senior Vice President, Operations 6 From left to right: Graham C. Brooks Executive Vice President, International Richard J. Ferrett Executive Vice President, Chief Financial Officer C. Wendell Emery Executive Vice President, Operations & Information Technology Peter J.M. Rodger Senior Vice President & Group Legal Adviser, Secretary to the Board Results of operations for the year ended 31 December 2005 compared with the year ended 31 December 2004. The Butterfield Bank Group2 achieved net income of $109.4 million for the year ended 31 December 2005, representing a 20.9% increase in net income over the same period last year. The Group’s performance was supported by the successful integration of acquisitions made in 2004, including Leopold Joseph’s businesses in the UK and Guernsey, which began to perform in line with expectations. This resulted in increased net income from outside Bermuda. The Bermuda businesses represented 48.3% of Group net income in 2005, compared to 75.9% in 2004. Across all Group operations, including Bermuda, a solid overall performance was achieved. Net interest income was a record, at $185.3 million before credit related provisions. Up year on year by 22.8%, the increase reflects balance sheet growth, a 16.6% increase in the loan portfolio and higher US interest rates, which rose eight times in 2005 to 4.25%. Non-interest income also increased year on year by $15.6 million, or 10.0%, to $172.1 million, reflecting strong growth across all revenue lines. The Group’s balance sheet remains highly liquid, with a loan to customer deposits ratio of 38.8%. Customer deposits increased significantly by 7.3% year on year to $7.9 billion, reflecting growth in Cayman, up $219 million, the United Kingdom, up $122 million, and Bermuda, up $57 million. Loan portfolio growth of 16.6% to $3.1 billion across the Group’s operations reflected our ability to meet new demand for lending products, with Bermuda’s community banking business up 20.5%, the United Kingdom up 9.7% and Guernsey up 16.6%. Non-performing loans totalled $27.0 million at year-end 2005, representing 0.9% of total loans, compared to 0.8% a year ago. As at 31 December 2005 the general allowance for credit losses of $20.6 million was equivalent to 0.7% of total loans. A specific allowance of $4.1 million is held for possible shortfalls in the security held for non-performing loans. In total the allowance for credit losses is $24.7 million, or 0.8% of the loan portfolio. Delinquency and charge- off ratios continued to be well below industry average. 1Management’s discussion and analysis of results of operations and financial condition should be read in conjunction with the Group’s Consolidated Financial Statements, beginning on page 26, and the notes to those financial statements, which begin on page 30. These statements and notes have been prepared in accordance with generally accepted accounting principles in the United States of America (US GAAP). 2All 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. 7 Management’s Discussion and Analysis of Results of Operations and Financial Condition Shareholder Value Sustained strong performances have enabled the Group to continue building shareholder value and, for the third consecutive year, a ‘one for ten’ bonus share issue was made in August 2005. This equates to a 10% stock dividend. Additionally, for the fourth quarter the Board approved a dividend increase of 3 cents, resulting in a total dividend for 2005 of $1.67 per share, an increase of 12 cents, or 7.7%, over last year. The cash dividend paid to shareholders in 2005 was $38.5 million, up 19.5% on the previous year and represents a 35.2% payout on net income for the period. The increase in shareholder value for the year, defined as the increase in share price plus dividends reinvested, was 31.4%. Share Purchase Activity Under the Share Buy-back Plan, during the year 32,890 shares were repurchased and cancelled at an average cost of $41.46 per share. In addition, the Stock Option Trust bought 285,854 shares at an average cost of $44.10 per share to satisfy the Bank’s obligations with respect to the Stock Option Plan. Performance Indicators The Group’s overall strength and performance are indicated by certain key measures. Return on shareholders’ equity was 23.6% for the period, up from 21.2% in 2004. Diluted earnings per share was $4.23, up 72 cents, or 20.5% compared with $3.51 last year. The Group’s efficiency ratio, which is operating expenses (excluding corporation tax and amortisation of intangible assets) expressed as a percentage of operating income (excluding credit provisions and gain on sale of subsidiaries and affiliates), saw a year on year improvement, from 69.1% the previous year to 66.4% in 2005. 8 From left to right: Lloyd O. Wiggan Senior Vice President, Retail Banking James R. Stewart Senior Vice President, Enterprise Risk Management Ian M. Coulman Managing Director, Butterfield Asset Management Andrew R. Collins Managing Director, Butterfield Fund Services (Bermuda) Limited From left to right: Michael A. McWatt Senior Vice President, Credit Risk Management Bob W. Wilson Senior Vice President, Corporate and Private Banking Donna E. Harvey Maybury Senior Vice President, Human Resources 9 Jurisdictional Overview From left to right: Graham M. Jack Managing Director, Butterfield Trust (Bermuda) Limited Pete D. Ramsdale Senior Vice President, Chief Information Officer Fred H. Tesch Senior Vice President, Group Internal Audit 10 The Bahamas Robert V. Lotmore Managing Director Butterfield Bank (Bahamas) Limited The Group’s Bahamian operations provide private banking, wealth management and fiduciary services and investment and pension fund administration through Butterfield Bank (Bahamas) Limited and Butterfield Fund Services (Bahamas) Limited. Total net income for The Bahamas in 2005 increased by 147.8% to $1.7 million from $0.7 million in 2004. At 31 December 2005 total assets in The Bahamas were $96.9 million, an increase of 52.8% from $63.4 million the previous year. Total assets under administration in The Bahamas stood at $4.0 billion at year-end. Butterfield Bank (Bahamas) Butterfield Bank (Bahamas) Limited provides a premier service, administering tailored solutions for international, high net worth and corporate clients with wealth management needs. Areas of expertise include private banking, fiduciary services and global custody. Total assets under administration at 31 December 2005 were $2.4 billion. During the year much focus was placed on business growth and on enhancing the Group’s Bahamas presence locally and internationally. Led by private banking, Butterfield Bank (Bahamas) saw strong growth, with international recognition gained through targeted marketing efforts. At 31 December 2005 the total lending portfolio had increased by 78.3%, or $2.3 million, year on year to $5.2 million, due in part to the Bank’s mortgage product. Butterfield Fund Services (Bahamas) Butterfield Fund Services (Bahamas) Limited is a specialist provider of administration services to the investment and pension fund industry. It offers Net Asset Value (“NAV”) calculations, accounting, corporate and shareholder services to alternative investment, hedge, mutual and pension funds. The introduction of innovative products like SMART Funds, which are regulated vehicles for investment funds, and the support of The Bahamas’ progressive investment fund legislation, introduced in 2003, have assisted growth in 2005. Barbados Mariano R. Browne Managing Director Butterfield Bank (Barbados) Limited The Group’s Barbados operations provide a comprehensive range of banking services through Butterfield Bank (Barbados) Limited, a full service community and commercial bank. A separate entity, Butterfield Asset Management (Barbados) Limited, acts as a representative office for the Group’s investment business. Total net income for Barbados in 2005 was $1.4 million, an increase of $1.1 million from 2004. This reflects a significant increase of 29.4% in loan growth, improvement in the quality of the loan portfolio that reduced provisions for loan losses by $0.5 million year on year, and a rising interest rate environment. At 31 December 2005, total assets in Barbados were $194.4 million, an increase of 12.2% from $173.3 million in 2004. 11 Services (Bermuda) Limited and Butterfield Trust (Bermuda) Limited. Home to the Group’s headquarters and largest operations, Bermuda continued to deliver a solid financial performance in 2005. This performance was recognised by The Banker magazine, which named Butterfield Bank as Bermuda's Bank of the Year for the fourth consecutive year and by Global Finance Magazine which awarded the Bank Best Developed Market Bank in Bermuda. To improve the all-round customer experience, premises continued to be refurbished and, as part of our service programme, service training took place for over 80% of employees in the jurisdiction. In 2005, total revenues for the Bermuda operations increased by $13.9 million, or 7.4%, to $200.1 million when excluding a $5.8 million realised gain in 2004 from the sale of a venture capital investment. The year also saw a 35.6% increase in assets under administration, up $11.9 billion to $45.2 billion. Operating expenses increased by 19.4% in 2005, reflecting investment in people, technology and risk management, and the increasing cost of health care in Bermuda. Butterfield Bank Working under the brand of Butterfield Bank, the Group’s community banking operations in Bermuda comprise corporate, private and retail banking and treasury services. In 2005, these businesses achieved a 5.8% year on year increase in total revenues before provisions for credit losses, and excluding the above realised gain in 2004. Net interest income was up 13.0% to $106.9 million, reflecting strong loan growth and a 6.8% increase in average interest earning assets to $4.0 billion. Net income in 2004 was driven up by a significant one-off loan recovery and investment gain. This has impacted the year on year net income comparison for 2005, which fell to $28.1 million, despite solid revenue increases across the community banking businesses. Retail Banking saw substantial growth during 2005, especially in the areas of residential mortgage and personal lending, which increased year on year by 13.1% to $0.9 billion. Debit and credit card business continued to grow aggressively, with the Butterfield/ AAdvantage© MasterCard® credit card portfolio showing impressive growth during its first full year. This new credit card now represents 49.1% of total personal credit card expenditures at year-end 2005. Overall, credit card outstandings grew 11.8% year on year. Investments in electronic banking included a complete upgrade for the Island’s Butterfield Direct ATM network, with all ATMs being replaced. Additionally, free security tokens were introduced to protect the growing number of corporate and individual customers using the Bank’s online banking service, Butterfield Direct Internet Banking, from potential internet fraud. Their introduction set a new standard of security for online banking in Bermuda, with the security tokens being recognised by banks around the world as providing one of the most secure log-in processes. The growth of Corporate Banking in 2005 exceeded expectations with the loan portfolio growing by 28.0%, to $1.1 billion. In excess of $400 million was written in new loans. This strong performance reflected a buoyant local economy, close relationships with customers and an ability to execute opportunities quickly and efficiently. A highly selective approach to corporate lending maintained loan quality and the diversity of the portfolio. Letters of Credit business reduced slightly due to a falling demand in the market although fee income held up reasonably well. Private Banking continued to grow during 2005 by maintaining its focus on building long-term relationships with high net worth clients. The business will be moving in 2006 to the former Butterfield Bank (Barbados) Butterfield Bank (Barbados) Limited is headquartered in the commercial centre of Bridgetown, the capital city, with three other branches in commercial and suburban areas. The Bank’s range of community banking services includes personal and commercial loans, overdraft facilities, credit cards, ATMs, merchant and e-commerce facilities, and fixed deposit, chequing and saving accounts. The Bank has successfully established itself in the Barbados market by providing consistently high levels of customer service and offering products to meet the needs of the local community. In 2005, the total lending portfolio grew by $24.9 million to $109.5 million. Residential mortgages introduced in 2004 are now a significant portion of the loan portfolio amounting to 30.3% of total loans. Investments increased by 53.7% to $64.5 million and customer deposits grew 14.9% to $159.4 million. Butterfield Asset Management (Barbados) Butterfield Asset Management (Barbados) Limited acts as a local representative for the Group’s investment business services, meeting the asset and cash management needs of captive insurance companies, international businesses, trusts and private clients. Bermuda The Group’s Bermuda operations provide community banking, asset management, trust and investment and pension fund administration services through The Bank of N. T. Butterfield & Son Limited under the Butterfield Bank brand and its wholly owned subsidiaries: Butterfield Asset Management Limited, Butterfield Fund 12 Bermuda Monetary Authority Building in Hamilton which was purchased by the Group in 2005 and is currently undergoing refurbishment. To be called Butterfield House, the new offices will enable Private Banking to offer clients greater privacy and improved services. Butterfield Trust (Bermuda) Providing a comprehensive range of trust, estate and company administration, company management and custody services, Butterfield Trust (Bermuda) Limited (BTBL) focuses on local and international clients, both corporate and individual. BTBL’s operations comprise Trust Administration Services and Investment Services. Grosvenor Trust Company Limited, a wholly owned subsidiary of BTBL that was acquired in the last quarter of 2004, was successfully integrated in 2005 within Trust Administration Services, although Grosvenor's identity has been retained. BTBL reported 2005 net income of $7.3 million, an increase of 8.7% over 2004. Net income from Trust Administration Services was $4.1 million, slightly down from $4.2 million in 2004 reflecting the lower level of estate fees earned. Personal trust business continued to expand, attracting families who value the flexibility and independence provided by BTBL’s customised services when managing their financial affairs in today's increasingly regulated international environment. Supporting Butterfield Trust and the Bank, the Investment Services department provides comprehensive custodial services including safekeeping of assets, trade settlement, income collection, funds transfer and capital reorganisation processing. In 2005 Investment Services enjoyed a record year with net income of $3.2 million, up 25.1% on 2004, and completed major upgrades of its core record-keeping and payments systems. The year saw a 28.2% increase in total revenues, to $9.8 million, driven by significant growth in external trust company and mutual funds business. At year-end, the department had $17.8 billion in assets under custody, up from $17.5 billion the previous year. Butterfield Asset Management Butterfield Asset Management Limited (BAM) provides discretionary and advisory investment management and brokerage services to a wide range of individual investors and organisations, and manages the family of ten Butterfield Funds as well as the Group's investment portfolios. BAM reported 2005 net income of $14.1 million, an increase of 4.9% over 2004. Assets under management by BAM, including client assets invested in Butterfield Funds, rose by $0.1 billion to $7.6 billion. The year again saw significant growth in Butterfield Select, BAM's Fund of Funds product, which rose by 31.3% to $342.7 million and the Butterfield Liquid Reserve, which rose 19.5% to $522.5 million. In Bermuda, BAM's strong performance was driven by its consistent proven investment strategy and by actively marketing wealth management services to private clients, trust companies and intermediaries. Having launched a new web site early in 2005, BAM also continued to develop close relationships with the insurance industry and co-ordinated the Bank's platinum level sponsorship of the first Bermuda Captive Conference. In April BAM's Butterfield Select Fixed Income Class fund won the Standard & Poor's (S&P) award for the best three- year performance of a US Dollar offshore fixed income fund. Continuing to innovate to meet customer’s investment needs, BAM launched two new products in 2005. The Butterfield Guaranteed Equity Deposit offered investors a guaranteed six-year fixed term deposit with Butterfield Bank, while the Butterfield Select Invest Fund provided investors with an easy and affordable way to invest, with exposure to more than 50 internationally-recognised funds for a minimum investment of only US$1,000. Butterfield Fund Services (Bermuda) Butterfield Fund Services (Bermuda) Limited (BFS Bermuda) provides valuation, accounting, corporate and shareholder services to offshore hedge funds, pensions and mutual funds. It acts for a number of the world’s leading investment management groups as well as accounting for the Bank’s portfolio of assets, the share register of the Group and administering the Butterfield family of funds. For the year ended 31 December 2005 net income was $9.5 million, up 32.9% compared with $7.2 million the previous year, reflecting another year in which BFS Bermuda significantly increased its client base. Net assets under administration, excluding the Butterfield Funds, increased by 58.7% from $16.7 billion in 2004 to $26.5 billion as at 31 December 2005. Cayman Islands Conor J. O’Dea Managing Director Butterfield Bank (Cayman) Limited The Group’s Cayman operations offer a comprehensive range of services to the local and international market through Butterfield Bank (Cayman) Limited 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. Butterfield Bank is currently the largest private sector employer in financial services in Cayman. The number of 13 growth and increased market share in its community and commercial banking services. Revenues were driven by a rise in interest rates, robust foreign exchange commissions and ongoing investment in technology to enhance customer services through ATM and internet banking. Revenues from banking services increased 21.2% year on year, up $1.3 million to $7.6 million, while foreign exchange revenues rose $2.4 million, or 32.4%, to $9.7 million. The Cayman Islands’ economy has been extremely robust over the past year. This is mainly attributed to post-Ivan rebuilding as well as new developments in the real estate market. By successfully managing its loan portfolio after Hurricane Ivan the Bank was able to release some of the Ivan-related credit loss provisions that were set aside. As a result, there was a $1.6 million net release of provisions for credit losses in 2005, compared to a charge of $3.6 million the previous year. Investment and Custody services experienced good revenue growth increasing by 14.5% to $5.2 million. During 2005, ground was broken on the Bank’s new headquarters, Butterfield Place, which will be a showcase building and is due for completion in 2007. The development will be the first seven storey building in George Town, designed to the highest standards and comprising 60,000 square feet of office space together with a six-level parking garage. Butterfield Miles, the loyalty programme with Cayman Airways, earned customers over six million air miles in its first year. The programme awards Bank customers free air miles on the national flight carrier every time they make a purchase with their Butterfield Bank VISA Gold credit card. An innovative service for prepaid mobile phone customers, “iTopUp with Butterfield”, was introduced by Butterfield Bank (Cayman) in April 2004. Through this service prepaid telecom customers can “top up” their phone balance using any local debit card at all Butterfield Bank ATMs. The service has seen significant growth in volume since its introduction. Butterfield Fund Services (Cayman) Butterfield Fund Services (Cayman) Limited (BFS Cayman) provides investment and pension fund administration services. BFS Cayman took on the administration of 49 new hedge funds in 2005. Revenues rose from $8.1 million in 2004 to $10.1 million, up 24.9% year on year. BFS Cayman now has 50 employees, up from 35 last year. Guernsey Robert S. Moore Managing Director Butterfield Bank (Guernsey) Limited The Group’s Guernsey operations offer private banking, wealth management and fiduciary services, administered banking services, and investment and pension fund administration services. These services are offered through Butterfield Bank (Guernsey) Limited, Butterfield Trust (Guernsey) Limited and Butterfield Fund Services (Guernsey) Limited. A positive international economic environment and generally strong investment market conditions provided a supportive backdrop for the Guernsey operations in 2005. Pre-tax net income in Guernsey increased from $2.2 million in 2004 to $8.2 million. Post-tax net income was increased from $2.6 million in 2004 to $7.2 million. In 2004 a tax credit of $0.4 million was recognised, compared to a tax expense of $1.0 million in 2005. Total revenues in Guernsey rose by 14.5% to $40.1 million. Private client business, including deposit and loan volumes, grew strongly and the benefits of the acquisition of Leopold Joseph Guernsey in 2004 also impacted positively on operating profits. Institutional client business registered high growth levels on all fronts, including fund administration, custody services and administered banking services. employees increased from 273 in 2004 to 317 in 2005 reflecting growth in all business divisions. The Bank continued to develop comprehensive training and employment programmes in Cayman and remains committed to providing quality career growth and educational opportunities for ambitious young Caymanians. In 2005, the Cayman operations continued to play a leading role in the Islands’ recovery from the devastation caused by Hurricane Ivan in September 2004, and the Bank’s services and community involvement were key factors in rebuilding Cayman’s physical and economic infrastructure during the year. Butterfield Bank sponsored and hosted a Cinema Premiere of “36 Hours in September”, a Hurricane Ivan documentary benefiting the Cayman Islands National Recovery Fund that we had helped launch in 2004. Net income was $45.8 million, up 85.3% over 2004, which represents a return on equity of 33.0%, up from 20.2% in 2004. Net interest income before provisions for credit losses was up 42.7% on 2004 at $44.1 million, while non-interest income totalled $36.5 million, an increase of 26.1% on 2004. Total income was up 46.1%, or $25.9 million to $82.2 million. The efficiency ratio saw a significant improvement, from 52.7% in 2004 to 45.2% and the net interest margin widened by 0.7% to 2.4%. Total assets increased year on year from $2.3 billion to $2.6 billion, reflecting continued growth in customer deposits. Total assets under administration at 31 December 2005 were $31.7 billion, up 26.5% from $25.0 billion at year-end 2004. Butterfield Bank (Cayman) The Bank continued to achieve solid 14 Total assets under administration in Guernsey stood at $20.2 billion, an increase of 23.0% from 2004. Butterfield Bank (Guernsey) Butterfield Bank (Guernsey) Limited provides quality banking services tailored to the needs of private and institutional clients. Customer deposits increased by 4.5% to $1.4 billion, while loans outstanding at 31 December 2005 stood at $214.9 million, an increase of 16.6% from 2004 with good growth both in property- related lending and in facilities collateralised by securities portfolios. Net interest income increased by 40.1% to $12.6 million, while banking and foreign exchange fees and commissions increased by 13.3% to $11.4 million. Total assets under management, primarily for high net worth individuals and families, stood at $869 million, an increase of $15 million year on year. Guernsey continued to be a market leader for administered banking – the provision of outsourcing solutions such as operational, accounting, compliance and corporate secretarial services – for Guernsey branches and subsidiaries of leading international banks and other financial institutions. This business line saw further growth in 2005, with assets under administration increasing by 29.2% to $7.1 billion. Custody Services also registered strong business growth. Institutional custody clients, including sponsors of both Guernsey and non-Guernsey regulated investment funds, continue to be attracted by the combination of technical expertise and high quality service that the Bank offers. Custody assets under administration increased more than 100% in 2005, by $2.6 billion to $5.1 billion. Butterfield Trust (Guernsey) Fiduciary services offered by Butterfield Trust (Guernsey) Limited include tailored trust and company administration services for institutional families, and sophisticated structures for corporate and institutional clients. The latter includes employee benefit trusts, and outsourcing support for the investment management, finance company and trust company operations of leading financial services companies. 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. It is the jurisdiction’s largest specialist in administration of Cayman and other non- Guernsey funds. In partnership with other companies in the Group it also provides administration solutions for family offices. Total assets under administration at 31 December 2005 stood at $6.6 billion, up from $6.1 billion a year ago. The United Kingdom Paul A. Turtle Managing Director Butterfield Bank (UK) Limited The Group's UK operation offers a full private banking service targeting high net worth individuals and their families with interests in the UK who are either UK or non-UK residents, through Butterfield Bank (UK) Limited, under the brand of Butterfield Private Bank. The acquisition of Leopold Joseph Holdings plc in 2004 has impacted earnings positively. Total revenues for the UK in 2005 increased by 16.8% to $22.6 million. A post-tax loss of $0.3 million was recorded, compared to a loss of $7.2 million in 2004. The loan portfolio in the UK increased by 8.6% to $423.2 million, while customer deposits increased year on year by 15.0% to $929.1 million. Total assets in the UK increased year on year by 22.7% when expressed in sterling terms, reflecting strong growth in customer deposits. However, due to the UK pound weakening by 10.3% during 2005, when expressed in dollar terms the growth reduces to 10.0%, with total assets ending the year at $1.2 billion. A key element of Butterfield Private Bank's strategic direction includes involvement with the pensions market for high earners in the UK. During the year substantial progress was made to become one of the UK’s major providers of Self Invested Personal Pensions (SIPPs). From April 2006, higher annual levels of pension contributions will be permitted and the range of investments allowed will also be expanded. Butterfield Private Bank provides full banking services for SIPPs, lending to assist gearing within SIPPs to purchase commercial property and full discretionary investment management for the pension fund. To identify clients looking to extend business activities or investments in the UK, Butterfield Private Bank works closely with professional financial advisors in the UK and other Group offices. The Bank has continued to strengthen its ability to meet the financial service requirements of high net worth clients through integrated services comprising high interest deposit banking, lending for residential and commercial property investment and discretionary investment management. Its Family Office offers a more holistic-based approach to meeting the needs of high net worth individuals and their families. With a distinctive approach to investments and the abilities and discretion of its financial advisors, Butterfield Private Bank has a solid platform and an advantage in a highly competitive market. 15 Group Business Lines & Support Divisions Human Resources While complying with local regulations and employment law in its different jurisdictions, the Group has an over-riding philosophy with regards to retaining and attracting quality people. Embracing a ‘total rewards’ approach, the Group aims to create an all-round rewarding and service- oriented environment. In 2005 this has meant improving premises, having competitive and meaningful benefits, recognising and rewarding performing employees and investing in training and development for employees. The Group provides ongoing training and development opportunities for all its employees, co-ordinating and facilitating programmes ranging from technical skills to personal and professional development. The programmes help maintain the Bank’s high quality of customer service, enhance the workplace experience and ensure that Butterfield Bank remains a competitive employer in all its jurisdictions. Technology The Group is moving towards a common approach to technology and finding areas of synergy across different jurisdictions and businesses that often require different systems. In 2005, investment in technology has helped streamline the Group’s operations and support the delivery of new products and services. In Bermuda, the project to replace the core banking system has progressed with the software having now been received in preparation for a 2006 implementation. 2005 also saw the commencement of a project to develop a single Butterfield Bank Group website. This is a critical development that will enable the Group to provide additional capabilities as customer demand for access to information and online transactions continues to rise. During the year, work was also completed on developing the Group’s Financial Systems Roadmap – a key activity in order to build capabilities in Bermuda and standardise across the Group. Risk Management Risk is inherent in virtually all of the Group’s daily activities and, as such, managing risk is a cornerstone of our business. Established risk management structures, policies and procedures are in place to identify, prioritise and manage risks across the Group in order to develop businesses with an appropriate balance between risk and reward. The three key risk types faced by the Group are credit risk, market risk and operational risk. Credit Risk is the risk of loss associated with the failure of a borrower or counterparty to fulfil its financial or contractual obligation to the Bank. The Group manages its credit risk through comprehensive governance and management processes, including Group Asset Management Bruce Albrecht Senior Vice President Group Head of Asset Management The Group’s Asset Management businesses provide investment management and brokerage services to institutional and private clients from The Bahamas, Barbados, Bermuda, Cayman, Guernsey and the UK. In 2005, Asset Management strengthened its senior management team by appointing a Senior Vice President, Head of Group Asset Management. The creation of this new position reflected the increasingly significant role that the Asset Management businesses play across the Group and the importance of developing it as a consistent offering to clients going forward. In 2005, Group revenues from Asset Management were $34.7 million, up 20.8% on $28.7 million in 2004. Group Assets under Management at year end 2005 were $9.4 billion. Group Fund Services Frank J. Sebestyen, III Senior Vice President Group Head of Fund Services From 2006, we will be working to more closely integrate our fund services businesses across jurisdictions under a Senior Vice President, Head of Group Fund Services. Fund Services specialises in providing third party administration for investment and pension funds in Bermuda, The Bahamas, the Cayman Islands and Guernsey and acts for a number of the world’s leading investment management groups. The international client base serviced by Fund Services, along with the desire to seek efficiencies, make a more cohesive approach a natural progression for the business. Across all four jurisdictions, Fund Services employs over 200 employees, has assets under administration in excess of $61 billion, and provides full administration services to over 750 mutual and hedge funds. 16 established credit policies, guidelines and clearly defined credit authorities. The Group Credit Committee, chaired by the President & Chief Executive Officer, provides a forum to review credit exposures, establish and review credit policies and approve selected credit transactions for the Group. The Enterprise Risk Management (ERM) function identifies, manages and reports on all types of risk by business line or process. ERM identifies and assigns ownership for market and operational risks, develops risk priorities, approves appropriate mitigation strategies, and examines the cause-and- effect relationships between individual product risks. It also ensures 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 Head of Enterprise Risk Management, 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. Market risk and liquidity risk are managed through appropriate controls and reporting systems. The Asset and Liability Management Committee (ALCO), chaired by the Chief Financial Officer, 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 successfully addressed several incidents throughout the year in several of its jurisdictions. During the island-wide power outage in Bermuda in July, Butterfield Bank was one of the few Hamilton businesses that were able to remain open and continue to serve its customers. Full disaster tests were conducted in respect of two major operations over the year with positive results. The Compliance function within ERM, seeks to ensure the Group is adequately safeguarded from criminals and fraud. Undertaking Know Your Customer research, monitoring of account activity, working with regulators and assisting with criminal investigations, Compliance is an integrated part of the Group’s business processes. 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. Financial Overview Income Total income for the Group after provisions was $355.1 million for the year ended 31 December 2005, up $44.0 million, or 14.1% from $311.2 million for the same period a year ago. Net interest income before provision for credit losses increased by 22.8% to $185.3 million. The increase reflects growth in average interest earning assets, which was up 11.6% to $8.8 billion, and the Group’s continually successful asset/liability management strategies. As a result the net interest margin widened by 0.2% to 2.1% and the interest rate spread increased by 0.1% to 1.7%. The Group continues to be appropriately reserved with total provisions of $24.7 million. Non-performing loans totalled $27.0 million as at 31 December 2005, up from $20.5 million a year ago, reflecting loan growth. They represent 0.9% of the total loan portfolio, compared to 0.8% a year ago. Provisions in respect of credit losses charged to income were $3.2 million, compared to $2.9 million last year. Non-interest income grew by 10.0% to $172.1 million, reflecting growth across all revenue lines, notably from asset management (+20.8%), foreign exchange (+17.3%), and investment & pension fund administration (+15.4%). Other revenues during the year totalled $0.9 million, down from $6.6 million the previous year reflecting a $5.8 million gain on sale of an affiliate in 2004. 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 2005 2004 Average balance Interest Rate Average balance Interest Rate 2,660,107 3,307,160 2,855,086 8,822,353 69,346 129,092 180,743 379,181 2.6% 3.9% 6.3% 4.3% 2,654,554 2,952,327 2,300,024 7,906,904 333,286 9,155,639 – 379,181 – 4.1% 275,191 8,182,095 188,493 8,514 197,007 – – 197,007 7,345,378 223,335 7,568,713 963,599 157,380 8,689,692 465,947 9,155,639 6,444,827 132,602 6,577,429 1,070,187 129,248 7,776,863 405,232 8,182,095 2.6% 3.8% 2.6% – – 2.3% 1.7% 2.1% 46,275 89,553 130,743 266,571 – 266,571 115,249 3,247 118,496 – – 118,496 1.7% 3.0% 5.7% 3.4% – 3.3% 1.8% 2.4% 1.8% – – 1.5% 1.6% 1.9% Note: Underlying assets and liabilities are comprised of various currencies. 17 Financial Overview Expenses The Group remains committed to the prudent management of its expense base and continually seeks opportunities to improve efficiency. The efficiency ratio was 66.4% in 2005, down from 69.1% in 2004, reflecting the growth in the Group’s operating revenue, up 14.1%, was higher than the percentage increase for operating expenses, which were up 9.8% year on year. The operating expense increase primarily reflected the expanding size of the Group with salaries and employee benefits up 13.2% to $144.3 million, and accounting for 59.1% of total Group operating expenses, compared with 57.3% last year. Increases of 16.5% and 17.0% respectively were seen in systems and communication and marketing costs, reflecting continued spending on information systems and marketing as we build and improve our operations. At 31 December 2005 there were 789 employees in Bermuda, up from 786 a year ago. Overseas, the total headcount increased by 42 to 808 primarily due to continued growth in Cayman. Other Expenses 13.2% Non-Corporation Taxes 4.9% Marketing 2.3% Systems & Communications 9.3% Property 11.2% Distribution Of 2005 Total Expenses Cayman 14.4% Guernsey 12.7% UK 9.0% Barbados 3.6% The Bahamas 2.0% Salaries & Other Employee Benefits 59.1% Bermuda 58.3% Distribution Of 2005 Expenses By Location 18 Balance Sheet Total assets increased by 6.6% to $9.2 billion, up from $8.6 billion a year ago. This increase reflects the rise in the customer deposit base, up year on year by $0.5 billion, or 7.3%, to $7.9 billion. The increase in the customer deposit base was primarily employed in term deposits with banks, and in funding our loan portfolios, which were both up year on year by 20.7% and 16.6% respectively to $2.7 billion and $3.1 billion. The Balance Sheet remains highly liquid with a loans to customer deposits ratio of 38.8% and loans to total assets ratio of 33.5%. A 29.3% BBB 0.7% Other 1.8% AAA 25.3% AA 42.9% Investment Portfolio By Long Term Debt Rating Cayman 9.9% Guernsey 6.9% UK 13.5% Barbados 3.5% The Bahamas 0.2% Bermuda 66.0% Lending By Location 19 Financial Overview Financial Institutions & Government 12.8% Credit Card 1.9% Mortgages 33.8% Commercial Real Estate 23.0% Commercial & Industrial 17.9% Other Consumer Loans 10.6% Group Loans By Type Taxes For the period under review the corporation tax of the Group was an expense of $1.6 million compared to a credit of $1.7 million for the same period a year ago. Corporation tax of $0.9 million in Guernsey, $0.6 million in Barbados and $0.1 million in the UK was incurred for the year. $11.9 million in non-profits taxes was also paid across the Group, up from $10.8 million in the previous year, primarily reflecting an increase in employer related payroll tax paid in Bermuda. Capital and Liquidity The Group continues to maintain a strong capital base that ensures stability and allows it to take advantage of opportunities for growth. At 31 December 2005 the risk weighted total capital ratio was 13.1%, compared to the 10.0% minimum requirement of the Bermuda Monetary Authority, and up from 10.7% a year ago. Of the total, the Tier 1 ratio was 8.6%, compared to a 5% minimum requirement and 7.3% at year-end 2004. Shareholders’ equity increased by $67.2 million, or 15.7%, over a year ago reflecting the increase in retained earnings less share buy-backs. Weighted risk assets rose year on year by 5.8% to $4.7 billion, primarily due to growth in loans and deposits with banks, offset by reductions in investments and letters of credit. The loan to the Stock Option Trust of $25.5 million is in respect of potential obligations under the Group’s Stock Option Plan and is deducted from shareholders’ equity as treasury stock. The loan remained at the same level as a year ago, reflecting repayments from cash received on the exercise of stock options by directors and employees, offset by the purchase by the Trust of 285,854 shares at a total cost of $12.6 million during the year. 20 In June 2005 the Group successfully issued US$150 million of subordinated lower tier II capital notes by way of a private placement with US institutional investors. The notes were issued in two tranches, namely US$90 million in Series A notes due 2015, and US$60 million in Series B notes due 2020. The Series A notes were priced at a coupon of 1.00% over the five year US Treasury yield and Series B notes at 1.10% over the ten year US Treasury yield. This brings the Group’s total subordinated capital issued to $283.6 million and provides capital financing to support business growth. During the year under review, the Group issued 242,738 shares under the Dividend Re-investment Programme, which represents a cash savings of $10.6 million, or 26.4% of the total dividend declared. As a result of the one-for-ten stock dividend in August 2005 2,436,730 new shares were also issued. Under the Share Buy-Back Plan, the Bank repurchased and cancelled 32,890 shares, at a cost of $1.4 million. Capital Composition (In $ thousands) For the year ended 31 December Tier 1 capital Tier 2 capital Deductions* Total capital Weighted Risk Assets (In $ thousands) Cash and inter-bank placements Investments Loans Other assets Off-balance sheet items Total weighted risk assets Capital Ratios (%) Tier 1 Tier 2 Deductions* Total 2005 2004 402,766 222,012 (13,351) 611,427 321,987 156,496 (4,272) 474,211 569,030 874,306 2,407,471 218,971 611,571 4,681,349 471,518 1,064,824 2,005,775 189,583 691,594 4,423,294 8.6% 4.7% (0.2%) 13.1% 7.3% 3.5% (0.1%) 10.7% *Deductions from capital comprise investments in affiliates 21 Financial Overview Selected Quarterly Results of Operations (Unaudited, in $ thousands except per share data and ratios) Quarter ended 31 December 30 September 30 June 31 March 2005 Net interest income after provision for credit losses Total fees and other income Total revenue Total non-interest expense Net income for the quarter Earnings per share ($)* Basic Diluted Return on shareholders’ equity (%) 47,918 42,638 90,556 66,218 24,338 0.97 0.93 19.7 47,602 43,919 91,521 60,893 30,628 1.21 1.18 25.7 45,760 44,564 90,324 60,274 30,050 1.19 1.17 27.3 40,894 41,834 82,728 58,393 24,335 0.97 0.95 22.7 Quarter ended 31 December 30 September 30 June 31 March 2004 Net interest income after provision for credit losses Total fees and other income Gain on sale of affiliate Total revenue Total non-interest expense Net income for the quarter Earnings per share ($)* Basic Diluted Return on shareholders’ equity (%) 38,340 40,105 – 78,445 56,858 21,587 0.87 0.84 19.3 43,011 39,851 – 82,862 60,012 22,850 0.91 0.89 22.0 35,151 41,067 – 76,218 55,879 20,339 0.81 0.79 20.1 31,573 36,317 5,750 73,640 47,950 25,690 1.03 0.99 25.5 *Comparative per share data has been restated to reflect the 1 for 10 stock dividends in August 2005 and 2004. 22 Financial Summary (In thousands of Bermuda dollars, except per share data) At year end Cash and deposits with banks Investments Loans, net of 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 Fee and other income Gain on sale of subsidiaries Salaries and other employee benefits Other non-interest expenses Net income from continuing operations Net income Dividends paid 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 declared Net book value Number of employees Bermuda Overseas Total Shareholder data Number of shareholders Number of shares (in thousands)** 31 December 2005 31 December 2004 Year ended 31 December 2003 31 December 2002 30 June 2002 2,849,920 2,916,399 3,085,594 141,708 9,197,566 8,240,109 278,679 495,226 182,174 172,955 – 144,331 101,447 109,351 109,351 38,504 1.2% 23.6% 35.2% 8.4% 13.1% 66.4% 4.23 4.23 1.67 19.48 789 808 1,597 2,396,724 3,266,400 2,645,331 126,031 8,630,383 7,907,450 142,333 428,030 2,912,383 2,638,253 1,954,716 99,979 7,733,806 7,122,577 122,871 382,095 148,075 163,090 – 127,459 93,240 90,466 90,466 32,217 1.1% 21.2% 35.6% 6.6% 10.7% 69.1% 3.51 3.51 1.55 17.13 786 766 1,552 115,066 118,985 – 100,104 63,109 70,838 70,838 26,809 1.0% 17.9% 37.8% 6.5% 13.0% 67.7% 2.79 2.79 1.43 15.30 734 647 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 25,432 1.2% 20.5% 30.3% 6.9% 13.1% 66.4% 2.96 2.96 1.37 13.68 724 476 1,200 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 24,081 1.2% 21.2% 29.3% 7.0% 13.8% 61.9% 3.09 3.12 1.31 13.08 749 480 1,229 3,878 25,429 3,778 22,745 3,581 20,643 3,322 18,603 3,364 19,247 * Excludes discontinued operations and gain on sale of subsidiaries. **Excludes shares held by the Bank's Stock Option Trust. Comparative per share data, with the exception of dividends has been restated to reflect the 1 for 10 stock dividends in August 2005, 2004 and 2003. The number of shares in 2005 increased primarily due to the issue of the stock dividend. # Inclusive of gain on sale of subsidiaries. Data for 2005, 2004 and 2003 is shown under US GAAP and for 2002 under Canadian GAAP. 23 Financial Overview 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 our external independent auditors 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 2 March 2006 Richard J. Ferrett Executive Vice President & Chief Financial Officer 2 March 2006 24 Independent Auditors’ Report to the Shareholders 25 Financials 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, net of allowance for credit losses Premises, equipment and computer software Accrued interest Goodwill 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. 2005 2004 154,698 2,695,222 2,849,920 164,431 2,232,293 2,396,724 2,233,577 546,302 136,520 2,916,399 3,085,594 141,708 44,648 22,840 69,622 66,835 9,197,566 2,592,824 29,681 643,895 3,266,400 2,645,331 126,031 30,843 24,638 81,405 59,011 8,630,383 858,358 999,826 7,090,608 291,143 8,240,109 19,093 11,049 153,410 183,552 278,679 8,702,340 26,948 341,647 152,501 (25,548) (322) 495,226 9,197,566 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 James A.C. King, JP Chairman of the Board Robert J. Stewart, JP Vice Chairman Alan R. Thompson President & Chief Executive Officer 26 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 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 loss Gain on sale of affiliate Realised / unrealised 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 Net income before income taxes Income 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 2005. 2005 2004 29,309 34,687 39,617 36,404 29,894 2,188 172,099 69,346 183,915 129,092 382,353 188,493 8,514 197,007 185,346 (3,172) 182,174 (129) – 895 90 355,129 144,331 27,301 22,813 5,658 44,047 244,150 110,979 (1,628) 109,351 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 4.34 4.23 3.62 3.51 27 Financials 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 (2004: 70,000,000) of par value $1 each Issued Issued and outstanding at beginning of year (January 2005: 24,301,337 shares; January 2004: 22,335,533 shares) Dividend reinvestment (December 2005: 242,738 shares; December 2004: 207,109 shares) Stock dividend (December 2005: 2,436,730 shares; December 2004: 2,217,927 shares) Shares repurchased and cancelled (December 2005: 32,890 shares; December 2004: 459,232 shares) Issued and outstanding at end of year (December 2005: 26,947,915; December 2004: 24,301,337 shares) Additional paid in capital Balance at beginning of year Dividend reinvestment Stock dividend Issued under directors' and executive officers' and employees’ stock option plans Shares repurchased and cancelled Balance at end of year Retained earnings Balance at beginning of year Net income for year Cash dividends declared Stock dividend Balance at end of year 2005 2004 24,301 22,335 243 207 2,437 2,218 (33) (459) 26,948 24,301 229,495 10,395 102,769 321 (1,333) 341,647 88,674 109,351 198,025 (40,318) (105,206) 52,501 149,454 8,659 89,941 413 (18,972) 229,495 124,002 90,466 214,468 (33,635) (92,159) 88,674 Appropriated retained earnings – general reserve 100,000 100,000 Accumulated other comprehensive income Balance at beginning of year Net change in unrealised gains (losses) on translation of net investment in foreign operations Net change in unrealised gains (losses) on available for sale securities Net change in unrealised losses on cash flow hedges Net change in minimum pension liability Balance at end of year Treasury stock Balance at beginning of year (January 2005: 1,556,476 shares; January 2004: 1,692,698 shares) Net issuances (purchases) Balance at end of year (December 2005: 1,519,203 shares; December 2004: 1,556,476 shares) Total shareholders' equity Comprehensive income Net income Other comprehensive loss Total comprehensive income The accompanying notes are an integral part of these consolidated financial statements. 28 11,031 (7,752) (328) (2,869) (404) (322) (25,471) (77) (25,548) 17,362 4,455. 201. (10,987) –. 11,031. (31,058) 5,587. (25,471) 495,226 428,030 109,351 (11,353) 97,998 90,466 (6,331) 84,135 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 Write down of equipment and computer software Change in carrying value of investment in affiliate Gain on sale of affiliate Realised gain on sale of available for sale securities Provision for credit losses Increase in accrued interest receivable Increase in other assets 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 Held to maturity securities: purchases Available for sale securities: proceeds from sale and maturities Available for sale securities: purchases Net proceeds on sale of affiliate Purchase of subsidiaries Cash used in investing activities Cash flows from financing activities Increase in demand and term deposit liabilities Issuance of subordinated capital and senior debt Repayment of senior debt Proceeds from dividend re-investment plan Shares repurchased and cancelled Treasury stock Cash dividends paid Cash provided by (used in) financing activities Effect of exchange rates on cash and demand deposits with banks Net increase (decrease) 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. 2005 2004 109,351 90,466 20,822 1,100 833 –. (90) 3,172 (15,237) (10,359) 10,743 30,280 150,615 487,611 638,226 (555,669) (35,569) (504,151) 1,168,313 (883,195) 731,186. (1,263,259) – –. (1,342,344) 583,108 150,000 (9,666) 10,638 (1,366) (77) (38,504) 694,133. 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) 252 350 (9,733) 52,729. 164,431 154,698 111,702 164,431 187,429 322 117,008 1,649 29 Financials Notes to Consolidated Financial Statements For the year ended 31 December 2005 (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 in designated variable 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 VIEs when the Bank is determined to be the primary beneficiary under the Financial Accounting Standards Board (FASB) interpretation No. 46 (Revised 2003) Consolidation of Variable Interest Entities (FIN 46R). (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 balance sheet 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, adjusted to recognise other than temporary impairment 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 from which it is unlikely that future interest payments will be received as scheduled. Realised gains and losses on sales of investments are included in earnings on a specific identified cost basis. 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. 30 (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 allowances and a general allowance, 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 Allowances Specific allowances are determined on an item by item basis and reflect the associated estimated credit loss. The specific allowances for credit 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 Allowances 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 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 (defined as loans with payments contractually over 30 days past due), 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. (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 tested annually for impairment at the reporting unit level, or 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. Intangible assets' estimated lives are reevaluated annually and an impairment test is carried out if certain indicators of impairment exist. 31 Financials (k) Premises, Equipment and Computer Software Land, building, equipment and computer 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 buildings, 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 between 5 and 7 years. If deemed significant the Bank will capitalise interest cost in accordance with FAS No. 34 Capitalisation of Interest Cost (FAS 34). (l) Derivatives In accordance with FAS No. 133 Accounting for Derivative Instruments and Hedging Activities (FAS 133), all derivatives are recognised on the Consolidated Balance Sheet at their fair value. FAS 133, as amended by FAS No. 138 Accounting for Certain Derivative Instruments and Certain Hedging Activities (FAS 138) and FAS No. 149 Amendment of Statement 133 on Derivative Instruments and Hedging Activities (FAS 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. (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 in accordance with FAS No. 87 Employers' Accounting for Pensions (FAS 87) and FAS No. 88 Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits (FAS 88). Its post- retirement medical and life insurance plans are accounted for in accordance with FAS No. 106 Employers' Accounting for Postretirement Benefits Other Than Pensions (FAS 106). 32 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 each of the defined benefit pension plans, the cumulative excess (deficit) of funding contributions over expenses is reported in other assets (other liabilities). 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 of the grant of stock options, no compensation cost 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 FAS No. 91 Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (FAS 91), 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. (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 one 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. 33 Financials 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. ii) Investments: The fair values of investments are based upon quoted market prices where available. iii) Loans: The majority of loans are variable rate and re-price 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 and senior debt: The fair value of the subordinated capital and senior debt 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 Sheet, 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 honour 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 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 tax 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. 34 (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 2005 (see also Notes 18 and 22). 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 FIN 46R requires a VIE 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 an entity meets the criteria to be considered the primary beneficiary of a VIE requires an evaluation of all transactions (such as investments, loans and fee arrangements) with the entity. (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 There were no significant acquisitions in 2005. 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. 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. 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 2005 Deerfield 2004 Leopold Joseph Grosvenor Total – – – – – – – – 205 – – 173 2,700 1,031 290 4,399 78,957 497,258 260,971 4,126 32,439 13,695 13,466 900,912 396 – – 41 8,337 – 988 9,762 79,558 497,258 260,971 4,340 43,476 14,726 14,744 915,073 35 Financials Fair value of liabilities assumed Deposits Other liabilities Subordinated capital Total liabilities Fair value of identifiable net assets acquired Total purchase consideration NOTE 3: Cash and Deposits with Banks 31 December Unrestricted Non-interest earning Cash and demand deposits 2005 Deerfield 2004 Leopold Joseph Grosvenor Total – – – – – – – 149 – 149 4,250 4,250 765,155 23,229 8,892 797,276 103,636 103,636 – 1,022 – 1,022 8,740 8,740 765,155 24,400 8,892 798,447 116,626 116,626 2005 Bermuda Non-Bermuda Total 2004 Bermuda Non-Bermuda Total 22,962 16,200 39,162 118,975 25,651 144,626 Interest earning Deposits maturing within three months and on demand Deposits maturing between three to six months Deposits maturing between six to twelve months Sub-total – Interest earning 307,898 – – 307,898 1,628,157 810,453 58,235 2,496,845 1,936,055 810,453 58,235 2,804,743 124,688 10,000 – 134,688 160,042 1,898,352 39,211 2,097,605 284,730 1,908,352 39,211 2,232,293 Total unrestricted cash and deposits 330,860 2,513,045 2,843,905 253,663 2,123,256 2,376,919 Affected by drawing restrictions related to minimum reserve and derivative margin requirements Interest earning Deposits maturing within three months Subtotal – Interest earning Total restricted deposits 1,586 1,586 1,586 4,429 4,429 4,429 6,015 6,015 6,015 1,535 1,535 18,270 18,270 19,805 19,805 1,535 18,270 19,805 Total cash and deposits with banks 332,446 2,517,474 2,849,920 255,198 2,141,526 2,396,724 NOTE 4: Investments Trading Trading assets include debt and equity securities held for trading purposes that the Bank owns ("long" positions). Trading positions are carried at fair value on the Consolidated Balance Sheet. 31 December Realised / unrealised gains (losses) on trading securities Equities (a) Fixed income and other (b) Total (a) Includes equity securities and equity derivatives. (b) Includes bonds, commercial paper, interest rate and foreign exchange derivatives. 2005 2004 1,084 (189) 895 307 340. 647 36 Trading assets The following table presents the fair value of trading assets and liabilities: 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 Available for sale The following table presents realised gains and losses from available for sale securities: 31 December Realised gains Realised losses Net realised gains 2005 2004 86,185 10,631 39,704 136,520 628,147 12,475 3,273 643,895 2005 2004 90 – 90 362 – 362 The amortised cost and estimated fair value of available for sale and held to maturity securities were as follows: 31 December cost gains losses Fair value 2005 Gross Amortised unrealised unrealised Gross 2004 Amortised cost Gross unrealised gains Gross unrealised losses Fair value Available for sale Debt securities issued by non-US governments Corporate debt securities Equity securities Other, primarily asset-backed securities Total available for sale 42,669 468,996 301 34,400 546,366 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 96,628 151,135 93,517 1,662,515 229,782 2,233,577 – 67 – 3 70 – (134) – – (134) 42,669 468,929 301 34,403 546,302 – 26,304 2,890 223 29,417 99 106 177 1,315 124 1,821 (716) (157) (703) 96,011 151,084 92,991 (2,662) 1,661,168 (11,117) 218,789 (15,355) 2,220,043 85,421 242,249 57,246 2,023,810 184,098 2,592,824 – – 264 – 264 364 111 228 3,560 335 4,598 – – – – – – 26,304 3,154 223 29,681 (36) (378) (4) 85,749 241,982 57,470 (1,363) 2,026,007 (8,452) 175,981 (10,233) 2,587,189 Investments at carrying value includes $1,738,105 (2004: $2,521,170) of floating-rate instruments and $1,144,491 (2004: $707,165) of fixed-rate instruments. The approximate yield on floating rate securities at 31 December 2005 was 4.36% (2004: 2.69%), while the approximate yield on fixed rate securities was 4.46% (2004: 5.31%). 37 Financials The following table presents securities by remaining term to maturity: 31 December 2005 Available for sale Debt securities issued by non-US governments 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 Certificates of deposit, bankers acceptances and commercial paper Debt securities issued by non-US governments Corporate securities and other Total trading Within 3 months 3 to 12 months 1 to 5 years Over 5 years No specific maturity Carrying value Remaining term to maturity 33,226 207,094 – – 240,320 – – 5,003 161,603 – 166,606 – 260,185 – 34,403 294,588 – – 3,178 266,427 – 269,605 9,443 – – – 9,443 59,950 – 71,761 1,229,485 48,888 1,410,084 – 1,650 – – 1,650 36,678 151,134 13,576 5,000 180,894 387,282 – – 301 – 301 42,669 468,929 301 34,403 546,302 – – – – – – 96,628 151,134 93,518 1,662,515 229,782 2,233,577 73,285 – 219 73,504 12,901 828 – 13,729 – 2,126 692 2,818 – 7,677 – 7,677 – – 38,792 38,792 86,186 10,631 39,703 136,520 Total investments 480,430 577,922 1,422,345 396,609 39,093 2,916,399 Total by currency (in Bermuda dollars equivalent) Bermuda dollars US dollars Other Total investments 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 61 217,295 263,074 480,430 – 194,576 383,346 577,922 – 1,350,436 71,909 1,422,345 – 370,949 25,660 396,609 800 28,536 9,757 39,093 861 2,161,792 753,746 2,916,399 Within 3 months 3 to 12 months 1 to 5 years Over 5 years No specific maturity Carrying value Remaining term to maturity 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 38 31 December 2004 Trading Certificates of deposit, bankers acceptances and commercial paper Debt securities issued by non-US governments Corporate securities and other Total trading Within 3 months 3 to 12 months 1 to 5 years Over 5 years No specific maturity Carrying value Remaining term to maturity 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 Bermuda dollars equivalent) Bermuda dollars US dollars Other Total investments NOTE 5: Loans – 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 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 2005 Bermuda Non-Bermuda Total 2004 Bermuda Non-Bermuda Total 468,803 87,718 556,521 375,390 121,765 497,155 133,626 Commercial mortgage 140,101 Construction 321,383 Financial institutions 19,303 Government 1,083,216 Total commercial loans Less allowance for credit losses on commercial loans (13,765) Total commercial loans after allowance for credit losses 1,069,451 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 38,990 52,919 799,922 78,378 970,209 (5,978) 964,231 431,440 8,980 58,156 – 586,294 (2,158) 584,136 18,254 8,948 252,549 190,858 470,609 (2,833) 467,776 565,066 149,081 379,539 19,303 1,669,510 (15,923) 1,653,587 57,244 61,867 1,052,471 269,236 1,440,818 (8,811) 1,432,007 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 Total loans Less allowance for credit losses Net loans 2,053,425 (19,743) 2,033,682 1,056,903 (4,991) 1,051,912 3,110,328 (24,734) 3,085,594 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 2,669,152 (23,821) 2,645,331 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 2005 is 6.37% (2004: 6.32%). During the year loans of nil (2004: $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. 39 Financials The table below sets forth information about the Bank's impaired loans: 31 December Commercial loans – Bermuda Commercial loans – Non-Bermuda Consumer loans – Bermuda Consumer loans – Non-Bermuda Mortgages – Bermuda Mortgages – Non-Bermuda Total Gross 6,293 7,791 900 2,700 4,597 4,681 26,962 2005 Allowance (2,625) (729) (165) (358) (165) (62) (4,104) Total 3,668 7,062 735 2,342 4,432 4,619 22,858 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 For the year ended 31 December 2005, the amount of gross interest income that would have been recorded had impaired loans been current was $2,711 (2004: $2,666). For the year ended 31 December 2005, the Bank recovered overdue interest of $529 (2004: $172) on impaired loans that were repaid in the year. The average balance of impaired loans during the year ended 31 December 2005 was $24,705 (2004: $18,429). The table below summarises the changes in the allowance for credit losses: Year ended 31 December Specific allowances 2005 General allowance Allowance for credit losses at beginning of year Provision this year Recoveries Charge-offs Other Allowance for credit losses at end of year 1,918 4,464 255 (2,528) (5) 4,104 21,903 (1,292) 1,195 (1,176) – 20,630 Total 23,821 3,172 1,450 (3,704) (5) 24,734 Specific allowances 3,949 723 2,215 (5,330) 361 1,918 2004 General allowance 17,937 2,171 3,204 (1,053) (356) 21,903 The table below presents information about the loan delinquencies, and charge-offs: 31 December Credit card Automobile financing Other consumer and mortgages Consumer loans Commercial loans Total loans reported Total delinquent loans 2005 Loans 90 days or more past due Charge-Offs Total delinquent loans 2004 Loans 90 days or more past due 4,198 765 22,637 27,600 6,433 34,033 845 369 11,798 13,012 5,127 18,139 897 42 2,431 3,370 334 3,704 3,812 872 25,882 30,566 12,563 43,129 587 569 12,969 14,125 11,168 25,293 Total 21,886 2,894 5,419 (6,383) 5 23,821 Charge-offs 763 554 1,286 2,603 3,780 6,383 40 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 allowance Total The following table summarises the credit exposure of the Bank by region: 31 December Bermuda Barbados Cayman Guernsey The Bahamas United Kingdom Sub-total General allowance Total 2005 2004 55,679 725,874 967,681 30,994 1,262,226 19,303 1,378,195 4,439,952 (20,630) 4,419,322 95,155 572,940 1,340,454 56,322 938,413 38,474 944,747 3,986,505 (21,903) 3,964,602 2005 2004 3,029,684 119,620 444,276 324,196 5,182 516,994 4,439,952 (20,630) 4,419,322 2,752,005 84,148 428,962 225,902 2,904 492,584 3,986,505 (21,903) 3,964,602 41 Financials NOTE 7: Premises, Equipment and Computer Software The following table summarises land, buildings, equipment and computer software: 31 December Land Buildings Equipment Computer software Total 31 December 2005 Accumulated depreciation Net carrying value – (28,403) (25,229) (19,172) (72,804) 11,997 81,339 17,696 30,676 141,708 Cost 11,997 109,742 42,925 49,848 214,512 Cost 12,345 105,907 62,162 62,610 243,024 Depreciation Buildings and equipment (included in property expenses) Computer software (included in systems and communication expenses) Total depreciation charged to operating expenses NOTE 8: Goodwill and Other Intangible Assets The following table presents goodwill and other intangible assets by business segment: Goodwill Business segment Barbados Guernsey Balance as at 31 December 2003 Goodwill acquired during the year Foreign exchange translation adjustment Balance as at 31 December 2004 Foreign exchange translation adjustment Balance as at 31 December 2005 Other intangible assets 31 December Bermuda Barbados Cayman Guernsey The Bahamas United Kingdom Customer relationships 5,220 – – 5,220 – 5,220 2005 Gross carrying amount 8,337 6,681 1,211 45,491 7,790 17,905 87,415 Accumulated amortisation (695) (926) (108) (12,205) (1,465) (2,394) (17,793) 3,014 4,758 419 8,191 (848) 7,343 Net carrying amount 7,642 5,755 1,103 33,286 6,325 15,511 69,622 2004 Accumulated depreciation Net carrying value – (30,633) (47,281) (39,079) (116,993) 12,345 75,274 14,881 23,531 126,031 2005 2004 6,633 7,698 14,331 6,686 6,334 13,020 The Bahamas United Kingdom 892 1,031 – 1,923 – 1,923 Gross carrying amount 8,337 6,681 1,211 50,740 7,790 19,831 94,590 – 8,937 367 9,304 (950) 8,354 2004 Accumulated amortisation (139) (482) (27) (10,202) (1,067) (1,268) (13,185) Total 9,126 14,726 786 24,638 (1,798) 22,840 Net carrying amount 8,198 6,199 1,184 40,538 6,723 18,563 81,405 There have been no impairment losses for the years ended 31 December 2005 and 2004. The estimated aggregate amortisation expense for each of the succeeding years until 31 December 2009 is $6.0 million. Customer relationships are initially 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 2005, the Bank did not acquire new customer relationships (2004: $44.9 million), the amortisation expense amounted to $6.3 million (2004: $5.4 million) and the foreign exchange translation adjustment decreased the net carrying amount by $5.5 million (2004: increased by $3.2 million). 42 NOTE 9: Customer Deposits and Deposits from Banks (a) By maturity 31 December Customer and bank demand deposits Demand deposits – Non-interest bearing Demand deposits – Interest bearing Sub-total – demand deposits Customer and bank term deposits Term deposits maturing within six months Term deposits maturing between six to twelve months Term deposits maturing after twelve months Sub-total – term deposits Total (b) By type and location 2005 2004 858,358 3,964,017 4,822,375 3,086,510 148,667 182,557 3,417,734 999,826 3,878,707 4,878,533 2,690,114 105,695 233,108 3,028,917 8,240,109 7,907,450 31 December Bermuda Customers Banks Cayman Customers Banks Guernsey Customers Banks Other international Customers Banks Total Payable on demand 2005 Payable on a fixed date Total Payable on demand 2004 Payable on a fixed date Total 1,970,607 8,069 1,243,597 24,831 3,214,204 32,900 2,098,322 223,951 1,069,535 – 3,167,857 223,951 1,522,129 55,185 689,696 75,994 2,211,825 131,179 1,528,645 – 438,140 184,943 1,966,785 184,943 654,654 5,681 695,709 2,005 1,350,363 7,686 524,102 5,711 756,042 488 1,280,144 6,199 594,803 11,247 4,822,375 577,771 108,131 3,417,734 1,172,574 119,378 8,240,109 497,802 – 4,878,533 492,267 87,502 3,028,917 990,069 87,502 7,907,450 The effective yield on deposits at 31 December 2005 was 2.6% (2004: 2.2%). 43 Financials 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 30 November. 2005 Post-retirement Pension plans medical benefit plan 2004 Pension plans Post-retirement medical benefit plan Accumulated benefit obligation at end of year 103,713 – 98,084 – Change in projected benefit obligation Opening projected benefit obligation Acquisitions Service cost Employee contributions Interest cost Benefits paid Past service cost Actuarial loss (gain) Foreign currency exchange rate changes Closing projected benefit obligation Change in plan assets Opening fair value of plan assets New acquisitions Actual return on plan assets Employer contribution Employee contributions Benefits paid Foreign currency exchange rate changes Closing fair value of plan assets Funded status Deficit of plan assets over projected benefit obligation at end of year Employer contribution during the period from measurement date to fiscal year end Unamortised net actuarial loss Unamortised past service cost Net amount recognised 105,515 – 3,748 272 5,729 (3,650) – 5,342 (4,728) 112,228 86,448 – 8,461 9,348 272 (3,650) (3,619) 97,260 (14,968) 5,176 4,854 146 (4,792) 82,524 – 2,256 – 5,572 (1,257) – 8,150 – 97,245 – – – 1,257 – (1,257) – – (97,245) – 41,048 – (56,197) 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) – – (82,524) – 36,874 – (45,650) 44 2005 Post-retirement Pension plans medical benefit plan 2004 Pension plans Post-retirement medical benefit plan Amounts recognised in balance sheet consist of Prepaid pension benefit cost included in other assets Accrued pension benefit cost 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 (gain) loss Defined benefit expense Defined contribution expense Total benefit expense 180 (5,376) 404 (4,792) 3,748 5,729 (5,733) 36 (71) 3,709 3,378 7,087 2005 – (56,197) – (56,197) 2,256 5,572 – – 3,976 11,804 – 11,804 – (16,473) – (16,473) 4,443 5,278 (5,046) 28 21 4,724 3,121 7,845 2004 – (45,650) – (45,650) 1,472 4,755 – – 3,175 9,402 – 9,402 December 31 Post-retirement Pension plans medical benefit plan Pension plans Post-retirement medical benefit plan 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 5.60% 3.70% 6.50% N/A 5.45% 3.80% N/A 6.00% N/A N/A 12% to 5% in 2013 6.00% N/A 11% to 5% in 2013 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 For 2005, the effect of a one percentage point increase or decrease in the assumed medical cost increase rate on the aggregate of service and interest costs is a $1.6 million increase and a $1.2 million decrease, respectively, and on the benefit obligation a $16.8 million increase and a $13.6 million decrease, respectively. To develop the expected long-term rate of return on the plan 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. The weighted average discount rate used to determine benefit obligations at the end of the year is derived from interest rates on high quality corporate bonds with maturities that match the expected benefit payments. 45 Financials The weighted average actual and target asset allocations of the pension plans by asset category, are as follows: 31 December 2005 Actual allocation Target allocation 2004 Actual allocation Target allocation Asset category Equity securities (including equity mutual funds) Debt securities (including debt mutual funds) Other Total 55% 40% 5% 100% 50% 50% – 100% 57% 37% 6% 100% 51% 49% – 100% At 31 December 2005, 52.6% (2004: 50.8%) of the assets of the pension plans were mutual funds and alternative investments managed or administered by wholly-owned subsidiaries of the Bank. At 31 December 2005, 2.0% (2004: 1.8%) 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 2006 Bank contribution to, and estimated benefit payments for the next ten years under, the pension and post-retirement medical benefit plans are as follows: Year Pension plans Post-retirement medical benefit plan Estimated Bank contributions Estimated benefit payments Estimated benefit payments Estimated benefit payments Estimated benefit payments Estimated benefit payments Estimated benefit payments 2006 2006 2007 2008 2009 2010 2011-2015 5,400 3,400 3,700 3,900 4,000 4,300 27,500 2,760 2,760 3,087 3,510 3,925 4,363 27,598 The projected benefit obligation and fair value of plan assets for pension plans with projected benefit obligations in excess of plan assets were $110 million and $94 million respectively, as at 31 December 2005 ($103 million and $84 million respectively, as at 31 December 2004). NOTE 11: Commitments, Credit Related Arrangements and Contingencies Commitments The Bank was committed to expenditures under contract for software development and construction of $5.4 million and $29.5 million respectively, as at 31 December 2005 (2004: $8.7 million and $25 million). Rental expense for premises leased on a long-term basis for the year ended 31 December 2005 amounted to $5.1 million (2004: $4.9 million). The following table summarises the Bank's commitments for construction, software development and long-term leases: 27,464 17,445 4,712 4,560 4,243 5,652 Year 2006 2007 2008 2009 2010 2011 & thereafter 46 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 Forward guarantees Total Gross 2005 Collateral Net Gross 2004 Collateral Net 775,689 – 245,875 – 529,814 – 650,973 2,464 156,106 2,464 494,867 – 560,419 2,324 37,441 2,846 1,378,719 529,593 2,324 32,347 2,846 812,985 30,826 – 5,094 – 565,734 544,587 3,025 15,296 2,151 1,218,496 515,432 2,599 11,074 2,151 689,826 29,155 426 4,222 – 528,670 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 not exceed one year, while the term of the guarantees does not exceed four years. The types and amounts of collateral security held by the Bank for these standby letters of credit and guarantees is generally represented by deposits with the Bank or a charge over assets held in mutual funds. During the year, the Bank was provided with a facility by one of its custodians, whereby the Bank may offer up to $150 million of standby letters of credit to its customers on a fully secured basis. Under the standard terms of the facility, the custodian has the right of set-off against securities held of 110% of the utilised facility. At 31 December 2005, $20.4 million (2004: nil) of standby letters of credit were issued under this facility. 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 and proceedings, 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 2005 2004 Mortgages Other loans Amortisation of loan origination fees (net of amortised costs) Total loan interest income 85,134 95,201 180,335 3,580 183,915 68,212 63,203 131,415 2,222 133,637 Balance of unamortised loan fees as at 31 December 10,843 9,195 47 Financials 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 & Fiduciary Services and Investment & Pension Fund Administration, and Real Estate), Barbados, Cayman, Guernsey, The Bahamas, the United Kingdom, and Hong Kong. Accounting policies of the reportable segments are the same as those described in Note 1. The Bermuda Community Banking segment provides a full range of retail, corporate and treasury 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. Treasury services include money market and foreign exchange activities. Community Banking also includes treasury operations and Promisant (Technology) Limited. The Bermuda Wealth Management & Fiduciary Services and Investment & 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 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 four branch locations, ATMs and debit cards. Services include deposit services, commercial banking, consumer and mortgage lending and credit cards. The Cayman segment provides a comprehensive range of community and commercial banking services to private and corporate customers through five locations and through 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 RBC Dexia Investor Services Limited (formerly Dexia Holdings (Hong Kong) Limited). Operating segment information follows: 31 December 2005 2004 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 overseas 4,459,464 4,176,846 32,432 76,265 4,568,161 194,433 2,579,080 1,495,284 96,903 1,206,154 233 5,572,087 28,952 65,082 4,270,880 173,324 2,322,657 1,442,522 63,433 1,096,629 2,076 5,100,641 Less: inter-segment eliminations Total (942,682) 9,197,566 (741,138) 8,630,383 48 Business Area Analysis Year ended 31 December 2005 Net interest income Allowance for Fees and Customer Intersegment credit losses other income Total revenue Other Depreciation & amortisation expenses Total expenses Net income Bermuda 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 112,658 (5,730) (4,513) 28,285 130,700 96,893 5,709 102,602 28,098 – – 112,658 7,934 37,345 10,993 (301) 16,717 – 72,688 342 (1,115) (6,503) – 6,717 1,652 1,354 (3,220) – 6,503 – – (4,513) 67,692 2,518 98,495 68,034 1,403 200,137 35,907 5,692 138,492 1,160 1,925 8,794 37,067 7,617 147,286 (255) 1,622 – (26) – – 1,341 3,495 36,520 27,493 5,763 9,058 639 82,968 11,174 82,204 40,138 6,790 22,555 639 163,500 8,136 33,454 28,622 4,476 20,284 – 94,972 1,595 2,935 4,310 659 2,529 – 12,028 9,731 36,389 32,932 5,135 22,813 – 107,000 30,967 (6,214) 52,851 1,443 45,815 7,206 1,655 (258) 639 56,500 Total income 185,346 – (3,172) 181,463 363,637 233,464 20,822 254,286 109,351 Less: inter-segment eliminations (principally rent and management fees) Total – 185,346 – – – (3,172) (8,508) 172,955 (8,508) 355,129 (8,508) 224,956 – 20,822 (8,508) 245,778 – 109,351 Year ended 31 December 2004 Customer Intersegment Net interest income Allowance for Fees and credit losses other income Total revenue Other Depreciation & amortisation expenses Total expenses Net income 94,275 363 1,437 38,941 135,016 82,479 5,388 87,867 47,149 Bermuda 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 5,608 29,037 7,378 131 14,540 – 56,694 Total income 150,969 Less: inter-segment eliminations (principally rent and management fees) Total – 150,969 249 (1,114) (502) (6) 1,835 1,649 389 (3,365) – 502 – – – – – 1,437 (721) (3,582) – (28) – – (4,331) 55,357 2,515 96,813 3,576 28,972 26,015 5,369 8,137 688 72,757 55,606 1,401 192,023 8,457 56,262 35,042 5,861 19,312 688 125,622 27,531 5,632 115,642 6,572 28,767 29,273 4,454 24,081 – 93,147 706 1,581 7,675 1,561 2,775 3,193 739 2,447 – 10,715 28,237 7,213 123,317 8,133 31,542 32,466 5,193 26,528 – 103,862 27,369 (5,812) 68,706 324 24,720 2,576 668 (7,216) 688 21,760 (2,894) 169,570 317,645 208,789 18,390 227,179 90,466 – (2,894) (6,480) 163,090 (6,480) 311,165 (6,480) 202,309 – 18,390 (6,480) 220,699 – 90,466 For the year ended 31 December 2005, included within other expenses are the following income tax expense / (refund) amounts: Guernsey $984 (2004: ($376)), United Kingdom $60 (2004: ($1,551)), and Barbados $584 (2004: $192). 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. 49 Financials 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. Included in other assets (other liabilities) are the reported receivables and unrealised gains (payables and 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). (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 2005 the Bank recognised a net loss of $0.4 million (2004: $0.2 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 2005 the Bank has recorded the fair value of derivative instrument assets of $1.3 million (2004: $0.4 million) in other assets and derivative instrument liabilities of $7.2 million (2004: $3.2 million) in 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 2005 and 2004, there was no hedge ineffectiveness related to cash flow hedges. As of 31 December 2005, ($0.5) million (2004: $1.9 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 2 years (2004: 3 years). As of 31 December 2005, the Bank has recorded the fair value of derivative instrument assets of $0.2 million (2004: $2.9 million) in other assets and $1.5 million (2004: $1.4 million) in other liabilities. 50 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 Sub-total Foreign exchange contracts Spot and forwards Currency options Sub-total Trading 2005 ALM Total value Trading 2004 ALM Total value 26,748 52,332 79,080 444,204 – 444,204 470,952 52,332 523,284 59,593 66,000 125,593 595,320 – 595,320 654,913 66,000 720,913 5,604,472 – 5,604,472 – – – 5,604,472 – 5,604,472 2,415,658 5,130 2,420,788 – – – 2,415,658 5,130 2,420,788 Total notional amount of financial derivatives outstanding 5,683,552 444,204 6,127,756 2,546,381 595,320 3,141,701 Included in the notional amounts for cash flow hedges using interest rate swaps for 31 December 2005, are $225.2 million (2004: $372.8 million), pertaining to specific floating rate notes included in the investment portfolio which were classified as held to maturity, and $12.9 million (2004: nil) pertaining to floating rate deposits. Included in the notional amounts for fair value hedges using interest rate swaps for 2005, are $51.2 million (2004: $29.8 million) pertaining to specific loans, $125 million (2004: $125 million) pertaining to subordinated debt, and $42.8 million (2004: $24.5 million), pertaining to fixed rate 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 fair value Positive 2005 Negative Net Positive 1,519 26,318 1,136 28,973 8,740 24,613 1,070 34,423 (7,221) 1,705 66 (5,450) 3,690 26,555 506 30,751 2004 Negative 4,271 23,734 477 28,482 Net (581) 2,821 29 2,269 51 Financials (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 2005 Within 6 months 6 to12 months 1 to 3 years 3 to 5 years After 5 years Total Interest rate contracts Interest rate swaps Interest rate caps Sub-total Foreign exchange contracts Spot and forwards Currency options Sub-total Total notional amount by remaining maturity 158,310 – 158,310 78,380 24,000 102,380 130,663 17,440 148,103 22,157 10,892 33,049 81,443 – 81,443 470,953 52,332 523,285 5,560,957 – 5,560,957 39,891 – 39,891 3,624 – 3,624 – – – – – – 5,604,472 – 5,604,472 5,719,267 142,271 151,727 33,049 81,443 6,127,757 31 December 2004 Within 6 months 6 to 12 months 1 to 3 years 3 to 5 years After 5 years Total Interest rate contracts Interest rate swaps Interest rate caps Sub-total Foreign exchange contracts Spot and forwards Currency options Sub-total Total notional amount by remaining maturity 97,373 – 97,373 2,280,033 – 2,280,033 111,511 – 111,511 124,496 5,130 129,626 275,797 66,000 341,797 100,659 – 100,659 69,573 – 69,573 654,913 66,000 720,913 11,129 – 11,129 – – – – – – 2,415,658 5,130 2,420,788 2,377,406 241,137 352,926 100,659 69,573 3,141,701 (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 Sub-total Trading 156 1,136 1,292 26,318 – 26,318 2005 ALM 1,364 – 1,364 – – – Total value Trading 1,520 1,136 2,656 26,318 – 26,318 – 305 305 26,555 201 26,756 2004 ALM 3,690 – 3,690 – – – Total value 3,690 305 3,995 26,555 201 26,756 Total replacement cost 27,610 1,364 28,974 27,061 3,690 30,751 52 NOTE 15: Fair Value of Financial Instruments The following table presents the carrying value and fair value of financial assets and liabilities under FAS No. 107 Disclosures About Fair Value of Financial Instruments (FAS No. 107). 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) 2005 2004 2,849,920 2,849,920 – 2,396,724 2,396,724 – Financial assets Cash and deposits with banks Investments Held to maturity Available for sale Trading Loans Commercial, net of allowance for credit losses 1,653,587 1,432,007 Consumer, net of allowance for credit losses 345,653 9,197,566 Other assets Total financial assets 2,233,577 546,302 136,520 2,220,043 546,302 136,520 1,653,265 1,432,443 345,653 9,184,146 Financial liabilities Customer deposits Demand deposits Term deposits Deposits, financial institutions Other liabilities Subordinated capital and senior debt Total financial liabilities 4,742,193 3,206,773 291,143 183,552 278,679 8,702,340 4,742,193 3,209,043 291,143 183,552 275,408 8,701,339 (13,534) – – (322) 436 – (13,420) – (2,270) – – 3,271 1,001 2,592,824 29,681 643,895 1,342,778 1,302,553 321,928 8,630,383 2,587,189 29,681 643,895 1,343,503 1,304,684 321,928 8,627,604 4,633,654 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 (5,635) – – 725 2,131 – (2,779) – 9,100 – – – 9,100 53 Financials 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 2005 (in $ millions) Within 3 months Assets Cash and demand 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 1,943 1,745 2,948 – – 6,636 – 6,183 – 125 6,308 328 328 Earlier of contractual maturity or repricing date 1 to 5 years After Non-interest 5 years bearing funds 6 to 12 months 3 to 6 months 810 353 26 – – 1,189 – 913 – – 913 276 604 58 355 9 – – 422 – 103 – – 103 319 923 – 368 118 – – 486 – 144 – 90 234 252 – 56 21 – – 77 – 39 – 69 108 39 39 (36) 142 204 388 495 858 184 (5) 1,532 (31) (1,144) 1,175 1,144 – 31 December 2004 (in $ millions) Within 3 months 3 to 6 months Earlier of contractual maturity or repricing date After 5 years 6 to 12 months 1 to 5 years Non-interest bearing funds Assets Cash and demand 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 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 9 126 196 481 428 1,001 153 – 1,582 (14) (1,082) (560) 799 1,096 1,082 – Total 2,850 2,916 3,086 142 204 9,198 495 8,240 184 279 9,198 – – Total 2,397 3,266 2,645 126 196 8,630 428 7,907 153 142 8,630 – – (a) Includes interest rate swaps with fair value of ($4.9 million) (2004: ($2 million)), that are highly effective, designated and qualify as fair value hedges. 54 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 (BSX) 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 pays a fixed coupon of 3.94% until 27 May 2008 when they become redeemable in whole at the option of the Bank. The Series B notes pays a fixed coupon of 5.15% 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 $8.6 million. The issuance was by way of private placement in the United Kingdom 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’s UK subsidiary, the Bank of Butterfield (UK) Limited issued senior debt of £5.2 million which was included in the Consolidated Balance Sheet in the amount of $10 million. The issue was exclusively to the shareholder's of Leopold Joseph and paid a variable rate of interest of 3 months LIBOR plus 30 basis points. The debt was repaid in full on 4 January 2005. On 27 June 2005, the Bank issued US $150 million of Subordinated Lower Tier II capital notes. The notes were issued at par in two tranches, namely US $90 million in Series A notes due 2015 and US $60 million in Series B notes due 2020. The issuance was by way of private placement with US institutional investors. The notes are listed on The BSX in the specialist debt securities category. The notes issued under Series A pays a fixed coupon of 4.81% until 2 July 2010, when they will become redeemable in whole at the Bank's option. The Series B notes pays a fixed coupon of 5.11% until 2 July 2015 when they also become redeemable in whole at the Bank’s option. The Series A notes were priced at a spread of 1.00% over the 5-year US Treasury yield and the Series B notes were priced at a spread of 1.10% over the 10-year US Treasury yield. Interest capitalised in accordance with FAS 34 during the year amounted to $1,165 (2004: $461) and is included in interest expense – subordinated capital and senior debt in the Consolidated Statement of Income. The following table presents the contractual maturity and interest payments for subordinated capital issued by the Bank as at 31 December 2005: Subordinated capital Bermuda 2003 issuance – Series A 2003 issuance – Series B 2005 issuance – Series A 2005 issuance – Series B Subsidiary Other (a) Total Within 1 year 1 to 5 years After 5 years Carrying value Fixed rate Fixed rate Fixed rate Fixed rate Fixed rate – 3,073 2,421 4,377 3,100 799 – 13,770 90,293 9,682 107,316 12,264 3,195 – 222,750 7,683 65,154 21,645 90,660 14,222 – 199,364 78,000 47,000 90,000 60,000 8,600 (4,921) 278,679 (a) Other includes interest rate swaps with notional amount of $125 million, that are highly effective, designated and qualify as fair value hedges. 55 Financials 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 2005 and 2004 (see also Note 22). 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) 31 December 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 (in thousands) Adjusted weighted average number of diluted common shares (in thousands) 2005 2004 109,351 90,466 26,830 (1,632) 25,198 4.34 26,882 (1,862) 25,020 3.62 2005 2004 109,351 90,466 26,830 (1,632) 674 25,872 4.23 26,882 (1,862) 736 25,756 3.51 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 equal to the market price on 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 3,000,000. On 12 December 2005, the Board of Directors of the Bank approved the acceleration of the vesting of all outstanding unvested stock options (the Acceleration) for certain classes of employees. The Acceleration was effective for all such options outstanding on 25 November 2005, all of which were granted by the Bank when the accounting rules permitted use of the intrinsic value method of accounting for stock options. All of the other terms and conditions applicable to such outstanding stock option grants still apply. Under Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees (APB 25), the Acceleration resulted in recognition of stock-based compensation expense of $0.3 million which was determined by measuring the intrinsic value on the date of the modification of the options that otherwise would have expired unexercised. The Company's decision to accelerate the vesting of these options was made to reduce administrative burden and in anticipation of compensation expense to be recorded in connection with outstanding unvested stock options issued to employees subsequent to the effective date of FAS No. 123 (Revised 2004) Share Based Payment (FAS 123R). The compensation expense that would have been recognised in the income statements for the years 2006 to 2009 as a result of the adoption of FAS 123R had the Acceleration not taken place is $0.7 million. As a result of the Acceleration, options to purchase 206,588 shares of the Bank’s common stock became immediately exercisable. 56 At 31 December 2005, the Bank held as treasury stock 1,519,203 shares (2004: 1,556,476) that will be used to satisfy the Bank’s obligations with respect to the Stock Option Plan. Directors’ and Executive Officers' Stock Option Plan 2005 31 December Outstanding at beginning of year Granted Stock dividend granted Exercised Forfeited / cancelled Outstanding at end of year Vested and exercisable at end of year Characteristics of Options Granted to Directors and Executive Officers as at 31 December 2005 Exercise Price Range 10.94 – 12.23 21.17 – 25.16 25.35 – 31.61 33.51 – 38.86 45.00 – 46.55 Total 31 December Outstanding at beginning of year Granted Stock dividend granted Exercised Forfeited / cancelled Outstanding at end of year Vested and exercisable at end of year Characteristics of Options Granted to Employees as at 31 December 2005 Exercise Price Range 10.94 – 12.23 21.17 22.99 – 24.95 36.57 – 37.73 Total Weighted average stock options exercise price ($) Number of Number of stock options 2004 Weighted average exercise price ($) 520,229 129,425 60,937 (95,893) – 614,698 311,265 25.47 38.48 26.42 15.98 – 27.82 20.81 385,471 117,211 45,616 (28,069) – 520,229 290,888 20.87 40.18 24.92 22.94 – 25.47 18.66 Outstanding Weighted average life Weighted Number average of shares remaining (years) exercise price ($) Exercisable Weighted Number average of shares exercise price ($) 107,005 215,449 10,001 268,734 13,509 614,698 3.7 5.3 2.6 7.4 4.8 5.9 11.46 23.38 27.07 37.03 45.71 27.82 107,005 160,983 5,835 37,442 – 311,265 11.46 23.17 27.06 36.46 – 20.81 Weighted average stock options exercise price ($) Number of Number of stock options 2004 Weighted average exercise price ($) 1,217,466 495,309 159,708 (350,820) (114,598) 1,407,065 708,588 28.72 37.53 29.65 25.65 34.07 30.00 24.87 984,639 424,240 120,965 (231,393) (80,985) 1,217,466 521,134 22.08 40.23 28.26 19.84 32.88 28.72 21.06 Outstanding Weighted average life Weighted Number average of shares remaining (years) exercise price ($) Exercisable Weighted Number average of shares exercise price ($) 115,459 162,139 345,232 784,237 1,407,067 4.0 5.5 6.7 8.7 7.4 11.27 21.17 24.30 37.09 30.00 115,459 162,139 242,710 188,280 708,588 11.27 21.17 24.47 36.91 24.87 57 Employees Stock Option Plan 2005 Financials The weighted average fair value of stock options granted in the year ended 31 December 2005 was $5.18 per stock option (2004: $6.80), calculated using the Black-Scholes option-pricing model with the following weighted average assumptions: Year Ended 31 December Projected dividend yield Risk free interest rate Projected volatility Expected life 2005 2004 4.00% 3.71% 19% 5.0 3.14% 3.17% 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: Year Ended 31 December Net income as reported Net income – pro-forma Earnings per share – as reported (basic) Earnings per share – pro-forma (basic) NOTE 20: Share Buy-Back Plan 2005 2004 109,351 107,560 4.34 4.27 90,466 89,122 3.62 3.56 During the year under review, 32,890 shares (2004: 459,232) were purchased and cancelled at a cost of $1.4 million (2004: $19.4 million). During the same period, the Bank's Stock Option Trust bought 285,854 shares at a cost of $12.6 million (2004: nil). The Bank has the present intention to repurchase over the twelve month period commencing 1 January 2006, up to 2,000,000 million of its ordinary shares of par value $1 each, pursuant to its share repurchase programme authorised by the shareholders on 29 October 1997. 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 BSX regulations may sell shares which may result in such shares being repurchased pursuant to the programme, but under BSX regulations such trades must not be pre-arranged and all repurchases must be made in the open market. Prices paid by the Bank must not, according to BSX regulations, be higher then the last independent trade. The BSX is advised monthly of shares repurchased and cancelled by the Bank and shares purchased by the Stock Option Trust. 58 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 2005 and August 2004, the Bank distributed a 10% stock dividend to shareholders of record on 5 August 2005 and 5 August 2004 respectively. All prior period per share amounts have been restated to reflect the stock dividend. NOTE 23: Variable Interest Entities The effect of FIN 46R was a decrease in the Bank's net assets of approximately $0.6 million for the year ended 31 December 2005 (2004: $0.5 million). The decrease primarily relates to the Bank's venture capital investment subsidiary (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. As at 31 December 2005 the total assets of VIEs consolidated in the balance sheet is $17.7 million (2004: $10.7 million). 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 periods 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 2005 2004 Income taxes in consolidated statement of income Current Deferred Total tax expense (recovery) Deferred income tax asset Tax loss carried forward General bad debt allowance Pension liability allowance Allowance for compensated absence Onerous leases Other Total asset Deferred income tax liability Depreciation Net unrealised gain on derivatives Other Total liability 1,358 270 1,628 3,229 33 2,230 14 190 495 6,191 – – 3 3 Net deferred income tax asset 6,188 (422) (1,300) (1,722) 8,168 39 1,186 40 225 214 9,872 2,367 16 – 2,383 7,489 59 Financials NOTE 25: Future Accounting Developments a) Share-based payment In December 2004, the Financial Accounting Standards Board issued a revised version (FAS 123R) of the previously issued FAS 123 Accounting for Stock-Based Compensation. Under FAS 123R, share-based payments classified as equity, such as the Bank’s stock option plan, will be measured and recognised in the statement of income at their fair value. Under the original FAS 123, the Bank chose the option to present such compensation costs not in the consolidated statement of income but instead measured at their fair value as a pro-forma item which is presented in note 19 to the consolidated financial statements for the year ended 31 December 2004, as set out in the Annual Report and in note 4 to these interim financial statements. Following a further pronouncement in April 2005, FAS 123R will now be effective for all periods beginning after 1 January 2006 and, therefore, effective from the Bank’s first quarter in 2006. b) Pension and post-retirement medical benefits accounting and disclosures The FASB is expected to issue an exposure draft in March 2006 proposing changes that would require the Bank to recognise a balance sheet asset or liability equal to the full amount of its net surplus or deficit in the pension and other post-retirement benefit plans, with the corresponding income or loss included in other comprehensive income. Management is currently evaluating the effect of adoption which may be material. 60 Directory BOARD OF DIRECTORS & PRINCIPAL BOARD COMMITTEES Committees indicated by numbers 2 James A. C. King, JP, Chairman Chairman, KeyTech Ltd. Chairman, Argus Insurance Co. Ltd. 1 Robert J. Stewart, JP, Vice Chairman Chairman, Island Circle Limited, Bermuda Director, Shell Trust (Bermuda) Limited 2 Arlene Brock Lawyer / Mediator Retired from the Board 11 April 2005 2, 4 Brian Duperreault Chairman, ACE Limited Director, Tyco International Ltd. 1, 4 Roderick A. Ferguson III, JP Chairman, Gorham’s Ltd. Chairman, Purvis Ltd. Deputy Chairman, KeyTech Ltd. 4 A.L. Vincent Ingham, JP Executive Vice President & Chief Operating Officer, BELCO Holdings Limited Director, BELCO Holdings Limited 3, 4 Sheila G. Manderson Chief Executive Officer, KeyTech Ltd. 1, 3 Robert A. Mulderig Retired Chairman & Chief Executive Officer, Mutual Risk Management Ltd. Chairman, Woodmont Trust Co. Ltd. 1, 2 Robert Steinhoff, Retired Partner, KPMG Director, Argus Insurance Co. Ltd. 3 Alan R. Thompson* President & Chief Executive Officer, The Bank of N. T. Butterfield & Son Limited 3, 4 Glenn M. Titterton Chairman, BF&M Insurance Group Retired President & Chief Executive Officer, BF&M Insurance Group Chairman, Insurance Corporation of Barbados Limited 1, 2 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 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.com/web2000/shareholder_info. 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 2005 were 899,201 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 30 June 2007. Non-Bermudian 30.3% 50,000-99,999 Shares 11.1% Bermudian 69.7% 10,000-49,999 Shares 25.0% 100,000 & Above Shares 47.9% 5,000-9,999 Shares 5.6% 1,000-4,999 Shares 7.9% 1-999 Shares 2.5% Split Of Share Ownership: Bermudian / Non-Bermudian Distribution Of Shares By Number Held 61 Directory 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 Bruce Albrecht Senior Vice President, Group Head of Asset Management Mariano R. Browne Managing Director, Butterfield Bank (Barbados) Limited Sheila M. Brown Senior Vice President, Investment Services Andrew R. Collins Managing Director, Butterfield Fund Services (Bermuda) Limited Ian M. Coulman Managing Director, Butterfield Asset Management 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 62 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 Pete D. Ramsdale Senior Vice President, Chief Information Officer Peter J.M. Rodger Senior Vice President & Group Legal Adviser, Secretary to the Board Frank J. Sebestyen, III Senior Vice President, Group Head of Fund Services 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 and Private Banking Grosvenor Trust Company Limited Bermuda Trust and private banking services Field Real Estate Holdings Limited Bermuda Real estate holding Butterfield Bank (Bahamas) Limited The Bahamas Private banking, treasury, wealth management and fiduciary services, and fund administration services Butterfield Fund Services (Bahamas) Limited The Bahamas Investment and pension fund administration services Butterfield Bank (Barbados) Limited Barbados Banking, credit and treasury services Butterfield Bank (Cayman) Limited Cayman Islands Banking, credit, treasury, wealth management and fiduciary services Butterfield Fund Services (Cayman) Limited Cayman Islands Investment and pension fund administration services Butterfield Bank (Guernsey) Limited Guernsey Private banking, treasury and wealth management services Butterfield Fund Services (Guernsey) Limited Guernsey Investment and pension fund Administration services Butterfield Trust (Guernsey) Limited Guernsey Fiduciary services Butterfield Bank (UK) Limited United Kingdom Private banking, credit, treasury and investment management services SHAREHOLDER INFORMATION Dividend Payment Payment of dividends is quarterly, 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 Exhange (CSX), located at: 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 (Secondary Listing) Elizabethan Square, 4th Floor, P.O. Box 2408 GT, Grand Cayman, Cayman Islands Tel: (345) 945-6060 Fax: (345) 945-6061 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 (www.bsx.com). Dividend Reinvestment Plan Details are available from Butterfield Fund Services (Bermuda) Limited. Certain restrictions apply. Annual Dividend Declared ($) 1.67 1.55 1.43 1.37 1.31 Dec 02 Jun 02 for 12 months to 30 June Dec 03 Dec 04 for 12 months to 31 December Dec 05 Directory 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.bankofbutterfield.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 2006, 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, 2005, 2,000,000 shares represented 7.4% 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 2005 totalled 32,890 at an average price of $41.46 and aggregate cost of $1,365,448 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. In addition and separate to the above, the Bank’s Stock Option Trust may from time to time purchase shares of the Bank through the BSX to satisfy the Bank’s obligations with respect to the Stock Option Plan, and such purchases will likewise be advised to the BSX monthly. Shares purchased in this way in the 12 months to 31 December, 2005 totaled 285,854 shares at an average price of $44.10 and aggregate cost of $12,621,318. Large Shareholders The following professional nominees at 31 December 2005 were registered holders of 5% or more of the issued share capital: Harcourt & Co. (15.2%), Palmar Limited (5.72%) and Murdoch & Co. (5.14%). Known beneficial holdings of 5% or more of issued share capital, at that date, were: Bermuda Life Insurance Company Limited (6.83%); Jardine Strategic Holdings Limited (6.57%); and the Bank’s Stock Option Trust (5.85%). Market Value & Net Book Value per Share ($) 50 40 30 20 10 June 02 Dec 02 Dec 03 Dec 04 Dec 05 Market Value Book Value 63 Directory PRINCIPAL BERMUDA OFFICES & SUBSIDIARIES PRINCIPAL OVERSEAS OFFICES & SUBSIDIARIES HEAD OFFICE The Bank of N.T. Butterfield & Son Limited President & CEO: Alan R. Thompson 65 Front Street, Hamilton HM 12 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) 299-3954 Fax: (441) 295-6759 E-mail: andrewcollins@bntb.bm Butterfield Trust (Bermuda) Limited Managing Director: Graham M. Jack 65 Front Street, Hamilton HM 12, Bermuda Tel: (441) 299-3980 Fax: (441) 292-1258 E-mail: contact@bntb.bm THE BAHAMAS Butterfield Bank (Bahamas) Limited Managing Director: Robert V. Lotmore GUERNSEY Butterfield Bank (Guernsey) Limited Managing Director: Robert S. Moore Butterfield Trust (Guernsey) Limited Managing Director: Paul D.H. Hodgson P.O. Box 25, Regency Court, Glategny Esplanade, St Peter Port, Guernsey GY1 3AP, Channel Islands Tel: (01481) 711-521 Fax: (01481) 714-533 E-mail: info@butterfield.gg www.butterfieldbank.gg Butterfield Fund Services (Guernsey) Limited Managing Director: Patrick A.S. Firth P.O. Box 211, Regency Court, Glategny Esplanade, St Peter Port, Guernsey GY1 3AP, Channel Islands Tel: (01481) 720-321 Fax: (01481) 716-117 E-mail: info@butterfield.gg www.butterfieldbank.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 Butterfield Fund Services (Bahamas) Limited Managing Director: Heather Bellot 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 1st Floor, Carlisle House, Hincks Street, Bridgetown, Barbados Tel: (246) 431-4500 Fax: (246) 430-0221 E-mail: contact@butterfieldbank.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 Fund Services (Cayman) Limited Managing Director: John Lewis Butterfield House, 68 Fort Street, George Town, P.O. Box 705 GT Grand Cayman, Cayman Islands Tel: (345) 949-7055 Fax: (345) 949-7004 E-mail: info@butterfieldbank.ky www.butterfieldbank.ky 64 Missi on S tat em en t Butt erfield Bank wi ll pro vid e c on sist ent and su perior r et ur ns t o ou r sha r eh ol d er s, offer security and opp ort un it ie s to ou r e mp loy ees, and be reco gn is ed as m a k in g a val u a bl e c o n t r ib ut i o n to t he communiti es i n wh ich we op er a t e by a customer focused, e ffi ci en t a nd eth ic al d el iv ery of bankin g and o th er s ele cte d f in a n c ia l s er v ic es . 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 6 5 F r o n t S t r e e t , H a m i l t o n H M 1 2 , B e r m u d a w w w. b u t t e r f i e l d b a n k . c 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 5 A N N U A L R E P O R T 2 0 0 5 B A H A M A S | B A R B A D O S | B E R M U D A | C AY 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 

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