Quarterly Banking Digest

HIGHLIGHTS

Q4 2011

Capitalisation continues to be high. The aggregate risk asset ratio of Bermuda banks remained flat at 23.2% during the quarter as lower risk-weighted assets (down by 3.8%) offset an increase in leverage. Balance sheets have returned to positive growth. Total assets rose by 6.0% for the quarter resulting from increases in investment activity (up 38.1% during the last quarter and 42.2% year-on-year), which is mainly funded by increases in demand deposits (up 17.9%). Although customer deposits increased during the quarter, the funding gap in Bermuda dollars has widened. The BD$ loan-to-deposit ratio increased to 149.5% (up from 145.8% in Q3 and 139.7% a year earlier) due to a higher FX share (84.3%) of total deposits (up from 82.9% in Q3 2011) as a result of a surge in USD demand deposits (up by 30.1%) and declines in FX time deposits (down 11.2%). Investment exposure to sovereign debt more than doubled. Investments held with banks declined to 34.8% (Q3 2011: 49.2%) while highly-rated sovereign investments increased to 42.3% (Q3 2011: 19.0%). Quarterly loan activity has slowed. Loans and advances decreased in Q4 2011 by 0.6%, as USD lending declined by 3.8%, offset by marginal increases in BD$ and FX$ lending (up 1.0% and 0.4%, respectively). Table I: Selected Indicators (continued)
(Ratios in percentages)
Profitability Interest margin to interest income Return on assets Return on equity Loan Book Provisions to nonperforming loans (NPLs) NPLs to total loans NPLs to capital Other BD$ money supply growth Asset growth rate Change in RWA
29.0 41.8 36.0 45.1 38.8 42.3* 34.5 44.5* 37.1 44.0 -1.6 6.0 -3.8 7.3 84.3 -1.5 -0.9 -2.5 -0.8 82.9 0.2* 4.4* 0.3 4.9* 82.8* -0.8 -0.3 -0.6 0.5 80.9 -1.2 4.9 -2.1 5.4 81.7

Selected Indicators Table I below is a summary of selected indicators, including capital, earnings and asset quality. Table I: Selected Indicators
(Ratios in percentages)
Capital Position Risk Asset Ratio (RAR) Asset to regulatory capital (multiple) Equity to total assets Liquidity Cash/cash equivalents to total deposits liabilities Loans to total deposit liabilities
*restated numbers 23.2 10.6 10.8 23.2 9.6 11.9 21.8 10.1 12.0 21.2 9.9 12.3 25.6 8.2 12.4

Dec
86.2 0.7 5.8

Sep
85.8 0.7 6.2

2011 Jun
86.5* 1.1 8.8

Mar
84.2 1.1 8.8

2010 Dec
83.6 0.6 4.5

Dec

2011 Sep Jun

Mar

2010 Dec

18.4 7.0 26.7

19.8 6.8 25.1

19.2 6.7 24.7*

20.8 5.4 20.5

18.8 5.7 17.2

*restated numbers

Customer deposits growth rate FX denominated deposits to total deposits

All figures in this report are reported at the consolidated level and simple sector averages unless otherwise stated.

BALANCE SHEET Aggregate Balance Sheet

Table II below provides a balance sheet summary showing recent trends in the sector. Table II: Aggregate Balance Sheet Condition
(BD$ billions) Dec
Assets Cash Deposits Loans & advances Investments Other assets Total assets Liabilities Savings deposits Demand deposits Time deposits Total deposits Other liabilities Total liabilities 5.3 10.2 6.6 22.0 0.5 22.5 5.1 8.6 6.8 20.5 0.4 21.0 5.3 8.9 6.5* 20.7* 0.4 21.1* 4.9 8.1 6.6* 19.6* 0.4 20.0* 4.8 8.1 6.7 19.6 0.5 20.2 2.6% 17.9% -2.9% 7.3% 15.6% 7.4% -3.9% 6.0% 9.1% 25.5% -1.8% 12.2% -7.6% 11.7% -5.6% 9.3% 0.1 6.3 9.2 9.1 0.9 25.5 0.1 7.3 9.3 6.6 0.9 24.1 0.1 8.0 8.7* 6.5 1.0 24.3* 0.1 6.7 8.7* 6.6 1.1 23.1* 0.1 7.2 8.6 6.4 1.1 23.4 18.7% -13.8% -0.6% 38.1% -2.1% 6.0% -0.2% -12.5% 6.7% 42.2% -18.9% 9.3%

Summary of Balance Sheet Ratios

Table III provides a summary of balance sheet ratios measuring asset quality and capital. Table III: Summary Balance Sheet Ratios
Change QoQ YoY (Ratios in percentages unless indicated otherwise)
Asset allocation Investments Loans Deposits Deposits allocation Savings Demand Time Capital position Risk Asset Ratio 23.2 23.2 21.8 21.2 12.3 9.9 25.6 12.4 8.2 Equity to total 10.8 11.9 12.0 assets Asset to regulatory capital 10.6 9.6 10.1 (multiple) Loan book NPLs to total 7.0 6.8 6.7 loans Provisions to 18.4 19.8 19.2 NPLs Provisions to total 1.3 1.4 1.3 loans Totals may not add due to rounding. *restated numbers 23.8 46.3 29.8 24.9 42.1 33.0 25.7* 42.9* 31.4* 25.1* 41.2* 33.8* 24.5 41.4 34.1

2011 Sep Jun Mar

201 0 Dec

2011 Dec
35.5 36.1 24.7

2010 Jun Mar

28.6* 37.6* 28.8*

Sep
27.3 38.4 30.3

Dec
27.3 36.9 30.8

26.9* 36.0* 32.6*

5.4 20.8 1.1

5.7 18.8 1.1

Equity and subordinated 3.0 3.1 3.2 3.1 3.2 debt Total liabilities 25.5 24.1 24.3* 23.1 23.4 and equity Totals may not add due to rounding. *restated numbers

The proportion of assets allocated to investments continues to rise, up 35.5% in Q4 2011 from 27.3% in Q3 2011. Deposits with other financial institutions, as a percentage of total assets, continue to decline and are at their lowest level since end-Q3 2009. Provisions decreased by 5.5% in Q4 2011 while NPLs increased by 2.1%. As a result, there was a decrease in the overall ratio of provisions to NPLs to 18.4% in Q4 2011 from 19.8% in Q3 2011. NPLs to total loans have steadily increased throughout the year, but have remained fairly flat since Q2 2011.

Total assets increased by 6.0% during the quarter and 9.3% year-on-year. The quarterly balance sheet growth was influenced primarily by the investment activity, which has risen by 38.1% and 42.2% year-on-year. Total customer deposits rose during the quarter by 7.3% and 12.2% year-on-year, respectively. The quarterly change is driven by higher USD demand deposits (up 30.1%), which was partly offset by lower FX time deposits (down 11.2%). USD demand deposits continue to show quarterly growth, particularly when compared to a year earlier (up 49.7%). Deposits with other financial institutions declined by 13.8% during the quarter and 12.5% year-on-year.

Capital Adequacy
Chart I below shows the movement in the risk asset ratio and the ratio of equity to total assets for the last eight quarters. Chart I: Risk Asset Ratios and Proportion of Equity to Total Assets

Table IV: Quality of the Loan Book

(Ratios in percentages) Loans and advances quarter-over-quarter growth rate Dec
-0.6

Sep
5.9

2011 Jun
0.6*

Mar
0.7*

2010 Dec
2.5

Mortgages on residential property to total loans BD$ denominated loans to total loans Non-performing loans NPLs to total loans NPLs to capital Net charge-offs to loans (annualised) Provisioning practices Provisions to NPLs Provisions to total loans
*restated numbers

51.2 56.1

50.5 55.3

52.2* 57.9*

52.2 * 58.5 * 5.4 20.5 0.3

51.9 58.2

7.0 26.7 0.6

6.8 25.1 0.8

6.7 24.7 0.8

5.7 17.2 1.1

Total assets rose during the quarter from BD$24.1 billion to BD$25.5billion and BD$23.4billion year-onyear. The aggregate risk asset ratio remains flat at 23.2% in Q4 2011, which continues to be fairly high when compared to international standards. The leverage ratio (equity to total assets) declined from 11.9% to 10.8% as total assets grew (up 6.0%) compared to the decline in shareholders equity (down 4.2%)

18.4 1.3

19.8 1.4

19.2 1.3

20.8 1.1

18.8 1.1

Sectoral Distribution of Loans Chart II below shows the sectoral distribution of loans as of end-December 2011. Chart II: Sectoral Distribution of Loans and Advances

Asset Quality
Loan Book Table IV is a summary of ratios measuring the composition and quality of the loan book for the last five quarters The proportion of performing loans to total loans declined slightly during the quarter from 93.2% to 93.0%. Net charge-offs amounted to 0.6% of total loans which declined during the quarter. BD$ denominated loans to total loans increased for the first time since end-2010 (from 55.3% to 56.1%) but was accompanied by a relative decline of BD$ deposits, which led to a greater funding gap in BD$. Trend Chart I - Sectoral distribution of Loans and Advances

The real estate-related loans continue to dominate the loan book, reported at 62.5% (Q3 2011: 61.7%) of total loans and advances in Q4 2011. 3

Other loans and advances show continued growth from 20.0% to 22.3% in Q4, while other business and services decreased from 11.2% to 7.2% of total loans and advances.

Chart IV: Total Loans and Customer Deposits

Investment Book
Chart III below shows the structure of the aggregate investment book as of end-December 2011. Chart III: Sectoral structure of the Investment Book Total customer deposit liabilities increased from BD$20.5 billion to BD$22.0 billion (up 7.3 %) in Q4, driven mainly by the increase in demand deposits (17.9%). The combination of a large increase in USD demand deposits (up 30.1%) amid declining credit supply (down 0.6%) has resulted in the loan-to-deposit ratio decreasing from 45.1% to 41.8%.

*includes other investments and subsidiaries and associated companies

Sovereign exposures have more than quadrupled since end-2010. Over the last year, the investment portfolio structure has shown noticeable movement towards sovereign debt instruments. Investments held with banks continue to decline (down from 49.2% in Q3 2011 to 34.8% in Q4 2011), while investments in highly-rated sovereign debt grows (up from 19.0% to 42.3%).

PROFIT AND LOSS

Table VI below is a summary of profitability ratios for the sector for the last five quarters. Table VI: Summary of Profitability Ratios
(Ratios in percentage)
Interest margin to total income Interest margin to interest expense (multiple) Interest income to earning assets Banking income to total income Non-interest expenses to total income Personnel expenses to non-interest expenses Return on assets (RoA) Return on equity (RoE) Dec
63.7 6.26 2.6 80.4 74.5 52.3 0.7 5.8

2011 Sep Jun

57.4* 6.39 2.9 71.3 66.1 57.8 1.1 8.8

Mar
54.6 5.32 2.7 70.6 69.1 56.9 1.1 8.8

2010 Dec
54.6 5.11 2.6 70.2 75.6 54.3 0.6 4.5

76.1 6.03 2.7 95.1 65.8* 55.8* 0.7 6.1*

Liquidity
Table V is a summary of ratios measuring the liquidity of the aggregate bank balance sheet for the last five quarters Table V: Liquidity Indicators
(Ratios in percentages) Dec
25.0 29.0

2011 Sep Jun

30.6 36.0 33.0 38.8

Mar
29.2 34.5

2010 Dec
31.2 37.1

Cash and deposits to total assets Cash and cash equivalents to total deposit liabilities Loans to total deposit liabilities Loans to total assets
*restated numbers

*restated numbers 41.8 36.1 45.1 38.4 42.3 36.0 44.5 37.6 44.0 36.9

Margin Analysis
The interest margin to total income decreased to 63.7% in Q4 2011, down from 76.1% in Q3 2011, while non-interest expenses to total income increased from 65.5% to 74.5%. Both movements are attributed to the reduction in non-banking income from the prior quarter.

No institution breached the minimum liquidity standards. Cash and cash equivalents to total deposit liabilities decreased from 36.0% to 29.0% in Q4 2011, driven by a decline in cash and cash equivalents (down 13.5%) and an increase of total customer deposit liabilities (up 7.3%) . Chart IV below shows the changes in total loans, customer deposits and the loan-to-deposit ratio (for both BD$ and FX) over the last five quarters.

Profitability Ratios
Chart V below shows the trend in both the return on assets and return on equity over the last five quarters. Chart V: Annualised Return on Assets and Return on Equity

Chart VII: Net Annualised Charge-offs and Proportion of Charge-offs to Loans

Total income declined during the quarter, which led to a decrease of RoE to 5.8% (Q3 2011: 6.1%) as a result of a very slight decline in RoA at 0.7% (Q3 2011: 0.7%).

The net profit and loss charge for bad debt (provisions) in Q4 2011 totalled BD$13.4m, which is $4.9m less than the previous quarter (BD$18.3m) and BD$24.3m year-on-year for the sector. The annualised proportion of net charge-off to total loans declined to 0.6% for Q4 2011 compared to 0.8% in Q3 2011

Distribution of Income Sources

Chart VI below shows the distribution of income sources as of end-2011. Chart VI: Distribution of Income Sources

Foreign Currency Position

Table VII below shows the foreign currency position for the sector for the last five quarters. Table VII: Foreign Currency Position
(Ratios in percentage)
FX denominated assets to total assets FX denominated loans to total loans FX denominated deposits to total deposits Changes in FX assets Changes in FX loans and advances Changes in FX customer deposits* Dec
77.0 43.9 84.3 7.3 -2.4 9.1

Sep

2011 Jun**
76.5 42.1 82.8 7.4 2.1 7.4

Mar**
75.0 41.5 81.7 -2.1 0.1 -0.5

2010 Dec
75.7 41.8 81.7 6.5 5.4 7.0

76.1 44.7 82.9 -1.5 12.5 -0.6

Net interest income dropped and contributed only 63.7% (Q3 2011: 76.1%) of total income while the remainder was due to other banking income and non-banking income, with the latter having increased significantly from 4.9% in Q3 2011 to 19.6%.

* The percentage change is based on absolute numbers. **Restated numbers

Net Profit and Loss Charge for Loan Provisions

Chart VII shows the trend in the net charge-offs for bad and doubtful loans and net charge-off as a proportion of total loans over the last five quarters.

Foreign currency lending declined in Q4 2011, but still remains higher year-on-year. FX denominated total loans declined by 2.4% during the quarter, when compared to the FX lending growth experienced over the last four quarters. FX-denominated deposits to total deposits increased from 82.9% to 84.3%, which is driven mainly by the increase in FX-denominated demand deposits (up 19.9%) US dollar assets made up 52.2% (Q3 2011: 47.6%) of total assets for the sector, representing approximately two-thirds of foreign currency-denominated exposures.

Bermuda Dollar-Denominated Balance Sheet

Table VIII below shows the Bermuda dollar balance sheet for the sector for the last five quarters. Total Bermuda dollar assets, loans and deposit liabilities remained flat quarter-on-quarter.
2011 Sep Jun
5.1 5.8 3.5 2.1

Monetary Aggregates
Table IX shows the trend in the domestic money supply over the last five quarters. Table IX: Bermuda Money Supply (Unconsolidated)
2011 (BD$ millions) Notes and coins in circulation* Deposit liabilities Banks and deposit companies Less: Cash at banks and deposit companies Bermuda dollar money supply % Growth on previous period % Growth year-onyear Dec
133 3,521 3,654 67 3,587 -1.60 -3.62

2010 Dec
127 3,660 3,787 65 3,722 -1.22 -4.73

Table VIII: Bermuda Dollar Balance Sheet Position

(BD$ billions) Loans and advances Total assets Deposit liabilities Equity and subordinated debt Dec
5.2 5.9 3.5 2.0

Sep
120 3,582 3,702 56 3,646 -1.46 -3.25

Jun
121 3,641 3,762 62 3,700 0.18 -2.13

Mar
118 3,637 3,755 62 3,693 -0.78 -3.17

Mar
5.1* 5.8* 3.6* 2.0

2010 Dec
5.0 5.7 3.6 2.1

Change (%) QoQ YoY

1.0 1.8 -1.6 -4.3 2.9 3.4 -3.9 -6.5

5.1* 5.7* 3.6* 2.1

*restated numbers

Chart VIII shows the movement in Bermuda dollardenominated loans and customer deposits, and the ratio of Bermuda dollar-denominated loans to customer deposits for the last five quarters. Chart VIII: Bermuda Dollar Loans and Customer Deposits

* The table includes the supply of Bermuda dollars only.

The BD$ money supply decreased 1.6% during the quarter and 3.6% year-on-year as it continues to show quarter-on-quarter declines, resulting from decreasing BD$ customer deposits.

The Bermuda dollar loan-to-deposit ratio increased to 149.5% (up from 145.8% in Q3 and 139.7% a year earlier, respectively). This is attributed to the decline in BD$ customer deposits (down 1.5%) as compared to BD$ total loans (up 1.0%). The funding gap between BD$-denominated loans and BD$ customer deposits continues to widen, which is offset by growing FX denominated deposits.

SELECT INTERNATIONAL DEVELOPMENTS This section lists important publications by international organisations and national authorities during the last quarter, as they contribute to shaping international regulatory and financial trends. This section does not reflect the views of the BMA. Bank for International Settlements (BIS) In January, the BIS issued its working paper (WP), Stresstesting macro stress testing: does it live up to expectations? The WP examines the state of macro stress testing and assesses the strengths and weaknesses of the tool. http://www.bis.org/publ/work369.pdf BIS along with the Centre for Advanced Financial Research and Learning (CAFRAL) organised an international conference forum for central banks and regulators with the focus on Financial sector regulation for growth, equity and stability in post-crisis world. The topics discussed at the forum focused on understanding the complex interactions between the financial system and the real economy. http://www.bis.org/publ/bppdf/bispap62.pdf In December, the Basel Committee on Banking Supervision (BCBS) published its responses to the Basel III definition of capital Frequently asked questions. The publication provides answers and interpretative guidance to their 16th December 2010 publication of the Basel III regulatory frameworks for capital and liquidity and the 13th January 2011 press release on the loss absorbency of capital at the point of non-viability. http://www.bis.org/publ/bcbs211.pdf The BIS and the Bank of Korea (BoK) jointly organised a conference with the aim of discussing macroprudential regulation and policy. Twelve papers were selected for discussion by BIS and Bok focusing on the following four themes: (i) systemic risk; (ii) financial system procyclicality; (iii) macroeconomic impact studies and early warning indicators; and (iv) effective implementation of macroprudential policy. http://www.bis.org/publ/bppdf/bispap60.pdf The BIS released its Quarterly Review for December, entitled, International banking and financial market developments. The review looks at concerns about sovereign risk in the euro area affecting financial markets across the globe. http://www.bis.org/publ/qtrpdf/r_qt1112.pdf The BCBS published its consultative paper (CP) Definition of capital disclosure requirements outlining the requirements that aim to improve the transparency and comparability of a bank's capital base. http://www.bis.org/publ/bcbs212.pdf The Joint Forum published its CP, Principles for the supervision of financial conglomerates Consultative Report, which provides national authorities, standard setters and supervisors with a set of internationallyagreed principles that support consistent and effective supervision of financial conglomerates and in particular those financial conglomerates that are active across borders. The proposed principles are organised into five sections and expand on and supplement the 1999 Principles in a number of ways: Supervisory powers and authority; supervisory responsibility; corporate governance; capital adequacy and liquidity; risk management. http://www.bis.org/publ/joint27.pdf The BCBS published its CP, Core principles for effective banking supervision, which updates BCBSs 2006 Core principles for effective banking supervision and the associated Core principles methodology. The paper takes into account significant developments in the global financial markets and regulatory landscape since October 2006, including post-crisis lessons for promoting sound supervisory systems. http://www.bis.org/publ/bcbs213.pdf

Glossary
Adjusted return on assets is the return on assets computed using net income excluding extraordinary items. Adjusted return on equity is the return on equity computed using net income excluding extraordinary items. Annualised is expressing (a quantity such as an interest rate, profit, expenditure etc.) as if it applied or were measured over one year. Earning assets includes deposits with other financial institutions, loans, advances and leases, and investments. Equity refers to the shareholders equity. Fees and commissions consist of net income from banking fees, charges and commissions, investment management fees, trust and company administration fees, trustee and custodian fees, and fund management fees. Foreign currency is any currency other than the Bermuda dollar. General provisions are provisions not attributed to specific assets but to the amount of losses that experience suggests may be in a portfolio of loans. Interest expenses to customer deposits is computed by dividing the annualised interest paid and payable by the average total customer deposit liabilities. Interest income to earning assets is computed by dividing the annualised interest received and receivable by the average total earning assets. Interest income includes interest received and receivable, and consists of interest from deposits with financial institutions, government securities, loans and other interest earning assets. Interest margin is calculated as interest received or receivable less interest paid or payable. Leverage is calculated as shareholders equity divided by total assets. Mortgages refer to financing for land and buildings for purchasing real estate estate/residential property. Net charge-offs for bad and doubtful loans is the sum of general and specific profit and loss charge for doubtful debts and transfers made to suspended interest account (net of recoveries). Net income is derived by netting off provision for taxation from gross profit, and takes into account extraordinary items. Non-interest income includes all other income received by the bank. Included are fees and commissions from provision of services, gains and losses on financial instruments, and other income. Non-interest expenses cover all expenses other than interest expenses, including fees and commissions. Non-Performing Loans (NPLs) consist of those loans classified as substandard, doubtful and loss as per the BMA guidance on the completion of the prudential information return for banks. A loan is classified as substandard when the delay in repayment is between 31 and 90 days, as doubtful when the delay is between 91 and 180 days and as loss when the delay exceeds 180 days. Other income consists of changes in the book value of investments, other non-banking services income, profit or loss on fixed assets and any other income that cannot be classified into any other specific income line item. Other operating expenses consist of services by external service providers and other operating expenses. Provisions include both specific and general provisions. Real estate is used to refer to lending to real estate operators, and owners and lessors of real property, as well as buyers, sellers, developers, agents and brokers. Regulatory capital is the total (net) capital as provided by the banks in their quarterly prudential information returns. It is the sum of Tier 1 and Tier 2 capital less total capital deductions. Regulatory capital to total assets is derived by dividing the regulatory capital by the total assets as provided in the prudential information returns. Return on assets is calculated by dividing the net income by the average value of total assets over the same period. The average assets are obtained by averaging the total assets at the beginning and at the end of the quarter. Return on equity is calculated by dividing net income by average value of shareholders equity over the same period. average shareholders equity is obtained by averaging shareholders equity at the beginning and at the end of quarter. the The the the

Risk Asset Ratio is calculated as total (net) regulatory capital divided by total risk-weighted assets. Risk-weighted assets (RWAs) refer to a concept developed by the Basel Committee on Banking Supervision (BCBS) for the capital adequacy ratio. Assets are weighted by factors representing their riskiness and potential for default. Specific provisions are the outstanding amount of provisions made against the value of individual loans, collectively assessed groups of loans and loans to other deposit takers. Tier 1 capital consists of ordinary shares, perpetual noncumulative preference shares, reserves verified by the auditors, current years losses and minority interest (in Tier 1) adjusted for goodwill and other intangibles, and securitisation but before capital deductions. Total income is the sum of net interest income and non-interest income. Total loans include loans, advances, bills and finance leases. Total risk-weighted assets (TRWA) is the sum of total credit risk weighted assets, total operational risk adjusted RWA and the total market risk adjusted RWA. Note: Refer to the Guidance on Completion of the Prudential Information Return for Banks for a detailed description of the individual components of specific line items.