Bank of N.T. Butterfield & Son Ltd Annual Report 2012

Plain-text annual report

The Bank of N.T. Butte rfield & So n Limited Cover 2012_final.indd 1-3 13-03-14 5:12 PM A n n u a l R e p o r t 2 0 1 2 Annual Repor t In line scope essence brief focus sight tune 2012 Overview Cover 2012_final.indd 4-6 Butterfield is committed to environmentally conscious printing. The following savings to our natural resources were realised in the printing of this Annual Report: Energy: 5,874,649 BTUs Trees: 8 Wastewater: 13,336 liters Air Emissions: 348 kg Solid Waste: 177 kg 13-03-14 5:12 PM As at 31 December 2012 Bermuda The Bahamas Cayman Islands Guernsey United Kingdom Switzerland In depth Find out more at: www.butterfieldgroup.com $8.9 billion Assets Two Core Businesses - Community Banking - Wealth Management 1,210 Employees Core Earnings 0 45.2% Fitch Efficiency Ratio improved by 479 bps Credit Ratings Moody’s ROE* 0 281 bps *Core cash return on tangible common equity Standard & Poor’s Short-Term F1 Long-Term Senior A- Short-Term P-1 Long-Term Senior A2 Short-Term A-2 Long-Term Senior A- Capital Strength Total Capital Ratio Tier 1 Capital Ratio 11.2% 7.5% 10.1% 7.2% 21.6% 15.7% 23.5% 17.7% 24.2% 18.5% 2008 2009 2010 2011 2012 1 Accolades Six Butterfield employees named to Citywealth International Financial Centre Leaders List 2012 Euromoney 2012 Global Private Banking Survey Best Private Banking Services Overall (First in Bermuda, Eighth in Caribbean Region) Best Relationship Management (First in Bermuda and Cayman, Fourth in Caribbean Region) Best Range of Investment Products (First in Bermuda) Best Net-Worth-Specific Services for Super-Affluent Clientele (First in Cayman, Third in Caribbean Region) In time order sight review motion brief hand Chairman & Chief Executive Officer’s Report to the Shareholders 2 Chairman & Chief Executive Officer’s Report to the Shareholders 2012 was a year of continued recovery for Butterﬁeld. The Bank’s Board Given the Bank’s ratios, and against a backdrop of the limited lending and Management team sought and delivered improved core earnings and investment opportunities available in the current economic and Shareholder returns despite ongoing economic challenges in our environment, your Board determined that it was appropriate to main jurisdictions and very low interest rates. Whilst we made good return a portion of the Bank’s capital to Shareholders as income. On progress in restoring value in the franchise, we continue to pursue 26 February 2013, the Board declared a special dividend of $0.04 per opportunities to unlock greater value as we move forward. Common and Contingent Value Convertible Preference Share to be paid on 22 March 2013 to Shareholders of record on 5 March 2013. Core earnings for the year ended 31 December 2012 were $54.9 million, up 45.2% over 2011 on gross revenues that increased by 1.5%. The improved core earnings reﬂect improvements in both our IN PURSUIT OF IMPROVED EARNINGS Butterﬁeld undertook or accelerated a number of initiatives in efﬁciency ratio and net interest margin. 2012 that proved beneﬁcial to earnings and which will contribute to improving the Bank’s sustainable proﬁtability over the long term. 2012 core earnings were offset by signiﬁcant net one-time charges of $29.3 million stemming from more conservative valuations of A 16 basis point increase in the net interest margin was achieved certain Balance Sheet assets not related to core operations; primarily principally through a more disciplined investment approach—matching goodwill, intangible assets and estimates of the market value of real investment maturities to deposit aging—that resulted in the purchase property owned and used by the Bank. As a result, 2012 net income of longer duration, higher-yielding (primarily US Government agency) was $25.6 million, reduced from $40.5 million in 2011. securities for the Bank’s portfolio. Butterﬁeld beneﬁts from stability and predictability in our deposit base, which allows for the effective In addition to growing core earnings, we improved the capital position application of such an approach, and also provides us with more of the Bank in 2012. The Tangible Common Equity Ratio increased by latitude to widen margins via deposit pricing than is the case for some 28 basis points to 7.17%, the Tier 1 Capital Ratio improved to 18.53% other ﬁnancial institutions. (from 17.70% at year-end 2011), and the Total Capital Ratio ended the year at 24.18% (up from 23.50% at year-end 2011). Relative to many The Bank sold its holdings in selected non-core assets, speciﬁcally other banks, our capital position is very strong. its wholly-owned Barbados subsidiary and its interest in the Cayman-based Island Heritage insurance company during the year. Core cash return on tangible common equity rose to 6.56% from 3.75%. Those transactions generated proceeds of $63.5 million. The capital Asset growth of $425 million, resulting primarily from increased values deployed in the ongoing development of our core businesses; those of securities in the Bank’s investment portfolios, drove improvements in which we believe we have the scale, market presence and expertise and Management resources that the sale of those assets freed will be in Shareholder value. Net book value per Share rose to $1.20 from to foster material growth going forward. $1.14 and tangible book value per Share improved from $1.05 to $1.16. To continue to effect improvements in ﬁnancial performance whilst team. During 2012, we reduced non-interest expenses by more than maintaining strong ratios, the Bank is following a focused strategy for $12 million. Headcount continues to be reduced across the Group, the deployment of capital. That strategy involves allocating funds enabled by changes in technology, process improvements, declines to initiatives that directly improve the franchise value, and applying in transaction volumes in some areas owing to the current economic excess capital and proceeds from the divestiture of non-core holdings climate, and changes in customer behaviour. Managing costs remains a key area of focus for the Management to core businesses and projects that will drive continued growth. IN THE INTERESTS OF SHAREHOLDERS As a means of improving trading liquidity and potential returns on The Bank also continues to seek ways to streamline operations as a means of managing expenses. During 2012, we made organisational and process changes to extract efﬁciencies from the previous equity, your Board authorised a Share Buy-back Programme in May centralisation of key functions in the areas of human resources, 2012 and increased the repurchase allowance in December to project management, information technology, compliance and risk 10 million Common Shares and 8,000 Preference Shares. At year end, management. We are seeking to reduce duplication of effort and the Bank had repurchased 7.3 million Common Shares at a cost of synchronise our policies and procedures to create savings and $9.0 million, and 4,422 Preference Shares at a cost of $5.4 million. improve customer service. In our two retail banking jurisdictions, Butterﬁeld Annual Report 2012 3 Bermuda and Cayman (which now use a common banking technology ﬁnancial services in the jurisdiction. Our Guernsey subsidiaries once platform), we are in the process of rationalising and simplifying our again sponsored a number of youth and sports-related events to raise product lineups to ensure customers in both markets have access to the community proﬁle of the businesses there, and our UK bank made our best offerings, whilst reducing the costs of back-ofﬁce processing a number of donations to charities connected to our private clients and administration. In 2013, we will complete the installation of a during the year. common system supporting our UK and Guernsey banking businesses, which will provide similar opportunities for operational improvements I was honoured to have been appointed Butterﬁeld’s Chairman & Chief Executive Ofﬁcer in 2012, and I look forward to continuing to work with my fellow Directors and Management to advance the Bank’s recovery. I would like to express my appreciation to our customers for their loyalty to the Bank, our employees for their continued dedication and hard work, and to the Shareholders for your ongoing support. Brendan McDonagh Chairman & Chief Executive Ofﬁcer and cost savings. IN BOARD MATTERS Three new Directors joined the Board during 2012—Independent, Non-Executive Director Alastair Barbour, Non-Executive Director Olivier Sarkozy (as one of Carlyle’s representatives), and myself—respectively ﬁlling the vacancies created by Robert Steinhoff, James Burr and Robert Mulderig upon their retirements from the Board in May. In June, sitting Independent, Non-Executive Director Barclay Simmons was named Vice Chairman. Bradford Kopp stepped down from the Board upon his resignation as Butterﬁeld’s Chief Executive Ofﬁcer in August. Shaun Morris resigned as a Director upon being appointed the Group’s General Counsel and Chief Legal Ofﬁcer, and in that capacity, Mr. Morris now serves as Secretary to the Board of Directors. IN THE COMMUNITY Butterﬁeld’s long-term success and growth is tied to the prosperity of the jurisdictions we serve. Across the Group in 2012, we supported worthy causes that helped enrich and improve the lives of people in our communities. In Bermuda, the Bank focused its corporate giving efforts through the Butterﬁeld Hope Award, making contributions to many local charities. Cayman sponsored several health, wellness and educational initiatives, and was an active member and supporter of industry-led organisations that foster the ongoing development of 4 In sight particular motion unison order detail scope Board of Directors & Group Executive Management Butterﬁeld Annual Report 2012 5 Board of Directors & Principal Board Committees COMMITTEES INDICATED BY NUMBERS 1 CHAIRMAN BRENDAN MCDONAGH Chief Executive Ofﬁcer, The Bank of N.T. Butterﬁeld & Son Limited 1,3,5 VICE CHAIRMAN BARCLAY SIMMONS* Managing Partner, Attride-Stirling & Woloniecki, Barristers & Attorneys 1,3,5 RICHARD VENN Senior Executive Vice-President, Advisor to the CEO Ofﬁce, CIBC 3 JOHN WRIGHT* Retired Bank Chief Executive 2,4 ALASTAIR BARBOUR* Director, RSA Insurance Group plc, Liontrust Asset Management plc, Standard Life European Private Equity Trust plc, CATCo Reinsurance Opportunities Fund Ltd, CATCo Reinsurance Fund Limited and Scottish Equitable Policyholders Trust Limited PRINCIPAL BOARD COMMITTEES 1. EXECUTIVE COMMITTEE OF THE BOARD OF DIRECTORS Supports the Board in fulﬁlling its overall governance responsibilities. 3,4 VICTOR DODIG Senior Executive Vice-President and Group Head, Wealth Management, CIBC 2,4 SHEILA LINES* Retired Chief Executive Ofﬁcer, KeyTech Limited 1,2,4 PAULINE RICHARDS* Chief Operating Ofﬁcer, Armour Reinsurance Group Holdings Limited Director, Wyndham Worldwide Inc. Former Director and Audit Committee Chair, Cendant Corporation 4,5 OLIVIER SARKOZY Managing Director and Head of The Carlyle Group’s Global Financial Services Group 1,3 WOLFGANG SCHOELLKOPF Managing Partner, Lykos Capital Management 2. AUDIT COMMITTEE Oversees Butterﬁeld’s ﬁnancial reports, internal ﬁnancial controls, internal audit processes and compliance. 3. RISK POLICY & COMPLIANCE COMMITTEE Focuses on credit, market and operational risk. 4. CORPORATE GOVERNANCE COMMITTEE Focuses on Directors’ and Board Committee governance, performance and Directors’ nominations. 5. COMPENSATION & HUMAN RESOURCES COMMITTEE Focuses on compensation and beneﬁts, employee development and succession. 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 Butterﬁeld’s principles of business, including ethics and conﬂicts of interest. Copies of the Codes can be accessed on www.butterﬁeldgroup.com. *Independent, Non-Executive Director. On an annual basis, the Corporate Governance Committee ensures the appropriate composition of the Board and its Committees in accordance with the Group’s Corporate Governance Policy. The assessment of the independence of a Director is based upon a number of factors including, but not limited to: whether he or she has been employed by the Group within the last ﬁve years; whether he or she has had, within the last three years, a material relationship with the Group; and whether he or she represents a signiﬁcant Shareholder. 6 Group Executive Management BRENDAN MCDONAGH Chairman & Chief Executive Ofﬁcer MICHAEL COLLINS Senior Executive Vice President Bermuda CONOR O’DEA Senior Executive Vice President International Banking DANIEL FRUMKIN Executive Vice President Chief Risk Ofﬁcer DONNA HARVEY MAYBURY Executive Vice President Human Resources ROBERT MOORE Executive Vice President Head of Group Trust SHAUN MORRIS General Counsel Group Chief Legal Ofﬁcer MICHAEL NEFF Executive Vice President Head of Group Asset Management BRADLEY ROWSE Executive Vice President Chief Financial Ofﬁcer JAMES MCPHERSON Senior Vice President Group Internal Audit Butterﬁeld Annual Report 2012 7 In touch focus line detail essence brief balance 8 Table CONTENTS of Contents MANAGEMENT’S DISCUSSION & ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cid:0) (cid:0) (cid:0) (cid:0) (cid:0) (cid:0) (cid:0) (cid:115)(cid:0) (cid:48)(cid:69)(cid:82)(cid:70)(cid:79)(cid:82)(cid:77)(cid:65)(cid:78)(cid:67)(cid:69)(cid:0)(cid:45)(cid:69)(cid:65)(cid:83)(cid:85)(cid:82)(cid:69)(cid:77)(cid:69)(cid:78)(cid:84)(cid:0) (cid:115)(cid:0) (cid:33)(cid:66)(cid:79)(cid:85)(cid:84)(cid:0)(cid:34)(cid:85)(cid:84)(cid:84)(cid:69)(cid:82)(cid:108)(cid:69)(cid:76)(cid:68)(cid:0) (cid:115)(cid:0) (cid:34)(cid:85)(cid:83)(cid:73)(cid:78)(cid:69)(cid:83)(cid:83)(cid:0)(cid:51)(cid:84)(cid:82)(cid:65)(cid:84)(cid:69)(cid:71)(cid:89)(cid:0) (cid:115)(cid:0) (cid:18)(cid:16)(cid:17)(cid:18)(cid:0)(cid:47)(cid:86)(cid:69)(cid:82)(cid:86)(cid:73)(cid:69)(cid:87)(cid:0) (cid:115)(cid:0) (cid:45)(cid:65)(cid:82)(cid:75)(cid:69)(cid:84)(cid:0)(cid:37)(cid:78)(cid:86)(cid:73)(cid:82)(cid:79)(cid:78)(cid:77)(cid:69)(cid:78)(cid:84)(cid:0) (cid:115)(cid:0) (cid:18)(cid:16)(cid:17)(cid:19)(cid:0)(cid:47)(cid:85)(cid:84)(cid:76)(cid:79)(cid:79)(cid:75)(cid:0) (cid:115)(cid:0) (cid:38)(cid:73)(cid:78)(cid:65)(cid:78)(cid:67)(cid:73)(cid:65)(cid:76)(cid:0)(cid:51)(cid:85)(cid:77)(cid:77)(cid:65)(cid:82)(cid:89)(cid:0) CONSOLIDATED RESULTS OF OPERATIONS AND DISCUSSION FOR FISCAL YEAR ENDED 31 DECEMBER 2012 CONSOLIDATED BALANCE SHEET AND DISCUSSION OFF BALANCE SHEET ARRANGEMENTS RISK MANAGEMENT JURISDICTION & GROUP BUSINESS OVERVIEWS (cid:0) (cid:0) (cid:0) (cid:0) (cid:0) (cid:0) (cid:115)(cid:0) (cid:34)(cid:69)(cid:82)(cid:77)(cid:85)(cid:68)(cid:65)(cid:0) (cid:115)(cid:0) (cid:35)(cid:65)(cid:89)(cid:77)(cid:65)(cid:78)(cid:0)(cid:41)(cid:83)(cid:76)(cid:65)(cid:78)(cid:68)(cid:83)(cid:0) (cid:115)(cid:0) (cid:39)(cid:85)(cid:69)(cid:82)(cid:78)(cid:83)(cid:69)(cid:89)(cid:0) (cid:115)(cid:0) (cid:53)(cid:78)(cid:73)(cid:84)(cid:69)(cid:68)(cid:0)(cid:43)(cid:73)(cid:78)(cid:71)(cid:68)(cid:79)(cid:77)(cid:0) (cid:115)(cid:0) (cid:39)(cid:82)(cid:79)(cid:85)(cid:80)(cid:0)(cid:33)(cid:83)(cid:83)(cid:69)(cid:84)(cid:0)(cid:45)(cid:65)(cid:78)(cid:65)(cid:71)(cid:69)(cid:77)(cid:69)(cid:78)(cid:84)(cid:0) (cid:115)(cid:0) (cid:39)(cid:82)(cid:79)(cid:85)(cid:80)(cid:0)(cid:52)(cid:82)(cid:85)(cid:83)(cid:84)(cid:0) FINANCIAL STATEMENTS (cid:115)(cid:0) (cid:45)(cid:65)(cid:78)(cid:65)(cid:71)(cid:69)(cid:77)(cid:69)(cid:78)(cid:84)(cid:7)(cid:83)(cid:0)(cid:38)(cid:73)(cid:78)(cid:65)(cid:78)(cid:67)(cid:73)(cid:65)(cid:76)(cid:0)(cid:50)(cid:69)(cid:80)(cid:79)(cid:82)(cid:84)(cid:73)(cid:78)(cid:71)(cid:0)(cid:50)(cid:69)(cid:83)(cid:80)(cid:79)(cid:78)(cid:83)(cid:73)(cid:66)(cid:73)(cid:76)(cid:73)(cid:84)(cid:89)(cid:0) (cid:115)(cid:0) 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(cid:35)(cid:79)(cid:78)(cid:83)(cid:79)(cid:76)(cid:73)(cid:68)(cid:65)(cid:84)(cid:69)(cid:68)(cid:0)(cid:51)(cid:84)(cid:65)(cid:84)(cid:69)(cid:77)(cid:69)(cid:78)(cid:84)(cid:83)(cid:0)(cid:79)(cid:70)(cid:0)(cid:35)(cid:79)(cid:77)(cid:80)(cid:82)(cid:69)(cid:72)(cid:69)(cid:78)(cid:83)(cid:73)(cid:86)(cid:69)(cid:0)(cid:41)(cid:78)(cid:67)(cid:79)(cid:77)(cid:69)(cid:0)(cid:8)(cid:44)(cid:79)(cid:83)(cid:83)(cid:9)(cid:0) (cid:115)(cid:0) (cid:35)(cid:79)(cid:78)(cid:83)(cid:79)(cid:76)(cid:73)(cid:68)(cid:65)(cid:84)(cid:69)(cid:68)(cid:0)(cid:51)(cid:84)(cid:65)(cid:84)(cid:69)(cid:77)(cid:69)(cid:78)(cid:84)(cid:83)(cid:0)(cid:79)(cid:70)(cid:0)(cid:35)(cid:72)(cid:65)(cid:78)(cid:71)(cid:69)(cid:83)(cid:0)(cid:73)(cid:78)(cid:0)(cid:51)(cid:72)(cid:65)(cid:82)(cid:69)(cid:72)(cid:79)(cid:76)(cid:68)(cid:69)(cid:82)(cid:83)(cid:7)(cid:0)(cid:37)(cid:81)(cid:85)(cid:73)(cid:84)(cid:89)(cid:0) (cid:115)(cid:0) (cid:35)(cid:79)(cid:78)(cid:83)(cid:79)(cid:76)(cid:73)(cid:68)(cid:65)(cid:84)(cid:69)(cid:68)(cid:0)(cid:51)(cid:84)(cid:65)(cid:84)(cid:69)(cid:77)(cid:69)(cid:78)(cid:84)(cid:83)(cid:0)(cid:79)(cid:70)(cid:0)(cid:35)(cid:65)(cid:83)(cid:72)(cid:0)(cid:38)(cid:76)(cid:79)(cid:87)(cid:83)(cid:0) (cid:115)(cid:0) (cid:46)(cid:79)(cid:84)(cid:69)(cid:83)(cid:0)(cid:84)(cid:79)(cid:0)(cid:84)(cid:72)(cid:69)(cid:0)(cid:35)(cid:79)(cid:78)(cid:83)(cid:79)(cid:76)(cid:73)(cid:68)(cid:65)(cid:84)(cid:69)(cid:68)(cid:0)(cid:38)(cid:73)(cid:78)(cid:65)(cid:78)(cid:67)(cid:73)(cid:65)(cid:76)(cid:0)(cid:51)(cid:84)(cid:65)(cid:84)(cid:69)(cid:77)(cid:69)(cid:78)(cid:84)(cid:83)(cid:0) (cid:0) (cid:0) (cid:0) (cid:0) (cid:0) (cid:0) (cid:0) SHAREHOLDER INFORMATION 10 (cid:17)(cid:16) (cid:17)(cid:17) (cid:17)(cid:17) (cid:17)(cid:18) (cid:17)(cid:19) (cid:17)(cid:19) (cid:17)(cid:20) 15 23 32 33 37 (cid:19)(cid:24) (cid:20)(cid:16) (cid:20)(cid:18) (cid:20)(cid:20) (cid:20)(cid:22) (cid:20)(cid:23) 48 (cid:20)(cid:25) (cid:21)(cid:16) (cid:21)(cid:18) (cid:21)(cid:19) (cid:21)(cid:20) (cid:21)(cid:21) (cid:21)(cid:22) (cid:21)(cid:23) 101 Butterﬁeld Annual Report 2012 9 Management’s Discussion & Analysis of Results of Operations and Financial Condition The ﬁnancial overview of results of operations and ﬁnancial condition should be read in conjunction with our Consolidated Financial Statements and the related notes. The ﬁnancial statements and notes have been prepared in accordance with generally accepted accounting principles in the United States of America (GAAP). All references to “Butterﬁeld”, the “Group” or the “Bank” refer to The Bank of N.T. Butterﬁeld & Son Limited and its subsidiaries on a consolidated basis. Certain statements in this discussion and analysis may be deemed to include “forward looking statements” and are based on Management’s current expectations and are subject to uncertainty and changes in circumstances. Forward looking statements are not historical facts but instead represent only Management’s belief regarding future events, many of which by their nature are inherently uncertain and outside of Management’s control. Actual results may differ materially from those included in these statements due to a variety of factors, including worldwide economic conditions, success in business retention and obtaining new business and other factors. PERFORMANCE MEASUREMENT We use a number of ﬁnancial measures to assess the performance of our business lines. Some measures are calculated in accordance with GAAP, while other measures do not have a standardised meaning under GAAP. Accordingly, these measures, described below, may not be comparable to similar measures used by other companies. Investors may however ﬁnd these non-GAAP ﬁnancial measures useful in analysing ﬁnancial performance. Core Cash Return on Tangible Common Equity (“CCROTCE”) CCROTCE measures core cash proﬁtability as a percentage of tangible Tier 1 Common Ratio The Tier 1 Common Ratio is the same as the Tier 1 Capital Ratio but common equity. CCROTCE is the amount of core net income excluding only includes common equity in the numerator and deducts the amortisation of intangible assets returned as a percentage of tangible Preference Shareholders’ equity. common equity and calculated as Core Cash Net Income / Tangible Common Equity. Core cash net income is for the full ﬁscal year (before dividends paid to Common Shareholders but after dividends Total Capital Ratio The Total Capital Ratio measures the amount of the Bank’s capital in to Preference Shareholders) adjusted for one-off items not in the relation to the amount of risk it is taking. All banks must ensure that a ordinary course of business plus amortisation of intangible assets reasonable proportion of their risk is covered by permanent capital. expensed in the year. Tangible common equity does not include the Under Basel II, Pillar I, banks must maintain a minimum Total Capital Preference Shareholders’ equity or goodwill and intangible assets. Ratio of 8%. In effect, this means that 8% of the risk-weighted assets Return on Common Shareholders’ Equity (“ROE”) ROE measures proﬁtability by revealing how much proﬁt is must be covered by permanent or near permanent capital. The risk weighting process takes into account the relative risk of various types of lending. The higher the Capital Adequacy Ratio a bank has, the generated with the money invested by Common Shareholders. ROE greater the level of unexpected losses it can absorb before is the amount of net income returned as a percentage of Common becoming insolvent. Shareholders’ Equity and calculated as Net Income / Average Common Shareholders’ Equity. Net income is for the full ﬁscal year (before dividends paid to Common Shareholders but after dividends to Preference Shareholders). Common Shareholders’ Equity does not include the Preference Shareholders’ equity. Return on Assets (“ROA”) ROA is an indicator of proﬁtability relative to total assets. ROA demonstrates how efﬁcient Management is at using its assets to generate earnings. The ROA ratio is calculated as Annual Net Income / Average Total Assets. Tier 1 Capital Ratio The Tier 1 Capital Ratio is the ratio of the Bank’s core equity capital, as measured under Basel II, to its total risk-weighted assets (“RWA”). Risk- weighted assets are the total of all assets held by the Bank weighted Tangible Common Equity / Tangible Asset Ratio (“TCE/TA”) TCE/TA is used to determine how much loss the Bank can take before other forms of capital, other than common equity, are impacted. The TCE/TA ratio is calculated as (Common Equity - Intangible Assets - Goodwill) / Tangible Assets. Tangible common equity does not include the Preference Shareholders’ equity or goodwill and intangible assets. Tangible assets are the Bank’s total assets from continuing operations less goodwill and intangibles. Net Interest Margin (“NIM”) NIM is a performance metric that examines how successful the Bank’s investment decisions are compared to its cost of funding assets and is calculated as (Interest Income – Interest Expenses) / Average Interest Earning Assets. The daily average was used in calculating the average balance for deposits to avoid any distortion caused by large by credit risk according to a formula determined by the Regulator. The ﬂuctuations at month ends. Bank follows the Basel Committee on Banking Supervision (“BCBS”) guidelines in setting formulae for asset risk weights. 10 Efﬁciency Ratio The Efﬁciency Ratio is deﬁned as non-interest expenses before amortisation of intangible assets and income taxes as a percentage of total revenue before gains and losses and provisions for credit losses. ABOUT BUTTERFIELD Established in 1858, Butterﬁeld provides community banking and wealth management in Bermuda and select markets in the Caribbean and Europe. Today we are the largest independent bank in Bermuda and have a signiﬁcant market position in the Cayman Islands. Group-wide, we have over 1,200 employees across six jurisdictions. Butterﬁeld offers a full range of community banking services in Bermuda and the Cayman Islands, consisting of institutional, corporate, commercial and retail banking and treasury activities. In wealth management, we provide private banking, asset management, custody and trust services to individual, family, institutional and corporate clients from our headquarters in Bermuda and subsidiary ofﬁces in The Bahamas, the Cayman Islands, Guernsey, Switzerland and the United Kingdom. BUSINESS STRATEGY Whilst remaining well capitalised with strong liquidity, our strategic by jurisdiction. However, we remain ﬂexible and nimble in each jurisdiction, with decision making on client service-related matters focus is on building Shareholder value by expanding our share of the based locally. In addition, we have invested heavily—and continue to community and private banking markets in jurisdictions in which we invest—in new technology that allows for new and ﬂexible products, have a meaningful presence and a depth of local market knowledge. enhanced customer service and a streamlined, more efﬁcient Our strategy also involves leveraging our multi-jurisdictional trust, operation. We expect our recent investment in new core banking custody and asset management offerings to build our wealth systems in our two largest markets (Bermuda and Cayman), and management business from both cross-referrals with existing customers upgrades in progress in Guernsey and the United Kingdom, will help and business development through referrals and relationships with drive new revenue opportunities, improved internal control, and ﬁduciaries and advisers. We aim to build upon our relationship- operational efﬁciencies. Our strategy of moving to centralised support based business approach by delivering exceptional client service services and centres of excellence is enhanced by these technological experiences, as well as a wide range of products to meet our clients’ investments and will drive further efﬁciencies. ﬁnancial services needs. Given the large, loyal customer deposit base enjoyed in our main The wide range of products on offer is reﬂective of our strategy of jurisdictions, and the relatively low volume of lending demand from pursuing opportunities in diversiﬁed businesses including community our customer base, our investment strategy is more important than banking, private banking, asset management, custody, corporate is the case for most ﬁnancial institutions. At 31 December 2012, we trust and personal trust services. Those diverse businesses directly had $4.6 billion of cash and investments representing 51.5% of total contribute to the high level of fee income relative to our total income. Despite the current economic environment reducing the volume of assets. In recognition of this deﬁning characteristic of Butterﬁeld, we have adopted a conservative approach to our investments, including customer activity, our fee income remains at almost 38% of revenue signiﬁcantly reducing the list of international banks from whom we before credit provisions and gains or losses. will purchase certiﬁcates of deposits. With the help of our investment advisers we continued to manage our Interest Rate Risk, which Building on our community banking and wealth management strategies measures the degree to which our proﬁtability is at risk due to changes will also leverage our strong and loyal client base. Unlike many banks, in interest rates. Our focused investment strategy has allowed us Butterﬁeld is almost exclusively funded by our Shareholders and to improve the proﬁtability of our investments despite the ongoing customers. Our core customer deposits have been remarkably stable challenges of a poor and volatile investment climate, whilst minimising throughout the credit crisis. In 2012, we focused on these core deposits credit risk in the investment book. Our continued management of and pricing discipline to signiﬁcantly improve their contribution to net interest income. This contribution reﬂects the strength of being a Interest Rate Risk requires us to purchase ﬁxed rate investments that, whilst complying with our credit safety requirements, will experience deposit-led organisation even in times of low interest rates. temporary declines in market values when rates start to increase. Rising interest rates will improve the proﬁtability of Butterﬁeld, such To support our strategy, our Management structure is aligned to focus that these anticipated negative marks are part of our strategy. They on lines of business and central support services with increasingly will not affect earnings, as they are not credit related, but they will less emphasis on independent management and support teams potentially give rise to negative impacts in equity through “Other Butterﬁeld Annual Report 2012 11 Comprehensive Income” due to accounting rules for Available-For-Sale Key accomplishments in 2012 were as follows: (“AFS”) investments. To minimise the impact on our equity in such circumstances, while implementing proper management of Interest (cid:115)(cid:0) Core proﬁtability: The Bank delivered good growth in core net income, up $17.1 million (45.2%) to $54.9 million (7 cents per Rate Risk, we have increased the Held-to-Maturity (“HTM”) portfolio to Share) from $37.8 million in 2011. $239 million at year end. (cid:115)(cid:0) Capital: We maintained a strong capital position, with over 2012 OVERVIEW In 2012, the Bank made solid progress, selling non-core holdings, $1.0 billion of regulatory capital, a Tier 1 Capital Ratio of 18.5% at 31 December 2012, with a TCE/TA ratio of 7.2%, up from 6.9% in 2011. streamlining and coordinating operations across jurisdictions, focusing on effective expense management and instituting a Share Buy-Back Programme. Core earnings improved, as a result, by $17.1 million to (cid:115)(cid:0) Investment strategy: We continued our investment strategy for the deployment of excess liquidity that contributed to our NIM $54.9 million, building on our very strong capital position with Total increasing by 16 basis points, from 2.42% in 2011 to 2.58% in 2012, and Tier 1 Capital Ratios of 24.2% and 18.5% respectively. The Board despite an environment of continued low interest rates. continues to monitor capital levels, maintaining a conservative capital management philosophy such that Butterﬁeld remains well capitalised. To further enhance Common Shareholder returns, the Board has declared a special dividend of $0.04 per Share. On a going-forward (cid:115)(cid:0) Expenses: We reduced non-interest expenses by $12.4 million (4.3%), from $286.6 million in 2011, to $274.2 million in 2012. basis, the Board will continue to assess capital planning options and (cid:115)(cid:0) Headcount: Across the Group, headcount was reduced by 60 declare dividends as warranted, subject to regulatory approval. (4.7%) from 1,270 as at 31 December 2011 to 1,210 by the end of 2012 on a full-time equivalent basis. The Bank’s Balance Sheet remains strong, with Shareholders’ equity ending the year up $27 million at $857 million, of which $196 million is 8% Preference Shareholders’ equity and $661 million is Common (cid:115)(cid:0) Deposits: The Bank maintained stable core customer deposits, whilst decreasing deposit costs by 10 basis points, from 43 basis and Contingent Value Convertible Preference Shareholders’ equity points in 2011 to 33 basis points in 2012. (“common equity”). Total assets grew by $118 million to $8.9 billion, but when adjusted for the $307 million of assets from discontinued operations in the prior year, total assets grew by $425 million, primarily (cid:115)(cid:0) Loan quality: Gross non-accrual loans as a percentage of gross loans held relatively ﬂat at 2.8% at year-end 2012 compared to reﬂecting a $245 million increase in deposits, $109 million of funding from repurchase agreements, and a $27 million increase in 2.7% at year-end 2011. Net non-accrual loans were $86.6 million, equivalent to 2.2% of total loans, after speciﬁc provisions for such Shareholders’ equity. loans of $26.7 million, reﬂecting an improved speciﬁc coverage ratio of 23.6%, up from 21.3% at 31 December 2011. Loans and advances to customers decreased from 2011 levels by $113 million largely reﬂecting the $226 million repayment of a Bermuda Government loan offset by loan growth in our European operations, (cid:115)(cid:0) Systems: We continued preparations for a common technology system in Europe and have successfully upgraded the UK principally low loan-to-value residential mortgages secured by prime system subsequent to year-end, with plans to upgrade Guernsey Central London property. by year-end 2013. Core deposit levels showed resilience in this low interest rate environment. Total deposits grew $244 million over 2011 to $7.5 billion, a reﬂection of Butterﬁeld’s strategy targeting certain segments of the deposit market. 12 MARKET ENVIRONMENT In 2012, the economic environment in the United States (“US”) 2013 OUTLOOK The past few years have tested the ability of market researchers with improved over the year. Gross Domestic Product (“GDP”) growth ongoing changes and adjustments to economic forecasts. 2011 was a remained positive, albeit at an uninspiring rate, the unemployment year of extreme volatility with investors ﬂeeing to quality, followed by a rate continued to slowly drift lower, the housing market improved and year of increasing stability in 2012. Many market participants began to appears to have returned to a net creator of economic growth, and an return to the (still volatile) equity markets, comforted by the continued agreement was reached to avoid the worst of the “ﬁscal cliff” in early support of the central banks through bond buying programmes. What 2013. In Europe, the economy remains in a very difﬁcult situation does that mean for the year ahead? Long-term interest rates are with weakness in the peripheral economies making its way into the beginning to rise above historic lows, but given the central banks’ core. With heightened levels of unemployment and the restraints of a intent of maintaining low interest rates, many ﬁnancial institutions common currency, there are indications that Europe will not emerge remain focused on optimising their business models, adjusting to the quickly from its credit crisis. Some comfort was taken by the markets current economic conditions; Butterﬁeld is no exception. from the European Central Bank’s Outright Monetary Transactions programme, which removed funding issues earlier in the year. The Low interest rates are expected to continue in 2013, however, our asset impacts of the global economic conditions on the economies in which and liability management strategy focuses on net interest income at we operate were mixed. Bermuda has continued to experience rising risk in varying interest rate environments. This means we position our unemployment, a shrinking population and declining GDP, whilst Balance Sheet to maximise net interest income over a three to Cayman began to see encouraging signs of growth, including growth ﬁve-year period with investment ﬂows matching our expected in air arrivals, population and infrastructure spending. However, in maturities and turnover on the liability side of the Balance Sheet, Bermuda the change in government in late 2012 has delivered a whilst partially neutralising the impact of changing interest rates in any Government agenda focused on job creation, which is expected to given reporting period. These investments position us to not be reliant translate into more policy changes targeted at bringing new business to on rising rates to achieve adequate proﬁtability. When higher rates the island. The mixed economic climate in our two largest operations in occur, core proﬁtability will be further improved. Higher rates will also 2012 resulted in limited loan demand and more pressure on customers’ have a restraining effect on capital levels as it reduces the market value ability to service loan payment obligations. Conversely, our private of our longer dated securities in our AFS book, partially offset by lower banking business in Europe continued to enjoy strong loan demand liabilities for future pension and health costs for employees. resulting in growth in our low loan-to-value residential mortgage portfolio to high net worth customers. In 2013, our strategy remains relatively unchanged as we continue to focus our attention on the development of our core businesses, Amidst this macroeconomic uncertainty, the Bank continues to maintain which we expect will drive revenue growth. We expect to be able to a highly liquid Balance Sheet with a low risk investment portfolio and continue to improve our efﬁciency ratio in 2013 based on leveraging minimal reliance on wholesale money markets for liquidity. our investments in technology, redesigning processes and centralising support services. Incentive plans have been more closely aligned with business development and results targets and metrics that reﬂect Shareholders’ interests. Butterﬁeld Annual Report 2012 13 FINANCIAL SUMMARY (in $ thousands, except per Share data) As at 31 December Cash and cash equivalents Short-term investments Investments in debt and equity securities Loans, net of allowance for credit losses Premises, equipment and computer software Goodwill and intangible assets Assets of discontinued operations Total assets Total deposits Subordinated capital Shareholders’ equity Preference Shareholders’ equity Common and Contingent Value 2012 1,651,547 76,213 2,881,704 3,955,960 243,321 22,276 - 8,942,030 7,502,259 260,000 2011 1,902,726 20,280 2,061,639 4,069,419 272,472 46,100 307,044 8,824,350 7,256,561 267,755 2010 2,222,934 18,157 2,764,723 3,858,138 257,468 51,435 276,573 9,623,487 7,988,501 282,799 2009 1,932,189 14,881 2,899,668 4,025,981 240,010 62,867 281,524 9,594,806 8,451,311 283,085 2008 2,168,057 17,019 3,789,136 4,235,435 194,256 67,196 268,227 10,911,703 9,570,172 282,296 195,578 200,000 200,000 200,000 - Convertible Preference Shareholders’ equity 661,596 629,725 609,289 155,460 518,440 For the year ended 31 December Net interest income before provision for credit losses Provision for credit losses Non-interest income (as reported) Non-interest income (excluding fund administration services business) Salaries and other employee beneﬁts Other non-interest expenses (including income taxes) Net income (loss) before gains and losses Net gains (losses) Net income (loss) from continuing operations Net income (loss) from discontinued operations Net income (loss) Dividends and guarantee fee of Preference Shares Net income (loss) available to Common Shareholders Common dividends paid Financial ratios Return on assets (1) Return on Common Shareholders’ equity Tier 1 Capital Ratio Total Capital Ratio Tangible Common Equity Ratio Net interest margin Efﬁciency ratio Per participating share ($) Net income (diluted) (1) Cash dividends (1) Net book value (1) Number of employees Bermuda Overseas Total Other data Weighted average number of participating Shares on a fully diluted basis (2) Risk-weighted assets 2012 211,058 (14,190) 128,543 2011 202,249 (13,169) 132,349 2010 166,025 (40,262) 143,264 2009 174,708 (102,716) 148,473 2008 244,838 (2,753) 209,312 128,543 137,433 142,705 45,273 (27,312) 17,961 7,620 25,581 18,000 7,581 - 132,349 145,136 141,186 35,107 4,238 39,345 1,127 40,472 21,270 19,202 - 143,264 153,246 143,174 (27,393) (180,366) (207,759) 144 (207,615) 18,000 (225,615) - 148,473 151,346 135,898 (66,779) (147,635) (214,414) 1,001 (213,413) 9,450 (222,863) 14,938 0.3% 1.1% 18.5% 24.2% 7.2% 2.58% 79.27% 0.4% 3.0% 17.7% 23.5% 6.9% 2.42% 84.06% 0.01 - 1.20 0.03 - 1.14 615 595 1,210 664 606 1,270 (2.2%) (44.3%) 15.7% 21.6% 6.0% 1.91% 95.03% (0.47) - 1.10 732 649 1,381 (2.1%) (47.0%) 7.2% 10.1% 1.0% 1.90% 87.26% (2.34) 0.12 1.64 761 708 1,469 173,729 178,194 160,769 112,434 (105,782) 6,652 (2,028) 4,624 - 4,624 57,733 - 0.8% 7.5% 11.2% 4.3% 2.15% 72.42% 0.05 0.52 5.44 803 774 1,577 556,357 4,275,055 555,615 4,425,639 477,225 4,934,569 95,065 96,683 5,734,096 6,199,963 Includes both Common and Contingent Value Convertible Preference Shareholders’ equity. All prior period per Common Share data and number of Common Shares, with the exception of dividends, have been restated to reﬂect the $0.04 stock dividend declared for March, May, August and November 2009 and the one-for-ten stock dividend of February 2008. (1) (2) 14 CONSOLIDATED RESULTS OF OPERATIONS AND DISCUSSION FOR FISCAL YEAR ENDED 31 DECEMBER 2012 For 2012 and 2011, transactions that were viewed by Management as not being in the normal course of day-to-day business and unusual in nature were excluded from core earnings as they obscure or distort the analysis of trends. Certain earnings measures, such as core earnings, do not have standardised meanings as prescribed by GAAP and therefore are unlikely to be comparable to similar measures presented by other companies. Net Income The Bank reported net income of $25.6 million for the year ended 31 December 2012, compared to $40.5 million in 2011. Results in both years were adversely affected by various non-operating gains and losses. After deduction of Preference dividends ($16.0 million) and the guarantee fee ($2.0 million) on Preference Shares, the net income available to Common Shareholders was $7.6 million ($0.01 per Share) in 2012 compared to $19.2 million ($0.03 per Share) in 2011. The following table states reported earnings for 2012 compared to 2011: (in $ millions) Non-interest income Net interest income before provision for credit losses Total revenue before provision for credit losses and gains and losses Net gains (losses) Provision for credit losses Total net revenue Non-interest expenses Net income before taxes Income tax (expense) beneﬁt Net income from continuing operations Net income from discontinued operations Net income Dividends and guarantee fee of Preference Shares Net earnings attributable to Common Shareholders Net earnings per Common Share - Basic - Diluted 2012 128.5 211.1 339.6 (27.3) (14.2) 298.1 (274.2) 23.9 (5.9) 18.0 7.6 25.6 (18.0) 7.6 0.01 0.01 Year ended 31 December 2011 132.4 202.3 334.7 4.2 (13.2) 325.7 (286.6) 39.1 0.3 39.4 1.1 40.5 (21.3) 19.2 0.03 0.03 $ change (3.9) % change (3.0%) 8.8 4.9 (31.5) (1.0) (27.6) 12.4 (15.2) (6.2) (21.4) 6.5 (14.9) 3.3 (11.6) (0.02) (0.02) 4.4% 1.5% N/A (7.6%) (8.5%) 4.3% (38.9%) N/A (54.3%) N/A (36.8%) 15.5% (60.4%) (66.7%) (66.7%) Butterﬁeld Annual Report 2012 15 Core Earnings The following table reconciles the Bank’s GAAP net income for 2012 and 2011: (in $ millions) Net income Non-core items: Net income from discontinued operations (1) Net gain on sale of afﬁliate (2) Early retirement programme (3) Impairment of goodwill and intangible assets (4) Impairment of ﬁxed assets (5) Deferred tax valuation allowance and tax adjustments (6) Onerous leases (7) Total one-time items Core earnings EPS impact of non-core items EPS core earnings – fully diluted Year ended 31 December 2012 25.6 (7.6) (4.2) 2.2 18.6 14.5 5.0 0.8 29.3 54.9 0.05 0.07 2011 40.5 (1.1) (3.2) 1.6 - - - - (2.7) 37.8 - 0.03 (1) During the third quarter of 2012, Butterﬁeld sold its wholly-owned Barbados subsidiary, Butterﬁeld Bank (Barbados) Limited, to Trinidad and Tobago-based First Citizens Bank Limited (“First Citizens”) for a net gain of $7.2 million. As a result, the Barbados segment has been reported as discontinued operations. The operating results from this business were not material on a per Share basis; however, year-to-date net income includes $7.6 million of discontinued operations in 2012 and $1.1 million in 2011. (2) In the second quarter of 2012, the Bank sold its 27.8% interest in Island Heritage Holdings Ltd., a Cayman-based insurance company, to BF&M Limited for gross proceeds of $18.5 million, resulting in a gain of $4.2 million. In the second quarter of 2011, the Bank sold its 36% equity interest on a diluted basis in Butterﬁeld Fulcrum Group Limited (“BFG”) for a gain of $3.2 million. (3) As part of the Bank’s cost reduction programme, incentive packages for optional early retirement were offered to eligible employees. In 2012 and 2011, the cost of this programme, recorded in salaries and other employee beneﬁts, amounted to $2.2 million and $1.6 million respectively. (4) The Bank’s annual impairment test concluded that the carrying amount of goodwill and intangible assets of our United Kingdom segment was considered fully impaired due to a continuous period of losses incurred and future estimated proﬁtability being unable to sustain current valuations. The intangible asset of the Bahamas segment was impaired as the present value of net cash ﬂows expected to be derived for the remaining customer base is signiﬁcantly less than the expectations as at the acquisition date. (5) The Bank’s annual property impairment assessment resulted in the impairment of various properties and a write down of $6.5 million was recorded as the carrying value was not considered recoverable. Additionally at the end of 2012, the Bank changed its commitment with respect to certain Bermuda properties which were being used in its operations but are now held for sale and, therefore, the properties have been reclassiﬁed to other real estate owned assets in the Consolidated Balance Sheet. The reclassiﬁcation resulted in an $8 million write down of the carrying amount to its fair value less cost to sell. (6) Management assesses the available positive and negative evidence to estimate if sufﬁcient future taxable income will be generated to utilise deferred tax assets. A signiﬁcant piece of objective negative evidence evaluated with respect to our UK bank was the cumulative loss incurred over the three-year period ended 31 December 2012. Such objective evidence limits the ability to consider other subjective evidence such as our projections for future growth. On the basis of this evaluation, as of 31 December 2012, a deferred tax valuation allowance of $4.1 million was recognised in addition to $0.9 million of tax adjustments related to the prior year. (7) The Bank leases certain properties in the normal course of business. Certain of the leased premises have been subleased. If the net present value of the lease obligations exceeds the expected rent receipts, an onerous lease charge is recognised. During 2012, $0.8 million of such charges were recognised. 16 Revenue Total revenue before provisions for credit losses and gains and losses for 2012 was $339.6 million, up $4.9 million (1.5%) from $334.7 million in 2011. Total non-interest income was down $3.9 million (2.9%) from $132.4 million in 2011 to $128.5 million in 2012, which was more than offset by the $8.8 million increase in net interest income before provisions for credit losses from $202.3 million in 2011 to $211.1 million in 2012. The increase in net interest income was driven by a 16 basis point increase in the net interest margin, from 2.42% in 2011 to 2.58% in 2012. The efﬁcient deployment of excess liquidity under our new investment strategy, loan growth and disciplined deposit pricing drove the improvement in the net interest margin despite the sustained low interest rate environment. DISTRIBUTION OF 2012 TOTAL REVENUES BEFORE PROVISIONS FOR CREDIT LOSSES AND GAINS AND LOSSES DISTRIBUTION OF 2012 TOTAL REVENUES BY LOCATION BEFORE PROVISIONS FOR CREDIT LOSSES AND GAINS AND LOSSES Other Non-Interest Income 2% Custody and Other Administration Services 3% Trust 9% Foreign Exchange Revenue 8% Asset Management 6% The Bahamas 2% Guernsey 12% United Kingdom 7% Bermuda 57% Net Interest Income 62% Banking 10% Cayman 22% Switzerland N/A Non-Interest Income Non-interest income is a function of a number of factors including the composition and value of client assets under management and administration, the volume and nature of clients’ transaction activities, and the types of products and services our clients use. Our fee structure provides for varied pricing that depends on the value of client assets and the nature of services provided. As a result, it is not always possible to draw a direct relationship between the value of client assets and the level of non-interest income, although the trend of non-interest income generally follows the trend in client asset levels. Total non-interest income was down $3.9 million from $132.4 million in 2011 to $128.5 million in 2012 and represents 38% of total revenues before provisions for credit losses and gains and losses for 2012, compared to 40% in 2011. The following table presents the components of non-interest income for the years ended 31 December 2012 and 2011: (in $ thousands) Asset management Banking Foreign exchange revenue Trust Custody and other administration services Other non-interest income Total non-interest income 2012 22,323 33,713 26,524 29,122 10,646 6,215 128,543 2011 22,942 31,648 30,277 29,451 12,324 5,707 132,349 $ change (619) % change (2.7%) 2,065 (3,753) (329) (1,678) 508 (3,806) 6.5% (12.4%) (1.1%) (13.6%) 8.9% (2.9%) Asset Management Asset management revenues are generally based on the market value of assets managed and the volume of transactions and fees for other services rendered. We provide asset management services from our ofﬁces in Bermuda, the Cayman Islands, Guernsey and the United Kingdom. Revenues from asset management were $22.3 million in 2012, compared to $22.9 million in 2011; the $0.6 million decrease is principally a result of the termination of the management agreement with Bentley Reid in the second quarter of 2012, offset by an increase in fees earned on the Butterﬁeld Money Market Fund as a result of higher LIBOR rates. Assets under management decreased by $0.9 billion to end at $4.7 billion for 2012 due to the terminated agreement with Bentley Reid and due to a decline in Money Market balances as clients sought better yielding alternatives for short-term investments. Butterﬁeld Annual Report 2012 17 The table that follows shows the changes in the year-end values of clients’ assets under management, sub-divided between those managed for clients on a discretionary basis and those client funds invested in mutual funds that Butterﬁeld manages: (in $ thousands) Butterﬁeld Funds Discretionary Total assets under management 2012 2,869 1,871 4,740 2011 3,375 2,269 5,644 $ change (506) % change (15.0%) (398) (904) (17.5%) (16.0%) Banking During 2012, Butterﬁeld provided a full range of community, commercial and private banking services in select jurisdictions. Community banking services are offered to individuals and small to medium-sized businesses through branch locations, telephone banking, Internet banking, automated teller machines and debit cards in Bermuda and the Cayman Islands, whilst private banking services were offered in Bermuda, the Cayman Islands, Guernsey and the United Kingdom. Banking fee revenues reﬂect loan, transaction and processing and other fees earned in these jurisdictions. Banking fee revenues increased by 6.5% in 2012 to $33.7 million, compared to $31.6 million in 2011, primarily as a result of loan prepayment penalty fee revenue received during 2012. Foreign Exchange We provide foreign exchange services in the normal course of business in all jurisdictions. The major contributors to foreign exchange revenues are Bermuda and the Cayman Islands, accounting for 83% of the Group’s foreign exchange revenue (2011: 80%). The Bank does not have a proprietary trading book. Foreign exchange income is thus generated from client-driven transactions and totalled $26.5 million in 2012, compared with $30.3 million in 2011. The $3.8 million year-on-year decrease reﬂects declining client volumes, in line with the slowing economic conditions, and lower margins on institutional transactions as a result of intensifying competition from online platforms. Trust We provide both personal and institutional trust services from our operations in Bermuda, The Bahamas, the Cayman Islands, Guernsey and Switzerland. Trust revenues are derived from a combination of ﬁxed fees, fees based on the market values of assets held in trust and fees based on time spent in relation to the range of personal trust and company administration services and pension and employee beneﬁt trust services we provide. In 2012, trust revenues totalled $29.1 million, marginally lower than the $29.5 million recorded in 2011 due mainly to substantial one-time fees in 2011 which did not recur in 2012 and also to the loss of one managed trust company mandate during 2011 offset by an increase in recurring income through structured, proactive business development activities, with good new business growth in our Switzerland, Guernsey and Bermuda trust businesses and increasing pipelines in our Bahamas and Cayman businesses. Trust revenues represented 23% of total non-interest income in 2012, up from 22% in 2011. Total Trust assets under administration were $47.1 billion as at 31 December 2012 compared to $43.9 billion the prior year. Custody and Other Administration Services Custody fees are generally based on market values of assets in custody, the volume of transactions and ﬂat fees for other services rendered. We provide custody services from our ofﬁces in Bermuda, the Cayman Islands, Guernsey and the United Kingdom, and other administration services — primarily administered banking — in Guernsey. In 2012, revenues were $10.6 million compared to $12.3 million in 2011, down 13.6%, in part due to lower transaction volumes and expired mandates in our custody business, and partly due to a reduction in administered banking mandates. Total custody and other administration assets under administration (which includes the administered banking services operations provided by our Guernsey business) were $39.9 billion as at 31 December 2012, up from $39.1 billion the prior year. Other Non-Interest Income The components of other non-interest income are set forth in the following table: (in $ thousands) Net share of earnings from investments in afﬁliates Rental income Other Total other non-interest income Year ended 31 December 2012 920 3,062 2,233 6,215 2011 884 2,889 1,934 5,707 In 2012, we recorded equity pickup income of $0.9 million, which is consistent with the prior year. Rental income increased by $0.2 million to $3.1 million in 2012 from an increase in rented premises previously occupied by the Bank for its operations. Included in the “Other” category are maintenance fees from leased premises, Director fee income, and other miscellaneous income. 18 Net Interest Income Before Provision For Loan Losses Net interest income is the amount of interest earned on our interest-earning assets less interest paid on our interest-bearing liabilities. There are several drivers of the change in net interest income, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities, their relative sensitivity to interest rate movements, and the proportion of non-interest-bearing sources of funds, such as equity and non-interest-bearing current accounts. The following table presents the components of net interest income for the years ended 31 December 2012 and 2011: (in $ millions) Assets Cash and cash equivalents and short-term investments Investments Loans Interest-earning assets Other assets Total assets Liabilities Deposits Securities sold under agreement to repurchase Subordinated capital Interest-bearing liabilities Non-interest-bearing current accounts Other liabilities Total liabilities Shareholders’ equity Total liabilities and Shareholders’ equity Non-interest-bearing funds net of non-interest earning assets (free balance) Net interest margin Average balance Interest 2012 Average rate Average balance Interest 2011 Average rate 1,596.7 2,551.5 4,036.0 8,184.2 626.3 8,810.5 5.0 49.1 190.7 244.8 - 244.8 6,305.6 (21.1) - (12.6) (33.7) - - (33.7) 8.4 261.2 6,575.2 975.0 385.6 7,935.8 874.7 8,810.5 1,609.0 0.3% 1.9% 4.7% 3.0% - 2.8% (0.3%) - (4.8%) (0.5%) - - (0.4%) 1,946.4 2,452.0 3,952.1 8,350.5 754.2 9,104.7 6,604.1 3.6 278.4 6,886.1 931.1 452.8 8,270.0 834.7 9,104.7 1,464.4 9.6 43.8 188.1 241.5 - 241.5 (28.8) - (10.4) (39.2) - - 0.5% 1.8% 4.8% 2.9% - 2.7% (0.4%) - (3.8%) (0.6%) - - (39.2) (0.5%) 211.1 2.58% 202.3 2.42% Net interest income before provisions for credit losses increased by 4.4% to $211.1 million in 2012 compared to $202.3 million in 2011, of which 61% (2011: 65%) was generated in Bermuda and 21% (2011: 18%) in the Cayman Islands. Average investment yields of 1.9% on $2.6 billion, combined with a 0.1% decrease in deposit cost, drove a 16 basis point improvement in the net interest margin to 2.58% in 2012 compared to 2.42% in 2011. Although average interest-earning assets decreased by $166.3 million to $8.2 billion in 2012, the decrease had a positive impact on net interest income as the decline was driven by the migration of high-cost deposits which were deployed in lower yielding assets in the cash and cash equivalents category. Free balances of $1.6 billion in 2012 (2011: $1.5 billion) include non-interest-bearing current accounts of $1.0 billion (2011: $0.9 billion) and Shareholders’ equity of $875 million (2011: $835 million) net of other assets and other liabilities. See the Risk Management section for more information on how interest rate risk is managed. Provision For Credit Losses The Bank’s net provisions for credit losses in 2012 were $14.2 million compared to $13.2 million in 2011. The Bank anticipates the difﬁculties in the local economies will continue for the foreseeable future and has made prudent provisions in anticipation of a difﬁcult market. The $20.8 million incremental provisions were required principally for the speciﬁc reserves pertaining to commercial and residential exposures offset by a $2.9 million release in the general provision and recoveries of $3.7 million. Butterﬁeld Annual Report 2012 19 Net Gains (Losses) The following table represents the components of net gains (losses) for the years ended 31 December 2012 and 2011: (in $ thousands) Net realised / unrealised gains (losses) on trading investments Net realised gains on available-for-sale investments Net realised / unrealised losses on Other real estate owned Gain on sale of afﬁliates Impairment of ﬁxed assets Impairment of intangible assets Impairment of goodwill Net other gains (losses) Total net (losses) gains 2012 268 2,028 (2,053) 4,231 (14,527) (9,143) (9,505) 1,389 (27,312) 2011 (919) 2,058 - 3,178 - - - (79) 4,238 Net Realised / Unrealised Gains (Losses) on Trading Investments A $0.3 million gain was recorded with respect to trading securities in 2012 compared to a loss of $0.9 million in 2011, which relates primarily to the fair value adjustments of the Bank’s seed money in shares of the Butterﬁeld Select Investment Fund, the Butterﬁeld Select Alternative Fund and the BNY Mellon Butterﬁeld Income Advantage Fund, which was launched in 2011. Net Realised Gains on Available-For-Sale Investments Net realised gains of $2.0 million (2011: $2.1 million) were recorded on securities sold in the normal course of business as part of our asset and liability management strategy. Gain On Sale of Afﬁliates In the second quarter of 2012, the Bank sold its 27.8% interest in Island Heritage Holdings Ltd., a Cayman-based insurance company, to BF&M Limited for gross proceeds of $18.5 million, resulting in a gain of $4.2 million. In the second quarter of 2011, the Bank sold its 36% equity interest (on a diluted basis) in BFG for a gain of $3.2 million. Net Realised / Unrealised Losses on Other Real Estate Owned Valuation adjustments related to real estate held for sale were $2.1 million compared to nil in 2011. Impairment of Fixed Assets The Bank’s annual property impairment assessment resulted in the impairment of various properties and a write down of $6.5 million was recorded as the carrying value was not considered recoverable. Additionally, at the end of 2012, the Bank changed its commitment with respect to certain Bermuda properties that were being used in its operations but are now held for sale and, therefore, the properties have been reclassiﬁed to Other real estate owned assets in the Consolidated Balance Sheet. The reclassiﬁcation resulted in an $8 million write down of the carrying amount to its fair value less cost to sell. Impairment of Goodwill and Intangible Assets Annual impairment tests of goodwill and intangible assets concluded that the carrying amount of goodwill and intangible assets of our United Kingdom segment was considered fully impaired due to a continuous period of losses incurred and future estimated proﬁtability being unable to sustain current valuations. The intangible asset of the Bahamas segment was impaired as the present value of net cash ﬂows expected to be derived for the remaining customer base is signiﬁcantly less than the expectations as at the acquisition date. A $9.1 million impairment of intangible assets and a $9.5 million impairment of goodwill were recorded in 2012 compared to nil in 2011. Net Other Gains (Losses) Net other gains (losses) were $1.4 million in 2012 compared to net other losses of $0.1 million in 2011 and include gains and losses from the sales of ﬁxed assets and other miscellaneous items. Non-Interest Expenses Expense management continued to be a key focus of the Bank in 2012 as the challenging economic conditions and persistently low interest rates challenged the banking business model. Total non-interest expenses in 2012 were $274.2 million compared to $286.6 million recorded in 2011. Salary and employee beneﬁts account for 50% of non-interest expenses with technology, communications and property making up 30% combined. Bermuda expenses (including head ofﬁce costs) represent the majority of the Group costs at 59% of total non-interest expenses. 20 DISTRIBUTION OF 2012 NON-INTEREST EXPENSES DISTRIBUTION OF 2012 EXPENSES BY LOCATION Other Expenses 6% Marketing 1% The Bahamas 2% Amortisation of Intangible Assets 2% United Kingdom 7% Switzerland 1% Non-Income Taxes 5% Professional and Outside Services 6% Property 9% Guernsey 11 % Cayman 20 % Salaries and Other Employee Benefits 50% Technology and Communications 21% Bermuda 59 % The following table presents the components of non-interest expenses for the years ended 31 December 2012 and 2011: (in $ thousands) Salaries and other employee beneﬁts Technology and communications Property Professional and outside services Non-income taxes Amortisation of intangible assets Marketing Other non-interest expenses Total non-interest expense Income tax expense (beneﬁt) Total expenses 2012 137,433 57,715 26,129 15,409 13,158 5,040 3,963 15,401 274,248 5,890 280,138 2011 145,136 $ change % change (5.3%) (7,703) 53,929 27,080 18,430 14,029 5,367 4,891 17,766 286,628 (306) 286,322 3,786 (951) (3,021) (871) (327) (928) (2,365) (12,380) 6,196 (6,184) 7.0% (3.5%) (16.4%) (6.2%) (6.1%) (19.0%) (13.3%) (4.3%) N/A (2.2%) Salaries and Other Employee Beneﬁts Salaries and other employee beneﬁts decreased by $7.7 million (5.3%) to $137.4 million in 2012 from $145.1 million the prior year. A headcount reduction of 60 drove a $6.8 million reduction in net salary cost offset by an increase of $0.2 million in salaries for temporary contract workers. Additionally, overtime declined by $1.3 million, net pension expense fell by $3.2 million, offset by a $1.5 million increase in staff incentive expense, primarily from vesting of previously issued stock-based compensation, and rising medical costs, up $1.1 million to $7.1 million in 2012. Headcount at the end of 2012 was 1,210, compared to 1,270 a year ago on a full-time equivalency basis. Technology and Communications Technology and communication costs were $57.7 million in 2012, up $3.8 million on the $53.9 million recorded in 2011 as a result of increased depreciation costs related to system implementation projects that occurred in Bermuda and Cayman during 2011. Property Property costs, which reﬂect occupancy expenses, building maintenance, and depreciation of property, plant and equipment, decreased by $1.0 million to $26.1 million in 2012 versus $27.1 million in 2011. The decrease was primarily due to improved management of property maintenance costs. Professional and Outside Services Professional and outside services primarily include consulting, legal, audit, and other professional services. In 2012, the expense was $15.4 million, down $3.0 million compared to $18.4 million incurred in 2011 from the reduction in the use of consultants and other expense management initiatives. Butterﬁeld Annual Report 2012 21 Non-Income Taxes These taxes reﬂect non-income-related taxes levied on us in the various jurisdictions in which we operate, including those associated with employee-related costs such as payroll tax, customs duties and business licences. In 2012, we incurred costs of $13.2 million compared to $14.0 million in 2011; the decrease reﬂecting lower payroll tax in Bermuda due to a decreased number of employees and decrease in payroll tax rate part way through 2011. Amortisation of Intangible Assets Intangible assets relate to client relationships acquired from business acquisitions and are amortised on a straight-line basis over their estimated useful lives, not exceeding 15 years. Acquired intangible assets estimated lives are re-evaluated annually and tested for impairment. The amortisation expense associated with intangible assets was $5.0 million in 2012 compared to $5.4 million in 2011. Marketing Marketing expenses reﬂect costs incurred in advertising and promoting our products and services. They totalled $4.0 million in 2012, down $0.9 million from 2011 and represent 1.2% of total net revenues before gains and losses and provisions for credit losses in 2012 compared to 1.5% in 2011. Other Non-Interest Expenses (in $ thousands) Stationery & supplies Custodian & handling Charitable donations Insurance Other expenses Maintenance fees for liquidity facility Cheque processing Dues and subscriptions Registrar and transfer agent fee Agent commission fees Foreign bank charges Directors’ fees ATM fees General expenses Other Total other non-interest expenses 2012 1,421 1,417 911 2,456 306 1,488 541 739 492 370 1,021 455 1,417 2,367 15,401 2011 1,750 1,752 1,235 2,830 357 1,615 562 822 639 770 811 426 1,044 3,153 17,766 $ change (329) (335) (324) (374) (51) (127) (21) (83) (147) (400) 210 29 373 (786) (2,365) Other non-interest expenses were $15.4 million in 2012, a decrease of $2.4 million compared to 2011, in part due to lower transaction processing fees as a result of lower volumes and cost management initiatives resulting in a reduction in items such as stationery and supplies, insurance costs, and lower operational losses than in the prior year which are included in “other”. Income Taxes In 2012, income tax expenses associated with our businesses in taxable jurisdictions, namely Guernsey, Switzerland and the United Kingdom, netted to $5.9 million compared to a beneﬁt of $0.3 million in 2011. 2012 taxes reﬂect a tax expense of $5.0 million (2011: $1.2 million beneﬁt) in the United Kingdom operations and $0.9 million (2011: $0.8 million) in Guernsey. The $5.0 million tax expense in the UK reﬂects a $4.1 million valuation allowance against deferred income tax assets in addition to a $0.9 million tax adjustment related to prior year. 22 CONSOLIDATED BALANCE SHEET AND DISCUSSION The following table shows the Balance Sheet as reported as at 31 December 2012 and 31 December 2011: (in $ millions) Assets Cash and cash equivalents Short-term investments Investments Loans, net of allowance for credit losses Premises, equipment and computer software Goodwill and intangibles Other assets Total assets from continuing operations Assets of discontinued operations Total assets Liabilities Total deposits Total other liabilities Subordinated capital Total liabilities from continuing operations Liabilities of discontinued operations Total liabilities Preference Shareholders’ equity Common and Contingent Value Convertible Preference Shareholders’ equity Total Shareholders’ equity 2012 2011 $ change 1,652 76 2,882 3,956 243 22 111 8,942 - 8,942 7,502 323 260 8,085 - 8,085 196 661 857 1,903 20 2,062 4,069 272 46 145 8,517 307 8,824 7,257 197 268 7,722 272 7,994 200 630 830 (251) 56 820 (113) (29) (24) (34) 425 (307) 118 245 126 (8) 363 (272) 91 (4) 31 27 118 (151) 55 449 0.28% 0.86% 0.83% 0.68% Total liabilities and Shareholders’ equity 8,942 8,824 Capital Ratios Risk-weighted assets Tangible common equity (TCE) Tangible assets (TA) TCE/TA Tier 1 Common Ratio Tier 1 Capital Ratio Total Capital Ratio 4,275 639 8,920 7.17% 13.96% 18.53% 24.18% 4,426 584 8,471 6.89% 13.10% 17.70% 23.50% The Bank maintains a highly liquid Balance Sheet and is well capitalised. At 31 December 2012, total cash and cash equivalents, short-term investments and investments represented $4.6 billion, or 51.5% of total assets, up from 46.8% at year-end 2011 before discontinued operations. The Bank’s Balance Sheet remains strong, with Shareholders’ equity ending the year up $27 million to $857 million of which $196 million is 8% Preference Shareholders’ equity and $661 million is common equity. Total assets grew by $118 million to $8.9 billion, but when adjusted for the $307 million of assets from discontinued operations in the prior year, total assets grew by $425 million primarily reﬂecting a $245 million increase in deposits, $109 million of funding from repurchase agreements, and a $27 million increase in Shareholders’ equity. At 31 December 2012, Butterﬁeld’s capital ratios were strong, having improved from year-end 2011, with the TCE/TA Ratio ending 2012 at 7.17% (2011: 6.89%), whilst the Total Capital Ratio and Tier 1 Capital Ratio were 24.18% (2011: 23.50%) and 18.53% (2011: 17.70%) respectively. These Ratios are well in excess of regulatory minimums. Butterﬁeld Annual Report 2012 23 Cash, Cash Equivalents and Short-Term Investments The Bank only places deposits with highly rated institutions and ensures there is appropriate geographic diversiﬁcation in its exposures. Limits are set for aggregate geographic exposures for each institution and are monitored and reviewed by our Credit Risk Management (“CRM”) division and approved by the Financial Institutions Committee. Effective 1 January 2011, the Bank changed its accounting policy with respect to cash and cash equivalents for the purposes of the Consolidated Statement of Cash Flows. The Bank deﬁnes cash and cash equivalents to include cash on hand, cash items in the process of collection, amounts due from correspondent banks and highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insigniﬁcant risk of change in fair value. Such investments are those with less than three months maturity from the date of acquisition and include unrestricted term deposits, certiﬁcates of deposit and Treasury bills. Investments of a similar nature that are either restricted or have a maturity of more than three months but less than one year are classiﬁed as short-term investments. Previously, cash and demand deposits with banks only included cash and demand deposits, vault cash and cash in transit for the purposes of the Consolidated Statement of Cash Flows. The new policy more closely reﬂects the manner in which the Bank manages its liquid assets. As at 31 December 2012, cash and cash equivalents and short-term investments were $1.7 billion, compared to $1.9 billion as at 31 December 2011. See “Note 4: Cash and cash equivalents” in the 31 December 2012 Consolidated Financial Statements for additional tables and information. Investments Our investment policies require Management to maintain a portfolio of securities that will provide the liquidity necessary to facilitate the funding of loans and cover deposit ﬂuctuations, and to mitigate our overall Balance Sheet exposure to interest rate risk, whilst achieving a satisfactory return on the funds invested. The securities in which we may invest are limited to securities that are considered investment grade. Securities in our investment portfolio are accounted for under US GAAP as either trading, available for sale or held to maturity. Investment policies are approved by the Board of Directors, governed by the Group Asset and Liability Management Committee and monitored daily by Group Market Risk, a department of the Group Risk Management division. Effective 1 October 2010, the Bank entered into an investment advisory agreement with Carlyle Investment Management LLC, an afﬁliated company of the Carlyle Group. Under the agreement, Carlyle provided Balance Sheet management advisory services to the Bank including, but not limited to: development of investment strategies for consideration by the Bank’s Asset and Liability Committee; Balance Sheet simulation analysis, including interest rate sensitivity, economic value at risk, interest at risk and stress testing; detailed investment portfolio reporting; cash ﬂows and net interest income forecasting; deposit behaviour analysis and pricing strategies; and assistance with credit advisory and workout strategies. Effective 31 July 2012, the investment advisory business previously conducted by Carlyle Investment Management LLC was transferred to Alumina Investment Management LLC (“Alumina”) and the Bank agreed to the transfer of its contract to Alumina. As at 31 December 2012, 99% (2011: 98%) of our total investments were rated investment grade (i.e., rated “BBB” or higher). 31 DECEMBER 2012 INVESTMENT PORTFOLIO BY LONG-TERM DEBT RATING 31 DECEMBER 2012 INVESTMENT PORTFOLIO BY TYPE Other 1% Mutual Funds 2% A 23% Certificates of Deposit 19% Pass Through Notes 1% Commercial 5% AA 11% Asset-backed Securities- Student Loans 5% Corporate Debt Securities Guaranteed by Non-US Governments 2% US Government and Federal Agencies 49% Corporate Debt Securities 14 % Debt Securities Issued by Non-US Governments 3% AAA 65% 24 The following table presents the carrying value of investments by Balance Sheet category: (in $ millions) Trading Available for sale Held to maturity Total investments 2012 62 2,581 239 2,882 As at 31 December 2011 63 $ change (1) 1,934 647 65 174 2,062 820 Total investments were $2.9 billion as at 31 December 2012, up $0.8 billion from the prior year-end balance, due primarily to the sale of the majority of our European exposures in the fourth quarter of 2011 and the purchase of treasury securities, which are included in the cash and cash equivalents category. Trading securities, consisting of holdings of non-US government securities, corporate equities and seed money invested in mutual funds managed by us, totalled $62 million at year-end 2012, compared to $63 million at year-end 2011. Trading securities primarily reﬂect the $50 million initial seed money invested by the Bank in BNY Mellon Butterﬁeld Income Advantage Fund and $7 million invested in other Butterﬁeld Select Funds totalling $57 million, classiﬁed as equities in the table below. Available-for-sale (“AFS”) securities totalled $2.6 billion at year-end 2012, compared to $1.9 billion at year-end 2011. As at 31 December 2012, 45.7% or $1.2 billion (2011: 40.9% or $0.8 billion) of AFS securities consisted of holdings of mortgage-back securities issued by US government and federal agencies. Corporate debt securities, certain of which are guaranteed by non-US governments totalled 17.6%, or $453 million (2011: 27.2% or $527 million), and certiﬁcates of deposit represented 21.8% or $561 million (2011: 18.4% or $356.5 million). The remaining 15.0% of AFS securities is comprised primarily of commercial mortgage-backed securities ($130 million), government guaranteed student loan-backed securities ($136 million), debt securities issued by non-US governments ($90 million), and one pass-through note (“PTN”) ($31 million), which was formerly a structured investment vehicle (“SIV”). Held-to-maturity (“HTM”) investments were $239 million as at 31 December 2012 (2011: $65 million) and consisted entirely of mortgage-backed securities issued by US government agencies that Management has no intention to sell before maturity. Investment Valuation Securities in unrealised loss positions are analysed as part of Management’s ongoing assessment of Other-Than-Temporary Impairment (“OTTI”). When Management intends to sell securities, it recognises an impairment loss equal to the full difference between the amortised cost basis and the fair value of those securities. When Management does not intend to sell equity or debt securities in an unrealised loss position, potential OTTI is considered using a variety of factors, including the length of time and extent to which the market value has been less than amortised cost; adverse conditions speciﬁcally related to the industry, geographic area or ﬁnancial condition of the issuer or underlying collateral of a security; payment structure of the security; changes to the rating of the security by a rating agency; the volatility of the fair value changes; and changes in fair value of the security after the Balance Sheet date. For debt securities, Management estimates cash ﬂows over the remaining lives of the underlying collateral to assess whether credit losses exist and to determine whether any adverse changes in cash ﬂows have occurred. Management’s cash ﬂow estimates take into account expectations of relevant market and economic data, such as GDP and unemployment, during the cash ﬂow cycle as of the end of the reporting period and includes, for example, underlying loan-level data, and structural features of securitisation, such as subordination, excess spread, over-collateralisation or other forms of credit enhancement. Management compares the losses projected for the underlying collateral (“pool losses”) against the level of credit enhancement in the securitisation structure to determine whether these features are sufﬁcient to absorb the pool losses, or whether a credit loss on the debt security exists. Management also performs other analyses to support its cash ﬂow projections, such as stress scenarios. For debt securities, Management considers a decline in fair value to be other-than-temporary when it does not expect to recover the entire amortised cost basis of the security. See “Note 6: Investments” in the 31 December 2012 Consolidated Financial Statements for additional tables and information. Loans The loan portfolio stood at $4.0 billion at 31 December 2012, down $0.1 billion from $4.1 billion the year before, primarily due to the repayment of a Bermuda Government loan of $226 million and an increase in European mortgages of $180.3 million. At 31 December 2012, the loan portfolio represented 44.2% of total assets, compared to (47.8%) at 31 December 2011, whilst loans as a percentage of customer deposits were 53.6% (2011: 57.1%). Butterﬁeld Annual Report 2012 25 Allowance for credit losses at 31 December 2012 totalled $56.0 million, an increase of $0.5 million from 2011. The movement in the allowance is mainly the result of additional provisions, before recoveries, of $18.3 million taken during 2012 net of $17.8 million in charge-offs. Of the total allowance, the general allowance was $29.2 million (2011: $32.0 million) and the speciﬁc allowance was $26.7 million (2011: $23.5 million), reﬂecting an improved speciﬁc coverage ratio of 23.6%, up from 21.3% at 31 December 2011. Gross non-accrual loans totalled $113.4 million at 31 December 2012, down $3.2 million from $110.1 million at 31 December 2011, and represented 2.8% of the total loan portfolio at 31 December 2012, compared to 2.7% in 2011. During 2012, the Bank held Other Real Estate Owned properties (“OREO”) amounting to $34.4 million comprising commercial real estate of $19.3 million, foreclosed residential properties of $7.6 million and property held for sale reclassiﬁed during 2012 of $7.5 million. 31 DECEMBER 2012 LENDING BY LOCATION 31 DECEMBER 2012 GROUP LOANS BY TYPE Commercial and Industrial 8% Commercial Overdrafts 2% Government 2% United Kingdom 13% Guernsey 13% Bermuda 56% Cayman 18% Commercial Mortgages 19% Automobile Financing 1% Credit Cards 2% Other Consumer 4% Residential Mortgages 62% Commercial and Industrial Government Loans to governments decreased by $192.1 million, primarily as a result of the repayment of a Bermuda Government loan facility. Commercial The commercial and industrial loan portfolio includes loans and overdraft facilities advanced primarily to corporations and small and medium-sized entities, which are generally not collateralised by mortgages and where loan repayments are expected to ﬂow from the operation of the underlying businesses. Commercial mortgages are offered to real estate investors, developers and builders domiciled primarily in Bermuda and the United Kingdom. To manage our credit exposure on such loans, the principal collateral is real estate held for commercial purposes and is supported by a registered mortgage. Cash ﬂows from the properties, primarily from rental income, are generally supported by long-term leases to high quality international businesses. These cash ﬂows are principally sufﬁcient to service the loan. Commercial loans of $1.2 billion at 31 December 2012 decreased by $33.6 million from the previous year, primarily due to repayments of certain commercial lending facilities which were offset by advancing corporate loans. Residential The residential mortgage portfolio comprised of mortgages to clients with whom we are seeking to establish (or already have) a comprehensive ﬁnancial services relationship. It includes mortgages to individuals and corporate loans secured by residential property. At 31 December 2012, residential mortgages totalled $2.5 billion (or 62.2% of total gross loans), an increase of $166.5 million from 31 December 2011. Our Guernsey and United Kingdom ofﬁces increased residential mortgage lending to high net worth individuals, secured by high-end properties in the London, UK area, during the year, resulting in a $180.3 million increase in non-Bermuda residential mortgages in the portfolio. All mortgages were underwritten utilising our stringent credit standards. Residential loans consist of conventional home mortgages and equity credit lines. 26 Other Loan Portfolios We provide loans, as part of our normal banking business, in respect of automobile ﬁnancing, consumer ﬁnancing, credit cards, commercial ﬁnancing, loans to ﬁnancial institutions and overdrafts facilities to retail, corporate and private banking clients in the jurisdictions in which we operate. Our loan portfolio and contractual obligations and arrangements are discussed in more detail in “Note 7: Loans” and “Note 8: Credit Risk Concentrations” in the 31 December 2012 Consolidated Financial Statements. Deposits Deposits are our principal funding source for use in lending, investments and liquidity. Butterﬁeld is a deposit-led Bank and does not require the use of wholesale funding to fund its loan business. Deposit balances at the end of reporting periods, particularly in our Bermuda and Cayman Islands operations, can ﬂuctuate due to signiﬁcant balances that ﬂow in and out from hedge fund clients to meet quarter-end subscriptions and redemptions, and are generally paid out in the ﬁrst few days of the quarter. The table below shows the year-end and average customer deposit balances by jurisdiction, comparing 2012 with 2011: (in $ millions) Bermuda Cayman Guernsey The Bahamas UK Total average deposits 104 3,260 Year ended 31 December 2012 $ change 2011 3,364 1,862 1,370 70 709 7,375 1,743 7,131 1,334 735 (26) 59 36 11 244 119 Average balance 2012 3,209 1,791 1,389 62 730 7,181 2011 $ change 3,340 1,732 1,465 92 814 (131) 59 (76) (30) (84) 7,443 (262) Customer deposit balances increased $244 million from $7.1 billion as at 31 December 2011 to $7.4 billion as at 31 December 2012. The average balance of $7.2 billion in 2012 fell compared to 2011 as deposit balances started 2011 higher and ended lower, which reverses in 2012, rising in the latter part of the year particularly in Bermuda, Cayman and Guernsey. Customer demand deposits, which include chequing accounts (both interest-bearing and non-interest-bearing), savings and call accounts, totalled $5.4 billion, or 73.7% of total customer deposits at year-end 2012, compared to $5.0 billion, or 70.0%, at year-end 2011. Customer term deposits decreased by 9.2% from $2.1 billion at year-end 2011 to $2.0 billion at year-end 2012 as customers moved to demand deposits given the low interest rate spread on longer-term deposits. The cost of funds was 0.34% in 2012, down 10 basis points from the 0.44% paid in 2011 as a result of disciplined deposit pricing that contributed to the improvement in net interest income. See “Note 11: Customer Deposits and Deposits from Banks” in the 31 December 2012 Consolidated Financial Statements for additional tables and information. Borrowings We have no issuances of certiﬁcates of deposit (“CD”), commercial paper (“CP”) or senior notes outstanding and have no CD or CP issuance programmes. We are able to source funding on an uncommitted basis from a number of major banks, including our principal correspondent banks. We use funding from the inter-bank market as part of interest rate and liquidity management. At 31 December 2012, deposits from banks totalled $126 million, the same as the prior year. 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 and post-retirement medical plans are not open to new participants and are non-contributory and the funding required is provided by the Bank, based upon the advice of an independent actuary. Butterﬁeld Annual Report 2012 27 Effective 31 December 2011, the Bermuda Deﬁned Beneﬁt pension beneﬁts were amended to freeze credited service and ﬁnal average earnings for remaining active members. Effective January 2012, all the participants of the Bermuda Deﬁned Beneﬁt Pension Plan are inactive and in accordance with US GAAP, the net actuarial loss of the Bermuda Deﬁned Beneﬁt Pension Plan is amortised over the estimated average remaining life expectancy of the inactive participants of 22.8 years. Prior to all Bermuda participants being inactive, the net actuarial loss of the Bermuda Deﬁned Beneﬁt Pension Plan was amortised to net income over the estimated average remaining service period for active members of 4.5 years. As at 31 December 2012, the Bank had a substantial obligation for employee future beneﬁts in the amount of $103 million, down $2 million from $105 million at year-end 2011. See “Note 12: Employee Future Beneﬁts” in the 31 December 2012 Consolidated Financial Statements for additional tables and information. Subordinated Debt, Interest Payments and Maturities We have outstanding issuances of subordinated debt with a carrying value of $260 million as at 31 December 2012, all issued in US dollars, compared to $267.8 million as at 31 December 2011. All but $45.0 million of outstanding subordinated debt is eligible for inclusion in our Tier 2 regulatory capital base and is limited to 50% of Tier 1 capital. During September 2011, the Bank repurchased a portion of the outstanding 5.11% 2005 Series B Subordinated Notes (“the Note”). The Note had a face value of $15.0 million which was repurchased for $13.87 million, netting a gain of $1.13 million. On 9 February 2012, the Bank redeemed the 9.29%, £5.0m ($7.9 million) subordinated debt note issued by our United Kingdom operation. The following table presents the contractual maturity, interest rates and principal outstanding as at 31 December 2012: Subordinated capital 2003 issuance - Series B 2005 issuance - Series A 2005 issuance - Series B Earliest date redeemable 27 May 2013 2 July 2010 2 July 2015 2008 issuance - Series A 27 May 2013 2008 issuance - Series B Total 27 May 2018 Contractual Interest rate until date Interest rate from earliest date redeemable to maturity date redeemable 5.15% 27 May 2018 contractual maturity 3 months US$ LIBOR + 2.000% 2 July 2015 2 July 2020 27 May 2018 27 May 2023 4.81% 5.11% 7.59% 8.44% 3 months US$ LIBOR + 1.095% 3 months US$ LIBOR + 1.695% 3 months US$ LIBOR + 4.185% 3 months US$ LIBOR + 4.929% Principal outstanding 47,000 90,000 45,000 53,000 25,000 260,000 See “Note 19: Subordinated Capital” in the 31 December 2012 Consolidated Financial Statements for additional information. Repurchase Agreements We also obtain funds from time to time from the sale of securities to institutional investors under repurchase agreements. In a repurchase agreement transaction, we will generally pledge investment securities as collateral in a borrowing transaction, agreeing to repurchase the identical security on a speciﬁed later date, generally not more than 90 days, at a price greater than the original sales price. The difference between the sale price and repurchase price is the cost of the use of the proceeds, or interest expense. The investment securities underlying these agreements may be delivered to securities dealers who arrange such transactions as collateral for the repurchase obligation. Repurchase agreements represent a cost competitive funding source and also provide liquidity on agency paper for us. However, we are subject to the risk that the borrower of the securities may default at maturity and not return the collateral. In order to minimise this potential risk when entering into such transactions, we generally deal with large, established investment brokerage ﬁrms with whom we have Master Repurchase Agreements. Repurchase transactions are accounted for as ﬁnancing arrangements rather than as sales of such securities, and the obligation to repurchase such securities is reﬂected as a liability in our Consolidated Financial Statements. As at 31 December 2012, $109.0 million of repurchase agreements were outstanding compared to nil the year before. US government and federal agency investment securities with an amortised cost of $120.9 million and fair market value of $122.4 million were pledged to secure repurchase agreements at 31 December 2012. Shareholders’ Equity Shareholders’ equity increased during the year ended 31 December 2012 by $27.4 million to $857.2 million, reﬂecting: (cid:115)(cid:0) $25.6 million net income for the year (cid:115)(cid:0) $43.1 million from unrealised gains on AFS securities (cid:115)(cid:0) $5.5 million of Share-based compensation (cid:115)(cid:0) $0.8 million translation adjustments on foreign operations 28 These increases were offset by: (cid:115)(cid:0) $15.2 million net increase in employee future beneﬁts from the decline in interest rates used to discount the future cash ﬂows, and lower than expected return on plan assets (cid:115)(cid:0) $18.0 million Preference Share dividends and guarantee fee (cid:115)(cid:0) $5.4 million from the buy-back and cancellation of Preference Shares (cid:115)(cid:0) $9.0 million from the purchase of Treasury Common Shares Capital Resources One of Management’s primary objectives is to maintain a strong capital base to promote conﬁdence in the Bank among our clients, the investing public, bank regulators, rating agencies, and Shareholders. The Bank manages its capital both on a total Group basis and, where appropriate, on a legal entity basis. The Finance department has the responsibility for measuring, monitoring and reporting capital levels within guidelines and limits established by the Risk Policy & Compliance Committee of the Board. The management of capital will also involve regional Management to ensure compliance with local regulation. In establishing the guidelines and limits for capital, a variety of factors are taken into consideration, including the overall risk of the business in stressed scenarios, regulatory requirements, capital levels relative to our peers, and the impact on our credit ratings. The Bank is subject to Basel II which is a risk-based capital adequacy framework developed by the Basel Committee on Banking Supervision and has been endorsed by the central bank governors and heads of bank supervision of the G10 countries. The Bank calculates its capital requirement on the standardised approach under Basel II requirements. The Bank does not expect the changes being proposed to the capital adequacy ratios under Basel III to have a material impact on the Bank’s capital ratios. The Bank is fully compliant with all regulatory capital requirements and maintains capital ratios well in excess of regulatory minimums as at 31 December 2012. As at 31 December 2012, the Bank’s regulatory capital stood at $1.0 billion with the consolidated Tier 1 and Total Capital Ratios of 18.5% and 24.2% respectively (31 December 2011: 17.7% and 23.5% respectively). The following table sets forth our capital adequacy as at 31 December 2012 and 31 December 2011 in accordance with Basel II framework: (in $ millions) Capital Tier 1 Capital Tier 2 Capital Deductions Total Capital Weighted Risk Assets Cash and cash equivalents and investments Loans Other assets Off-Balance Sheet items Operational risk charge Total weighted risk assets Capital Ratios (%) Tier 1 Common Tier 1 Total Total Capital Year ended 31 December 2012 2011 792.3 244.2 (2.9) 1,033.6 913.8 2,232.3 350.7 261.7 516.5 4,275.0 14.0% 18.5% 24.2% 781.4 276.3 (16.7) 1,041.0 722.7 2,408.7 401.7 320.2 572.3 4,425.6 13.1% 17.7% 23.5% Under Basel II Pillar III (market disclosure) the Bank is required to publish further information about the risks to which it is exposed. The Bank’s Pillar III disclosures for the year ended 31 December 2012 will be published on the corporate website, www.butterﬁeldgroup.com, shortly after the publication of the Consolidated Financial Statements. Butterﬁeld Annual Report 2012 29 Preference Shares (See the Offering Memorandum for details) In June 2009, the Bank offered 200,000 of 8.00% Non-Cumulative Perpetual Limited Voting Preference Shares, liquidation preference of US $1,000 per share (the “Preference Shares”) and $200,000,000 in the aggregate. The Preference Shares are fully and unconditionally guaranteed, with the full faith and credit of the Government of Bermuda (the “Guarantor”), as to payment of dividends for up to ten years and as to payment of the liquidation preference on, or in certain circumstances prior to, the ten-year anniversary of the date of issuance (the “Guarantee”). Dividends on the Preference Shares are payable quarterly on a non-cumulative basis, only when, as and if declared by our Board of Directors, on 15 March, 15 June, 15 September and 15 December of each year at a ﬁxed rate equal to 8.00% per annum on the liquidation preference, commencing on 15 September 2009. In the event that, during the ten-year term of the Guarantee, the Bank does not pay full dividends in respect of any quarterly dividend period on any Preference Shares that are then issued and outstanding, the Guarantor has agreed to pay to holders of the Preference Shares an amount equal to such unpaid dividends pursuant to the Guarantee. The Bank may redeem the Preference Shares at its option, subject to approval of the Bermuda Monetary Authority (“BMA”), in whole or in part, on the tenth day prior to the ten-year anniversary of the date of issuance (the “Bank Redemption Date”), at a redemption price equal to 100% of the liquidation preference thereof plus any unpaid dividends for the then-current dividend period to the Guarantee End Date, regardless of whether any dividends are actually declared for such dividend period. In addition, the Bank may redeem the Preference Shares prior to the Bank Redemption Date, at its option, subject to approval of the BMA, in whole or in part, at any time and from time to time, at a redemption price equal to the “Make-Whole Redemption Price”. Unless previously redeemed, the Guarantor has agreed to purchase from the holders thereof, and such holders will be required to transfer to the Guarantor, on the ten-year anniversary of the date of issuance, all Preference Shares then issued and outstanding, at a price per Preference Share equal to the liquidation preference thereof plus any unpaid dividends for the then-current dividend period to the date of such purchase, regardless of whether any dividends are actually declared for such dividend period. In addition, upon the occurrence of a Liquidation Event at any time prior to the ten-year anniversary of the date of issuance of the Preference Shares, the Guarantor has agreed to purchase from the holders thereof, and such holders will be required to transfer to the Guarantor, all Preference Shares then issued and outstanding, at a price per Preference Share equal to the liquidation preference thereof plus any unpaid dividends for the then-current dividend period to the date of payment, regardless of whether any dividends are actually declared for such dividend period. Contingent Value Convertible Preference Shares (“CVCP Shares”) (See the Rights Offering Prospectus for details) In March 2010, the Bank offered up to 99.3 million Common Shares and 8.3 million CVCP Shares in the form of up to 107.6 million Rights Units, each Unit consisting of 0.92038 Common Shares and 0.07692 CVCP Shares, for each Common Share held at a price of BD$1.21 per Rights Unit. A holder of CVCP Shares has the option to convert any such Shares to Common Shares at any time. All CVCP Shares outstanding will automatically convert into Common Shares at the earlier of 31 March 2015 or a sale of the Bank. On such conversion, the CVCP Shares will convert into Common Shares at the Conversion Price. The initial Conversion Price shall be US$1.21 subject to any customary anti-dilution adjustments and certain downward notional adjustment based on certain Loan Recoveries. A holder of CVCP Shares is entitled to certain distributions in connection with certain sales or public offerings of the Bank’s equity interest in BFG. On 9 February 2011, the Bank announced that it had agreed to sell its minority ownership position in BFG. The sale transaction closed during the second quarter of 2011 and generated proceeds of $3.31 million. The completion of the sale triggered a dividend of $3.27 million ($0.42 per share) to holders of Butterﬁeld CVCP Shares, which was paid on 16 August 2011 to Shareholders of record on 26 July 2011. Through this transaction, the Bank has fully divested itself of its minority ownership stake in BFG. The Bank continues to provide BFG and its clients with commercial banking, foreign exchange and custody services. BFG was originally established in 2008 through the merger of Butterﬁeld Fund Services and the Fulcrum Group. When, as and if declared by the Board, holders of the outstanding CVCP Shares will be entitled to receive dividends based on the number of Common Shares into which the CVCP Shares would be convertible as of the dividend record date. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Bank, the holders of the CVCP Shares will be entitled to receive from its assets legally available for distribution to Shareholders as a liquidation preference before any distribution of assets is made to or set aside for the holders of any junior shares, such as the Common Shares, the greater of (1) US$1.21 per CVCP Share plus any declared but unpaid dividends with respect to the then-current dividend period and (ii) the amount per CVCP Share that would be received if such CVCP Share had converted into Common Shares immediately prior to such liquidation, dissolution or winding up. The CVCP Shares are issued as perpetual securities subject to conversion to Common Shares and shall not be redeemable by any holders at any time. The holders of the CVCP Shares will vote together with the holders of the Common Shares on all matters upon which the holders of the Common Shares are entitled to vote. The CVCP Shares shall be entitled to such number of votes based on the number of Common Shares into which the CVCP Shares are convertible as of the applicable record date. 30 The class vote of the holders of at least 66.6% of the CVCP Shares shall be required for (i) the creation or issuance of shares that are senior to liquidation, (ii) an amendment of rights of the CVCP Shares or (iii) a reclassiﬁcation, merger, amalgamation or consolidation where the holders of CVCP Shares would not receive the consideration that would be received if such CVCP Shares had converted into Common Shares immediately prior to such event. The CVCP Shares shall be privately transferable (subject to applicable securities laws and any required regulatory consents) but shall not be listed on the Bermuda Stock Exchange or any other stock exchange. The CVCP Shares will not be registered under the securities laws of any jurisdiction. This will result in limited market for the CVCP Shares. CVCP Shares are transferable to Common Shares at the holders’ option by contacting the Bank’s transfer agent and registrar. With respect to the 8.0% Preference Shares, the CVCP Shares rank pari passu as to liquidation and pari passu as to dividends and, with respect to Common Shares, the CVCP Shares rank senior as to liquidation and pari passu as to dividends (other than dividends relating to BFG, as to which the CVCP Shares rank senior). As at 31 December 2012, there were 7.3 million CVCP Shares outstanding with 0.2 million Shares converted to Common Shares at the holders’ option during the year ended as at 31 December 2012. As at 31 December 2012, there were no loan recoveries attributable to the CVCP Shares as deﬁned in the certiﬁcate of designation. Consequently, the conversion factor to Common Shares at 31 December 2012 remained one to one (1:1). Loan recoveries mean the amount by which the cumulative amount of collections actually received by the Bank with respect to “Covered Loans” from and after 1 January 2010 and through (and including) the Measurement Date exceeds $102.3 million. In no event shall the loan recoveries exceed US$42.0 million. As at 31 December 2012, the carrying value of the covered loans was $26.9 million (2011: $27.9 million) reﬂecting charge- offs during the year as approved by the Audit Committee and reviewed by an independent committee of the Board of Directors. Share Buy-Back Programme The Bank introduced a Share Buy-Back Programme on 1 May 2012 as a means to improve Shareholder liquidity and facilitate growth in Share value. Under the Bank’s Share Buy-Back Programme, the Board authorised the buy-back of up to 6 million Common Shares and 2,000 Preference Shares. On 10 December 2012, the Board approved an increase in the authorised number of Shares to be bought back to 10 million Common Shares and 8,000 Preference Shares. During 2012 the Bank bought back 7.3 million Common Shares to be held as Treasury Shares at an average price of $1.23 per Share (totalling $9.0 million) and 4,422 Preference Shares which were subsequently cancelled at a cost of $5.4 million. From time to time, the Bank’s associates, insiders and insiders’ associates as deﬁned by the Bermuda Stock Exchange (“BSX”) regulations may sell Shares which may result in such Shares being bought back pursuant to the programme, but under BSX regulations such trades must not be pre-arranged and all buy-backs 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 for a “round lot”, deﬁned as 100 Shares or more. The BSX must be advised monthly of Shares bought back and cancelled by the Bank and Shares purchased by the Bank’s Stock Option Trust. Warrants Following the capital raise on 2 March 2010, the terms of the 4,279,601 warrants with an exercise price of $7.01 previously issued to the Government of Bermuda in conjunction with the issuance of the Preference Shares in 2009 were adjusted in accordance with the terms of the guarantee. Subsequently, the Government of Bermuda now holds 4,150,774 warrants with an exercise price of $3.614 and an expiration date of 22 June 2019. Dividends No Common dividends were declared or paid in 2012 or 2011. Preference Share dividends declared and paid were $16.0 million during 2012 (2011: $16.0 million in relation to the Preference Shares). In 2011, a $3.3 million dividend was paid to holders of CVCP Shares triggered by the sale of the Bank’s minority interest in BFG. Guarantee fees paid to the Government of Bermuda were $2.0 million during each of 2012 and 2011. Subsequent to year end, the Board declared a special dividend of $0.04 per Common Share and Contingent Value Convertible Preference Share to be paid on 22 March 2013 to Shareholders of record on 5 March 2013. Cash Flows Cash and cash equivalents were $1.7 billion as at 31 December 2012, compared to $1.9 billion the prior year. The decrease is described below by category of operating, investing and ﬁnancing activities. For the year ended 31 December 2012, net cash provided by operating activities totalled $132.9 million (2011: $39.4 million). Cash ﬂows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. Cash provided by operating activities increased by $93.5 million from 2011 to 2012, due primarily from the $50 million investment of seed money in the new BNY Mellon Butterﬁeld Income Advantage Fund in 2011, classiﬁed as “trading investments” for accounting purposes. However, cash generated from operating activities before changes in trading investments increased $48.0 million from rising core earnings generating higher cash earnings compared to the prior year. Butterﬁeld Annual Report 2012 31 Our investing activities include capital expenditures, loan activities, investment activities, and divesture and acquisition activities. We do not own, directly or indirectly, any shares of stock or any other equity interest or long-term debt securities of any company, corporation, ﬁrm, partnership, joint venture, association or other entity, except pursuant to the ordinary course of investment activities, the strategic investment in an associated company or as a result of the ordinary course loan structuring. Net cash used by investing activities for the year ending 31 December 2012 totalled $627.4 million compared to cash provided by investing activities of $238.0 million in 2011. The $865.4 million decrease in 2012 over 2011 was mainly due to a $757.7 million net cash used to purchase HTM and AFS investments, compared to $530.6 million in net investment proceeds in 2011, offset by the movement in loans year over year (2012: net repayment of $137.1 million; 2011: net advances of $261.4 million). Net cash provided from ﬁnancing activities totalled $217.9 million in 2012, compared to net cash used in ﬁnancing of $765.7 million in 2011. The $983.6 million change reﬂects the net cash used to fund deposit decreases of $730.6 million in 2011, compared to the $149.2 million increase in deposits and $109.0 million increase in repurchase agreements in 2012 offset by the $14.4 million of Share buy-backs and $7.9 million of subordinated debt repayments. OFF BALANCE SHEET ARRANGEMENTS Assets Under Administration And Assets Under Management The Bank, in the normal course of business, holds assets under administration and assets under management in a ﬁduciary or agency capacity for our clients. In accordance with US GAAP, these assets are not assets of the Bank and are not included in our Consolidated Balance Sheet. Credit-Related Arrangements We enter into standby letters of credit, letters of guarantee and contractual commitments to extend credit in the normal course of business, which are not required to be recorded on the Balance Sheet. Since many commitments expire unused or only partially used, these totals do not necessarily reﬂect future cash requirements. Management believes there are no material commitments to extend credit that represent risks of an unusual nature. Standby letters of credit and letters of guarantee are issued at the request of our clients in order to secure a client’s payment or performance obligations to a third party. These guarantees represent our irrevocable obligation 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 client. Generally, the term of the standby letters of credit does not exceed one year, whilst the term of the letters of guarantee does not exceed four years. Credit risk is the principal risk associated with these instruments. The contractual amounts of these instruments represent the credit risk should the instrument be fully drawn upon and the client defaults. To control the credit risk associated with issuing letters of credit and letters of guarantee, we subject such activities to the same credit quality and monitoring controls as our lending activities. The types and amounts of collateral security we hold for these standby letters of credit and letters of guarantee is generally represented by our deposits or a charge over assets held in mutual funds. We are obligated to meet the entire ﬁnancial obligation of these agreements and in certain cases are able to recover the amounts paid through recourse against the collateral security. The following table sets forth the outstanding ﬁnancial guarantees with contractual amounts representing credit risk: As at 31 December (in $ millions) Standby letters of credit Letters of guarantee Total Gross 280.1 11.2 291.3 Collateral 277.3 8.7 286.0 2012 Net 2.8 2.5 5.3 Gross 321.0 13.1 334.1 Collateral 303.8 9.9 313.7 2011 Net 17.2 3.2 20.4 Collateral is shown at estimated market value less selling cost. Where cash is the collateral, it is shown in gross amounts including interest income. Contractual Obligations (Including Subordinated Debt) We enter into contractual commitments to extend credit, normally with ﬁxed expiration dates or termination clauses, at speciﬁed rates and for speciﬁc purposes. These credit arrangements are subject to our normal credit standards and collateral is obtained where appropriate. Substantially all of our commitments to extend credit are contingent upon clients maintaining speciﬁc credit standards at the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for possible loan losses. In the second quarter of 2011, the Bank cancelled its commitment for a $300 million line of credit with CIBC as Management deemed it was no longer necessary. Whilst outstanding, the facility fees were $200,000 per month. A $150.0 million committed line of credit to our Bank in the Cayman Islands, from one of its custodians, was allowed to expire on its maturity on 31 December 2011. Both committed lines were exited as they were no longer required as part of the Bank’s liquidity management programme. 32 Effective 1 October 2010, the Bank had retained Carlyle Investment Management LLC, an afﬁliated company of the Carlyle Group, to provide Balance Sheet management advisory services, including advisory services on valuation assignments, for an annual fee of $4 million for a three-year period. Effective 31 July 2012, the investment advisory business previously conducted by Carlyle Investment Management LLC was transferred to Alumina Investment Management LLC (“Alumina”) and the Bank agreed to the transfer of its contract to Alumina. The Bank has a facility, by one of its custodians, whereby the Bank may offer up to $200 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 to set-off against securities held of 110% of the utilised facility. At 31 December 2012, $137.0 million (2011: $137.1 million) of standby letters of credit were issued under this facility. The contractual amounts for these commitments represent the maximum payments we would have to make should the contracts be fully drawn, the counterparty default, and any collateral held prove to be of no value. Commitments, when drawn, would be funded from our free cash resources. We enter into other contractual obligations in the normal course of business. Certain of these obligations, such as subordinated debt, are recorded as liabilities in our Consolidated Balance Sheet. Other items, such as sourcing agreements, operating leases and other purchase contracts, are not required to be recorded on the Balance Sheet. Expected cash payments associated with subordinated debt are based on principal payment dates. See “Note 19: Subordinated Capital” in the 31 December 2012 Consolidated Financial Statements for terms of subordinated debt arrangements and interest obligations. The $75.4 million contractual obligation in respect of sourcing—for Bermuda and the Cayman Islands— relates to an eight-year agreement entered into in October 2008 with global technology service provider Hewlett Packard (“HP”) (previously EDS) to supply technology infrastructure and application development management, information security and technical support for our locations in Bermuda and the Cayman Islands. In 2011, working with HP, we completed the transition of all our business applications and legacy systems in these locations to a new, common platform that is centrally managed. Under our agreement with HP, server management and maintenance, technology ﬁeld support, application support and development and help desk functions are managed by HP. In addition, HP managed the installation of and conversion to our new, common core banking system in Bermuda and the Cayman Islands which went live in 2011. We have entered into additional contractual obligations in the normal course of business which are not signiﬁcant to the amounts above. RISK MANAGEMENT Risk Governance The Group’s risk governance and management structure is illustrated below: BOARD OF DIRECTORS RISK POLICY & COMPLIANCE COMMITTEE AUDIT COMMITTEE GROUP RISK COMMITTEE GROUP ASSET & LIABILITY COMMITTEE GROUP CREDIT COMMITTEE PROVISION & IMPAIRMENTS COMMITTEE POLICY DEVELOPMENT COMMITTEE JURISDICTIONAL BUSINESS UNITS & OVERSIGHT COMMITTEES Butterfield Annual Report 2012 33 The Board of Directors oversees the Group’s risk management programme through the approval of the Risk Appetite Framework and supporting risk management policies. It accomplishes its mandate through the activities of two dedicated committees: The Risk Policy & Compliance Committee: This Committee assists the Board in fulﬁlling its responsibilities by overseeing the Group’s risk proﬁle and its performance against approved risk appetites and tolerance thresholds. Speciﬁcally, the Committee considers the sufﬁciency of the Group’s policies, procedures and limits related to the identiﬁcation, measurement, monitoring and control of activities that give rise to credit, market, liquidity, interest rate, operational and reputational risks, as well as overseeing its compliance with laws, regulations and codes of conduct. The Audit Committee: This Committee reviews the overall adequacy and effectiveness of the Group’s system of internal controls and the control environment, including those that are brought to bear in respect of the risk management process. It reviews recommendations arising from internal and independent audit review activities and Management’s response to any ﬁndings raised. Both the Risk Policy & Compliance Committee and the Audit Committee are supported in the execution of their respective mandates by the dedicated Audit, Compliance & Risk Policy Committees for our UK, Guernsey, Cayman and The Bahamas, which oversee the sufﬁciency of local risk management policies and procedures and the effectiveness of the system of internal controls that are in place. These Committees are chaired by Non-Executive Directors drawn from our jurisdictional Boards. The Group Executive Management team, led by the Chairman & Chief Executive Ofﬁcer (“Chairman”) and including the members of Executive Management reporting directly to the Chairman, is responsible for setting business strategy and for monitoring, evaluating and managing risks across the Group. It is supported by the following committees: The Group Risk Committee (“GRC”): This is the Senior Management Committee with responsibility for risk governance. It provides a forum for the strategic assessment of risks assumed across the Group as a whole, based on an integrated view of credit, market, liquidity, legal and regulatory compliance, operational, interest rate, investment, capital and reputational risks, ensuring that these exposures are consistent with the risk appetites and tolerances promulgated by the Board. It is responsible for reviewing, evaluating and recommending the Group’s Risk Appetite Framework, the results of the capital assessment and risk proﬁle (“CARP”) process (including all associated stress testing performed) and the Group’s key risk policies to the Board of Directors for approval, for reviewing and evaluating current and proposed business strategies in the context of our risk appetites and for identifying, reviewing and advising on current and emerging risk issues and associated mitigation plans. Its membership is drawn from the Group Executive Management team, including the Chairman. The meeting is chaired by the Chief Risk Ofﬁcer. The Group Asset & Liability Committee: This Committee is responsible for liquidity, interest rate and exchange rate risk management and other Balance Sheet issues. It also oversees the execution of the Group’s investment and capital management strategies and monitors the associated risks assumed. It is supported in the execution of its mandate by the work undertaken by the dedicated Asset & Liability Committees in each of the Bank’s jurisdictional business units. Its membership is drawn from the Group Executive and Senior Management teams, including the Chief Risk Ofﬁcer and the Chairman. The meeting is chaired by the Chief Financial Ofﬁcer. The Group Credit Committee: This Committee is responsible for a broad range of activities relating to the monitoring, evaluation and management of credit risks assumed across the Group, at both transaction and portfolio levels. It is supported in the execution of its mandate by the Financial Institutions Committee, a dedicated sub-committee that is responsible for the evaluation and approval of recommended inter- bank and counterparty exposures assumed in the Group’s treasury and investment portfolios, and by the activities of Credit Committees for our European and Cayman operations, which review and approve transactions within delegated authorities and recommend speciﬁc transactions outside of these limits to the Group Credit Committee for approval. Its membership is drawn from the Group Executive and Senior Management teams. The meeting is chaired by the Chief Risk Ofﬁcer. The Provisions & Impairments Committee: This Committee is responsible for approving signiﬁcant provisions and other impairment charges. It also oversees the overall credit risk proﬁle of the Group in regard to non-accrual loans and assets. It is supported in the execution of its mandate by local Credit Committees and the Group Credit Committee, which make recommendations to this Committee. Its membership is drawn from the Group Executive Management team, including the Chairman. The meeting is chaired by the Chief Risk Ofﬁcer. 34 The Policy Development Committee: This Committee is responsible for overseeing the design, development and maintenance of the Group’s framework of operational policies. It develops recommendations regarding policy requirements, engages with nominated members of Executive Management to ensure that policies are drafted or updated on a timely basis and provides a forum through which they are debated Group-wide prior to their adoption, thereby ensuring a consistency of application and interpretation. It also ensures that all policies and any policy exception requests are reviewed and recommended prior to presentation to the Group Risk Committee or Risk Policy & Compliance Committee of the Board for approval. Its membership is drawn from the Senior Management team across the Group. It is chaired by the Group Head of Compliance. Risk Management The Group manages its exposure to risk through a three “lines of defence” model. This may be summarised as follows: The ﬁrst “line of defence”: This is provided by our jurisdictional business units, which retain ultimate responsibility for the risks they assume and for bearing the cost of risk associated with these exposures. The second “line of defence”: This is provided by the Risk Management group, which works in collaboration with our business units to identify, assess, mitigate and monitor the risks associated with our business activities and strategies. It does this by: (cid:115)(cid:0) Making recommendations to the Group Risk Committee regarding the constitution of the Risk Appetite Framework. (cid:115)(cid:0) Setting risk strategies that are designed to manage risk exposures assumed in the course of pursuing our business strategies and aligning them with agreed appetites. (cid:115)(cid:0) Establishing and communicating policies, procedures and limits to control risks in alignment with these risk strategies. (cid:115)(cid:0) Measuring, monitoring and reporting on risk levels. (cid:115)(cid:0) Opining on speciﬁc transactions that fall outside delegated risk limits. (cid:115)(cid:0) Identifying and assessing emerging risks. The four functions within the Risk Management group that support our risk management activities are outlined below. To ensure a formal separation of duties, each reports directly to the Chief Risk Ofﬁcer. Group Market Risk – This provides independent oversight of the measurement, monitoring and control of liquidity and funding risks, interest rate and foreign exchange risks as well as the market risks associated with the Group’s investment portfolios. It also monitors compliance with both regulatory requirements and the Group’s internal policies and procedures relating to the management of these risks. Credit Risk Management – This unit is responsible for the adjudication and oversight of credit risks associated with our retail and commercial lending activities and the management of risks associated with our investment portfolios and counterparty exposures. It also establishes the parameters and delegated limits within which credit risks may be assumed and promulgates guidelines on how exposures should be managed and monitored. Compliance – This unit provides independent analysis and assurance of the Group’s compliance with applicable laws, regulations, codes of conduct and recommended best practices, including those associated with anti-money laundering/counter terrorist ﬁnancing requirements. It is also responsible for assessing the Group’s potential exposure to upstream risks and for providing guidance on the preparations that should be made in advance of these changes coming into effect. Group Operational Risk – This unit assesses the effectiveness of the Group’s procedures and internal controls in managing its exposure to various forms of operational risk, including those associated with new business activities and processes and the deployment of new technologies. It also oversees the Group’s incident management processes and reviews the effectiveness of its loss data collection activities. The third “line of defence”: This is provided by our Group Internal Audit function, which provides ongoing review, oversight and challenge of the effectiveness of the internal controls that are executed by both the business and Risk Management communities in the management, monitoring and measurement of our exposure to risk. This includes the review of the accuracy of the underlying data and appropriateness of the stress testing methodologies that are executed as a part of our Capital Adequacy & Risk Proﬁle processes. The Risk Appetite Framework The Risk Appetite Framework is the cornerstone of our approach to risk management. Developed by Executive Management and approved formally by the Board of Directors, it communicates a willingness to take on certain risks in the pursuit of our strategic objectives and deﬁnes those that should be avoided. It also provides Management with a clear mandate regarding the amount and type of risk that it may accept and establishes minimum expectations regarding the practices and behaviours that should be brought to bear in managing the exposures assumed. It is aligned with the interests of our stakeholders, feeds into our business planning processes, and shapes our discussions on risk matters generally. Butterﬁeld Annual Report 2012 35 Our framework comprises the following elements: (i). Nine broad categories of risk: Credit; Market; Liquidity; Legal & Regulatory; Governance; Process & Technology; People; Country & Political; and Reputational. These represent the various risks that the Group assumes across the entirety of its operations in the pursuit of its strategic goals. (ii). For each risk category, there is a declared risk appetite. To ensure consistency in our risk conversations, these have been distilled into the three options set out in the table below, with each appetite designed to convey a clear strategic direction in terms of the risk/reward proﬁle assumed: APPETITE Averse Cautious Open DEFINITION PROFILE The Group will work to avoid exposure to this risk given its potential for ﬁnancial loss, reputational damage, and/or the loss of customer and / or investor conﬁdence. Given the potential for ﬁnancial loss, reputational damage, and the loss of customer and/or investor conﬁdence, the Group will be very selective in the exposures assumed to this risk and will monitor it closely. The Group will consider opportunities to accept this risk and will accept those that fall within clearly deﬁned parameters. The risk of loss or reputational damage is accepted but the exposure can be estimated reliably and can be managed to a tolerable level. Our processes and controls are defensive and focus on detection and prevention. Security is favoured over reward. Exposures are only assumed when the risk can be quantiﬁed accurately and is assessed as being acceptable. Reward is commensurate with the risk assumed. Exposures can be estimated reliably and structures, systems and processes are in place to manage it. (iii). A statement of our governing principles relating to each risk category. This establishes the characteristics of the risks that the Bank is willing to assume and the management behaviours that we should exhibit when doing so. Speciﬁc performance measures and tolerance thresholds in respect of each risk category, combining quantitative and qualitative targets (which are designed to reﬂect both forward looking as well as historical perspectives), are designed to provide Executive Management and the Board with an indication of the “direction” of our exposure relative to our declared risk appetite and an early warning of material adverse developments requiring remedial action. The metrics are monitored independently by the Group Risk function and are measured against actual results. The results of these analyses are reported to Management at all levels of the organisation and are reviewed regularly by both the Group Risk and Risk Policy and Compliance Committees in the performance of their oversight activities. Application Of The Risk Appetite Framework The limits, targets and thresholds used to measure performance continue to be reﬁned by the Group Risk Management function in an effort to express as complete a “picture” as possible of our exposure to a given risk, relative to the stated appetite. All changes proposed pass through a formal review and approval process at both the Executive Management and Board levels prior to their adoption. Through this approach, the Risk Appetite Framework sets the tone for our risk culture across the Group as a whole, inﬂuencing behaviours at all levels of the organisation and reinforcing accountability for decisions taken. Many of our Jurisdictional ofﬁces have developed subsidiary risk appetite frameworks in conjunction with their local Risk Management functions. This ensures appropriate coverage of local risk factors and the establishment of proportional tolerance thresholds. Group Risk has reviewed these frameworks prior to their adoption and has modiﬁed any appetites proposed that are considered to be inconsistent with the overall Group approach. Credit Ratings Our credit ratings are provided in the table below: Short-term deposits Long-term deposits and debt Outlook 36 Standard Moody’s Fitch & Poor’s A-2 A- P-1 A2 F1 A- Negative Negative Stable In scope hand touch particular motion sight addition Jurisdiction & Group Business Overviews Butterﬁeld Annual Report 2012 37 Bermuda F F or more than 150 years, Bermuda has served as Butterﬁeld’s headquarters and remains the Bank’s largest jurisdiction in terms of number of employees, Banking Centre locations and business volume. Butterﬁeld is Bermuda’s largest independent Non-interest income of $65.6 million in 2012 was down 2.3% from 2011, reﬂecting lower foreign exchange, custody, and trust revenues, which were partially offset by increases in asset management fees and higher than normal loan prepayment fees. bank, offering a full range of community banking services and wealth management, including private banking, asset management and Total expenses were down $12.5 million to $164.2 million in 2012, personal trust services. Butterﬁeld also provides services to corporate compared to $176.7 million in 2011. Salary costs declined $5.4 million and institutional clients in Bermuda, which include asset management as a result of reduced headcount which ended the year at 615, down and corporate trust services. 49, partially due to the Bank’s voluntary early retirement programme, combined with natural attrition and redundancies. Expense savings, Net income before gains and losses was $25.1 million in 2012, up principally from expense management initiatives, contributed an $3.4 million from $21.7 million in 2011. Including net gains and additional $9.5 million in cost reductions, offset by a $2.4 million losses—mainly one-time items in respect of ﬁxed asset impairments increase in technology costs from higher depreciation on system and write downs and the sale of an afﬁliate—net income of upgrades. $12.1 million for 2012 represented a decrease of $14.3 million year over year. Total assets as at 31 December 2012 were $4.7 billion, up $0.2 billion from 2011. Customer deposits ended the year at $3.4 billion, up Net interest income fell $2.4 million to $130.1 million in 2012 due to $0.1 billion from 2011, and loan balances decreased $0.2 billion to reduced loan volumes and depressed investment yields owing to the $2.2 billion compared to the prior year, mainly from the repayment of a historically low interest rates. The net interest margin held steady at Bermuda Government loan. 3.2%, due primarily to lower deposit costs that offset the lower yields earned on loans and investments. Client assets under administration for the trust and custody businesses were $30.1 billion and $27.8 billion, respectively, whilst Provisions for credit losses were $6.4 million in 2012, compared to assets under management declined by $0.3 billion to $3.1 billion. $1.2 million in 2011; the increase is mainly attributable to the Bank’s residential mortgage portfolio. An allowance for credit losses of $37.7 million represents a coverage ratio of 38.9% against non-performing loans of $96.7 million, which were up $8.0 million from $88.7 million in 2011. The increase was due to an $11.1 million rise in non-performing residential mortgages, totalling $45.9 million as at year end, offset by a decrease of $2.7 million in commercial non-performing loans to $47.8 million. Non-performing consumer loans improved by $0.4 million to end the year at $3.0 million. 38 (in $ thousands) Net interest income Provision for credit losses Non-interest income Revenue before gains and losses Total expenses Net income before gains and losses Net gains (losses) Net income As at 31 December (in $ millions) Customer deposits Loans, net of allowance for credit losses Total assets Assets under administration Custody and other administration services Trust Assets under management Butterﬁeld Funds Other assets under management Total assets under management 2012 130,133 (6,372) 65,559 189,320 2011 132,552 (1,202) 67,080 198,430 $ change % change (2,419) (1.8%) (5,170) (430.1%) (1,521) (2.3%) (9,110) (4.6%) (164,232) (176,725) 12,493 7.1% 25,088 (12,974) 12,114 21,705 4,753 3,383 15.6% (17,727) (373.0%) 26,458 (14,344) (54.2%) 3,364 2,208 4,733 3,260 2,456 4,575 104 3.2% (248) (10.1%) 158 3.5% 27,819 30,062 28,156 29,635 (337) (1.2%) 427 1.4% 2,335 747 3,082 2,653 752 3,405 (318) (12.0%) (5) (0.7%) (323) (9.5%) Number of employees 615 664 (49) (7.4%) Butterfield Annual Report 2012 39 Cayman Islands Butterﬁeld is a leading ﬁnancial services provider in the Cayman Islands, offering a comprehensive range of personal and corporate ﬁnancial services. In addition to our strong retail presence, Butterﬁeld is also focused on our wealth management offering through an award winning private banking service as well as asset management and trust services. Provisions for credit losses decreased by $2.7 million from reductions and recovery in provisions in the Cayman loan portfolio of $3.4 million in 2012 compared to 2011, offset by increased provisioning of $0.7 million on the Bahamian residential mortgage book in 2012. Non-interest income of $30.9 million in 2012 was up $0.3 million compared to the prior year, reﬂecting improved banking fees and 2012 saw the opening of Butterﬁeld’s new retail branch at Midtown foreign exchange commissions. Plaza. In keeping with our commitment to service excellence, the new Banking Centre offers contemporary, spacious surroundings Total expenses of $54.8 million were $0.2 million below prior-year in an excellent location. With three Banking Centres and 12 ATMs levels from broad-based expense management partially offset by strategically located around Grand Cayman, Butterﬁeld continues to increased technology and communications costs arising from increased be a leader in the provision of ﬁnancial services. depreciation and the introduction of a virtual private network system. Net income before gains and losses of $19.5 million was more than Total assets at 31 December 2012 were $2.1 billion, up $0.1 billion from double the prior year’s $9.0 million. The increase primarily reﬂects a year-end 2011, reﬂecting higher corporate client deposit levels. $7.3 million increase in net interest income and a reduction of $2.7 million in provisions for credit losses. Net income increased by Net loans decreased by $16.5 million from year-end 2011, reﬂecting $13.0 million to $24.0 million in 2012. signiﬁcant principal repayments primarily on residential mortgages. Net interest income before loan loss provisions was $44.6 million Client assets under administration for the trust and custody in 2012, $7.3 million ahead of the prior year, driven primarily by the businesses were $1.7 billion and $1.4 billion, respectively, whilst increase in investment income resulting from an average increase assets under management declined by $0.2 billion to $0.8 billion. of $152 million in ﬁxed income investments, which contributed to improved net interest margin of 2.3%, up from 2.0% in 2011. 40 (in $ thousands) Net interest income Provision for credit losses Non-interest income Revenue before gains and losses Total expenses Net income before gains and losses Net gains (losses) Net income As at 31 December (in $ millions) Customer deposits Loans, net of allowance for credit losses Total assets Assets under administration Custody and other administration services Trust Assets under management Butterﬁeld Funds Other assets under management Total assets under management Number of employees 2012 44,633 (1,291) 30,940 74,282 2011 37,325 (3,974) 30,651 64,002 $ change % change 7,308 19.6% 2,683 67.5% 289 0.9% 10,280 16.1% (54,829) (54,987) 158 0.3% 19,453 4,497 23,950 9,015 1,956 10,438 115.8% 2,541 129.9% 10,971 12,979 118.3% 1,862 705 2,117 1,743 119 6.8% 722 (17) (2.4%) 1,974 143 7.2% 1,417 1,710 1,226 2,188 191 15.6% (478) (21.9%) 176 621 797 296 211 760 971 308 (35) (16.6%) (139) (18.3%) (174) (17.9%) (12) (3.9%) Butterﬁeld Annual Report 2012 41 Guernsey In Guernsey, Butterﬁeld offers private banking, lending, asset management, custody, administered banking and ﬁduciary services. Total expenses, at $30.8 million, were $0.6 million higher than 2011, due mainly to an increase in salary and employee beneﬁt costs, up 8.9% to support increased regional centralisation, and an increase in technology expense, offset by savings in property, professional Guernsey posted net income of $9.7 million in 2012, compared to net services and other expenses. income of $9.4 million in 2011, an increase of $0.3 million or 3.6%. Total assets at 31 December 2012 of $1.5 billion were consistent with Net interest income increased $3.2 million to $21.6 million in 2012, year-end 2011. compared to $18.4 million in 2011. Average loan balances increased $92.1 million, contributing to a 0.32% increase in the net interest Client assets under administration for the trust, custody and margin to 1.43% in 2012, up from 1.16% in the prior year. administered banking businesses were $9.9 billion (2011: $8.2 billion), Provisions for credit losses of $1.0 million were required in 2012, respectively reﬂecting solid growth in the trust business line. Client compared to $0.6 million last year. assets under management were consistent with the prior year at $7.4 billion (2011: $6.7 billion), and $1.5 billion (2011: $1.7 billion), $0.6 billion. Non-interest income decreased $1.7 million to $20.0 million, due to lower foreign exchange, asset management and custody revenue combined with lower income from administered banking services. This was offset by a 4.7% increase in revenues from trust services, up $0.3 million year on year. 42 (in $ thousands) Net interest income Provision for credit losses Non-interest income Revenue before gains and losses Total expenses Net income before gains and losses Net gains (losses) Net income As at 31 December (in $ millions) Customer deposits Loans, net of allowance for credit losses Total assets Assets under administration Custody and other administration services Trust Assets under management Butterﬁeld Funds Other assets under management Total assets under management Number of employees 2012 21,564 (980) 20,005 40,589 2011 18,379 (636) 21,665 39,408 $ change % change 3,185 17.3% (344) (54.1%) (1,660) (7.7%) 1,181 3.0% (30,810) (30,245) (565) (1.9%) 9,779 (31) 9,748 1,370 533 1,522 9,163 242 9,405 1,334 453 1,480 616 6.7% (273) (112.8%) 343 3.6% 36 2.7% 80 17. 7% 42 2.8% 8,958 9,905 8,416 8,242 542 6.4% 1,663 20.2% 246 343 589 173 141 447 588 165 105 74.5% (104) (23.3%) 1 - 8 4.9% Butterfield Annual Report 2012 43 United Kingdom In the UK, Butterﬁeld provides a range of exclusive banking, lending, treasury and investment management services. This includes family ofﬁce services to high net worth international clients and their advisers from ofﬁces in London. Provisions for credit losses of $5.5 million were required in 2012, compared to $6.7 million of credit losses last year; both years’ provisions related to legacy commercial loan facilities. Non-interest income was $8.2 million, down $2.8 million from the prior During 2011, Butterﬁeld re-focused its business on providing exclusive year as a result of the cancellation of an investment management private banking and wealth management services to wealthy clients agreement with Bentley Reid at the end of the second quarter, and and their families through the exit of non-core business. As part of lower customer-led foreign exchange volumes. the re-focused private banking strategy, the Bank enhanced its credit offering through the recruitment of a specialist team of experienced Total expenses, at $24.6 million, were $4.3 million higher than 2011 relationship managers to meet the demand of its clients. The Bank’s due to the previously noted $5 million income tax expense offset by lending focus is on providing lending services to wealthy clients continued cost management initiatives and the reduction in the UK at modest loan-to-value ratios secured on Prime Central London headcount year on year. residential property. The United Kingdom recorded a net loss of $24.6 million in 2012, $1.0 billion at 31 December 2011. Loan balances increased $73 million compared to a loss of $3.3 million in 2011. The majority of the loss was from $433.6 million, offset by a reduction in investment and cash a result of one-off impairments of the UK’s goodwill and intangible balances. Customer deposit balances declined by $25.7 million to end assets totalling $16.6 million and a deferred tax valuation allowance the year at $709.3 million. Total assets stood at $0.9 billion at 31 December 2012, down from and tax adjustment of $5 million. Net interest income before credit provisions of $14.2 million was up $0.6 billion at year-end 2011 following the termination of the Bentley $1.5 million. The net interest margin climbed 0.20% to 1.52% in 2012 Reid investment services contract. Custody client assets under from growth of $62 million in average loan balances and the repayment administration at the end of 2012 amounted to $1.7 billion, up of subordinated debt in early 2012, offset by lower yields achieved on $0.4 billion from $1.3 billion at year-end 2011. Assets under management, totalling $0.2 billion, decreased from the investment portfolio. 44 (in $ thousands) Net interest income Provision for credit losses Non-interest income Revenue before gains and losses Total expenses Net income before gains and losses Net gains (losses) Net income As at 31 December (in $ millions) Customer deposits Loans, net of allowance for credit losses Total assets 2012 14,197 (5,547) 8,177 16,827 (24,565) (7,738) (16,895) 2011 12,687 (6,724) 10,928 16,891 (20,253) (3,362) $ change % change 1,510 11.9% 1,177 17.5% (2,751) (25.2%) (64) (0.4%) (4,312) (21.3%) (4,376) (130.2%) 45 (16,940) N/A (24,633) (3,317) (21,316) (642.6%) 709 507 925 735 434 976 (26) (3.5%) 73 16.8% (51) (5.2%) Assets under administration – Custody 1,662 1,276 386 30.3% Assets under management Butterﬁeld Funds Other assets under management Total assets under management Number of employees 77 160 237 89 330 309 639 101 (253) (76.7 %) (149) (48.2%) (402) (62.9%) (12) (11.9%) Butterﬁeld Annual Report 2012 45 Group Asset Management Butterﬁeld Asset Management focuses on fulﬁlling the ﬁnancial expertise. Each client has direct access to his or her portfolio needs of those who demand the highest level of service and manager who is, in turn, supported by a Group investment discipline Group Asset Management revenue was $22.3 million in 2012, compared to $22.9 million in 2011. The decrease of $0.6 million was principally due to the termination of the investment management agreement with Bentley Reid in the United Kingdom, offset slightly designed to leverage resources from across the organisation, including by increased fees earned on the Butterﬁeld Money Market Fund as a a Core Strategy and Research team based in the United Kingdom. result of higher LIBOR rates in 2012. The Group provides a broad range of investment services to Assets under management decreased by $0.9 billion and 19% to end institutional and private clients in Bermuda, the Cayman Islands, at $4.7 billion for 2012 due to the terminated agreement noted above Guernsey, and the United Kingdom. Principal services include and due to a decline in Money Market balances as clients sought discretionary investment management and managed portfolio better-yielding alternatives for short-term investments. Other trends services. Advisory and self-directed brokerage options are available to continued through 2012 where insurance captives moved their assets clients in Bermuda and the Cayman Islands. The Group also provides back onshore, away from the Cayman Islands, and private clients were money market and mutual fund offerings in all four jurisdictions. reluctant to invest in unstable markets. Institutional clients primarily consist of captive insurance companies in Bermuda and the Cayman Islands. Private clients are high net worth individuals and their ﬁduciary vehicles served in all four jurisdictions. Retail and mass afﬂuent clients are served in Bermuda and the Cayman Islands as part of Butterﬁeld’s community banking platform. Total assets under management (“AUM”) at 31 December: Butterﬁeld Funds 2,335 176 246 35 77 2012 Other assets 747 621 343 - 160 Total AUM 3,082 Butterﬁeld Funds 2,653 797 589 35 237 211 141 40 330 2011 Other assets 752 Total AUM 3,405 760 447 1 309 971 588 41 639 2,869 1,871 4,740 3,375 2,269 5,644 (in $ millions) Bermuda Cayman Islands Guernsey The Bahamas UK Total 46 Group Trust Our trust and corporate services specialists deliver ﬁduciary solutions to meet a range of client needs, including estate and succession planning, administration of complex asset holdings, and efﬁcient co-ordination for the affairs of international We provide both personal and institutional trust services from our operations in Bermuda, The Bahamas, the Cayman Islands, Guernsey and Switzerland, with our multi-jurisdictional capability therefore spanning the world’s leading international trust and ﬁduciary centres. families; as well as the pension, employee beneﬁt and other ﬁduciary Trust revenues are derived from a combination of ﬁxed fees, fees requirements of multi-national corporations and institutions. based on the market values of assets held in trust and fees based on time spent in relation to the range of personal trust and company Alongside our traditional strengths in providing services to families administration services, and the pension, employee beneﬁt and other and institutions with links to the United Kingdom, North America, and corporate trust services we provide. Europe, in 2012 we continued to progress in building relationships with clients connected to the Asian and Latin American regions. In 2012, trust revenues totalled $29.1 million, marginally lower than the $29.5 million recorded in 2011 due mainly to substantial one-time Our goal is to deliver consistently reliable service to our clients fees in 2011 which did not recur in 2012, and also to the loss of one underpinned by the technical expertise and competencies of managed trust company mandate during 2011 offset by an increase in our multi-jurisdictional team, which operates through separately recurring income through structured, proactive business development incorporated trust businesses in our jurisdictions of choice. To this activities, with good new business growth in our Switzerland, Guernsey end, training and continual professional development for our staff and Bermuda trust businesses and increasing pipelines in our remained a key priority in 2012. Active participation by our personnel Bahamas and Cayman businesses. Trust revenues represented 23% of in their local branches of leading trust industry associations and total non-interest income in 2012, up from 22% in 2011. bodies such as the Society of Trust and Estate Practitioners also assists our employees in remaining at the forefront of their specialisation. Total Trust assets under administration (“Trust AUA”) at 31 December: (in $ millions) Bermuda Cayman Islands Guernsey Switzerland The Bahamas UK Total 2012 30,062 1,710 9,905 2,142 3,250 2011 29,635 2,188 8,242 386 3,439 - 47,069 - 43,890 Butterﬁeld Annual Report 2012 47 In numbers order depth focus balance detail particular Financial Statements 48 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 judgment of Management. Management has established and maintains a system of ﬁnancial reporting and internal controls to provide reasonable assurance that transactions are properly authorised and recorded, assets are protected against unauthorised use or disposition and liabilities are recognised. These procedures include the careful selection and training of qualiﬁed staff, the establishment of organisational structures providing an appropriate and well-deﬁned division of responsibilities, and the communication of policies and standards of business conduct throughout the Bank. The system of internal controls is further supported by a professional staff of internal auditors who conduct periodic inspections of all aspects of the Bank’s operations. In addition, the Bank’s Head of Group Internal Audit reports to, and has full and free access to the Audit Committee of the Board of Directors. The Audit 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 Operations 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 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. Brendan McDonagh Chairman & Chief Executive Ofﬁcer 26 February 2013 Bradley Rowse Executive Vice President & Chief Financial Ofﬁcer 26 February 2013 Butterﬁeld Annual Report 2012 49 (cid:14)(cid:26)(cid:23)(cid:39)(cid:42)(cid:22)(cid:39)(cid:46) (cid:7)(cid:9)(cid:3) (cid:7)(cid:5)(cid:6)(cid:8) (cid:6)(cid:26)(cid:17)(cid:18)(cid:28)(cid:18)(cid:26)(cid:17)(cid:18)(cid:26)(cid:31) (cid:3)(cid:32)(cid:17)(cid:22)(cid:31)(cid:27)(cid:29)(cid:34)(cid:30) (cid:11)(cid:18)(cid:28)(cid:27)(cid:29)(cid:31) (cid:13)(cid:27) (cid:31)(cid:21)(cid:18) (cid:12)(cid:21)(cid:14)(cid:29)(cid:18)(cid:21)(cid:27)(cid:24)(cid:17)(cid:18)(cid:29)(cid:30) (cid:27)(cid:19) (cid:13)(cid:21)(cid:18) (cid:4)(cid:14)(cid:26)(cid:23) (cid:27)(cid:19) (cid:9)(cid:2)(cid:13)(cid:2) (cid:4)(cid:32)(cid:31)(cid:31)(cid:18)(cid:29)(cid:19)(cid:22)(cid:18)(cid:24)(cid:17) (cid:1) (cid:12)(cid:27)(cid:26) (cid:7)(cid:22)(cid:25)(cid:22)(cid:31)(cid:18)(cid:17) (cid:21)(cid:26) (cid:29)(cid:22)(cid:43)(cid:26) 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(cid:22)(cid:24)(cid:24)(cid:36)(cid:39)(cid:25)(cid:22)(cid:35)(cid:24)(cid:26) (cid:44)(cid:30)(cid:41)(cid:29) (cid:22)(cid:24)(cid:24)(cid:36)(cid:42)(cid:35)(cid:41)(cid:30)(cid:35)(cid:28) (cid:37)(cid:39)(cid:30)(cid:35)(cid:24)(cid:30)(cid:37)(cid:33)(cid:26)(cid:40) (cid:28)(cid:26)(cid:35)(cid:26)(cid:39)(cid:22)(cid:33)(cid:33)(cid:46) (cid:22)(cid:24)(cid:24)(cid:26)(cid:37)(cid:41)(cid:26)(cid:25) (cid:30)(cid:35) (cid:41)(cid:29)(cid:26) (cid:20)(cid:35)(cid:30)(cid:41)(cid:26)(cid:25) (cid:18)(cid:41)(cid:22)(cid:41)(cid:26)(cid:40) (cid:36)(cid:27) (cid:11)(cid:34)(cid:26)(cid:39)(cid:30)(cid:24)(cid:22)(cid:4) (cid:5)(cid:21)(cid:14)(cid:29)(cid:31)(cid:18)(cid:29)(cid:18)(cid:17) (cid:3)(cid:16)(cid:16)(cid:27)(cid:32)(cid:26)(cid:31)(cid:14)(cid:26)(cid:31)(cid:30) Butterﬁeld Annual Report 2012 51 Consolidated Balance Sheet As at 31 December (in thousands of Bermuda dollars) Assets Cash and demand deposits with banks Cash equivalents Total cash and cash equivalents Short-term investments Debt and equity securities Trading Available for sale Held to maturity Total investments in debt and equity securities Loans, net of allowance for credit losses Premises, equipment and computer software Accrued interest Goodwill Intangible assets Investments in afﬁliates Other real estate owned Other assets Assets of discontinued operations Total assets Liabilities Deposits Non-interest bearing Interest bearing Customers Banks Total deposits Securities sold under agreement to repurchase Employee future beneﬁts Accrued interest Preference Share dividends payable Other liabilities Liabilities of discontinued operations Total other liabilities Subordinated capital Total liabilities Shareholders’ equity Common Share capital (BMD 0.01 par; authorised Shares 26,000,000,000) issued and outstanding: 549,677,803 (2011: 549,468,349) Preference Share capital (USD 0.01 par; USD 1,000 liquidation Preference) issued and outstanding: 195,578 (2011: 200,000) Contingent Value Convertible Preference Share capital (USD 0.01 par) issued and outstanding: 7,254,732 (2011: 7,464,186) Additional paid-in capital Accumulated deﬁcit Less: Treasury Common Shares: 7,066,586 Shares (2011: 2,163,958 Shares) Accumulated other comprehensive loss Total Shareholders’ equity Total liabilities and Shareholders’ equity The accompanying notes are an integral part of these Consolidated Financial Statements. p y g Brendan McDonagh Chairman & Chief Executive Ofﬁcer 52 2012 2011 476,071 1,175,476 1,651,547 76,213 61,785 2,580,577 239,342 2,881,704 3,955,960 243,321 18,975 6,949 15,327 18,637 34,360 39,037 - 8,942,030 383,827 1,518,899 1,902,726 20,280 62,591 1,934,259 64,789 2,061,639 4,069,419 272,472 24,094 15,937 30,163 32,582 27,354 60,640 307,044 8,824,350 918,814 904,873 6,456,979 126,466 7,502,259 109,021 103,135 2,795 662 106,984 - 322,597 260,000 8,084,856 5,496 2 73 1,355,689 (482,796) (8,767) (12,523) 857,174 8,942,030 6,226,122 125,566 7,256,561 - 104,913 7,865 715 84,767 272,049 470,309 267,755 7,994,625 5,494 2 75 1,377,556 (490,377) (21,723) (41,302) 829,725 8,824,350 Consolidated Statements of Operations For the year ended 31 December (in thousands of Bermuda dollars, except per Share data) Non-interest income Asset management Banking Foreign exchange revenue Trust Custody and other administration services Other non-interest income Total non-interest income Interest income Loans Investments Deposits with banks Total interest income Interest expense Deposits Subordinated capital Securities sold under repurchase agreement Total interest expense Net interest income before provision for credit losses Provision for credit losses Net interest income after provision for credit losses Net realised / unrealised gains (losses) on trading investments Net realised gains on available-for-sale investments Net realised / unrealised losses on Other real estate owned Gain on sale of afﬁliates Impairment of ﬁxed assets Impairment of intangible assets Impairment of goodwill Net other gains (losses) Total other (losses) gains Total net revenue Non-interest expense Salaries and other employee beneﬁts Technology and communications Property Professional and outside services Non-income taxes Amortisation of intangible assets Marketing Other expenses Total non-interest expense Net income before income taxes from continuing operations Income tax (expense) beneﬁt Net income from continuing operations Discontinued operations Income from discontinued operations Gain on sale of discontinued operations Income tax expense Net income from discontinued operations Net income Cash dividends declared on Contingent Value Convertible Preference Shares Cash dividends declared on Preference Shares Preference Shares guarantee fee Net income attributable to Common Shareholders Earnings per Common Share Basic Earnings per Share Diluted Earnings per Share Basic Earnings per Share from continuing operations Diluted Earnings per Share from continuing operations 2012 22,323 33,713 26,524 29,122 10,646 6,215 128,543 190,691 49,117 4,999 244,807 21,158 12,573 18 33,749 211,058 (14,190) 196,868 268 2,028 (2,053) 4,231 (14,527) (9,143) (9,505) 1,389 (27,312) 298,099 137,433 57,715 26,129 15,409 13,158 5,040 3,963 15,401 274,248 23,851 (5,890) 17,961 693 7,240 (313) 7,620 25,581 - (16,000) (2,000) 7,581 0.01 0.01 - - 2011 22,942 31,648 30,277 29,451 12,324 5,707 132,349 188,041 43,816 9,636 241,493 28,756 10,486 2 39,244 202,249 (13,169) 189,080 (919) 2,058 - 3,178 - - - (79) 4,238 325,667 145,136 53,929 27,080 18,430 14,029 5,367 4,891 17,766 286,628 39,039 306 39,345 1,401 - (274) 1,127 40,472 (3,270) (16,000) (2,000) 19,202 0.03 0.03 - - The accompanying notes are an integral part of these Consolidated Financial Statements. Butterﬁeld Annual Report 2012 53 Consolidated Statements of Comprehensive Income (Loss) For the year ended 31 December (in thousands of Bermuda dollars) Net income Other comprehensive income (loss) Net change in unrealised gains on translation of net investment in foreign operations Net change in unrealised gains on available-for-sale investments Net change in employee future beneﬁts liability Other comprehensive income (loss) Total comprehensive income The accompanying notes are an integral part of these Consolidated Financial Statements. 2012 25,581 834 43,118 (15,173) 28,779 54,360 2011 40,472 823 19,845 (23,356) (2,688) 37,784 54 Consolidated Statements of Changes in Shareholders’ Equity For the year ended 31 December (in thousands of Bermuda dollars) Common Share capital issued and outstanding Balance at beginning of year (2012: 549,468,349 Shares; 2011: 549,143,448 Shares) Conversion of Contingent Value Convertible Preference Shares (2012: 209,454 Shares; 2011: 324,901 Shares) Balance at end of year (2012: 549,677,803 Shares; 2011: 549,468,349 Shares) Preference Shares Balance at beginning of year (2012: 200,000 Shares; 2011: 200,000 Shares) Repurchase and cancellation of Preference Shares (2012: 4,422 Shares; 2011: nil Shares) Balance at end of year (2012: 195,578 Shares; 2011: 200,000 Shares) Contingent Value Convertible Preference Shares Balance at beginning of year (2012: 7,464,186 Shares; 2011: 7,789,087 Shares) Conversion to Common Shares (2012: 209,454 Shares; 2011: 324,901 Shares) Balance at end of year (2012: 7,254,732 Shares; 2011: 7,464,186 Shares) Additional paid-in capital Balance at beginning of year Stock option plan expense Reduction of additional paid-in capital on transfer of Treasury Shares Reduction of additional paid-in capital on repurchase and cancellation of Preference Shares Balance at end of year Accumulated deﬁcit Balance at beginning of year Net income for year Cash dividends declared on Contingent Value Convertible Preference Shares Cash dividends declared on Preference Shares Preference Shares guarantee fee Balance at end of year Treasury Common Shares Balance at beginning of year (2012: 2,163,958 Shares; 2011: 2,401,593 Shares) Share-based compensation Purchases of Treasury Shares (2012: 7,260,051 Shares; 2011: nil Shares) Net transfers of Treasury Shares Balance at end of year (2012: 7,066,586 Shares; 2011: 2,163,958 Shares) Accumulated other comprehensive loss Balance at beginning of year Other comprehensive income Balance at end of year Total Shareholders’ equity Components of accumulated other comprehensive loss Cumulative unrealised losses on translation of investment in foreign operations Cumulative unrealised gains on available-for-sale investments Cumulative change in employee future beneﬁts liability Balance at end of year The accompanying notes are an integral part of these Consolidated Financial Statements. 2012 5,494 2 5,496 2 - 2 75 (2) 73 1,377,556 5,184 (21,662) (5,389) 1,355,689 (490,377) 25,581 - (16,000) (2,000) (482,796) (21,723) 293 (8,999) 21,662 (8,767) (41,302) 28,779 (12,523) 857,174 (10,487) 44,781 (46,817) (12,523) 2011 5,491 3 5,494 2 - 2 78 (3) 75 1,376,037 3,567 (2,048) - 1,377,556 (509,579) 40,472 (3,270) (16,000) (2,000) (490,377) (24,127) 356 - 2,048 (21,723) (38,614) (2,688) (41,302) 829,725 (11,321) 1,663 (31,644) (41,302) Butterfield Annual Report 2012 55 Consolidated Statements of Cash Flows For the year ended 31 December (in thousands of Bermuda dollars) Cash ﬂows from operating activities Net income Less: Net income from discontinued operations Net income from continuing operations Adjustments to reconcile net income from continuing operations to operating cash ﬂows: Depreciation and amortisation Impairment of goodwill Impairment of intangible assets Impairment of ﬁxed assets Decrease in carrying value of investments in afﬁliates Share-based payments Net gain on sale of afﬁliate Net realised / unrealised losses on Other real estate owned Net gain on repayment of sub-debt Net realised gains of available-for-sale investments Provision for credit losses Net change in net assets from discontinued operations Changes in operating assets and liabilities: Decrease (increase) in accrued interest receivable Decrease in other assets Decrease in accrued interest payable Decrease in other liabilities and employee future beneﬁts Net change in trading investments Cash provided by operating activities from continuing operations Cash ﬂows from investing activities Net increase in short-term investments Net proceeds on sale of afﬁliate Net proceeds on sale of subsidiary Net proceeds on sale of intangible assets Additions to premises, equipment and computer software Proceeds from Other real estate owned Net decrease (increase) in loans Held-to-maturity investments: proceeds from pay downs Held-to-maturity investments: purchases Available-for-sale investments: proceeds from sale Available-for-sale investments: proceeds from maturities and pay downs Available-for-sale investments: purchases Cash (used) provided by investing activities from continuing operations Cash ﬂows from ﬁnancing activities Net increase (decrease) in demand and term deposit liabilities Net increase in securities sold under agreement to repurchase Repayment of subordinated capital Preference Shares repurchased Common Shares repurchased Cash dividends paid on Contingent Value Convertible Preference Shares Cash dividends paid on Preference Shares Preference Shares guarantee fee paid Cash provided by (used in) ﬁnancing activities from continuing operations Net effect of exchange rates on cash and cash equivalents Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental disclosure of cash ﬂow information Cash interest paid Cash income tax paid Non-cash item Transfer to Other real estate owned The accompanying notes are an integral part of these Consolidated Financial Statements. 56 2012 25,581 (7,620) 17,961 46,958 9,505 9,143 14,527 (288) 5,477 (4,231) 2,053 - (2,028) 14,190 - 5,393 22,813 (5,129) (4,498) 131,846 1,069 132,915 (55,498) 18,464 41,862 1,428 (17,761) 4,726 137,077 16,127 (191,305) 414,347 1,514,538 (2,511,423) (627,418) 149,243 109,021 (7,946) (5,452) (8,999) - (15,989) (2,000) 217,878 25,446 (251,179) 1,902,726 1,651,547 28,620 1,230 13,755 2011 40,472 (1,127) 39,345 37,930 - - - 952 3,923 (3,178) - (1,125) (2,058) 13,170 (130) (7,883) 12,427 (948) (8,576) 83,849 (44,422) 39,427 (774) 3,178 - - (33,612) - (261,370) - (64,789) 971,540 1,407,514 (1,783,666) 238,021 (730,562) - (13,875) - - (3,270) (16,000) (2,000) (765,707) 6,536 (481,723) 2,384,449 1,902,726 47,051 871 27,354 Notes to the Consolidated Financial Statements (in thousands of Bermuda dollars) NOTE 1: NATURE OF BUSINESS The Bank of N.T. Butterﬁeld & Son Limited (“Butterﬁeld”, “Bank” or the “Company”) is incorporated under the laws of Bermuda and has a banking license under the Bank and Deposit Companies Act, 1999 (“the Act”). Butterﬁeld is regulated by the Bermuda Monetary Authority (“BMA”), which operates in accordance with Basel principles. Butterﬁeld is a full-service community bank and a provider of specialised wealth management services. Services offered include retail, private and corporate banking, treasury, custody, asset management and personal and institutional trust services. The Bank provides such services from six jurisdictions: Bermuda, Cayman, Guernsey, Switzerland, The Bahamas and the United Kingdom. The Bank holds all applicable licenses required in the jurisdictions in which it operates. NOTE 2: SIGNIFICANT ACCOUNTING POLICIES a. Basis of Presentation and Use of Estimates and Assumptions The accounting and ﬁnancial reporting policies of the Bank and its subsidiaries conform to generally accepted accounting principles in the United States of America (“GAAP”). The preparation of Consolidated 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 Consolidated Financial Statements and the reported amounts of revenues and expenses during the year, and actual results could differ from those estimates. Critical accounting estimates are those that require Management to make subjective or complex judgments about the effect of matters that are inherently uncertain and may change in subsequent periods. Changes that may be required in the underlying assumptions or estimates in these areas could have a material impact on the future ﬁnancial condition and results of operations. Management believes that the most critical accounting policies upon which the ﬁnancial condition depends, and which involve the most complex or subjective decisions or assessments, are as follows: i. ii. iii. iv. v. vi. vii. Allowance for credit losses Fair value and impairment of ﬁnancial instruments Impairment of long-lived assets Impairment of goodwill Income taxes Employee future beneﬁts Share-based payments b. Basis of Consolidation The Consolidated Financial Statements include the accounts of the Company and its majority-owned subsidiaries (collectively the “Bank”), and those variable interest entities (“VIEs”) where the Company is the primary beneﬁciary. Intercompany accounts and transactions have been eliminated. The Bank consolidates subsidiaries where it holds, directly or indirectly, more than 50% of the voting rights or where it exercises control. The Bank consolidates VIEs where it is considered to be the primary beneﬁciary. The Bank is deemed to have a controlling ﬁnancial interest and is the primary beneﬁciary of a VIE if it has both the power to direct the activities of the VIE that most signiﬁcantly impacts the VIE economic performance and an obligation to absorb losses or the right to receive beneﬁts that could potentially be signiﬁcant to the VIE. The determination of whether the Bank meets the criteria to be considered the primary beneﬁciary of a VIE requires a periodic evaluation of all transactions (such as investments, loans and fee arrangements) with the entity. 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 VIEs, are accounted for under the equity method, and the pro rata share of their income (loss) is included in other non-interest income. c. Foreign Currency Translation Assets, liabilities, revenues and expenses denominated in US dollars are translated to Bermuda dollars at par. Assets and liabilities of the parent company 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 Operations. 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 year. 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 (loss) (“AOCI”). Gains and losses on foreign currency-based subsidiaries are recorded in the Consolidated Statement of Operations 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 because the Bank is not the beneﬁciary of these assets. e. Cash and Cash Equivalents Cash and cash equivalents include cash on hand, cash items in the process of collection, amounts due from correspondent banks and highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insigniﬁcant risk of change in fair value. Such investments Butterﬁeld Annual Report 2012 57 are those with less than three months’ maturity from the date of acquisition and include unrestricted term deposits, certiﬁcates of deposit and Treasury bills. f. Short-Term Investments Short-term investments comprise restricted term and demand deposits and unrestricted term deposits and Treasury bills with less than one year but greater than three months’ maturity from the date of acquisition. g. Investments Investments in debt and equity securities are classiﬁed as trading, available for sale (“AFS”) or held to maturity (“HTM”). Investments are classiﬁed primarily as AFS when used to manage the Bank’s exposure to interest rate and liquidity movements, as well as to make strategic longer-term investments. AFS investments are carried at fair value in the Consolidated Balance Sheet with unrealised gains and losses reported as net increase or decrease to AOCI. Debt and equity securities classiﬁed as trading investments are carried at fair value in the Consolidated Balance Sheet, with unrealised gains and losses included in the Consolidated Statement of Operations as net realised/unrealised gains (losses) on trading investments. Investments that the Bank has the positive intent and ability to hold to maturity are classiﬁed as HTM and are carried at amortised cost in the Consolidated Balance Sheet. Unrecognised gains and losses on HTM securities are disclosed in the notes to the Consolidated Financial Statements. The speciﬁc identiﬁcation method is used to determine realised gains and losses on AFS and HTM investments, which are included in net realised gains and losses on AFS and HTM investments respectively in the Consolidated Statement of Operations. Dividend and interest income, including amortisation of premiums and discounts, on securities for which cash ﬂows are not considered uncertain are included in interest income in the Consolidated Statement of Operations. For securities with uncertain cash ﬂows, the investments are accounted for under the cost recovery method, whereby all principal and coupon payments received are applied as a reduction of the amortised cost and carrying amount. 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. Contained within other assets are investments in a closed ended fund and private equity companies for which the Bank does not have sufﬁcient rights or ownership interests to follow the equity method of accounting. With respect to the closed ended fund, the Bank uses the net assets value as a practical expedient for fair value. Unquoted equity investments which are held directly by the Bank and which do not have readily determinable fair values are recorded at cost and reviewed for impairment if indicators of impairment exist. Investments in afﬁliates includes investments whereby the Bank has the ability to inﬂuence, but not control, the ﬁnancial or operating policies of such entities, are accounted for using the equity method of accounting. Recognition of other-than-temporary impairments For debt securities, Management considers a decline in fair value to be other-than-temporary when it does not expect to recover the entire amortised cost basis of the security. Investments in debt securities in unrealised loss positions are analysed as part of Management’s ongoing assessment of other-than-temporary impairment (“OTTI”). When Management intends to sell such securities or it is more likely than not that the Bank will be required to sell the securities before recovering the amortised cost, it recognises an impairment loss equal to the full difference between the amortised cost basis and the fair value of those securities. When Management does not intend to sell or it is not more likely than not that the Bank will be required to sell such securities before recovering the amortised cost, Management determines whether any credit losses exist to identify any OTTI. Under certain circumstances, Management will perform a qualitative determination and consider a variety of factors, including the length of time and extent to which the fair value has been less than cost; adverse conditions speciﬁcally related to the industry, geographic area or ﬁnancial condition of the issuer or underlying collateral of a security; payment structure of the security; changes to the rating of the security by a rating agency; the volatility of the fair value changes; and changes in fair value of the security after the Balance Sheet date. Alternatively, Management estimates cash ﬂows over the remaining lives of the underlying security to assess whether credit losses exist. In situations where there is a credit loss, only the amount of impairment relating to credit losses on AFS and HTM investments is recognised in net income and for AFS investments, the decrease in fair value relating to factors other than credit losses are recognised in AOCI. Cash ﬂow estimates take into account expectations of relevant market and economic data as of the end of the reporting period, including, for example, underlying loan-level data, and structural features of securitisation, such as subordination, excess spread, over collateralisation or other forms of credit enhancement. The degree of judgment involved in determining the recoverable value of an investment security is dependent upon the availability of observable market prices or observable market parameters. When observable market prices and parameters do not exist, judgment is necessary to estimate recoverable value which gives rise to added uncertainty in the assessment. The assessment takes into consideration factors such as interest rate changes, movements in credit spreads, default rate assumptions, prepayment assumptions, type and quality of collateral, and market sentiment. With respect to the Pass-through note investment (“PTN”), Management compares cash ﬂow projections to fair value and amortised cost to determine if any credit losses exist. Management’s cash ﬂow forecasts for the PTN were created in conjunction with a specialist in analytical cash ﬂow modelling. Management also performs other analyses to support its cash ﬂow projections to assess the reasonability. Management’s fair valuations may include inputs and assumptions that are less observable or require greater estimation, thereby resulting in values which may be greater or lower than the actual value at which the investments may be ultimately sold or the ultimate cash ﬂows that may be recovered. 58 If the assumptions on which Management based its fair valuations change, the Bank may experience additional OTTI or realised losses or gains, and the period-to-period changes in value could vary signiﬁcantly. h. Loans Loans are reported as 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 effective 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. Impaired loans A loan is considered to be impaired when, based on current information and events, the Bank determines that it will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Impaired loans include all non-accruing loans and all loans modiﬁed in a troubled debt restructuring (‘‘TDR’’) even if full collectability is expected following the restructuring. When a loan is identiﬁed as impaired, the impairment is measured based on the present value of expected future cash ﬂows, discounted at the loan’s effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases the current fair value of the collateral, less selling costs, is used instead of discounted cash ﬂows. If the Bank determines that the expected realisable value of the impaired loan is less than the recorded investment in the loan (net of previous charge- offs, deferred loan fees or costs and unamortised premium or discount), impairment is recognised through an allowance estimate. If the Bank determines that part of the allowance is uncollectible, that amount is charged off. Non-accrual Commercial, commercial real estate and consumer loans (excluding credit card consumer loans) are placed on non-accrual status generally if: in the opinion of Management, full payment of principal or interest is in doubt; or (cid:115)(cid:0) (cid:115)(cid:0) principal or interest is 90 days past due. Residential mortgages are placed on non-accrual status immediately if: in the opinion of Management, full payment of principal or interest is in doubt; or (cid:115)(cid:0) (cid:115)(cid:0) when principal or interest is 90 days past due, unless the loan is well secured and any ongoing collection efforts are reasonably expected to result in repayment of all amounts due under the contractual terms of the loan. Interest income on non-accrual loans is recognised only to the extent it is received in cash. Cash received on non-accrual loans where there is no doubt regarding full repayment (no impairment recognised in the form of a speciﬁc allowance) is ﬁrst applied as repayment of the past due principal amount of the loan and secondly to past due interest and fees. Where there is doubt regarding the ultimate full repayment of the non-accrual loan (impairment recognised in the form of a speciﬁc allowance), all cash received is applied to reduce the principal amount of the loan. Interest income on these loans is recognised only after the entire balance receivable is recovered and interest is actually received. Loans are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured. Loans Modiﬁed in a Troubled Debt Restructuring A modiﬁcation of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing ﬁnancial difﬁculty and the modiﬁcation constitutes a concession. If a restructuring is considered a TDR, the Bank is required to make certain disclosures in the notes of the Consolidated Financial Statements and individually evaluate the restructured loan for impairment. The Bank employs various types of concessions when modifying a loan that it would not otherwise consider which may include extension of repayment periods, interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimise economic loss and to avoid foreclosure or repossession of collateral. Commercial and industrial loans modiﬁed in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested. Commercial mortgage and construction loans modiﬁed in a TDR often involve extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modiﬁed in a TDR may also involve extending the interest-only payment period. Residential mortgage modiﬁcations generally involve a short-term forbearance period after which the missed payments are added to the end of the loan term, thereby extending the maturity date. Interest continues to accrue on the missed payments and as a result, the effective yield on the mortgage remains unchanged. As the forbearance period usually involves an insigniﬁcant payment delay they typically do not meet the reporting criteria for a TDR. Automobile loans modiﬁed in a TDR are primarily comprised of loans where the Bank has lowered monthly payments by extending the term. Butterﬁeld Annual Report 2012 59 Loans modiﬁed in a TDR are typically already on non-accrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. Loans that have been modiﬁed in a TDR are restored to accrual status only when interest and principal payments are brought current for a continuous period of six months under the modiﬁed terms. However, performance prior to the modiﬁcation, or signiﬁcant events that coincide with the modiﬁcation, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modiﬁcation or after a shorter performance period. If the borrower’s ability to meet the revised payment schedule is uncertain, the loan remains on non- accrual status. A loan that is modiﬁed in a TDR prior to becoming impaired will be left on accrual status if full collectability in accordance with the restructured terms is expected. The Bank works with its customers in these difﬁcult economic times and may enter into a TDR for loans that are in default, or at risk of defaulting, even if the loan is not impaired. Delinquencies The entire balance of an account is contractually delinquent if the minimum payment of principal or interest is not received by the speciﬁed due date. Delinquency is reported on loans that are 30 days or more past due. Charge-offs The Bank recognises charge-offs when it determines that loans are uncollectible and this generally occurs when all commercially reasonable means of recovering the loan balance have been exhausted. Commercial and consumer loans are either fully or partially charged off down to the fair value of collateral securing the loans when: (cid:115)(cid:0) Management judges the loan to be uncollectible; (cid:115)(cid:0) (cid:115)(cid:0) (cid:115)(cid:0) repayment is expected to be protracted beyond reasonable time frames; the asset has been classiﬁed as a loss by either the Bank’s internal loan review process or external examiners; or the customer has ﬁled bankruptcy and the loss becomes evident owing to a lack of assets or cash ﬂow. The outstanding balance of commercial and consumer real estate secured loans and residential mortgages that are in excess of the estimated property value, less costs to sell, is charged off once there is reasonable assurance that such excess outstanding balance is not recoverable. Credit card consumer loans that are contractually 180 days past due and other consumer loans with an outstanding balance under $100,000 that are contractually 180 days past due are written off and reported as charge-offs. i. Allowance for Credit Losses The Bank maintains an allowance for credit losses, which in Management’s opinion is adequate to absorb all estimated credit-related losses in its lending and off-Balance Sheet credit-related arrangements at the Balance Sheet date. The allowance for credit losses consists of speciﬁc allowances and a general allowance as follows: Speciﬁc Allowances Speciﬁc allowances are determined on an exposure-by-exposure basis and reﬂect the associated estimated credit loss. The speciﬁc allowance for credit loss is computed as the difference between the recorded investment in the loan and the 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 an allowance with a corresponding charge to provision for credit losses. General Allowance The allowance for credit losses attributed to the remaining portfolio is established through various analyses that estimate the incurred loss at the Balance Sheet date inherent in the lending and off-Balance Sheet credit-related arrangements portfolios. 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 instalment, 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 and incurred in the portfolio, based upon various analyses. Management considers overall portfolio indicators including historical credit losses; delinquent (deﬁned as loans that are more than 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. 60 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 more frequently if events or circumstances 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 re-evaluated annually and an impairment test is carried out if certain indicators of impairment exist. k. Premises, Equipment and Computer Software Land, buildings, 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 three 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, including interest cost incurred during the development phase, 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 ﬁve and 10 years. Management reviews the recoverability of the carrying amount of premises, equipment and computer software when indicators of impairment exist and an impairment charge is recorded when the carrying amount of the reviewed asset is deemed not recoverable by future expected cash ﬂows to be derived from the use and disposition of the asset. l. Other Real Estate Owned Other real estate owned (“OREO”) is comprised of real estate property held for sale and commercial and residential real estate properties acquired in partial or total satisfaction of loans acquired through foreclosure proceedings, acceptance of a deed-in-lieu of foreclosure or by taking possession of assets that were used as loan collateral. These properties are recorded at fair value less estimated costs to sell the property. If the recorded investment in the loan exceeds the property’s fair value at the time of acquisition, a charge-off is recorded against the speciﬁc allowance. If the carrying value of the real estate exceeds the property’s fair value at the time of reclassiﬁcation, an impairment charge is recorded in the Consolidated Statement of Operations. Subsequent decreases in the property’s fair value and operating expenses of the property are recognised through charges to non-interest expense. m. Derivatives All derivatives are recognised on the Consolidated Balance Sheet at their fair value. On the date that the Bank enters into a derivative contract, it designates the derivative as: 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). The changes in the fair value of a derivative 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 year earnings. When the hedge is highly effective, the changes in the fair value of a derivative 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 year earnings. The changes in the fair value of a derivative that is designated and qualiﬁes as a foreign currency hedge is recorded in either current year earnings or other comprehensive income, depending on whether the hedging relationship satisﬁes the criteria for a fair value or cash ﬂow hedge when the hedge is highly effective. 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 year 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 recognised in net income. Butterﬁeld Annual Report 2012 61 n. Securities Sold Under Agreements to Repurchase Securities sold under agreements to repurchase (securities ﬁnancing agreements) are treated as collateralised ﬁnancing transactions. The obligation to repurchase is recorded at the value of the cash received on sale adjusted for the amortisation of the difference between the sale price and the agreed repurchase price. The amortisation of this amount is recorded as an interest expense. o. Collateral We pledge assets as collateral as required for various transactions involving security repurchase agreements, deposit products and derivative ﬁnancial instruments. Assets that have been pledged as collateral, including those that can be sold or repledged by the secured party, continue to be reported on the Bank’s Consolidated Balance Sheet. p. Employee Future Beneﬁts The Bank maintains trusteed pension plans for substantially all employees as either non-contributory deﬁned beneﬁt plans or 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 certain qualifying active and retired Bermuda-based employees. 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 plans, the expected investment return on the fair value of plan assets and (d) amortisation of certain items over the expected average remaining service life of employees in the case of the active deﬁned beneﬁt pension plans, estimated average remaining life expectancy of the inactive participants in the case of the inactive 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 experienced 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 revised accounting standards. For each of the deﬁned beneﬁt pension plans and for the post-retirement medical beneﬁts plan, the asset (liability) recognised for accounting purposes is reported in other assets and employee future beneﬁts respectively. The actuarial gains and losses, transition obligation and past service costs of the deﬁned pension plans and post-retirement medical beneﬁts plan are recognised in OCI net of tax and amortised to net income over the average service period for the active deﬁned beneﬁt pension plans and post-retirement medical beneﬁts plan and average remaining life expectancy for the inactive deﬁned beneﬁt pension plans. For the deﬁned contribution pension plans the Bank and participating employees provide an annual contribution based on each participating employee’s pensionable earnings. Amounts paid are expensed in the period. q. Share-Based Compensation The Bank engages in equity settled Share-based payment transactions in respect of services received from eligible employees. The fair value of the services received is measured by reference to the fair value of the Shares or Share options granted on the date of the grant. The cost of the employee services received in respect of the Shares or Share options granted is recognised in the Consolidated Statement of Operations over the shorter of the vesting or service period. The fair value of the options granted is determined using option pricing models, which take into account the exercise price of the option, the current Share price, the risk-free interest rate, expected dividend rate, the expected volatility of the Share price over the life of the option and other relevant factors. Time vesting conditions are taken into account by adjusting the number of Shares or Share options included in the measurement of the cost of employee services so that ultimately, the amount recognised in the Consolidated Statement of Operations reﬂects the number of vested Shares or Share options. The Bank recognises compensation cost for awards with performance conditions if and when the Bank concludes that it is probable that the performance condition will be achieved, net of an estimate of pre-vesting forfeitures (e.g., due to termination of employment prior to vesting). r. Revenue Recognition Trust and investment services fees include fees for private and institutional trust, executorship, and custody services. Asset management fees include fees for investment management, investment advice and brokerage services. Fees are recognised as revenue over the period of the relationship or 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 contingencies associated with the fee. 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. 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. 62 Dividend and interest income, including amortisation of premiums and discounts, on securities for which cash ﬂows are not considered uncertain are included in interest income in the Consolidated Statement of Operations. Loans placed on non-accrual status and investments with uncertain cash ﬂows are accounted for under the cost recovery method, whereby all principal, dividends, interest and coupon payments received are applied as a reduction of the amortised cost and carrying amount. s. Fair Values Fair value is deﬁned as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Bank determines the fair values of assets and liabilities based on the fair value hierarchy which requires an entity to maximise the use of observable inputs and minimise the use of unobservable inputs when measuring fair value. The relevant accounting standard describes three levels of inputs that may be used to measure fair value. Investments classiﬁed as trading and available for sale, and derivative assets and liabilities are recognised in the Consolidated Balance Sheet at fair value. Level 1, 2 and 3 valuation inputs Management classiﬁes items that are recognised at fair value on a recurring basis based on the level of inputs used in their respective fair value determination as described below. Fair value inputs are considered Level 1 when based on unadjusted quoted prices in active markets for identical assets. Fair value inputs are considered Level 2 when based on internally developed models or based on prices published by independent pricing services using proprietary models. To qualify for Level 2, all signiﬁcant inputs used in these models must be observable in the market place or can be corroborated by observable market data for substantially the full term of the instrument and includes, among others: interest yield curves, credit spreads, prices for similar assets and foreign exchange rates. Level 2 also includes ﬁnancial instruments that are valued using quoted price for identical assets but for which the market is not considered active due to low trading volumes. Fair value inputs are considered Level 3 when based on internally developed models using signiﬁcant unobservable assumptions involving Management’s estimations or non-binding bid quotes from brokers. The following methods and assumptions were used in the determination of the fair value of ﬁnancial instruments: Cash and cash equivalents The carrying amount of cash and demand deposits with banks, being short-term in nature, is deemed to equate to the fair value. Cash equivalents include unrestricted term deposits, certiﬁcates of deposits and Treasury bills with a maturity of less than three months from the date of acquisition and the carrying value at cost is considered to approximate fair value because they are short-term in nature, bear interest rates that approximate market rates, and generally have negligible credit risk. Short-term investments Short-term investments comprise restricted term and demand deposits and unrestricted term deposits and Treasury bills with less than one year but greater than three months’ maturity from the date of acquisition. The carrying value at cost is considered to approximate fair value because they are short-term in nature, bear interest rates that approximate market rates, and generally have negligible credit risk. Trading investments including deﬁned beneﬁt pension plan equity securities and mutual funds Trading investments include mutual funds and debt securities issued by non-US governments. The fair value of listed equity securities is based upon quoted market values. Investments in actively traded mutual funds are based on their published net asset values. See “Available-for-sale and held-to- maturity investments including deﬁned beneﬁt pension plan ﬁxed income securities” below for valuation techniques and inputs of ﬁxed income securities. Available-for-sale and held-to-maturity investments including deﬁned beneﬁt pension plan ﬁxed income securities The fair values for available-for-sale investments are generally sourced from third parties. The fair value of ﬁxed income securities is based upon quoted market values where available, “evaluated bid” prices provided by third-party pricing services (“pricing services”) where quoted market values are not available, or by reference to broker or underwriter bid indications where pricing services do not provide coverage for a particular security. To the extent the Bank believes current trading conditions represent distressed transactions, the Bank may elect to utilise internally generated models. The pricing services use market approaches for valuations using primarily Level 2 inputs (in the vast majority of valuations), or some form of discounted cash ﬂow analysis, to obtain investment values for a small percentage of ﬁxed income securities. Pricing services indicate that they will only produce an estimate of fair value if there is objectively veriﬁable information available to produce a valuation. Standard inputs to the valuations provided by the pricing services listed in approximate order of priority for use when available include: reported trades, benchmark yields, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data. The pricing services may prioritise inputs differently on any given day for any security, and not all inputs listed are available for use in the evaluation process on any given day for each security evaluation; however, the pricing services also monitor market indicators and industry and economic events. Information of this nature is a trigger to acquire further corroborating market data. When these inputs are not available, they identify “buckets” of similar securities (allocated by asset class types, sectors, sub-sectors, contractual cash ﬂows/structure, and credit rating characteristics) and apply some form of matrix or other modelled pricing to determine an appropriate security value which represents their best estimate as to what a buyer in the marketplace would pay for a security in a current sale. While the Bank receives values Butterﬁeld Annual Report 2012 63 for the majority of the investment securities it holds from pricing services, it is ultimately Management’s responsibility to determine whether the values received and recorded in the ﬁnancial statements are representative of appropriate fair value measurements. It is common industry practice to utilise pricing services as a source for determining the fair values of investments where the pricing services are able to obtain sufﬁcient market corroborating information to allow them to produce a valuation at a reporting date. In addition, in the majority of cases, although a value may be obtained from a particular pricing service for a security or class of similar securities, these values are corroborated against values provided by other pricing services. Broker/dealer quotations are used to value ﬁxed maturities where prices are unavailable from pricing services due to factors speciﬁc to the security such as limited liquidity, lack of current transactions, or trades only taking place in privately negotiated transactions. These are considered Level 3 valuations, as signiﬁcant inputs utilised by brokers may be difﬁcult to corroborate with observable market data, or sufﬁcient information regarding the speciﬁc inputs utilised by the broker was not available to support a Level 2 classiﬁcation. For disclosure purposes, investments held to maturity are fair valued using the same methods described above. Loans The majority of loans are variable rate and re-price in response to changes in market rates and hence Management estimates that the fair value of loans is not signiﬁcantly different than their carrying amount. For signiﬁcant ﬁxed-rate loan exposures fair value is estimated by discounting the future cash ﬂows, using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, of such loans. Accrued interest The carrying amounts of accrued interest receivable and payable are assumed to approximate their fair values given their short-term nature. Other real estate owned OREO assets are carried at the lower of cost or fair value less estimated costs to sell. Fair value is based on third-party appraisals adjusted to reﬂect Management’s judgment as to the realisable value of the properties. Appraisals of OREO properties are updated on an annual basis. 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 carrying amount of deposits with no stated maturity date is deemed to equate to the fair value. Subordinated capital The fair value of the subordinated capital has been estimated by discounting the contractual cash ﬂows, using current market interest rates. Derivatives Derivative contracts can be exchange traded or Over-the-counter (“OTC”) derivative contracts and may include forward, swap and option contracts relating to interest rates or foreign currencies. Exchange-traded derivatives typically fall within Level 1 of the fair value hierarchy depending on whether they are deemed to be actively traded or not. OTC derivatives are valued using market transactions and other market evidence whenever possible, including market-based inputs to models, model calibration to market clearing transactions, broker or dealer quotations or alternative pricing sources where an understanding of the inputs utilised in arriving at the valuations is obtained. Where models are used, the selection of a particular model to value an OTC derivative depends upon the contractual terms and speciﬁc risks inherent in the instrument as well as the availability of pricing information in the market. The Bank generally uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, interest rate swaps and options, model inputs can generally be veriﬁed and model selection does not involve signiﬁcant Management judgment. Reporting units The fair value of reporting units for which goodwill is recognised is determined by discounting estimated future cash ﬂows using discount rates reﬂecting valuation-date market conditions and risks speciﬁc to the reporting unit. t. 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: (cid:115)(cid:0) 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. (cid:115)(cid:0) 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. (cid:115)(cid:0) Documentary and commercial letters of credit, primarily related to the import of goods by customers, which represent agreements to honour drafts presented by third parties upon completion of speciﬁc activities. 64 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 13 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 are fully collateralised, the contractual amounts do not necessarily represent future cash requirements. The Bank does not carry any liability for these obligations. u. Income Taxes The Bank uses the asset and liability method of accounting for income taxes. Under this method, deferred income taxes reﬂect the net tax effect of temporary differences between the Consolidated 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. The effect of a change in tax rates on deferred tax assets and liabilities is recognised in income in the period that includes the enactment date. The Bank records net deferred tax assets to the extent the Bank believe these assets will more likely than not be realised. 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. In making such a determination, the Bank considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax- planning strategies, and results of recent operations. In the event the Bank were to determine that the Bank would be able to realise the deferred income tax assets in the future in excess of their net recorded amount, the Bank would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes. The Bank records uncertain tax positions on the basis of a two-step process whereby (1) the Bank determines whether it is more likely than not that the tax positions will be sustained based on the technical merits of the position and (2) where those tax positions that meet the more-likely-than-not recognition threshold, the Bank recognises the largest amount of tax beneﬁt that is greater than 50 percent likely to be realised upon ultimate settlement with the related tax authority. Income taxes on the Consolidated Statement of Operations include the current and deferred portions of the income taxes. The Bank recognises interest accrued and penalties related to unrecognised tax beneﬁts in operating expenses. Income taxes applicable to items charged or credited directly to Shareholders’ equity are included in such items. v. Consolidated Statement of Cash Flows For the purposes of the Consolidated Statement of Cash Flows, cash and cash equivalents include cash on hand, cash items in the process of collection, amounts due from correspondent banks and highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insigniﬁcant risk of change in fair value. w. Earnings Per Share Earnings per Share have been calculated using the weighted average number of Common Shares outstanding during the year (see also Note 20). Dividends declared on Preference Shares and related guarantee fees are deducted from net income to obtain net income available to Common Shareholders. In periods when basic earnings per Share is positive, the dilutive effect of Share-based compensation plans is calculated using the Treasury stock method, whereby the proceeds received from the exercise of Share-based awards are assumed to be used to repurchase outstanding Common Shares, using the quarterly average market price of the Bank’s Shares for the period. x. Impairment or Disposal of Long-Lived Assets Impairment losses are recognised when the carrying amount of a long-lived asset 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. y. Charitable Trust In July 2000, the Bank established a charitable trust with the irrevocable purpose to make charitable donations to persons ordinarily resident in Bermuda (the “Charitable Trust”). The Charitable Trust came to an end in December 2012 when its remaining assets were transferred to various charities in Bermuda. As a not-for-proﬁt organisation, the Charitable Trust is not consolidated in the Bank’s Consolidated Financial Statements. As the Charitable Trust’s trustees are representatives of the Bank, the Bank’s endowment donations to the Charitable Trust are recognised at their recoverable amount in Other assets in the Consolidated Balance Sheet until dispersed by the Charitable Trust, at which time, donations are recognised in Other expenses in the Consolidated Statement of Operations. z. New Accounting Pronouncements In May 2011, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update to amend existing requirements for fair value measurements and disclosures. The guidance expands the disclosure requirements around fair value measurements categorised in Level 3 of the fair value hierarchy, requiring quantitative and qualitative information to be disclosed related to: (1) the valuation processes used, (2) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, and (3) use of a nonﬁnancial Butterﬁeld Annual Report 2012 65 asset in a way that differs from the asset’s highest and best use. The guidance requires disclosure of the level in the fair value hierarchy of items that are not measured at fair value, but whose fair value must be disclosed. It also clariﬁes and expands upon existing requirements for fair value measurements of ﬁnancial assets and liabilities, as well as instruments classiﬁed in Shareholders’ equity. The Bank has applied this guidance from 1 January 2012; however, it impacted disclosure only and did not have an impact on the Bank’s ﬁnancial condition or results of operations. In June 2011, the FASB issued an accounting standards update concerning the presentation of comprehensive income in ﬁnancial statements. This guidance allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Under both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This guidance eliminates the option to present the components of other comprehensive income only as part of the statement of changes in Shareholders’ equity. The guidance does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassiﬁed to net income. The Bank applied the guidance from 1 January 2012; however, it did not have an impact on the Bank’s disclosure, ﬁnancial condition or results of operations. In September 2011, the FASB issued an accounting standards update to simplify how entities test goodwill for impairment, by allowing an entity the option to ﬁrst assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting entity is less than its carrying amount, as a basis for determining whether it is necessary to perform the two-step goodwill impairment test required in FASB Accounting Standards Codiﬁcation Topic 350. After assessing the circumstances that should be considered in making the qualitative assessment, if an entity determines that the fair value of a reporting unit as compared to its carrying value meets the threshold, then performing the two-step impairment step is unnecessary. In other circumstances, performance of the two-step test is required. The guidance also eliminates the option for an entity to carry forward its detailed calculation of a reporting unit’s fair value in certain situations. The amendments do not change the current guidance for testing other indeﬁnite-lived intangible assets for impairment. The Bank adopted this guidance beginning on 1 January 2012. It did not have an impact on the Bank’s consolidated ﬁnancial condition or results of operations. During December 2011, the FASB issued an accounting standard update, “Disclosures about Offsetting Assets and Liabilities”. The amendments in this update require an entity to disclose information about offsetting and related arrangements to provide users of the Consolidated Financial Statements with information to understand the extent of offsetting in the statement of ﬁnancial position. The amendment will allow companies to continue offsetting certain ﬁnancial instruments on their Balance Sheets, including certain derivatives and repurchase agreements subject to a master netting arrangement. Additionally certain industry-speciﬁc offsetting guidance for broker-dealers, construction companies and depository and lending institutions remains unchanged. The disclosure requirements will be effective for periods beginning on or after 1 January 2013, and must be shown for all periods presented on the Balance Sheet (i.e., applied retrospectively). The impact of this additional accounting update is expected to be primarily on disclosures. 66 NOTE 3: DISCONTINUED OPERATIONS On 7 May 2012, the Bank announced its agreement to sell Butterﬁeld Bank (Barbados) Limited, a wholly-owned subsidiary which is all of the Barbados segment, to First Citizens Bank Limited. The sale was completed on 27 August 2012 with gross proceeds, subject to normal adjustments, of $45 million, resulting in a net gain of $7.2 million included in net income from discontinued operations in the Consolidated Statements of Operations and Comprehensive Income. The Bank has determined that the requirements have been met to report the results of the subsidiary sold as discontinued operations effective from the second quarter in 2012. The Assets and Liabilities have been presented as discontinued operations on the face of the Consolidated Balance Sheet for all periods presented. The following summarises the assets and liabilities of Barbados at 31 December 2012 and 2011, which are reported as Assets of discontinued operations and Liabilities of discontinued operations in the Consolidated Balance Sheet. Assets Cash and cash equivalents Short-term investments Investments in debt and equity securities Loans, net of allowance for credit losses Premises, equipment and computer software Accrued interest Intangible assets Other assets Total assets Liabilities Deposits Accrued interest Other liabilities Total liabilities The following table summarises the results of the Barbados operating segment for the year ended: Non-interest income Net interest income Provision for credit losses Revenue before gains (losses) Gains (losses) Total net revenue Non-interest expenses Net income before income taxes Gain on sale of discontinued operations Income tax expense Net income from discontinued operations NOTE 4: CASH AND CASH EQUIVALENTS Unrestricted Non-interest earning Cash and demand deposits Interest earning Demand deposits Cash equivalents Sub-total - Interest earning 2012 Non- Bermuda Bermuda Total Bermuda 2011 Non- Bermuda Total 172,179 44,425 216,604 176,091 17,823 193,914 109,164 334,835 443,999 150,303 840,641 990,944 259,467 1,175,476 1,434,943 49 489,391 489,440 189,864 1,029,508 1,219,372 189,913 1,518,899 1,708,812 Total cash and cash equivalents 616,178 1,035,369 1,651,547 665,531 1,237,195 1,902,726 Butterﬁeld Annual Report 2012 67 2012 - - - - - - - - - - - - - 2012 1,701 7,267 (548) 8,420 249 8,669 (7,976) 693 7,240 (313) 7,620 2011 76,935 14,534 28,088 177,841 3,643 1,164 3,084 1,755 307,044 269,083 1,040 1,926 272,049 2011 2,897 11,485 (1,156) 13,226 37 13,263 (11,862) 1,401 - (274) 1,127 NOTE 5: SHORT-TERM INVESTMENTS Unrestricted Interest earning Term deposits maturing within three months Term deposits maturing between three to six months Term deposits maturing between six to twelve months Total unrestricted short-term investments Affected by drawing restrictions related to minimum reserve and derivative margin requirements Interest earning Demand deposits Total restricted short-term investments 2012 Non- Bermuda Bermuda Total Bermuda 2011 Non- Bermuda - - - - 56,727 7,672 4,761 69,160 56,727 7,672 4,761 69,160 - - - - - 4,630 2,900 7,530 Total - 4,630 2,900 7,530 6,942 6,942 111 111 7,053 7,053 12,641 12,641 109 109 12,750 12,750 Total short-term investments 6,942 69,271 76,213 12,641 7,639 20,280 NOTE 6: INVESTMENTS Amortised cost, carrying amounts and estimated fair value The amortised cost, carrying amounts and fair values are as follows: 2012 2011 Gross Gross Amortised unrealised unrealised losses gains cost Carrying amount / Fair value Gross Amortised unrealised gains cost Gross unrealised losses Carrying amount / Fair value Trading Debt securities issued by non-US governments 4,301 56,779 Mutual funds 61,080 Total trading 930 511 1,441 - (736) (736) 5,231 56,554 61,785 5,788 56,964 62,752 419 224 643 (236) (568) (804) 5,971 56,620 62,591 Available for sale 558,668 Certiﬁcates of deposit US government and federal agencies 1,156,307 Debt securities issued by non-US governments 89,609 Corporate debt securities guaranteed by non-US governments Corporate debt securities Asset-backed securities - Student loans Mortgage-backed securities - Commercial Pass-through note Equity securities Total available for sale 32,021 400,980 139,304 130,526 30,404 126 2,537,945 2,706 23,613 438 5 20,105 - 231 242 - 47,340 (14) 561,360 (1,134) 1,178,786 90,042 (5) - - (3,203) (279) - (73) 32,026 421,085 136,101 130,478 30,646 53 (4,708) 2,580,577 354,847 778,387 87,549 122,987 408,559 149,759 - 33,696 120 1,935,904 2,411 14,419 1,158 38 396 - - - - 18,422 (765) (2,002) (49) (1,377) (3,706) (5,413) - (6,705) (50) (20,067) 356,493 790,804 88,658 121,648 405,249 144,346 - 26,991 70 1,934,259 2012 2011 Amortised cost / Gross Gross Carrying unrealised unrealised losses amount gains Amortised cost / Gross Carrying unrealised gains Amount Gross unrealised losses Fair value Fair value Held to maturity (1) US government and federal agencies Total held to maturity 239,342 239,342 6,691 6,691 (1,240) (1,240) 244,793 244,793 64,789 64,789 228 228 (429) (429) 64,588 64,588 (1) For the years ended 31 December 2012 and 2011 non-credit impairments recognised in AOCI for held-to-maturity investments was $nil. Available for sale As at 31 December 2012, US government and federal agency investment securities classiﬁed as available for sale with an amortised cost of $255.7 million and fair value of $262.7 million were pledged to secure Bank deposit products where the secured party did not have the right to sell or repledge the collateral. 68 US government and federal agency investment securities with an amortised cost of $120.9 million and fair market value of $122.4 million were pledged to secure repurchase agreements at 31 December 2012. Held to maturity As at 31 December 2012, US government and federal agency investment securities with an amortised cost of $45.7 million were pledged to secure Bank deposit products where the secured party did not have the right to sell or repledge the collateral. Unrealised loss positions The following tables show the fair value and gross unrealised losses of the Bank’s AFS and HTM investments with unrealised losses that are not deemed to be OTTI, aggregated by investment category and length of time that individual securities have been in a continuous unrealised loss position. Debt securities are categorised as being in a continuous loss position for “Less than 12 months” or “12 months or more” based on the point in time that the fair value declined below the cost basis. 2012 Less than 12 months 12 months or more Available for sale Certiﬁcates of deposit US government and federal agencies Debt securities issued by non-US governments Corporate debt securities guaranteed by non-US governments Corporate debt securities Asset-backed securities - Student loans Mortgage-backed securities - Commercial Pass-through note Equity securities Total available-for-sale securities with unrealised losses Held to maturity US government and federal agencies Total held-to-maturity securities with unrealised losses 2011 Available for sale Certiﬁcates of deposit US government and federal agencies Debt securities issued by non-US governments Corporate debt securities guaranteed by non-US governments Corporate debt securities Asset-backed securities - Student loans Pass-through note Equity securities Total available-for-sale securities with unrealised losses Held to maturity US government and federal agencies Total held-to-maturity securities with unrealised losses Fair value 82,477 191,492 56,797 - - - 92,306 - - Gross unrealised losses (14) (342) (5) - - - (279) - - Fair value - 65,792 - - - 136,101 - - 53 Gross unrealised losses Total fair value Total gross unrealised losses - (792) - - - (3,203) - - (73) 82,477 257,284 56,797 - - 136,101 92,306 - 53 (14) (1,134) (5) - - (3,203) (279) - (73) 423,072 (640) 201,946 (4,068) 625,018 (4,708) 44,496 (1,240) 44,496 (1,240) - - - - 44,496 (1,240) 44,496 (1,240) Less than 12 months Gross unrealised losses (765) (1,585) (49) (3) (2,859) - - (50) Fair value - 72,600 - 47,267 124,152 144,346 26,992 - Gross unrealised losses - (417) - (1,374) (847) (5,413) (6,705) - 12 months or more Total fair value 48,623 216,964 7,749 77,446 341,764 144,346 26,992 70 Total gross unrealised losses (765) (2,002) (49) (1,377) (3,706) (5,413) (6,705) (50) Fair value 48,623 144,364 7,749 30,179 217,612 - - 70 448,597 (5,311) 415,357 (14,756) 863,954 (20,067) 30,034 30,034 (429) (429) - - - - 30,034 30,034 (429) (429) Butterﬁeld Annual Report 2012 69 The Bank does not believe that the investment securities that were in an unrealised loss position as of 31 December 2012, which was comprised of 38 securities, or 24% of the portfolio by market value, represent an other-than-temporary impairment. Total gross unrealised losses were only 0.9% of the market value of affected securities and were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities. The Bank does not intend to sell the investment securities that were in an unrealised loss position and it is not more likely than not that the Bank will be required to sell the investment securities before recovery of the amortised cost bases, which may be at maturity. The following describes the process for identifying credit impairment in security types with the most signiﬁcant unrealised losses as of 31 December 2012. US government and federal agencies As of 31 December 2012, gross unrealised losses on securities related to United States (“US”) government and federal agencies were $1.1 million (2011: $2.0 million). Overall, Management believes that all the securities in this class do not have any credit losses, given the explicit and implicit guarantees provided by the US federal government. Asset-backed securities − Student loans As of 31 December 2012, gross unrealised losses on student loan asset-backed securities were $3.2 million (2011: $5.4 million). Asset−backed securities collateralised by student loans are primarily composed of securities collateralised by Federal Family Education Loan Program (“FFELP loans”). FFELP loans beneﬁt from a federal government guarantee of at least 97% of defaulted principal and accrued interest, with additional credit support provided in the form of overcollateralisation, subordination and excess spread, which collectively total in excess of 100%. Accordingly, the vast majority of FFELP loan−backed securities are not exposed to traditional consumer credit risk. Contractual maturities The following table presents the remaining contractual maturities of the Bank’s securities. The remaining contractual principal maturities for the mortgage-backed securities (primarily US Government agencies) do not consider prepayments. Remaining expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations before the underlying mortgages mature. 2012 Within 3 months Remaining term to earlier of expected or contractual maturity 3 to 12 months Over 10 No speciﬁc years maturity 5 to 10 years 1 to 5 years Trading Debt securities issued by non-US governments Mutual funds Total trading - - - 1,382 - 1,382 1,157 - 1,157 1,611 - 1,611 1,081 - 1,081 - 56,554 56,554 Available for sale 255,624 Certiﬁcates of deposit US government and federal agencies - Debt securities issued by non-US governments 32,473 Corporate debt securities guaranteed by non-US governments Corporate debt securities Asset-backed securities - Student loans Mortgage-backed securities – Commercial Pass-through note Equity securities Total available for sale 32,026 - - - - - 320,123 274,357 - 50,081 - - - - - - 324,438 31,379 162,545 5,600 - 421,085 2,506 - - - 623,115 - 361,476 1,888 - - 82,825 130,478 30,646 - 607,313 - 654,765 - - - 50,770 - - - 705,535 - - - - - - - - 53 53 Carrying amount 5,231 56,554 61,785 561,360 1,178,786 90,042 32,026 421,085 136,101 130,478 30,646 53 2,580,577 Held to maturity US government and federal agencies Total held to maturity Total investments Total by currency US dollars Other Total investments - - - - - - 11,003 11,003 228,339 228,339 - - 239,342 239,342 320,123 325,820 624,272 619,927 934,955 56,607 2,881,704 166,289 153,834 320,123 179,536 146,284 325,820 623,115 1,157 624,272 618,315 1,612 619,927 933,874 1,081 934,955 55,513 1,094 56,607 2,576,642 305,062 2,881,704 70 2011 Within 3 months Remaining term to earlier of expected or contractual maturity 3 to 12 months 5 to 10 years 1 to 5 years Over 10 No speciﬁc years maturity Trading Debt securities issued by non-US governments Mutual funds Total trading - - - 811 - 811 Available for sale Certiﬁcates of deposit US government and federal agencies Debt securities issued by non-US governments Corporate debt securities guaranteed by non-US governments Corporate debt securities Asset-backed securities - Student loans Pass-through note Equity securities Total available for sale 105,318 - 7,749 - 27,514 - - - 140,581 174,301 - 64,057 90,882 106,639 - - - 435,879 2,026 - 2,026 76,874 82,444 5,333 30,766 257,990 58,183 - - 511,590 2,106 - 2,106 1,028 - 1,028 - 56,620 56,620 - 452,951 11,519 - 13,106 74,999 26,991 - 579,566 - 255,407 - - - 11,164 - - 266,571 Held to maturity US government and federal agencies Total held to maturity - - - - - - - - 64,789 64,789 Carrying amount 5,971 56,620 62,591 356,493 790,804 88,658 121,648 405,249 144,346 26,991 70 1,934,259 64,789 64,789 - 2 - - - - - 70 72 - - Total investments Total by currency US dollars Other Total investments 140,581 436,690 513,616 581,672 332,388 56,692 2,061,639 - 140,581 140,581 181,875 254,815 436,690 448,777 64,839 513,616 579,566 2,106 581,672 331,360 1,028 332,388 55,407 1,285 56,692 1,596,985 464,654 2,061,639 Sale proceeds and realised gains (losses) During the twelve months ended 31 December 2012, the Bank disposed of: (cid:115)(cid:0) Certiﬁcates of deposit totalling $170.1 million in sale proceeds, resulting in a gross realised gain of $0.1 million; (cid:115)(cid:0) US agency securities totalling $60.4 million in sale proceeds, resulting in gross realised gains of $0.5 million and gross realised losses of $0.1 million; (cid:115)(cid:0) Corporate bonds totalling $165.6 million in sale proceeds, resulting in gross realised gains of $1.0 million and gross realised losses of $0.3 million; and (cid:115)(cid:0) Other securities totalling $18.2 million in sale proceeds, resulting in a gross realised gain of $0.8 million. During the year ended 31 December 2011, the Bank disposed of: (cid:115)(cid:0) Certiﬁcates of deposit totalling $580.2 million in sale proceeds, resulting in a gross realised gain of $0.8 million and a gross realised loss of $0.4 million; (cid:115)(cid:0) US agency securities totalling $302.8 million in sale proceeds, resulting in a gross realised gain of $1.8 million; and (cid:115)(cid:0) Corporate bonds totalling $88.3 million in sale proceeds, resulting in a gross realised loss of $0.2 million. Butterﬁeld Annual Report 2012 71 Gains and losses on investments The following table presents gains and losses on investments: Year ended 2012 Trading Available Held to for sale maturity Total Trading 2011 Available for sale Held to maturity Gains (losses) other than OTTI recognised in net income 268 2,028 Total impairment applied against carrying amount Less: change in non-credit related impairments recognised in OCI OTTI impairments recognised in net income - - - - - - Net gains (losses) recognised in net income 268 2,028 Gross unrealised gains recorded in OCI Realised (gains) losses transferred to net income Total net gains recognised in OCI - - - 45,146 (2,028) 43,118 - - - - - - - - 2,296 (919) 2,058 - - - - - - - - - 2,296 (919) 2,058 45,146 (2,028) 43,118 - - - 21,903 (2,058) 19,845 - - - - - - - - Total 1,139 - - - 1,139 21,903 (2,058) 19,845 72 NOTE 7: LOANS The composition of the loan portfolio by collateral exposure at each of the indicated dates was as follows: Commercial loans Government Commercial and industrial Commercial overdrafts Total commercial loans Less: speciﬁc allowance for credit losses on commercial loans Total commercial loans after speciﬁc allowance for credit losses Commercial real estate loans Commercial mortgage Construction Total commercial real estate loans Less: speciﬁc allowance for credit losses on commercial real estate loans Total commercial real estate loans after speciﬁc allowance for credit losses Consumer loans Automobile ﬁnancing Credit card Overdrafts Other consumer Total consumer loans Less: speciﬁc allowance for credit losses on consumer loans Total consumer loans after speciﬁc allowance for credit losses Residential mortgage loans Less: speciﬁc allowance for credit losses on residential mortgage loans Total residential mortgage loans after speciﬁc allowance for credit losses Total gross loans Less: speciﬁc allowance for credit losses Less: general allowance for credit losses Net loans 31 December 2012 Non- Bermuda Bermuda 64,534 121,947 58,973 245,454 (166) 245,288 4,050 190,002 22,929 216,981 (1,250) 215,731 Total 68,584 311,949 81,902 462,435 (1,416) 461,019 31 December 2011 Non- Bermuda Bermuda Total 256,442 103,922 64,733 425,097 (1,222) 423,875 4,230 260,672 269,742 90,197 620,611 (2,472) 618,139 165,820 25,464 195,514 (1,250) 194,264 495,466 109 495,575 (8,772) 281,456 2,119 283,575 (4,711) 776,922 2,228 779,150 (13,483) 502,110 37,178 539,288 (9,225) 2,814 304,525 806,635 39,992 307,339 846,627 (12,017) (2,792) 486,803 278,864 765,667 530,063 304,547 834,610 19,663 58,500 8,488 66,044 152,695 (160) 152,535 6,050 15,446 3,933 94,819 120,248 - 120,248 25,713 73,946 12,421 160,863 272,943 (160) 272,783 23,964 59,469 9,147 87,889 180,469 (160) 180,309 5,862 13,800 5,359 121,298 146,319 - 146,319 29,826 73,269 14,506 209,187 326,788 (160) 326,628 1,351,680 1,145,709 2,497,389 (11,673) (3,930) (7,743) 1,348,606 (3,184) 982,278 2,330,884 (8,821) (5,637) 1,343,937 1,141,779 2,485,716 1,345,422 976,641 2,322,063 2,245,404 1,766,513 4,011,917 (26,732) (29,225) 2,207,746 1,748,214 3,955,960 (16,841) (20,817) (9,891) (8,408) 2,493,460 1,631,450 4,124,910 (23,470) (32,021) 2,456,195 1,613,224 4,069,419 (13,791) (23,474) (9,679) (8,547) 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 30 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 2012 was 4.72% (2011: 4.76%). Butterﬁeld Annual Report 2012 73 Age analysis of past due loans (including non accrual loans) The following table summarises the past due status of the loans at 31 December 2012 and 31 December 2011. The aging of past due amounts are determined based on the contractual delinquency status of payments under the loan. An account is generally considered to be contractually delinquent when payments have not been made in accordance with the loan terms. Commercial loans Government Commercial and industrial Commercial overdrafts Total commercial loans Commercial real estate loans Commercial mortgage Construction Total commercial real estate loans Consumer loans Automobile ﬁnancing Credit card Overdrafts Other consumer Total consumer loans Residential mortgage loans Total loans 30-59 days - 349 17 366 3,852 - 3,852 466 623 3 1,091 2,183 38,334 44,735 (1) Loans less than 30 days past due are included in Current. Commercial loans Government Commercial and industrial Commercial overdrafts Total commercial loans Commercial real estate loans Commercial mortgage Construction Total commercial real estate loans Consumer loans Automobile ﬁnancing Credit card (2) Overdrafts Other consumer Total consumer loans Residential mortgage loans Total loans 30-59 days - 449 - 449 9,866 16,680 26,546 611 1,719 6 1,879 4,215 63,805 95,015 60-89 days - 2,048 199 2,247 1,190 - 1,190 96 445 37 693 1,271 21,914 26,622 2012 90 days or more Total past due loans Total current (1) Total loans - 3,022 301 3,323 55,584 - 55,584 425 601 227 1,595 2,848 69,551 131,306 - 5,419 517 5,936 60,626 - 60,626 987 1,669 267 3,379 6,302 129,799 202,663 68,584 306,530 81,385 456,499 716,296 2,228 718,524 24,726 72,277 12,154 157,484 266,641 2,367,590 3,809,254 68,584 311,949 81,902 462,435 776,922 2,228 779,150 25,713 73,946 12,421 160,863 272,943 2,497,389 4,011,917 2011 60-89 days 90 days or more Total past due loans Total current (1) Total loans - 210 26 236 1,280 1,629 2,909 299 449 9 548 1,305 34,350 38,800 - 2,525 4,810 7,335 45,459 - 45,459 633 843 75 1,773 3,324 47,144 103,262 - 3,184 4,836 8,020 56,605 18,309 74,914 1,543 3,011 90 4,200 8,844 145,299 237,077 260,672 266,558 85,361 612,591 750,030 21,683 771,713 28,283 70,258 14,416 204,987 317,944 2,185,585 3,887,833 260,672 269,742 90,197 620,611 806,635 39,992 846,627 29,826 73,269 14,506 209,187 326,788 2,330,884 4,124,910 (1) Loans less than 30 days past due are included in Current. (2) Delinquency for credit cards was previously driven by reporting cycles rather than actual days past payment due date. Commencing in the third quarter delinquency is now consistently measured from the date payment is due. The resultant effect of the clariﬁcation of cycle reporting resulted in a disclosure reclassiﬁcation of $3.9 million from past due credit cards to current credit cards. Prior years have been adjusted to reﬂect the new measure of delinquency. 74 Non-accrual loans and accruing loans 90 days or more past due are summarised in the following table: 2012 Accruing loans past due 90 days Total non- performing loans Non-accrual loans 2011 Accruing loans past due 90 days Total non- performing loans Commercial loans Commercial and industrial Commercial overdrafts Total commercial loans Non-accrual loans 3,606 292 3,898 - 9 9 3,606 301 3,907 4,160 5,683 9,843 Commercial real estate loans 55,167 417 55,584 53,599 Consumer loans Automobile ﬁnancing Credit cards Overdrafts Other consumer Total consumer loans 581 - 217 1,984 2,782 57 600 10 76 743 638 600 227 2,060 3,525 983 - 65 1,789 2,837 - - - 8 - 844 11 173 1,028 4,160 5,683 9,843 53,607 983 844 76 1,962 3,865 Residential mortgage loans 51,506 27,229 78,735 43,828 17,372 61,200 Total loans 113,353 28,398 141,751 110,107 18,408 128,515 The table below presents information about the credit quality of the Bank’s loan portfolio: 2012 Commercial loans Government Commercial and industrial Commercial overdrafts Total commercial loans Commercial real estate loans Commercial mortgage Construction Total commercial real estate loans Consumer loans Automobile ﬁnancing Credit cards Overdrafts Other consumer Total consumer loans Pass Special mention Substandard Non-accrual 68,584 301,747 72,669 443,000 562,042 493 562,535 23,765 73,352 11,945 154,966 264,028 - 6,078 8,742 14,820 118,203 1,735 119,938 1,183 - 186 3,218 4,587 - 518 199 717 41,510 - 41,510 184 594 73 695 1,546 - 3,606 292 3,898 55,167 - 55,167 581 - 217 1,984 2,782 Total gross recorded investments 68,584 311,949 81,902 462,435 776,922 2,228 779,150 25,713 73,946 12,421 160,863 272,943 Residential mortgage loans 2,309,945 68,531 67,407 51,506 2,497,389 Total loans 3,579,508 207,876 111,180 113,353 4,011,917 Butterﬁeld Annual Report 2012 75 Pass Special mention Substandard Non-accrual 2011 Commercial loans Government Commercial and industrial Commercial overdrafts Total commercial loans Commercial real estate loans Commercial mortgage Construction Total commercial real estate loans Consumer loans Automobile ﬁnancing Credit cards Overdrafts Other consumer Total consumer loans 260,672 253,443 81,386 595,501 608,555 38,363 646,918 28,843 72,314 14,369 199,412 314,938 Residential mortgage loans 2,198,967 Total loans 3,756,324 - 9,732 3,128 12,860 102,705 1,629 104,334 - - 72 409 481 45,795 163,470 - 2,407 - 2,407 41,776 - 41,776 - 955 - 7,577 8,532 42,294 95,009 Total gross recorded investments 260,672 269,742 90,197 620,611 806,635 39,992 846,627 29,826 73,269 14,506 209,187 326,788 - 4,160 5,683 9,843 53,599 - 53,599 983 - 65 1,789 2,837 43,828 2,330,884 110,107 4,124,910 The four credit quality classiﬁcations set out above are deﬁned below and describe the credit quality of the Group’s lending portfolio. These classiﬁcations each encompass a range of more granular, internal credit rating grades assigned. Quality classiﬁcation deﬁnitions Pass: A pass loan shall mean a loan that is expected to be repaid as agreed. A loan is classiﬁed as pass where the Bank is not expected to face repayment difﬁculties because the present and projected cash ﬂows are sufﬁcient to repay the debt and the repayment schedule as established by the agreement is being followed. Special mention: A special mention loan shall mean a loan under close monitoring by the Bank’s Management. Loans in this category are currently protected and still performing (current with respect to interest and principal payments), but are potentially weak and present an undue credit risk exposure, but not to the point of justifying a classiﬁcation of substandard. Substandard: A substandard loan shall mean a loan whose evident unreliability makes repayment doubtful and there is a threat of loss to the Bank unless the unreliability is averted. Non-accrual: Either where Management is of the opinion full payment of principal or interest is in doubt or when principal or interest is 90 days past due and for residential loans which are not well secured and in the process of collection. The table below presents the impairment methodology applied to the Bank’s loan portfolio: Total gross loans evaluated for impairment Commercial loans Commercial real estate loans Consumer loans Residential mortgage loans Total gross loans 76 2012 Individually Collectively evaluated - - 270,161 2,437,479 2,707,640 evaluated 462,435 779,150 2,782 59,910 1,304,277 2011 Individually evaluated 620,611 846,627 2,837 51,210 1,521,285 Collectively evaluated - - 323,951 2,279,674 2,603,625 The table below presents the changes in the allowance for credit loan losses: 2012 2011 Residential Commercial real estate Consumer mortgage Commercial Total Commercial Commercial real estate Residential Consumer mortgage Total Allowances at beginning of year 8,336 Provision taken during the year Recoveries Charge-offs Other Allowances at end of year (860) 490 (1,490) 120 6,596 17,888 5,735 23,532 55,491 7,311 28,046 5,339 21,024 61,720 7,541 - (6,630) (405) 1,327 2,953 (4,678) 103 6,182 303 (4,972) 482 14,190 3,746 (17,770) 300 1,843 546 (1,361) (3) 1,483 634 (12,280) 5 3,958 2,890 (6,458) 6 5,885 13 (3,412) 22 13,169 4,083 (23,511) 30 18,394 5,440 25,527 55,957 8,336 17,888 5,735 23,532 55,491 Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment 1,416 13,483 160 11,673 26,732 2,472 12,017 160 8,821 23,470 5,180 4,911 5,280 13,854 29,225 5,864 5,871 5,575 14,711 32,021 A loan is considered to be impaired when, based on current information and events, the Bank determines that it will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Impaired loans include all non-accrual loans and all loans modiﬁed in a TDR even if full collectability is expected following the restructuring. For the year ended 31 December 2012, the amount of gross interest income would have been recorded had impaired loans been current was $7.7 million (2011: $6.9 million). The table below presents information about the Bank’s impaired loans: 2012 Impaired loans with an allowance Gross recorded Speciﬁc investments allowance Commercial loans Commercial and industrial Commercial overdrafts Total commercial loans Commercial real estate loans Consumer loans Automobile ﬁnancing Overdrafts Other consumer Total consumer loans Residential mortgage loans Total impaired loans 1,471 26 1,497 52,607 227 - 128 355 36,064 90,523 (1,390) (26) (1,416) (13,483) (75) - (85) (160) (11,673) (26,732) Net loans 81 - 81 39,124 152 - 43 195 24,391 63,791 Impaired loans with an allowance Gross recorded investments Speciﬁc allowance Net loans Impaired loans without an allowance Gross recorded investments Total impaired loans Gross recorded investments Speciﬁc allowance Net loans 3,846 266 4,112 12,132 354 217 1,856 2,427 23,846 42,517 5,317 292 5,609 64,739 581 217 1,984 2,782 59,910 133,040 (1,390) (26) (1,416) (13,483) 3,927 266 4,193 51,256 (75) - (85) (160) 506 217 1,899 2,622 (11,673) 48,237 (26,732) 106,308 Impaired loans without an allowance Gross recorded investments Total impaired loans Gross recorded investments Speciﬁc allowance Net loans 2,164 669 2,833 41,364 240 - 143 383 25,483 70,063 (1,803) (669) (2,472) (12,017) (75) - (85) (160) (8,821) (23,470) 361 - 361 29,347 165 - 58 223 16,662 46,593 4,844 6,056 10,900 21,937 743 65 1,646 2,454 25,727 61,018 7,008 6,725 13,733 63,301 983 65 1,789 2,837 51,210 131,081 (1,803) (669) (2,472) (12,017) (75) - (85) (160) (8,821) (23,470) 5,205 6,056 11,261 51,284 908 65 1,704 2,677 42,389 107,611 Butterﬁeld Annual Report 2012 77 2011 Commercial loans Commercial and industrial Commercial overdrafts Total commercial loans Commercial real estate loans Consumer loans Automobile ﬁnancing Overdrafts Other consumer Total consumer loans Residential mortgage loans Total impaired loans The following table presents information about the Bank’s average impaired loan balances and interest income recognised for the year ended 31 December 2012 on the impaired loans: Average recorded investment Interest income recognised Impaired loans 2012 Commercial loans Commercial and industrial Commercial overdrafts Total commercial loans Commercial real estate loans Consumer loans Automobile ﬁnancing Credit cards Overdrafts Other consumer Total consumer loans Residential mortgage loans Total impaired loans 6,163 3,509 9,672 64,020 782 - 141 1,887 2,810 55,560 132,062 105 - 105 523 - - - - - 388 1,016 Effect of modiﬁcation on recorded investment The table presents information about the Bank’s loans modiﬁed in a troubled debt restructuring: 2012 Commercial loans Commercial and industrial Total commercial loans Commercial real estate loans Residential mortgage loans Total loans Number of contracts Recorded investment Pre-modiﬁcation Post-modiﬁcation outstanding recorded outstanding recorded investment Changes in the timing of principal or Interest investment interest payments capitalisation 3 3 7 15 25 2,083 2,083 22,854 10,977 35,914 (1) 2,290 2,290 24,402 9,185 35,877 2,326 2,326 24,463 9,926 36,715 - - - - - 36 36 61 740 837 (1) The amount is comprised of $16.2 million of non-accrual loans and $19.7 million of loans on accrual status. Effect of modiﬁcation on recorded investment Pre-modiﬁcation outstanding recorded investment Recorded investment Post-modiﬁcation outstanding recorded investment Changes in the timing of principal or interest payments Interest capitalisation 2,847 1,042 3,889 22,279 7,382 33,550 (1) 2,777 1,142 3,919 23,121 7,146 34,186 2,777 1,142 3,919 23,183 7,336 34,438 - - - - 9 9 - - - 61 180 241 Number of contracts 4 1 5 5 11 21 2011 Commercial loans Commercial and industrial Commercial overdrafts Total commercial loans Commercial real estate loans Residential mortgage loans Total loans (1) The amount is comprised of $12.6 million of non-accrual loans and $20.9 million of loans on accrual status. The Bank had four loans modiﬁed in a TDR from 1 January 2012 to 31 December 2012 that subsequently defaulted (i.e., 90 days or more past due following a modiﬁcation) with a recorded investment amounting to $2.9 million. 78 NOTE 8: CREDIT RISK CONCENTRATIONS Concentrations of credit risk in the lending and off-Balance Sheet credit-related arrangements portfolios 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 by geographic region of loan origination. In the consumer portfolio, concentrations are primarily evaluated by products. Credit exposures include loans, guarantees and acceptances, letters of credit and commitments for undrawn lines of credit. Unconditionally cancellable credit cards and overdrafts lines of credit are excluded from the tables below. The following table summarises the credit exposure of the Bank by business sector. The on-Balance Sheet exposure amounts disclosed are net of speciﬁc allowances and the off-Balance Sheet exposure amounts disclosed is gross of collateral held. Banks and ﬁnancial services Commercial and merchandising Governments Individuals Primary industry and manufacturing Real estate Hospitality industry Transport and communication Sub-total General allowance Total On-Balance Sheet 277,273 263,723 58,811 2,334,272 65,608 887,178 90,978 7,342 3,985,185 (29,225) 3,955,960 2012 Off-Balance Sheet 394,858 88,551 28,153 94,430 6,161 36,523 - - 648,676 - 648,676 Total credit exposure 672,131 352,274 86,964 2,428,702 71,769 923,701 90,978 7,342 4,633,861 (29,225) 4,604,636 On-Balance Sheet 330,734 270,089 251,795 2,270,737 199,979 675,848 92,955 9,303 4,101,440 (32,021) 4,069,419 2011 Off-Balance Sheet 496,753 135,340 - 93,620 2,692 94,029 - - 822,434 - 822,434 The following table summarises the credit exposure of the Bank by geographic region of loan origination: Bermuda Cayman Guernsey The Bahamas United Kingdom Sub-total General allowance Total On-Balance Sheet 2,300,661 547,779 534,226 47,883 554,636 3,985,185 (29,225) 3,955,960 2012 Off-Balance Sheet 335,184 194,634 72,961 180 45,717 648,676 - 648,676 Total credit exposure 2,635,845 742,413 607,187 48,063 600,353 4,633,861 (29,225) 4,604,636 On-Balance Sheet 2,571,607 605,500 454,039 8,972 461,322 4,101,440 (32,021) 4,069,419 2011 Off-Balance Sheet 411,594 172,346 149,387 90 89,017 822,434 - 822,434 Total credit exposure 827,487 405,429 251,795 2,364,357 202,671 769,877 92,955 9,303 4,923,874 (32,021) 4,891,853 Total credit exposure 2,983,201 777,846 603,426 9,062 550,339 4,923,874 (32,021) 4,891,853 Butterﬁeld Annual Report 2012 79 NOTE 9: PREMISES, EQUIPMENT AND COMPUTER SOFTWARE The following table summarises land, buildings, equipment and computer software: Land Buildings Equipment Computer software in use Computer software in development Total 2012 Accumulated depreciation - (52,109) (37,552) (63,743) - (153,404) Cost 13,290 154,903 47,060 172,511 8,961 396,725 Net carrying amount 13,290 102,794 9,508 108,768 8,961 243,321 Cost 13,371 180,006 47,987 166,250 2,853 410,467 Depreciation Buildings (included in property expense) Equipment (included in property expense) Computer hardware and software (included in technology & communications expense) Total depreciation charged to non-interest expense Impairment Write off of buildings (included in impairment of ﬁxed assets) 2011 Accumulated depreciation - (50,728) (37,212) (50,055) - (137,995) Net carrying amount 13,371 129,278 10,775 116,195 2,853 272,472 2012 2011 6,823 2,735 16,194 25,752 14,527 6,489 2,590 9,253 18,332 - During 2012, the Bank’s intended use for ﬁve Bermuda properties changed and therefore the properties were assessed for impairment. The properties are subsequently held for rental income or possible sale and it was determined that the carrying values were not recoverable based on the undiscounted cash ﬂow analysis. The carrying amount of the Bermuda segment’s buildings was impaired and was written down by $6.5 million at 31 December 2012 because their respective fair values were lower than the carrying amounts. The fair values of the properties were calculated based on the market approach and, where applicable, a fair value discount rate was applied. At the end of 2012, the Bank changed its commitment with respect to certain Bermuda properties which were being used in its operations but are now contemplated for disposal and therefore the properties have been reclassiﬁed as held for sale and included in OREO assets in the Consolidated Balance sheet. The reclassiﬁcation resulted in an $8 million write down of the carrying amount to its fair value less cost to sell. The fair value was based on the discounted cash ﬂow of a projected sale. NOTE 10: GOODWILL AND OTHER INTANGIBLE ASSETS The following table presents goodwill and other intangible assets by business segment: Goodwill Business segment Balance as at 31 December 2010 Foreign exchange translation adjustment Balance as at 31 December 2011 Impairment Foreign exchange translation adjustment Balance as at 31 December 2012 Guernsey 6,672 (38) 6,634 - 315 6,949 United Kingdom 9,345 (42) 9,303 (9,505) 202 - Customer relationship intangible assets 2012 2011 Accumulated Accumulated impairment amortisation (4,590) (853) (31,735) (3,215) (9,803) (50,196) - - - (2,019) (7,124) (9,143) Cost 8,342 1,211 42,952 5,234 16,927 74,666 Net carrying amount 3,752 358 11,217 - - 15,327 Accumulated Accumulated amortisation (4,034) (773) (27,542) (2,867) (9,454) (44,670) impairment - - - - - - Cost 8,342 1,211 41,010 5,234 19,036 74,833 Bermuda - Wealth Management Cayman Guernsey The Bahamas United Kingdom Total 80 Total 16,017 (80) 15,937 (9,505) 517 6,949 Net carrying amount 4,308 438 13,468 2,367 9,582 30,163 During the 2012 annual review process, the carrying amount of goodwill relating to the United Kingdom segment was considered fully impaired due to a continuous period of losses incurred and future estimated proﬁtability being unable to sustain current valuations including the goodwill and the customer intangible assets and was therefore fully written off. 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. The 31 December 2012 fair value of customer relationship intangible assets is based on the present value of net cash ﬂows expected to be derived solely from the recurring originally purchased customer base existing as at 31 December 2012. The discount rate used for testing is the discount rate implied in the initial purchase price acquisition. The carrying amount of the United Kingdom and Bahamas segments’ customer relationship intangible assets were impaired and were fully written off as at 31 December 2012 as the present value of net cash ﬂows expected to be derived for the recurring customer base is no longer providing positive net cash ﬂows. During 2012 and 2011, the Bank did not acquire new customer relationship intangible assets. Intangible asset impairments for the year ended 31 December 2012 of $9.1 million were recognised. During 2012, the amortisation expense amounted to $5.0 million (2011: $5.4 million) and the foreign exchange translation adjustment decreased the net carrying amount by $0.2 million (2011: increased by $0.07 million). The estimated aggregate amortisation expense for each of the succeeding ﬁve years (until 31 December 2017) is $3.5 million. NOTE 11: CUSTOMER DEPOSITS AND DEPOSITS FROM BANKS a) By Maturity Demand deposits Demand deposits - Non-interest bearing Demand deposits - Interest bearing Sub-total - demand deposits 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 Customers 918,814 4,514,312 5,433,126 2012 Banks 567 99,573 100,140 Total Customers 2011 Banks Total 919,381 4,613,885 5,533,266 904,873 4,087,152 4,992,025 - 118,653 118,653 904,873 4,205,805 5,110,678 1,763,515 15,965 1,779,480 1,924,973 6,410 1,931,383 98,051 81,101 1,942,667 10,240 121 26,326 108,291 81,222 1,968,993 119,110 94,887 2,138,970 382 121 6,913 119,492 95,008 2,145,883 Total 7,375,793 126,466 7,502,259 7,130,995 125,566 7,256,561 b) By Type and Location Bermuda Customers Banks Cayman Customers Banks Guernsey Customers Banks The Bahamas Customers United Kingdom Customers Banks Total Customers Total Banks Total 2012 Payable on demand Payable on a ﬁxed date Total Payable on demand 2011 Payable on a ﬁxed date Total 2,473,454 88,169 1,468,025 10,643 1,073,711 1,281 890,886 249 3,364,340 88,418 2,237,849 110,127 1,021,747 - 3,259,596 110,127 394,159 26,077 1,862,184 36,720 1,319,357 5,692 296,255 - 1,369,966 1,281 1,018,084 2,834 423,436 6,074 316,172 388 1,742,793 11,766 1,334,256 3,222 65,587 4,413 70,000 55,350 3,968 59,318 352,349 47 5,433,126 100,140 5,533,266 356,954 - 1,942,667 26,326 1,968,993 709,303 47 7,375,793 126,466 7,502,259 361,385 - 4,992,025 118,653 5,110,678 373,647 451 2,138,970 6,913 2,145,883 735,032 451 7,130,995 125,566 7,256,561 Butterﬁeld Annual Report 2012 81 NOTE 12: 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 and post-retirement medical plans are not open to new participants and are non-contributory and the funding required is provided by the Bank, based upon the advice of an independent actuary. The following table presents the ﬁnancial position of the Bank’s deﬁned beneﬁt pension plans and the Bank’s post-retirement medical beneﬁts, which is unfunded. The beneﬁt obligations and plan assets are measured as at 31 December 2012 and 2011: For the year ended 2012 2011 Accumulated beneﬁt obligation at year end Change in projected beneﬁt obligation Opening projected beneﬁt obligation Service cost Employee contributions Interest cost Beneﬁts paid Settlement and curtailment of liability Plan amendment Actuarial loss Foreign exchange translation adjustment Closing projected beneﬁt obligation Change in plan assets Opening fair value of plan assets Actual return on plan assets Employer contribution Employee contributions Beneﬁts paid Foreign exchange translation adjustment Closing fair value of plan assets Post-retirement Pension plans medical beneﬁt plan - 163,106 Post-retirement Pension plans medical beneﬁt plan - 146,897 152,472 1,687 215 7,061 (7,754) - - 10,696 3,306 167,683 145,323 9,040 13,439 215 (7,754) 3,438 163,701 91,880 944 - 4,205 (2,951) - - 3,048 - 97,126 - - 2,951 - (2,951) - - 140,874 2,638 245 7,355 (9,377) (1,800) - 13,124 (587) 152,472 143,978 5,458 5,559 245 (9,377) (540) 145,323 81,114 740 - 4,428 (2,047) - (3,704) 11,349 - 91,880 - - 2,047 - (2,047) - - For the year ended 2012 2011 Post-retirement Pension plans medical beneﬁt plan Post-retirement Pension plans medical beneﬁt plan Amounts recognised in the Balance Sheet consist of: Prepaid beneﬁt cost included in other assets Accrued beneﬁt cost included in employee future beneﬁts liability (Deﬁcit) surplus of plan assets over projected beneﬁt obligation at measurement date Amounts recognised in accumulated other comprehensive income (loss) consist of: Net actuarial loss Past service credit Net amount recognised in accumulated other comprehensive income (loss) 2,026 (6,009) (3,983) (49,261) - (49,261) - 5,861 - (97,126) (97,126) (13,010) (91,880) (7,149) (91,880) (27,169) 28,347 (40,460) - (26,195) 35,066 1,178 (40,460) 8,871 Effective 31 December 2011, the Bermuda Deﬁned Beneﬁt pension beneﬁts were amended to freeze credited service and ﬁnal average earnings for remaining active members. The beneﬁts amendment resulted in a further reduction in the Bermuda Deﬁned Beneﬁt pension liability of $1.8 million as at 31 July 2011. Effective January 2012, all the participants of the Bermuda Deﬁned Beneﬁt pension plan are inactive and in accordance with US GAAP, the net actuarial loss of the Bermuda Deﬁned Beneﬁt pension plan is amortised over the estimated average remaining life expectancy of the inactive participants of 22.8 years. Prior to all Bermuda participants being inactive, the net actuarial loss of the Bermuda Deﬁned Beneﬁt pension plan was amortised to net income over the estimated average remaining service period for active members of 4.5 years. 82 The following table presents the expense constituents of the Bank’s Deﬁned Beneﬁt pension plans and the Bank’s post-retirement medical beneﬁt plan: For the year ended 2012 2011 Post-retirement Pension plans medical beneﬁt plan Post-retirement Pension plans medical beneﬁt plan Annual beneﬁt expense Service cost Interest cost Expected return on plan assets Amortisation of past service credit Amortisation of net actuarial loss Deﬁned Beneﬁt expense Deﬁned Contribution expense Total beneﬁt expense Other changes recognised in other comprehensive income (loss) Net (loss) gain arising during the year Past service credit arising during the year Amortisation of past service credit Amortisation of net actuarial loss Total changes recognised in other comprehensive income (loss) 1,687 7,061 (8,145) - 1,366 1,969 5,593 7,562 (9,864) - - 1,366 (8,498) 944 4,205 - (6,719) 2,074 504 - 504 (3,048) - (6,719) 2,074 (7,693) 2,638 7,355 (9,173) - 4,027 4,847 5,496 10,343 (15,082) - - 4,027 740 4,428 - (6,158) 935 (55) - (55) (11,349) 3,704 (6,158) 935 (11,055) (12,868) The estimated portion of the net actuarial loss for the pension plans that will be amortised from accumulated other comprehensive loss into beneﬁt expense over the next ﬁscal year is $1.5 million. The estimated portion of the net actuarial loss and the past service credit for the post-retirement medical beneﬁt plan that will be amortised from accumulated other comprehensive loss into beneﬁt expense over the next ﬁscal year is $2.4 million for the net actuarial loss and a credit of $6.7 million for the past service credit. For the year ended Pension plans 2012 Post-retirement medical beneﬁt plan Pension plans 2011 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 (1) For 2012 excludes the inactive Bermuda Deﬁned Beneﬁt pension plan. 5.60% N/A 4.65% 3.95% (1) 4.60% N/A N/A 7.5% to 4.5% in 2027 5.30% 3.75% 6.35% N/A 5.50% N/A N/A 7.5% to 4.5% in 2027 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 4.20% 1.80% N/A 4.40% N/A 7.5% to 4.5% in 2027 4.65% 1.70% N/A 4.60% N/A 7.5% to 4.5% in 2027 For 2012, 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 $1.1 million increase (2011: $1.0 million) and a $0.9 million decrease (2011: $0.8 million) respectively, and on the beneﬁt obligation a $19.1 million increase (2011: $17.2 million) and a $15.3 million decrease (2011: $13.8 million) 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. The expected weighted average annual medical cost increase rate remained unchanged commencing at 7.5% and reducing to 4.5% by 2027. Investments policies and strategies The pension plans’ assets are managed according to each plan’s Investment Policy Statement which outlines the Purpose of the Plan, Statement of Objectives and Guidelines & Investment Policy. The asset allocation is diversiﬁed and any use of derivatives is limited to hedging purposes only. Butterﬁeld Annual Report 2012 83 The weighted average actual and target asset allocations of the pension plans by asset category are as follows: Asset category Debt securities (including debt mutual funds) Equity securities (including equity mutual funds) Other Total 2012 2011 Actual allocation Target allocation Actual allocation Target allocation 48% 50% 2% 100% 51% 47% 2% 100% 45% 50% 5% 100% 40% 47% 13% 100% Fair value measurements of pension plans’ assets The following table presents the fair value of plans assets by category and level of Inputs used in their respective fair value determination as described in Note 2: 2012 Fair value determination 2011 Fair value determination US government and federal agencies Corporate debt securities Debt securities issued by non-US governments Equity securities and mutual funds Other Total fair value of plans’ assets Level 1 - - - - - - Level 2 9,389 57,491 12,232 81,112 3,477 163,701 Level 3 - - - - - - Total fair value 9,389 57,491 12,232 81,112 3,477 163,701 Level 1 - - - - - - Level 2 5,890 51,295 10,143 74,089 3,521 144,938 Total fair value 5,890 51,295 10,143 74,474 3,521 145,323 Level 3 - - - 385 - 385 At 31 December 2012, 32.9% (2011: 26.3%) of the assets of the pension plans were mutual funds and equity securities managed or administered by wholly-owned subsidiaries of the Bank. At 31 December 2012, 0.2% and 1.4% (2011: 0.2% and 1.6%) of the plans’ assets were invested in Common and Preference Shares of the Bank respectively. 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 2012 Bank contribution to, and estimated beneﬁt payments for the next ten years under, the pension and post-retirement medical beneﬁt plans are as follows: 2012 Estimated Bank contributions for 2013 Estimated beneﬁt payments by year: 2013 2014 2015 2016 2017 2018 - 2021 Pension Plans 7,816 6,000 6,200 6,500 6,700 6,800 35,800 Post-retirement medical beneﬁt plan 3,033 3,033 3,270 3,554 3,790 4,033 24,220 The projected beneﬁt obligation and fair value of plan assets for pension plans with projected beneﬁt obligations in excess of plan assets were $137.8 million and $131.9 million as at 31 December 2012 (2011: $127.5 million and $114.5 million). NOTE 13: CREDIT-RELATED ARRANGEMENTS AND COMMITMENTS Commitments The Bank was committed to expenditures under contract for sourcing and leases of $75.4 million and $24.7 million respectively as at 31 December 2012 (2011: $112.5 million and $30.2 million respectively). Rental expense for premises leased on a long-term basis for the year ended 31 December 2012 amounted to $4.7 million (2011: $4.6 million). 84 The following table summarises the Bank’s commitments for sourcing, long-term leases and other agreements: 2012 2013 2014 2015 2016 2017 2018 & thereafter Total commitments Sourcing 20,883 19,514 19,252 15,769 - - 75,418 Leases 5,143 5,029 4,447 3,617 2,974 3,555 24,765 Other agreements 4,097 3 1 - - - 4,101 Total 30,123 24,546 23,700 19,386 2,974 3,555 104,284 Credit-Related Arrangements 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, whilst the term of the letters of guarantee does not exceed four years. The types and amounts of collateral security held by the Bank for these standby letters of credit and letters of guarantee is generally represented by deposits with the Bank or a charge over assets held in mutual funds. The Bank considers the fees collected in connection with the issuance of standby letters of credit and letters of guarantee to be representative of the fair value of its obligation undertaken in issuing the guarantee. In accordance with applicable accounting standards related to guarantees, the Bank defers fees collected in connection with the issuance of standby letters of credit and letters of guarantee. The fees are then recognised in income proportionately over the life of the credit agreements. The following table presents the outstanding ﬁnancial guarantees with contractual amounts representing credit risk as follows: Standby letters of credit Letters of guarantee Total Gross 280,089 11,207 291,296 2012 Collateral 277,259 8,694 285,953 Net 2,830 2,513 5,343 Gross 320,968 13,147 334,115 2011 Collateral 303,769 9,876 313,645 Net 17,199 3,271 20,470 Collateral is shown at estimated market value less selling cost. Where cash is the collateral, this is shown gross including interest income. The Bank enters into contractual commitments to extend credit, normally with ﬁxed expiration dates or termination clauses, at speciﬁed rates and for speciﬁc purposes. Substantially all of the Bank’s commitments to extend credit are contingent upon customers maintaining speciﬁc credit standards at the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for possible loan losses. The following table presents the unfunded legally binding commitments to extend credit with contractual amounts representing credit risk as follows: Commitments to extend credit Commitments to extend credit with terms modiﬁed by troubled debt restructuring Documentary and commercial letters of credit Total 2012 356,122 - 1,258 357,380 2011 483,020 779 4,520 488,319 The Bank has a facility by one of its custodians, whereby the Bank may offer up to US$200 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 to set-off against securities held of 110% of the utilised facility. At 31 December 2012, $137.0 million (2011: $137.1 million) of standby letters of credit were issued under this facility. On 31 December 2010, the Bank entered a credit line facility of up to $150.0 million with the same custodian. The custodian had the right of set-off against the scaled market value of the Bank’s investment portfolio. There were no draws on this facility during the year ended 31 December 2011. The facility expired on 31 December 2011. Guarantees As part of the BFG disposal negotiations, the Bank guaranteed to purchase services from BFG, on normal commercial market terms, for three years at minimum agreed revenue levels of $5.5 million, $5.0 million and $4.5 million per annum. In the event there is a shortfall, the Bank is required to pay 38% of the shortfall. Renegotiations of agreements occurred during the third and fourth quarter of 2011 resulting in an expected shortfall from the revenue guarantees over the three-year period whereby the resultant fair value of the liability is estimated at approximately $0.5 million as at 31 December 2012. Butterﬁeld Annual Report 2012 85 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 14: INTEREST INCOME Loans The following table presents the components of loan interest income: Mortgages Other loans Amortisation of fair value hedge Amortisation of loan origination fees (net of amortised costs) Total loan interest income Balance of unamortised fair value hedge as at 31 December Balance of unamortised loan fees as at 31 December 2012 88,263 100,594 188,857 (2,578) 4,412 190,691 (9,078) 7,452 2011 89,446 96,401 185,847 (2,498) 4,692 188,041 (11,656) 7,567 NOTE 15: SEGMENTED INFORMATION At 31 December 2012, for Management reporting purposes, the operations of the Bank are grouped into the following six business segments based upon the geographic location of the Bank’s operations: Bermuda, Cayman, Guernsey, Switzerland, The Bahamas and the United Kingdom. Accounting policies of the reportable segments are the same as those described in Note 2. Bermuda provides a full range of retail, commercial and private banking 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. Commercial banking includes commercial lending and mortgages, cash management, payroll services, remote banking and letters of credit. Treasury services include money market and foreign exchange activities. Bermuda’s wealth management offering consists of Butterﬁeld Asset Management Limited, which provides investment management, advisory and brokerage services and Butterﬁeld Trust (Bermuda) Limited, which provides trust, estate, company management and custody services. The Cayman segment provides a comprehensive range of community and commercial banking services to private and corporate customers through three locations and through Internet banking, ATMs and debit cards. Wealth management and ﬁduciary 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. The Switzerland segment provides ﬁduciary services. The Bahamas segment provides institutional, corporate and private clients with a range of wealth management & ﬁduciary 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 Barbados segment was sold on 27 August 2012 as disclosed in Note 3: Discontinued operations. Total Assets by Segment Bermuda Cayman Guernsey Switzerland The Bahamas United Kingdom Total assets from continuing operations Total assets from discontinued operations Less: inter-segment eliminations Total 86 2012 4,733,057 2,116,520 1,522,429 1,521 82,712 925,389 9,381,628 - 9,381,628 (439,598) 8,942,030 2011 4,574,921 1,974,338 1,479,901 1,118 77,565 976,451 9,084,294 307,044 9,391,338 (566,988) 8,824,350 For the year ended 2012 Net interest income Bermuda Cayman Guernsey Switzerland The Bahamas United Kingdom Total before eliminations Add / (Less): inter-segment eliminations / transactions Total from continuing operations Inter- Customer segment 1,316 1,220 (54) - 395 (2,877) - 128,817 43,413 21,618 1 135 17,074 211,058 - 211,058 - - For the year ended 2011 Net interest income Bermuda Cayman Guernsey Switzerland The Bahamas United Kingdom Total before eliminations Add / (Less): inter-segment eliminations / transactions Total from continuing operations Customer 131,671 36,568 18,396 1 1,041 14,572 202,249 - 202,249 Inter- segment 881 757 (17) - 264 (1,885) - - - Provision for credit losses (6,372) (1,291) (980) - - (5,547) (14,190) Revenue before Non- interest gains income and losses 189,320 65,559 74,282 30,940 40,589 20,005 1,443 1,442 5,291 4,761 16,827 8,177 327,752 130,884 Total Net income (loss) before gains expense and losses 25,088 164,232 19,453 54,829 30,810 9,779 (1,021) 2,464 (288) 5,579 (7,738) 24,565 45,273 282,479 Gains and losses (12,974) 4,497 (31) - (2,018) (16,895) (27,421) Net income (loss) 12,114 23,950 9,748 (1,021) (2,306) (24,633) 17,852 - (2,341) (2,341) (2,341) - 109 109 (14,190) 128,543 325,411 280,138 45,273 (27,312) 17,961 Provision for credit losses (1,202) (3,974) (636) - (633) (6,724) (13,169) Non- interest income 67,080 30,651 21,665 662 5,114 10,928 136,100 Revenue before gains and losses 198,430 64,002 39,408 663 5,786 16,891 325,180 Net income (loss) before gains and losses 21,705 9,015 9,163 (1,412) (2) (3,362) 35,107 Total expense 176,725 54,987 30,245 2,075 5,788 20,253 290,073 Gains and losses 4,753 1,956 242 - 3 45 6,999 Net income (loss) 26,458 10,971 9,405 (1,412) 1 (3,317) 42,106 - (3,751) (3,751) (3,751) - (2,761) (2,761) (13,169) 132,349 321,429 286,322 35,107 4,238 39,345 NOTE 16: ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND RISK MANAGEMENT The Bank uses derivatives in the asset and liability management (“ALM”) of positions and to meet the needs of its customers with their risk management objectives. The Bank’s derivative contracts principally involve over-the-counter transactions that are privately negotiated between the Bank and the counterparty to the contract and include interest rate contracts and foreign exchange contracts. The Bank may pursue 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. Certain of these agreements contain credit risk-related contingent features in which the counterparty has the option to accelerate cash settlement of the Bank’s net derivative liabilities with the counterparty in the event the Bank’s credit rating falls below speciﬁed levels or the liabilities reach certain levels. All derivative ﬁnancial instruments, whether designated as hedges or not, are recorded on the Consolidated Balance Sheet at fair value within Other assets or Other liabilities. These amounts include the effect of netting. The accounting for changes in the fair value of a derivative in the Consolidated Statement of Operations depends on whether the contract has been designated as a hedge and qualiﬁes for hedge accounting. Notional amounts 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. Credit risk is limited to the positive fair value of the derivative instrument, which is signiﬁcantly less than the notional amount. Butterﬁeld Annual Report 2012 87 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. 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 fair value is deﬁned as the proﬁt or loss associated with replacing the derivative contracts at prevailing market prices. Risk management derivatives 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. Derivative instruments that are used as part of the Bank’s interest rate risk management strategy include interest rate swap 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. The Bank uses derivative instruments to hedge its exposure to interest rate risk and foreign currency risk. Certain hedging relationships are formally designated and qualify for hedge accounting as fair value or cash ﬂow hedges. Other derivatives that are entered into for risk management purposes as economic hedges are not formally designated as hedges and, therefore, are accounted for as if they were trading instruments. In order to qualify for hedge accounting, a formal assessment is performed on a calendar quarter basis to verify that derivatives used in designated hedging transactions continue to be highly effective as offsets to changes in fair value or cash ﬂows of the hedged item. If a derivative ceases to be highly effective, or if the hedged item matures, is sold, or is terminated, hedge accounting is terminated and the derivative is treated as if it were a trading instrument. Risk management derivatives comprise: Fair value hedges Derivatives are designated as fair value hedges to minimise the Bank’s exposure to changes in the fair value of assets and liabilities due to movements in interest rates. The Bank enters into interest rate swaps to convert its ﬁxed-rate long-term loans to ﬂoating-rate loans, and convert ﬁxed-rate deposits to ﬂoating-rate deposits. Changes in fair value of these derivatives are recognised in income. For fair value hedges, the Bank applies the “shortcut” method of accounting, which assumes there is no ineffectiveness in a hedge. As a result, changes recorded in the fair value of the hedged item are equal to the offsetting gain or loss on the derivative and are reﬂected in the same line item. During the year ended 31 December 2011, the Bank cancelled its Interest Rate Swaps designated as fair value hedges of loans receivable and therefore discontinued hedge accounting for these ﬁnancial instruments. The fair value attributable to the hedged loans are accounted for prospectively and are being amortised to net income over the remaining life of each individual loan using the effective interest method. Derivatives not formally designated as hedges Derivatives not formally designated as hedges are entered into to manage the interest rate risk of ﬁxed rate deposits with banks and foreign exchange risk of the Bank’s non-USD investments in subsidiaries. Changes in the fair value of derivative instruments not formally designated as hedges are recognised in income. Client service derivatives The Bank enters into foreign exchange contracts and interest rate caps primarily to meet the foreign exchange needs of its customers. Foreign exchange contracts are agreements to exchange speciﬁc amounts of currencies at a future date at a speciﬁed rate of exchange. Changes in the fair value of client services derivative instruments are recognised in income. The following table shows the aggregate notional amounts of derivative contracts outstanding listed by type and respective gross positive or negative fair values and divided by those used for risk management (sub-classiﬁed as hedging and those that do not qualify for hedge accounting), client services and credit derivatives. Fair value of derivatives is recorded in the Consolidated Balance Sheet in Other assets and Other liabilities. Gross positive fair values are recorded in Other assets and gross negative fair values are recorded in Other liabilities, subject to netting when master netting agreements are in place. 88 Notional amounts Positive fair value Negative fair value Net fair value 8,529 8,529 343,684 343,684 352,213 - - 113 113 113 (89) (89) (89) (89) (10,895) (10,895) (10,782) (10,782) (10,984) (10,871) Derivative Instrument 2012 Risk management derivatives Fair-value hedges Fixed-rate loans Subtotal fair-value hedges Derivatives not formally designated as hedging instruments Currency swaps Interest rate swaps Subtotal not designated as hedges Subtotal risk management derivatives Client services derivatives Subtotal client services derivatives Derivative Instrument 2011 Risk management derivatives Fair-value hedges Fixed-rate loans Investments Subtotal fair-value hedges Derivatives not formally designated as hedging instruments Currency swaps Foreign currency options Interest rate swaps Interest rate swaps Subtotal not designated as hedges Subtotal risk management derivatives Client services derivatives Subtotal client services derivatives Spot and forward foreign exchange 2,444,357 2,444,357 14,312 14,312 (13,972) (13,972) 340 340 Total derivative instruments 2,796,570 14,425 (24,956) (10,531) Notional amounts Positive fair value Negative fair value Net fair value 11,436 18,613 30,049 346,453 65,335 411,788 441,837 - 18 18 1,031 3,160 4,191 4,209 (227) - (227) (105) (651) (756) (983) (227) 18 (209) 926 2,509 3,435 3,226 451 - 451 Spot and forward foreign exchange Interest rate caps 5,775,477 37,225 5,812,702 44,207 89 44,296 (43,756) (89) (43,845) Total derivative instruments 6,254,539 48,505 (44,828) 3,677 The following table shows the location and amount of gains (losses) recorded in the Consolidated Statement of Operations: Derivative Instrument Interest rate swaps Forward foreign exchange Foreign currency options Total net gains recognised in net income Consolidated Statement of Operations line item Net other gains (losses) Foreign exchange revenue Foreign exchange revenue For the year ended 2012 - 1,823 (852) 971 2011 (906) 699 1,092 885 NOTE 17: FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents the ﬁnancial assets and liabilities that are measured at fair value on a recurring basis and classiﬁes such fair value based on the type of input used in the related valuations, as described in Note 2. Management reviews the price of each security monthly, comparing market values to expectations and to the prior month’s price. Management’s expectations are based upon knowledge of prevailing market conditions and developments relating to speciﬁc issuers and/or asset classes held in the investment portfolio. Where there are unusual or signiﬁcant price movements, or where a certain asset class has performed out-of-line with expectations, the matter is reviewed by the Group Asset and Liability Committee. Butterﬁeld Annual Report 2012 89 Management classiﬁes items that are recognised at fair value on a recurring basis based on the level of inputs used in their respective fair value determination, as described in Note 2. Financial instruments in Level 1 include listed equity shares and actively traded redeemable mutual funds. Financial instruments in Level 2 include equity securities not actively traded, certiﬁcates of deposit, corporate bonds, mortgage-backed securities and other asset-backed securities, interest rate swaps and caps and forward foreign exchange contracts, and mutual funds not actively traded. Financial instruments in Level 3 include non-redeemable private equity shares, corporate bonds, mortgage-backed securities and other asset-backed securities for which the market is relatively illiquid and for which information about actual trading prices is not readily available. Items that are recognised at fair value on a recurring basis 2012 Fair value 2011 Fair value Financial assets Trading Debt securities issued by non-US governments Mutual funds Total Trading Available for sale Certiﬁcates of deposit US government and federal agencies Debt securities issued by non-US governments Corporate debt securities guaranteed by non-US governments Corporate debt securities Asset-backed securities - Student loans Mortgage-backed securities - Commercial Pass-through note Equity securities Total available for sale Level 1 Level 2 Level 3 - 5,337 5,337 5,231 51,217 56,448 - 561,360 - 1,178,786 90,042 - 32,026 - 421,085 - 124,937 - 130,478 - - - - 53 - 2,538,767 - - - - - - - - 11,164 - 30,646 - 41,810 Total carrying amount / Fair value Level 1 Level 2 5,231 56,554 61,785 - 5,368 5,368 5,971 51,252 57,223 561,360 1,178,786 90,042 32,026 421,085 136,101 130,478 30,646 53 2,580,577 - - - 356,493 790,804 88,658 121,648 - 405,249 - 133,182 - - - - - - 70 - 1,896,104 Total carrying amount / Level 3 Fair value - - - - - - 5,971 56,620 62,591 356,493 790,804 88,658 - - 11,164 - 26,991 - 121,648 405,249 144,346 - 26,991 70 38,155 1,934,259 Other assets - Derivatives Other assets - Closed ended real estate fund - - 14,425 - - 4,397 14,425 4,397 - - 48,505 - - 6,199 48,505 6,199 Financial liabilities Other liabilities – Derivatives - (24,956) - (24,956) - (44,828) - (44,828) Transfers of securities 2012 2011 Transfers out of Level 1 Transfers in to Level 2 Trading investments - - Available-for- sale investments - - Trading investments (50,035) 50,035 Available-for- sale investments - - The transfer out of Level 1 and into Level 2 represents transfers of a mutual fund classiﬁed at measurement date based on the level of trading. The following table presents quantitative information about recurring fair value measurements of assets classiﬁed with Level 3 of the fair value hierarchy as of 31 December 2012: Financial Instrument Type Asset-backed securities - Student loans Pass-through note Closed ended real estate fund Valuation Technique Unadjusted third party priced Unadjusted third party priced Net asset value of fund Fair Value 11,164 30,646 4,397 The valuation techniques used for the Level 3 assets as presented in the above table, are described as follows: 90 Unadjusted third party priced Prices obtained from third party pricing vendors or brokers that are used to record the fair value of the asset of which the related valuation technique and signiﬁcant unobservable inputs are not provided. (cid:115)(cid:0) Asset-backed securities (“ABS”) – The ABS is a Federal Family Education Loan Program guaranteed student loan security and is valued using a non-binding broker quote. The fair value provided by the broker is based on the last trading price of similar securities but as the security is trading illiquidly, a Level 2 classiﬁcation is not supported. (cid:115)(cid:0) Pass-through note (“PTN”) – The PTN consists of a pool of ﬂoating rate income securities (typically US sub-prime collateralised mortgage obligations and mortgage-backed securities). The third-party investment manager of the PTN determines the fair value of each underlying security within the PTN. The investment manager uses a variety of valuation techniques consistent with those disclosed in Note 2. Despite relying on the fair values provided by the investment manager, Management is still responsible for the ﬁnal fair valuation used. Signiﬁcant increases (decreases) in any of the above inputs in isolation could result in a signiﬁcantly different fair value measurement. Generally a change in assumption used for the probability of defaults is accompanied by a directionally similar change in the assumption used for the loss severity. Net Asset value of fund The per-share dollar amount of the fund is calculated by dividing the total value of all the assets in its portfolio, less any liabilities, by the number of fund shares outstanding. Level 3 reconciliation 2012 2011 Carrying amount at beginning of year Purchases Proceeds from sale / Capital distributions Accretion recognised in net income Realised and unrealised gains (losses) recognised in other comprehensive income Transfers in and out of Level 3 Foreign exchange translation adjustment Carrying amount at end of year Available- for-sale investments 38,155 - (4,992) 1,701 6,946 - - 41,810 Closed ended property fund 6,199 - (1,154) - 33 - (681) 4,397 Available- for-sale investments 44,483 290 (3,973) 1,776 (4,421) - - 38,155 Closed ended property fund 9,044 1,185 (3,765) - (251) - (14) 6,199 Items that are recognised at fair value on a non-recurring basis 2012 Fair value 2011 Fair Value Other real estate owned Level 1 - Level 2 34,360 Level 3 - Total carrying amount / Fair value 34,360 Level 1 - Level 2 27,354 Total carrying amount / Level 3 Fair value 27,354 - Consistent with the signiﬁcant accounting policy in Note 2, the current carrying value of Other real estate owned will be adjusted to fair value only when there is devaluation below cost. Items other than those recognised at fair value on a recurring basis Financial assets Cash and cash equivalents Short-term investments Investments held to maturity Loans, net of allowance for credit losses Carrying amount 1,651,547 76,213 239,342 3,955,960 1,651,547 76,213 244,793 3,946,081 Financial liabilities Customer deposits Demand deposits Term deposits Deposits from banks Subordinated capital 5,433,126 1,942,667 126,466 260,000 5,433,126 1,944,531 126,466 254,127 2012 2011 Fair Appreciation / (depreciation) value Carrying amount Fair Appreciation / (depreciation) value - - 5,451 (9,879) - (1,864) - 5,873 1,902,726 20,280 64,789 4,069,419 1,902,726 20,280 64,588 4,060,193 4,992,025 2,138,970 125,666 267,755 4,992,025 2,142,748 125,666 225,019 - - (201) (9,226) - (3,778) - 42,736 All of the held-to-maturity securities held by the Bank as at 31 December 2012 and 2011 are classiﬁed as Level 2 of the fair value hierarchy. Butterﬁeld Annual Report 2012 91 NOTE 18: INTEREST RATE RISK The following table sets out the assets, liabilities and Shareholders’ equity and off-Balance Sheet instruments on the date of the earlier of contractual maturity, expected 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 subject to prepayment penalties. Investments are shown based on remaining contractual maturities. The remaining contractual principal maturities for mortgage-backed securities (primarily US Government agencies) do not consider prepayments. Remaining expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations before the underlying mortgages mature. 2012 Earlier of maturity or repricing date (in $ millions) Assets Cash and cash equivalents Short-term investments Investments Loans Premises, equipment and computer software Other assets Total assets Liabilities and Shareholders’ equity Shareholders’ equity Demand deposits Term deposits Securities sold under agreement to repurchase Other liabilities Subordinated capital Total liabilities and Shareholders’ equity Interest rate swaps Interest rate sensitivity gap Cumulative interest rate sensitivity gap Within 3 months 3 to 6 months 6 to 12 months 1 to 5 years After 5 years Non-interest bearing funds 1,435 64 673 3,490 - - 5,662 - 4,614 1,576 109 - 90 6,389 8 (719) (719) - 8 314 180 - - 502 - - 204 - - 100 304 - 198 (521) - 4 43 41 - - 88 - - 108 - - - 108 (8) (28) (549) - - 559 100 - - 659 - - 81 - - 45 126 - 533 (16) - - 1,236 94 - - 1,330 - - - - - 25 25 - 1,305 1,289 217 - 57 51 243 133 701 857 919 - - 214 - 1,990 - (1,289) - 2011 Earlier of maturity or repricing date (in $ millions) Assets Cash and cash equivalents Short-term investments Investments Loans Premises, equipment and computer software Other assets Total assets Liabilities and Shareholders’ equity Shareholders’ equity Demand deposits Term deposits Other liabilities Subordinated capital Total liabilities and Shareholders’ equity Interest rate swaps Interest rate sensitivity gap Cumulative interest rate sensitivity gap Within 3 months 3 to 6 months 6 to 12 months 1 to 5 years After 5 years Non-interest bearing funds 1,709 12 451 3,508 - - 5,680 - 4,205 1,667 - 98 5,970 2 (288) (288) - 5 207 117 - - 329 - - 265 - - 265 8 72 (216) - 3 123 36 - - 162 - - 119 - - 119 (2) 41 (175) - - 440 310 - - 750 - - 95 - 145 240 (8) 502 327 - - 784 51 - - 835 - - - - 25 25 - 810 1,137 194 - 57 47 272 498 1,068 830 905 - 470 - 2,205 - (1,137) - Total 1,652 76 2,882 3,956 243 133 8,942 857 5,533 1,969 109 214 260 8,942 - - - Total 1,903 20 2,062 4,069 272 498 8,824 830 5,110 2,146 470 268 8,824 - - - 92 NOTE 19: SUBORDINATED CAPITAL 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 paid a ﬁxed coupon of 3.94% until 27 May 2008 when it was redeemed in whole by the Bank. The Series B notes pay a ﬁxed coupon of 5.15% until 27 May 2013 when they become redeemable in whole at the Bank’s option. 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 $7.8 million. The issuance was by way of private placement in the United Kingdom and paid a ﬁxed coupon of 9.29% until February 2012 when it became redeemable in whole at the option of the Bank and 10.29% thereafter until February 2017. During February 2012, the Bank exercised its option to redeem the United Kingdom note outstanding at face value. 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 $60 million in Series B notes due 2020. The issuance was by way of private placement with US institutional investors. The notes are listed on the BSX in the specialist debt securities category. The notes issued under Series A paid a ﬁxed coupon of 4.81% until 2 July 2010 after which the coupon rate became ﬂoating and the principal became redeemable in whole at the Bank’s option. At 31 December 2012, the Bank has not redeemed any of the notes issued under Series A and effective 2 July 2010 the coupon rate became ﬂoating at 3 months US$ LIBOR + 1.095%. The Series B notes pay 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. During September 2011, the Bank repurchased a portion of the outstanding 5.11% 2005 Series B Subordinated notes (“the Note”). The face value of the portion of the Note repurchased was $15 million and the purchase price paid for the repurchase was $13,875 million, which realised a gain of $1,125 million. On 27 May 2008, the Bank issued US $78 million of Subordinated Lower Tier II capital notes. The notes were issued at par and in two tranches, namely US $53 million in Series A notes due 2018 and US $25 million in Series B notes due 2023. 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 proceeds of the issue were used to repay the entire amount of the US $78 million outstanding subordinated notes redeemed in May 2008. The notes issued under Series A pay a ﬁxed coupon of 7.59% until 27 May 2013 when they become redeemable in whole at the option of the Bank. The Series B notes pay a ﬁxed coupon of 8.44% until 27 May 2018 when they also become redeemable in whole at the Bank’s option. The Series A notes were priced at a spread of 4.34% over the 5-year US Treasury yield and the Series B notes were priced at a spread of 4.51% over the 10-year US Treasury yield. No interest was capitalised during 2012 (2011: $2.8 million). The following table presents the contractual maturity and interest payments for subordinated capital issued by the Bank as at 31 December 2012. The interest payments are calculated until contractual maturity using the current LIBOR rates. Interest payments until contractual maturity Interest rate until date Earliest date redeemable maturity date redeemable Contractual Interest rate from earliest date Principal Within 1 to 5 After redeemable to contractual maturity outstanding 1 year years 5 years 27 May 2013 2 July 2010 2 July 2015 27 May 2013 27 May 2018 27 May 2018 2 July 2015 2 July 2020 27 May 2018 27 May 2023 5.15% 3 months US$ LIBOR + 2.000% 3 months US$ LIBOR + 1.095% 4.81% 3 months US$ LIBOR + 1.695% 5.11% 3 months US$ LIBOR + 4.185% 7.59% 3 months US$ LIBOR + 4.929% 8.44% 1,757 4,338 47,000 90,000 1,261 2,204 45,000 2,300 6,629 3,211 53,000 9,527 2,110 8,440 25,000 537 - 2,477 1,180 7,602 260,000 10,639 31,138 11,796 Subordinated capital Bermuda 2003 issuance - Series B 2005 issuance - Series A 2005 issuance - Series B 2008 issuance - Series A 2008 issuance - Series B Total NOTE 20: EARNINGS PER SHARE Earnings per Share have been calculated using the weighted average number of Common Shares outstanding during the year after deduction of the Shares held as Treasury stock. The dilutive effect of Share-based compensation plans was calculated using the Treasury stock method, whereby the proceeds received from the exercise of Share-based awards are assumed to be used to repurchase outstanding Shares, using the average market price of the Bank’s Shares for the year. Diluted earnings per Common Share include the dilutive effect resulting from the conversion of Treasury stock. Numbers of Shares are expressed in thousands. Butterﬁeld Annual Report 2012 93 Basic Earnings per Share (1) Basic earnings per Share from continuing operations Basic earnings per Share from discontinued operations Net income for the year Less: Preference dividends declared and guarantee fee Net income from continuing operations attributable for Common Shareholders Net income from discontinued operations Net income attributable for Common Shareholders Weighted average number of participating Shares Weighted average number of Common Shares held as Treasury stock Adjusted weighted average number of Common Shares Diluted Earnings per Share (1) Diluted earnings per Share from continuing operations Diluted earnings per Share from discontinued operations Net income from continuing operations attributable for Common Shareholders Net income from discontinued operations Net income attributable for Common Shareholders Adjusted weighted average number of Common Shares Weighted average number of dilutive Share-based awards Adjusted weighted average number of diluted Common Shares 2012 0.01 - 0.01 17,961 (18,000) (39) 7,620 7,581 556,933 (2,515) 554,418 0.01 - 0.01 (39) 7,620 7,581 554,418 1,939 556,357 2011 0.03 0.03 - 39,345 (21,270) 18,075 1,127 19,202 556,933 (2,283) 554,650 0.03 0.03 - 18,075 1,127 19,202 554,650 965 555,615 (1) Due to rounding, earnings per Share on continuing and discontinued operations may not sum to earnings per Share amount on net. The Contingent Value Convertible Preference Shares are classiﬁed as participating securities as they are entitled to dividends declared to Common Shareholders on a 1:1 basis and are therefore included in the basic earnings per Share calculation. During 2012, weighted-average options to purchase 33.3 million (2011: 34.5 million) Shares of Common stock (see Note 21), were outstanding. Only options where the option’s expense that will be recognised in the future and its exercise price was lower than the average market price of the Bank‘s Common stock were considered dilutive and, therefore, included in the computation of diluted earnings per Share. The dilution effect of such options is a net increase of 89,835 of the weighted-average number of Common Shares outstanding on a fully diluted basis. The awards’ yet unrecognised expense is considered to be the proceeds the employees would need to pay to purchase accelerated vesting of the awards. During 2012 the weighted-average number of outstanding awards of unvested Common Shares (see Note 21) was 7.2 million (2011: 3.8 million). All unvested awards of Common Shares were considered dilutive because each award’s unrecognised expense was lower than the average market price of the Bank‘s Common stock. The awards’ yet unrecognised expense is considered to be the proceeds the employees would need to pay to purchase accelerated vesting of the awards. For purpose of calculating dilution, such proceeds are assumed to be used by the Bank to buy back Shares at the average market price. The weighted-average number of outstanding awards net of the assumed weighted-average number of Shares bought back is included in the number of diluted participating Shares. Warrants issued to the Government of Bermuda in exchange for the Government’s guarantee of the Preference Shares, with an exercise price of $3.61 for 4.15 million Shares of Common stock were not included in the computation of earnings per Share in 2012 and 2011 because the exercise price was greater than the average market price of the Bank‘s Common stock. NOTE 21: SHARE-BASED PAYMENTS As at 31 December 2012, the Bank has three Share-based compensation plans, which are described below. Stock Option Plans 1997 Stock Option Plan Prior to the capital raise on 2 March 2010, the Bank granted stock options 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. Generally, the options granted vest 25 percent at the end of each year for four years, however as a result of capital raise, the options granted under the Bank’s 1997 Stock Option Plan to employees became fully vested and options awarded to certain executives were surrendered. 2010 Stock Option Plan In conjunction with the capital raise, the Board of Directors approved the 2010 Stock Option Plan. Under the Plan, ﬁve percent of the Company’s fully diluted Common Shares, equal to approximately 29.5 million Shares, are available for grant to certain Ofﬁcers. During May 2012, the Board of Directors approved an increase to the options allowed to be granted under the 2010 Stock Option Plan to 50 million Shares. 94 Under the 2010 Stock Option Plan, options are awarded to Bank employees and Executive Management, based on predetermined vesting conditions that entitle the holder to purchase one Common Share at a subscription price usually equal to the last-traded Common Share price when granted and have a term of 10 years. Two types of vesting conditions upon which the options will be awarded comprise the Plan, i.e.,: Time Vesting Condition 50% of each option award is granted in the form of Time Vested Options and vests 25% on each of the second, third, fourth and ﬁfth anniversaries of the effective grant date, subject to the employee’s continued employment; and Performance Vesting Condition 50% of each option award is granted in the form of Performance Options and vests on a “Valuation Event” date (date any of the 2 March 2010 Investors transfers at least 5% of total number of Shares or the date that there is a change in control) and any of the New Investors achieve a Multiple of Invested Capital (“MOIC”) based on predetermined MOIC tiers. In the event of a Valuation Event and the MOIC reaching 200% of the original $1.21 per Share invested capital, all options would vest. The Bank determined the performance stock options granted have an aggregate fair value of $9.6 million. If the probability of a Valuation Event becomes more likely than not, some or all of the $9.6 million unrecognised expense relating to the performance vesting options will be recognised as an expense. The table below presents the weighted average fair value of stock options granted: Weighted average fair value of stock options granted in the year ended 31 December 2012 Weighted average fair value of stock options granted in the year ended 31 December 2011 Weighted average fair value of stock options granted in the year ended 31 December 2010 Time Vested Options $0.42 $0.41 $0.62 Performance Options $0.44 $0.43 $0.66 The weighted average fair value of stock options granted in the year ended 31 December 2012 was calculated using the Black-Scholes-Merton option-pricing model for the Time Vested Options and a lattice-based binomial option-pricing model for the Performance Options using the following weighted average assumptions: Projected dividend yield Risk-free interest rate Projected volatility Expected life (years) Time Vested Options 0% for 2010-2013 1.0% for 2014 2.0% for 2015 and later years 0.94% to 1.44% 36% to 38% 6.75 years Performance Options 0% for 2010-2013 1.0% for 2014 2.0% for 2015 and later years 0% to 2.09% 36% to 38% 8 to 10 years The projected dividend yield is based on the Bank’s best estimate at grant date. The projected volatilities are based on the historical trading prices of the Bank’s Common Shares. The risk-free interest rate for periods within the expected life of the option is based on the US Treasuries yield curve in effect at the time of grant. As the time vested options granted are “plain vanilla” options, the Bank uses one-half of the time between the average vesting date and the full option term to estimate the expected option life; separate groups of employees that have similar historical exercise behaviour are considered separately for valuation purposes. The table below presents the number of Shares transferable upon exercise of the options outstanding at 31 December: Number of Shares transferable upon exercise (thousands) 1997 Stock Option Plan 5,269 - - (543) - (149) 4,577 4,577 2010 Stock Option Plan 28,363 3,100 (5) (2,062) (646) - 28,750 3,598 Total 33,632 3,100 (5) (2,605) (646) (149) 33,327 8,175 Weighted average exercise price($) 3.02 1.25 1.21 3.84 1.21 6.87 2.81 7.71 Outstanding at beginning of year Granted Exercised Forfeited / cancelled Resignations / Retirement / Redundancy End of plan expiration Outstanding at end of year Vested and exercisable at end of year 2012 Weighted average life remaining (years) Aggregate intrinsic value ($ thousands) 7.14 5.47 1,245 Butterﬁeld Annual Report 2012 95 Number of Shares transferable upon exercise (thousands) 1997 Stock Option Plan 6,274 - - (847) - (158) 5,269 5,269 2010 Stock Option Plan 28,034 1,260 - (25) (906) - 28,363 162 Total 34,308 1,260 - (872) (906) (158) 33,632 5,431 Weighted average exercise price ($) 3.26 1.24 - 11.10 1.22 5.84 2.81 12.41 2011 Weighted average life remaining (years) Aggregate intrinsic value ($ thousands) 7.85 4.95 - Outstanding at beginning of year Granted Exercised Forfeited / cancelled Resignations / Retirement / Redundancy End of plan expiration Outstanding at end of year Vested and exercisable at end of year Employee Deferred Incentive Plan (“EDIP”) Under the Bank’s EDIP Plan, Shares were awarded to Bank employees and Executive Management, based on time-vesting condition, which states that the Shares will vest equally over a three-year period from the effective grant date, subject to the employee’s continued employment. Outstanding at beginning of year Granted Vested Forfeited / cancelled Outstanding unvested at end of year For the year ended 2012 2011 Number of Shares transferable upon vesting (thousands) 1,276 1,554 (477) (377) 1,976 Number of Shares transferable upon vesting (thousands) - 1,361 (11) (74) 1,276 Executive Long-Term Incentive Share plan (“ELTIP”) Under the Bank’s ELTIP, Shares were awarded to Bank employees and Executive Management, based on predetermined vesting conditions. Two types of vesting conditions upon which the Shares will be awarded comprise the ELTIP Plan, i.e.,: Time Vesting Condition – 50% of each Share award is granted in the form of Time Vested Shares, vesting equally over a three-year period from the effective grant date, subject to the employee’s continued employment; and Performance Vesting Condition - 50% of each Share award is granted in the form of Performance Shares, vesting upon the achievement of certain performance targets in three-year period from the effective grant date. Outstanding at beginning of year Granted Vested Forfeited / cancelled Outstanding at end of year For the year ended 2012 2011 Number of Shares transferable upon vesting (thousands) 2,515 4,056 (928) (412) 5,231 Number of Shares transferable upon vesting (thousands) - 2,560 (10) (35) 2,515 The Board approved the 2011 Employee Deferred Incentive Plan and the 2012 Executive Long-Term Incentive Share Plan on 28 February 2012. 96 The following table presents the Share-based compensation cost that has been charged against net income and the value of Share-based settlements: Stock Option Plans 2012 EDIP and ELTIP For the year ended Stock Option Plans Total Share-based compensation plans – continuing operations Awards granted in years 2010, 2011 and 2012 Share-based compensation plans – discontinued operations Awards granted in years 2010, 2011 and 2012 Total Share-based compensation Share-based settlement plans Directors’ Shares and retainers settlement plans Total Share-based payments 1,398 - 1,398 The following table presents the unrecognised expense attributable to each plan: Unrecognised expense 2010, 2011 and 2012 Stock Option Plan Time Vesting Options Performance Vesting Options 2011 and 2012 EDIP 2011 and 2012 ELTIP Time Vesting Shares Performance Vesting Shares 3,723 5,121 63 3,786 63 5,184 293 5,477 1,719 (16) 1,703 2012 3,665 9,608 1,557 1,914 2,358 19,102 2011 EDIP and ELTIP Total 1,845 3,564 31 1,876 For the year ended 15 3,579 344 3,923 2011 5,731 9,169 915 952 961 17,728 Directors’ Compensation The Bank’s Non-Executive Directors received their annual retainer compensation in the form of cash or fully vested and unrestricted Bank Shares. NOTE 22: SHARE BUY-BACK PLANS The Bank introduced a Share Buy-Back Programme on 1 May 2012 as a means to improve Shareholder liquidity and facilitate growth in Share value. Under this Programme, up to six million Common Shares and 2,000 Preference Shares may be repurchased. On 10 December 2012, the Board of the Bank approved increasing the number of Common Shares available for repurchase up to 10 million and the number of Preference Shares up to 8,000. During 2012 the Bank repurchased 7.3 million Common Shares to be held as Treasury Shares at a cost of $9 million and 4,422 Preference Shares, which were subsequently cancelled, at a cost of $5.4 million. 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 than the last independent trade for a “round lot”, deﬁned as 100 Shares or more. The BSX must be advised monthly of Shares repurchased and cancelled by the Bank and Shares purchased by the Bank’s Stock Option Trust. NOTE 23: CAPITAL STRUCTURE Authorised capital The Bank’s total authorised Share capital as of 31 December 2012 and 2011 consisted of (i) 26 billion Common Shares of par value BD$0.01, (ii) 100,200,001 Preference Shares of par value US$0.01 and (iii) 50 million Preference Shares of par value £0.01. Following the Bank’s Annual General Meeting held on 8 April 2010, The Bank of N.T. Butterﬁeld & Son Limited’s Shareholders approved an increase in the authorised Share capital to 26,000,000,000 Common Shares of par value BD$0.01. Preference Shares On 22 June 2009, the Bank issued 200,000 Government guaranteed, 8.00% Non-Cumulative Perpetual Limited Voting Preference Shares (the “Preference Shares”). The issuance price was US$1,000 per Share. During 2012, the Bank repurchased and cancelled 4,422 Preference Shares for a net cost of $5.4 million. As at 31 December 2012, 195,578 Preference Shares were outstanding. Butterﬁeld Annual Report 2012 97 The Preference Share principal and dividend payments are guaranteed by the Government of Bermuda. At any time after the expiry of the guarantee offered by the Government of Bermuda, and subject to the approval of the Bermuda Monetary Authority, the Bank may redeem, in whole or in part, any Preference Shares at the time issued and outstanding, at a redemption price equal to the liquidation Preference plus any unpaid dividends at the time. Holders of Preference Shares will be entitled to receive, on each Preference Share only when, as and if declared by the Board of Directors, non-cumulative cash dividends at a rate per annum equal to 8.00% on the liquidation preference of $1,000 per Preference Share payable quarterly in arrears. In exchange for the Government’s commitment, the Bank issued to the Government 4,279,601 warrants to purchase Common Shares of the Bank at an exercise price of $7.01. The warrants expire on 22 June 2019. During 2010, the warrants issued to the Government were adjusted in accordance with the terms of the guarantee and as a result now holds 4,150,774 warrants with an exercise price of $3.61. On 11 May 2010 the Bank’s Rights offering was over subscribed with the maximum allowable number of rights of 107,438,016 exercised and subsequently converted on the ratio of 0.07692 Contingent Value Convertible Preference Shares (“CVCP”) for each right unit exercised amounting to 8,264,157 CVCP issued. The CVCP have speciﬁc rights and conditions attached which is explained in detail in the Prospectus of The Rights Offering. Regulatory capital The Bank is subject to Basel II which is a risk-based capital adequacy framework developed by the Basel Committee on Banking Supervision (the “Basel Committee”) and has been endorsed by the central bank governors and heads of bank supervision of the G10 countries. In December 2008, the Bermuda Monetary Authority published ﬁnal rules, effective 1 January 2009, with respect to the implementation of the Basel II framework. From this date the Bank has calculated its capital requirement on the Standardised approach under Basel II requirements. The Bank is fully compliant with all regulatory capital requirements and maintains capital ratios well in excess of regulatory minimums as at 31 December 2012 and 2011. As at 31 December 2012, the Bank’s regulatory capital stood at $1,034 million (2011: $1,041 million) with risk weighted assets of $4,275 million (2011: $4,426 million). Consolidated Tier 1 total and Total Capital ratios being 18.5% and 24.2% respectively (2011: 17.7% and 23.5% respectively). NOTE 24: DISPOSAL OF AFFILIATES On 8 February 2011, the Bank entered into an agreement with an investor group (comprised of BV Investor Partners, Glen Henderson and Tim Calveley, “BV Investor Group”) to dispose of its 36% equity interest on a diluted basis in Butterﬁeld Fulcrum Group Limited (“BFG”). The sale was completed in the second quarter of 2011 and resulted in a gain on sale of $3.2 million. On 5 April 2012, the Bank sold its 27.76% interest in Island Heritage Holdings Ltd.; a Cayman-based insurance company, to BF&M Limited. The sale was completed in the second quarter of 2012 with gross proceeds on the sale of $18.5 million, resulting in a gain of $4.2 million. NOTE 25: VARIABLE INTEREST ENTITIES The Bank had no investments in variable interest entities for which it was deemed the primary beneﬁciary for the years ended 31 December 2012 and 2011. The Bank has equitable mortgages in two hospitality-related companies that have been placed under Receivership, and as the Bank is an equity holder at risk, the hospitality-related companies were considered to be variable interest entities. As the Bank did not have the legal power to direct the activities of the companies that most signiﬁcantly impact the company’s economic performance it was considered not to be the primary beneﬁciary. NOTE 26: INCOME TAXES The Bank is incorporated in Bermuda, and pursuant to Bermuda law is not taxed on either income or capital gains. The Bank’s subsidiaries in the Cayman Islands and The Bahamas are not subject to any taxes in their respective jurisdictions on either income or capital gains under current law applicable in the respective jurisdictions. The Bank’s subsidiaries in the United Kingdom, Guernsey, Barbados (prior to disposal) and Switzerland are subject to the tax laws of those jurisdictions. For the years ended 31 December 2012 and 2011, the Bank did not record any unrecognised tax beneﬁts or expenses and has no uncertain tax positions as at 31 December 2012 and 2011. The Bank records income taxes based on the enacted tax laws and rates applicable in the relevant jurisdictions for each of the years ended 31 December 2012 and 2011. For the years ended 31 December 2012 and 2011, the Bank did not incur any interest or pay any penalties. 98 The components of income taxes attributable to the Bank’s subsidiaries’ operations for the years ended 31 December 2012 and 2011 were as follows: 31 December Income taxes in Consolidated Statement of Operations Current tax expense Deferred tax expense (beneﬁt) Total tax expense (beneﬁt) 2012 936 4,954 5,890 The reconciliation between the Bank’s effective tax rate on income from continuing operations and the statutory tax rate is as follows: 31 December Income tax expense at Bermuda corporation tax rate of 0% Income tax expense in international ofﬁces taxed at different rates Change in valuation allowance Prior year tax adjustments Tax loss carried forward Change in tax rate Other — net Income tax expense (beneﬁt) at effective tax rate $ - 841 4,132 900 - - 17 5,890 31 December Deferred income tax asset Tax loss carried forward Pension liability Fixed assets Allowance for compensated absence Onerous leases Other Deferred income tax asset Less: valuation allowance Net deferred income tax asset Deferred income tax liability Other Net deferred income tax asset $ - 1,742 - (303) (1,451) 245 (539) (306) 2012 % - 4 17 4 - - - 25 2012 5,818 615 510 10 12 (225) 6,740 (5,378) 1,362 - 1,362 2011 789 (1,095) (306) 2011 % - 4 - (1) (4) 1 (1) (1) 2011 6,452 747 14 27 11 532 7,783 (1,110) 6,673 (444) 6,229 Management assesses the available positive and negative evidence to estimate if sufﬁcient future taxable income will be generated to use the existing deferred tax assets. A signiﬁcant piece of objective negative evidence evaluated was the cumulative loss incurred in the UK bank over the three-year period ended 31 December 2012. Such objective evidence limits the ability to consider other subjective evidence such as projections for future growth. On the basis of this evaluation, as of 31 December 2012, a valuation allowance of $5.4 million has been recognised to record only the portion of the deferred tax asset that more likely than not will be realised. The amount of the deferred tax asset considered realisable, however, could be adjusted if estimates of future taxable income during the carry forward period are reduced or increased, or if objective negative evidence in the form of cumulative losses is no longer present and additional weight may be given to subjective evidence such as projections for growth. Operating loss and tax credit carry forwards The Bank has net taxable losses carry forwards related to the Bank’s international operations of approximately $23.4 million, which have an indeﬁnite life. NOTE 27: RELATED PARTY TRANSACTIONS Employee loan programme As of 17 May 2005, the Bank established a programme to offer loans with preferential rates to eligible Bank employees, subject to certain conditions set by the Bank and provided that such employees meet certain credit criteria. Loan payments are serviced by automatically debiting the employee’s chequing or savings account with the Bank. Applications for loans are handled according to the same policies as those for the Bank’s regular retail banking clients. The Bank’s ability to offer preferential rates on loans depends upon a number of factors, including market conditions, regulations and the Bank’s overall proﬁtability. The Bank has the right to change its employee loan policy at any time after notifying participants. The staff loans outstanding at 31 December 2012 amount to $225.7 million (2011: $251.9 million) resulting in an interest rate beneﬁt to employees of $6.2 million (2011: $6.5 million). Butterﬁeld Annual Report 2012 99 Interested Director transactions The Bank provides loans and other banking services to the Bank’s Directors, as well as their immediate family members and companies with whom they are afﬁliated as described in Section 96 of the Companies Act 1981, in the ordinary course of business. The Bank provides these services on normal commercial terms in respect of interest rates, repayment terms and security. During the third quarter of 2011 the Bank provided a loan to a trust company controlled by a Bank Non-Executive Director, amounting to $2.45 million. The terms of the loan are market related including comprehensive security provided. The outstanding loan was repaid during 2012. Charitable Trust The Bank historically has provided a loan facility to the Charitable Trust. During December 2012 the carrying value of the loan was repaid and subsequently the Charitable Trust was terminated. Financing transactions Capital transaction Canadian Imperial Bank of Commerce (“CIBC”) and funds associated with the Carlyle Group each hold approximately 19%, of the Bank’s equity voting power, along with the right to each designate two persons for nomination for election by the Shareholders as members of the Bank’s Board of Directors. Liquidity facility agreement During 2010, the Bank entered into a commitment letter for a $500 million line of credit at market rates with CIBC which was subsequently reduced to $300 million. The Bank cancelled the credit facility effective 1 March 2011. Financial instruments with related parties At 31 December 2012, the Bank held $125.3 million in cash and cash equivalents with CIBC. For the year ended 31 December 2012 the Bank held forward exchange contracts with CIBC with a notional amount of $284.1 million (unrealised gain of $1.0 million) and foreign currency deposit swaps with CIBC with a notional amount of $89.4 million (unrealised loss of $8.7 million). As noted in Note 16 the Bank enters into client service forward exchange contracts to meet the foreign exchange needs of its customers. Balance Sheet management advisory agreement From 1 October 2010, the Bank had retained Carlyle Investment Management LLC, an afﬁliated company of the Carlyle Group, to provide Balance Sheet management advisory services, including advisory services on valuation assignments, for an annual fee of $4 million for a three-year period. Effective 31 July 2012, the investment advisory business previously conducted by Carlyle Investment Management LLC was transferred to Alumina Investment Management LLC (“Alumina”) and the Bank agreed to the transfer of its contract to Alumina. The Carlyle Group holds a 15% interest in Alumina and as Alumina is not considered afﬁliated with the Carlyle Group, the related-party transaction ceased on the effective date. NOTE 28: COMPARATIVE INFORMATION Certain prior-year ﬁgures have been reclassiﬁed to conform to current year presentation and restated for discontinued operations. NOTE 29: SUBSEQUENT EVENTS The Bank has performed an evaluation of subsequent events through to 26 February 2013. Subsequent to year end, the Board declared a special dividend of $0.04 per Common and Contingent Value Convertible Preference Share to be paid on 22 March 2013 to Shareholders of record on 5 March 2013. 100 In numbers addition brief touch essence scope balance Shareholder Information Butterﬁeld Annual Report 2012 101 Shareholder Information 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 ownership of Common Shares and Contingent Value Convertible Preference Shares of the Bank by all Directors and Executive Ofﬁcers* at 31 December 2012 was 2,617,914 Shares. In addition, this group owns 120 Non-Cumulative Perpetual Limited Voting Preference Shares. As of 31 December 2012, Executive Ofﬁcers also owned 15,600,000 stock options pursuant to the 2010 Stock Option Plan to vest in accordance with timelines established by the Plan. None of the Directors or Executive Ofﬁcers had any interest in any debt securities issued by the Bank or its subsidiaries as at 31 December 2012. There are no service contracts with Directors, except for that of Brendan McDonagh, Chairman & Chief Executive Ofﬁcer, whose contract expires on 5 April 2015. Save for the foregoing contract, and those arrangements described in Note 27 to the Bank’s 31 December 2012 Consolidated Financial Statements, there are no other contracts of signiﬁcance subsisting during or at the end of the ﬁnancial year ended 31 December 2012 in which a Director of the Bank is or was materially interested, either directly or indirectly. *As listed on pages 6 and 7 of this Annual Report. EXCHANGE LISTING The Bank’s Shares are listed on the Bermuda Stock Exchange (BSX) and the Cayman Islands Stock Exchange (CSX), which are located at: BERMUDA STOCK EXCHANGE (Primary Listing) 30 Victoria Street Hamilton, HM 12 P.O. Box HM 1369 Hamilton HM FX Bermuda Tel: (441) 292 7212 Fax: (441) 292 7619 www.bsx.com CAYMAN ISLANDS STOCK EXCHANGE (Secondary Listing) Elizabethan Square, 4th Floor P.O. Box 2408 George Town, Grand Cayman KY1-1105 Cayman Islands Tel: (345) 945 6060 Fax: (345) 945 6061 www.csx.com.ky SHARE DEALING SERVICE Butterﬁeld Securities (Bermuda) Limited 65 Front Street Hamilton, HM 12 Bermuda Tel: (441) 299 3972 Fax: (441) 292 9947 E-mail: info@butterﬁeldgroup.com 102 102 SHARE PRICE Published daily in The Royal Gazette in Bermuda and available on Bloomberg Financial Markets (symbol: NTB BH). Also available on the BSX website. REGISTRAR AND TRANSFER AGENT Butterﬁeld Fulcrum Group (Bermuda) Limited 26 Burnaby Street Hamilton, HM 11 Bermuda Tel: (441) 299 3882 Fax: (441) 295 6759 E-mail: bntbshareholders@bfgl.com MEDIA RELATIONS / PUBLICATION REQUESTS Vice President, Communications, Brand & Public Affairs Tel: (441) 299 1624 E-mail: mark.johnson@butterﬁeldgroup.com INVESTOR RELATIONS Senior Vice President, Finance Tel: (441) 298 4758 E-mail: john.maragliano@butterﬁeldgroup.com WRITTEN NOTICE OF SHARE REPURCHASE PROGRAMME — BSX REGULATION 6.38 The Bank introduced a Share Buy-Back Programme on 1 May 2012. Under this Programme, the Board of Directors authorised the repurchase of up to six million Common Shares and 2,000 Preference Shares. On 10 December 2012, the Board approved an increase in the number of Common Shares available for buy-back to 10 million, and the number of Preference Shares to 8,000. During 2012, the Bank bought back 7.3 million Common Shares to be held as Treasury Shares at a cost of $9 million, and 4,422 Preference Shares, which were subsequently cancelled, at a cost of $5.4 million. From time to time, the Bank’s associates, insiders and insider’s 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 than the last independent trade for a “round lot” deﬁned as 100 Shares or more. 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. No Shares were purchased by the Bank’s Stock Option Trust in the 12 months to 31 December 2012. The Bank will continue to advise the BSX monthly of Shares repurchased and cancelled by the Bank and Shares purchased by the Bank’s Stock Option Trust. LARGE SHAREHOLDERS As at 31 December 2012, the following were registered holders of 5% or more of the issued Share capital:* Carlyle Global Financial Services Partners LP, 19.34% Canadian Imperial Bank of Commerce, 18.81% Wellcome Trust Investments, 6.94% Ithan Creek Master Investor (Cayman) LP, 6.77% Rosebowl Western, 6.77% *Includes Common and Contingent Value Convertible Preference Shares and excludes Treasury Shares held. PRINCIPAL OFFICES & SUBSIDIARIES This list does not include all companies in the Group. The Bank of N.T. Butterﬁeld & Son Limited Group Parent Company, Community Banking, Corporate Banking, Private Banking, Credit and Treasury Services Head Ofﬁce 65 Front Street Hamilton, HM 12 Bermuda Tel: (441) 295 1111 Fax: (441) 292 4365 SWIFT: BNTB BM HM E-mail: info@butterﬁeldgroup.com Mailing Address: P.O. Box HM 195 Hamilton, HM AX Bermuda BERMUDA Country Head: Michael Collins, Senior Executive Vice President Butterﬁeld Asset Management Limited Investment Management Managing Director: Michael Neff 65 Front Street Hamilton, HM 12 Bermuda Tel: (441) 299 3817 Fax: (441) 292 9947 E-mail: info@butterﬁeldgroup.com Butterﬁeld Securities (Bermuda) Limited Brokerage Services 65 Front Street Hamilton, HM 12 Bermuda Tel: (441) 299 3972 Fax: (441) 292 9947 E-mail: info@butterﬁeldgroup.com Butterﬁeld Trust (Bermuda) Limited Grosvenor Trust Company Limited Trust & Fiduciary Services Managing Director: Martin Pollock 65 Front Street Hamilton, HM 12 Bermuda Tel: (441) 299 3980 Fax: (441) 292 1258 E-mail: info@butterﬁeldgroup.com THE BAHAMAS Butterﬁeld Trust (Bahamas) Limited Trust & Fiduciary Services Managing Director: Julien Martel 3rd Floor, Montague Sterling Centre, East Bay Street P.O. Box N-3242 Nassau, N.P. The Bahamas Tel: (242) 393 8622 Fax: (242) 393 3772 E-mail: bahamas@butterﬁeldgroup.com CAYMAN ISLANDS Butterﬁeld Bank (Cayman) Limited Community Banking, Corporate Banking, Private Banking, Asset Management Managing Director: Conor O’Dea Butterﬁeld House 68 Fort Street P.O. Box 705 Grand Cayman KY1-1107 Cayman Islands Tel: (345) 949 7055 Fax: (345) 949 7004 E-mail: cayman@butterﬁeldgroup.com Butterﬁeld Trust (Cayman) Limited Trust & Fiduciary Services Managing Director: Brian Balleine Butterﬁeld House 68 Fort Street P.O. Box 705 Grand Cayman KY1-1107 Cayman Islands Tel: (345) 949 7055 Fax: (345) 949 7004 E-mail: trust.cayman@butterﬁeldgroup.com Butterﬁeld Annual Report 2012 103 GUERNSEY Butterﬁeld Bank (Guernsey) Limited Private Client and Institutional Banking, Credit, Investment Management, Custody and Custodian Trustee Services, Administered Banking Managing Director: John Robinson P.O. Box 25 Regency Court Glategny Esplanade St Peter Port Guernsey GY1 3AP Channel Islands Tel: (44) 1481 711 521 Fax: (44) 1481 714 533 E-mail: guernsey@butterﬁeldgroup.com Butterﬁeld Trust (Guernsey) Limited Trust & Fiduciary Services Managing Director: Paul Hodgson P.O. Box 25 Regency Court Glategny Esplanade St Peter Port Guernsey GY1 3AP Channel Islands Tel: (44) 1481 711 521 Fax: (44) 1481 728 665 E-mail: guernsey@butterﬁeldgroup.com SWITZERLAND Butterﬁeld Trust (Switzerland) Limited Trust & Fiduciary Services Managing Director: Jim Parker Boulevard des Tranchées 16 1206 Geneva Switzerland Tel: (41) 22 839 0000 Fax: (41) 22 839 0099 E-mail: switzerland@butterﬁeldgroup.com UNITED KINGDOM Butterﬁeld Bank (UK) Limited Private Banking, Asset Management, Credit and Treasury Services Managing Director: Raymond Sykes 99 Gresham Street London, EC2V 7NG United Kingdom Tel: (44) 207 776 6700 Fax: (44) 207 776 6701 E-mail: uk@butterﬁeldgroup.com 104

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