Butterfield Bank is expected to make significant markdowns in its "held to maturity" portfolio by the end of this year due to a widening in credit spreads and the further deterioration of the US housing market, according to a new equity research report released by LOM.

The size of the bank's loss provisions could be negatively affected by new, more rigorous accounting standards in the face of increased scrutiny regarding the conventional valuation methods of mortgage-related and asset-backed securities, it said.

And depending on the institution and adoption of such rules, LOM estimates more impairment to Butterfield Bank's "held to maturity" investment book of up to $100 million.

As of year-end 2007, the bank held $1.46 billion (at cost) in CMO (collateralised mortgage obligations) and (primarily) ABS (asset-backed securities) investments, representing a year-on-year net increase of $959 million, or 191 percent.

The majority of these holdings (89 percent of CMOs and 75 percent of ABS) are long-term in nature (over five-year term-to maturity).

Gross unrealised losses on the bank's "held to maturity" portfolio totaled $165 million at the end of last year, with the complexity of most CMO and ABS securities and the lack of a liquid market making them difficult to value.

NTB shares have fallen by more than 22 percent from late summer 2007 to the present date and while LOM believes the bank's core operations are in good shape, it finds this fall in price to be reasonable, given the malaise of the global financial sector combined with the problems associated with the bank's investment portfolio. Butterfield Bank Group shares are rated as a "hold".

Butterfield Bank ceased any further purchase of asset-backed securities in the first half of 2007.

However it did report an unrealised loss of $6.25 million related to credit derivatives held in a money-market fund. This problem appeared relatively minor and was financially subsidised by the bank to protect client interests.

During 2007, the bank made the unfortunate misstep of investing almost $1 billion in CMO's and ABS, according to LOM. The majority of these new holdings had a term-to-maturity of "over five years".

While these assets were likely seen as "investment grade" or of sufficient credit-quality upon purchase, they proved to be significantly impaired by fiscal year-end due to the deterioration in the US housing market and the subsequent "credit crunch". Butterfield Bank intends to hold these investments until maturity, and "expects the recovery of all amounts due".

LOM found that there were still distinct differences between the bank's predominantly "offshore" operating environments and those of its "onshore" peers: its earnings and revenue growth has traditionally derived from leading market positions in Bermuda, the Cayman Islands, and Guernsey.

But lately, the UK, Barbados, and Bahamas operations have shown robust growth in a range of categories, and ventures into Hong Kong, Malta and Switzerland could be poised for similar future successes.

With its strong brand name and capital strength, LOM reckons, the bank should be able to successfully expand into these proven financial markets.