M&T Bank Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 19, 2022

There are 9 speakers on the call.

Operator

Welcome to the M&T Bank Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen only mode. Following management's prepared remarks, the call will be open for questions. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Brian Clough, Head of Markets and Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, Gretchen, and good morning. I'd like to thank everyone for participating in Amity's Q2 2022 earnings conference call, both by telephone and through the webcast. If you have not read the earnings release we issued this morning, you may access it Along with the financial tables and schedules from our website, www.mtb.com, And by clicking on the Investor Relations link and then on the Events and Presentations link. Also before we start, I'd like to mention that today's presentation may contain forward looking information. Cautionary statements about this information As well as reconciliations of non GAAP financial measures are included in today's earnings release materials as well as our SEC filings and other investor materials.

Speaker 1

These materials are all available on our Investor Relations webpage, and we encourage participants to refer to them for a complete discussion of forward looking statements And risk factors. These statements speak only as of the date made and M and T undertakes no obligation to update them. Now, I'd like to turn the call over to our Chief Financial Officer, Darren Kang.

Speaker 2

Thank you, Brian, and good morning, everyone. As we reflect on the past quarter and the first half of the year, we're very pleased with our progress. The 2nd quarter results Include the impact of the Peoples United Financial Acquisition, which closed on April 1. We're excited about the momentum we have as a combined organization, especially the progress both franchises are making in preparation for the planned systems conversion later this quarter. With strong NII growth and effective expense management, M and T generated positive operating leverage As pretax, pre provision net revenue increased by more than $300,000,000 versus last quarter.

Speaker 2

We repurchased $600,000,000 of our common stock in the Q2. And yesterday, the Board of Directors authorized a new program to repurchase up to $3,000,000,000 in M and T common stock. Our balance sheet management enabled us to benefit from the changing interest rate environment, Boosting the net interest margin and allowing us to deploy excess cash into investment securities with higher yields. With more Fed hikes projected this year, we continue to add more fixed rate asset to our balance sheet and to continue Expanding our interest rate hedging program. While we're just beginning to see the positive net interest income benefit from rising rates, Those same higher rates have prompted headwinds in our mortgage banking business, both for origination volumes and for gain on sale margins.

Speaker 2

We expect these headwinds to persist. Despite the macro challenges, the unemployment rate remains low and credit quality remains strong. We're well positioned for the future and excited to continue the integration of the People's United franchise and to deploying our excess cash and excess capital. Now let's review the results for the quarter. Diluted GAAP earnings per common share For $1.08 for the Q2 of 2022 compared with $2.62 in the Q1 of 2022.

Speaker 2

Net income for the quarter was $218,000,000 compared with $362,000,000 in the linked quarter. On a GAAP basis, M and T's 2nd quarter results produced an annualized rate of return on average assets of 0.42% And an annualized return on average common equity of 3.21%. This compares with rates of 0.97 percent and 8.55 percent respectively in the previous quarter. Included in GAAP results In the recent quarter, were after tax expenses from the amortization of intangible assets amounting to $14,000,000 or $0.08 per common share. That compares to $1,000,000 or $0.01 per common share in the prior quarter.

Speaker 2

Pre tax merger related expenses of $465,000,000 related to the Peoples United acquisition We're also included in these GAAP results. These merger related expenses are comprised of the so called CECL Day 2 Double Count of $242,000,000 plus additional pre tax merger related expenses of $223,000,000 The total merger related charges translate to $346,000,000 after tax or $1.94 per common share. Consistent with our long term practice, Amity provides supplemental reporting of its results on a net operating or tangible basis, from which we only ever exclude the after tax effect of amortization of intangible assets as well as any gains or expenses associated with mergers and acquisitions. M and T's net operating income for the Q2, which excludes intangible amortization And the merger related expenses was $578,000,000 compared with $376,000,000 in the linked quarter. Diluted net operating earnings per common share were $3.10 for the recent quarter compared with $2.73 in 2022's Q1.

Speaker 2

Net operating income yielded annualized rates of return on average tangible assets An average tangible common shareholders' equity of 1.16% 14.41% for the recent quarter. The comparable returns were 1.04% 12.44% in the Q1 of 2022. In accordance with the SEC's guidelines, this morning's press release contains a reconciliation of GAAP and non GAAP results, including tangible assets and equity. As a reminder, included in the Q1's GAAP and net operating results With a $30,000,000 distribution from our investment in Bayview Lending Group, this amounted to $23,000,000 after tax effect and $0.17 per common share. We did not receive any distributions in this year's 2nd quarter.

Speaker 2

Next, let's take a little deeper dive into the underlying trends that generated these results. Taxable equivalent net interest income was $1,420,000,000 in the Q2 of 2022, an increase of $515,000,000 or 57% from the linked quarter. The linked quarter increase was due largely to the $420,000,000 net interest income contribution from People's United. This amount included $35,000,000 from purchase accounting accretion. The legacy M and T Bank net interest income Increased $95,000,000 sequentially, inclusive of the $138,000,000 impact from higher rates on interest earning assets, An $8,000,000 increase from 1 additional day in the quarter, partially offset by a $22,000,000 decline in the benefit from cash flow swaps And a $16,000,000 decrease in interest received on non accrual loans and a $9,000,000 decline in interest income and fees related to PPP loans.

Speaker 2

Net interest margin for the past quarter was 3.01%, up 36 basis points From 2.65 percent in the linked quarter. The primary driver of the increase to the margin was from higher interest rates, which we estimate boosted the margin by 26 basis points. The Peoples United Earning asset yields added 8 basis points to the net interest margin. And in addition, margin benefited from a reduced level of cash held on deposit with the Federal Reserve, which we estimate added 7 basis points. These items were partially offset By a 6 basis point decline resulting from the lower interest income recovered on non accrual loans.

Speaker 2

All other factors, including the day count, Had a negligible impact on the margin. Before we discuss the average loan balance trends for the quarter, We note there were reclassifications within the People's United Commercial Loan Portfolios. In order to be more consistent with M and T's reporting methodology, Just over $2,000,000,000 in loans that People's United had classified as C and I were reclassified into CRE loans. Compared with the Q1 of 2022, average loans outstanding increased by $35,400,000,000 or 38 percent, due primarily to the $35,500,000,000 average impact of the People's United loans. Looking at loans by category on an average basis compared with the linked quarter, commercial and industrial loans increased by 14.5 1,000,000,000 or about 62%.

Speaker 2

The average impact from the acquired People's United loans was $13,800,000,000 Legacy M and T C and I average loans increased by about $1,200,000,000 With strong growth in middle market C and I loans and average dealer floor plan balance growth of $209,000,000 This growth was partially offset by a decrease of approximately $466,000,000 in PPP loans. On an end of period basis, for the combined bank, PPP loans amounted to $351,000,000 Average commercial real estate loans increased by $12,300,000,000 or 35% compared with the 1st quarter. The average impact from the acquired Peoples United Loans was $13,100,000,000 Legacy M and T CRE average balances declined $830,000,000 during the 2nd quarter due to almost equal reductions in construction and permanent loans. We continue to reduce our construction exposure as there is a lack of new activity to offset the conversion of construction loans into permanent mortgages. There was an uptick in permanent mortgage financing in the quarter.

Speaker 2

However, it was outpaced by an elevated level of paydowns. Residential real estate loans increased by $6,900,000,000 or 43%, Due almost entirely to the average impact of the People's United loans, the legacy M and T average loan balances were essentially flat As the retention of new originations retained for investment were offset by normal runoff combined with the sale of Ginnie Mae buyouts became eligible for re pooling into new RMBS. Average consumer loans We're up $1,800,000,000 or 10 percent, again due in large part to the $1,600,000,000 average impact from the People's United loans. For legacy M and T, recreational finance loan growth continues to be a key driver of growth. Average investment securities increased by $14,700,000,000 due to the $11,200,000,000 average impact from the acquired Peoples United Securities and a $3,500,000,000 increase in legacy M and T Investment Securities.

Speaker 2

Average earning assets excluding money market placements, which is inclusive of cash on deposits at the Federal Reserve Increased $50,000,000,000 or 50 percent due largely to the $46,700,000,000 average impact of People's United And growth in legacy M and T average investment securities. After closing the acquisition, We implemented various balance sheet restructuring actions to optimize the funding base of the combined bank. These actions utilize some of the cash available and resulted in a decrease in deposits. Many of these actions occurred during the quarter, so we thought it would be more informative to look at the change In end of period cash balances, cash balances decreased by $11,800,000,000 to $33,400,000,000 at the end of June, Down from just over $45,200,000,000 on April 1. The decline was the result of several factors.

Speaker 2

These include a $2,000,000,000 increase in investment securities, a $1,500,000,000 restructuring of some Peoples United high cost deposits, notably broker deposits a $3,000,000,000 decline in escrow and mortgage warehouse Related deposits, reflecting lower levels of activity associated with the rising rate environment a $500,000,000 reduction in trust demand deposits resulting from lower levels of capital market activity compared with the Q1 and a $2,000,000,000 drop in municipal deposits. We continue to actively manage higher cost deposits and in many cases retain the customer and are able to move their balances to an off balance sheet alternative that provides the interest rate they desire. With that background, average core customer deposits, which excludes CDs over $250,000 increased by $45,000,000,000 or 36% compared with the Q1. The average impact from the Peoples United Deposits was about $49,000,000,000 Turning to non interest income. Non interest income totaled $571,000,000 in the second quarter compared with $541,000,000 in the linked quarter.

Speaker 2

The Peoples United non interest income contributed $79,000,000 While legacy M and T declined by $49,000,000 As noted, M and T received a $30,000,000 distribution from Bayview Lending Group in the 1st quarter and did not receive any distribution in the Q2 of this year. Mortgage banking revenues were $83,000,000 in the recent quarter compared with $109,000,000 in the linked quarter. Revenues from our residential mortgage business were $50,000,000 in the 2nd quarter compared with $76,000,000 in the prior quarter. Residential loans originated for sale were $77,000,000 in the recent quarter compared with $161,000,000 in the Q1. Both figures reflect our decision to retain a substantial majority of our mortgage originations For investment on our balance sheet, the primary driver of the linked quarter decline in revenue is the higher interest rate environment, which has pressured gain on sale margins for loans previously purchased from Ginnie Mae servicing pools and which became eligible for resale or re pooling.

Speaker 2

With the rapid increase in yields for new mortgage originations over the past few months, these Ginnie Mae repulled loans have fallen below new origination yields, which has driven the negative gain on sale margin. During the quarter, Residential mortgage loans were sold at a loss of $17,000,000 compared to a $14,000,000 gain on sale in the prior quarter. Commercial mortgage banking revenues were $33,000,000 in the 2nd quarter, essentially unchanged from the linked quarter. That figure was $35,000,000 in the year ago quarter. Trust income was $190,000,000 in the recent quarter and included about $14,000,000 in income from People's United.

Speaker 2

Legacy M and T Trust income increased about 4%, Due largely to about $10,000,000 from the recapture of money market fee waivers and $4,000,000 in seasonal tax preparation fees, partially offset by the impact of lower market valuations on assets under management and administration. Service fees on deposit accounts were $124,000,000 compared with $102,000,000 in the 1st quarter. People's United contributed $33,000,000 to this fee income line during the quarter. The decline Legacy M and T service charges primarily reflects the previously announced repricing of our consumer checking products. We expect foregone revenues from the program to reach a run rate of $15,000,000 per quarter during the second half of the year.

Speaker 2

Operating expenses for the Q2, which exclude the amortization of intangible assets And merger related expenses were $1,160,000,000 and included about $259,000,000 in expenses From the operations of Peoples United. Legacy M and T operating expenses were about $903,000,000 compared to $941,000,000 in the linked quarter $859,000,000 in the year ago quarter. Recall, operating expenses for the Q1 include approximately $74,000,000 of seasonally higher compensation costs. Aside from those seasonal factors that flow through salaries and benefits, legacy M and T operating expenses Increased by $36,000,000 from the Q1. This increase was due almost entirely to higher salaries and benefits costs resulting from one additional business day, a full quarter impact of merit increases and increased incentive accruals tied to improved bank performance.

Speaker 2

The efficiency ratio, which excludes intangible amortization and merger related expenses from the numerator And securities gains or losses from the denominator was 58.3% in the recent quarter compared with 64.9% in 20 22's Q1 And 58.4% in the Q2 of last year. Next, let's turn to credit. Despite the lingering challenges of the pandemic and its variance, supply chain disruption, labor shortages and persistent inflation, Credit is stable to improving. The allowance for credit losses amounted to $1,820,000,000 at the end of the second quarter, up $352,000,000 from the end of the linked quarter. The increase was due largely to the impact of the allowance related to the acquired Peoples United loan portfolio.

Speaker 2

We ran the acquired loan book through our allowance methodology and essentially confirm their allowance at closing. Applying the provisions from the CECL accounting principle, We assigned $99,000,000 of the People's United allowance to purchase credit deteriorated or PCD loans and $242,000,000 to non PCD loans. In addition, we recorded a $60,000,000 provision in the 2nd quarter. Partially offsetting these increases were net charge offs of $50,000,000 in the 2nd quarter compared to just $7,000,000 in this year's Q1. Economic indicators continue to show improvement from the prior period, but inflation remains at a historically high levels.

Speaker 2

Aside from movements in forward interest rate curves, the 2nd quarter's baseline macroeconomic forecast was relatively unchanged from the prior quarter For those indicators that have a significant impact on our CECL modeling results, including the unemployment rate, GDP growth And residential and commercial real estate values. Non accrual loans increased to $2,600,000,000 compared to $2,100,000,000 sequentially. The increase was entirely the result of the acquired Peoples United loan portfolio as non accrual loans at Legacy M and T decreased sequentially. At the end of the second quarter, Non accrual loans represented 2.1% of loans, down from 2.3% at the end of the linked quarter. When we file our Q2 10 Q in a few weeks, we expect to report an increase in criticized loans.

Speaker 2

However, the percentage of loans recognized as criticized will decrease. Similar to the trends in the non accrual portfolio, The increase in the dollar amount of criticized loans is due entirely to the acquired Peoples United portfolio. We expect a modest decline in criticized legacy M and T loans. As noted, charge offs for the recent quarter amounted to $50,000,000 Annualized net charge offs as a percentage of total loans 16 basis points for the quarter compared to 3 basis points in the Q1. Loans 90 days past due on which we continue to accrue interest For $524,000,000 at the end of the quarter, down from $777,000,000 sequentially.

Speaker 2

In total, 89% of these 90 days past due loans were guaranteed by government related entities. Turning to capital. M and T's common equity Tier 1 ratio was an estimated 10.9% compared with 11.7% at the end of the Q1. The decrease was largely due to the impact of the Peoples United acquisition And the repurchase of $600,000,000 in common shares, which represented 2% of our outstanding common stock. Tangible common equity totaled $15,300,000,000 increased 33% from the end of the prior quarter due largely to the impact of the Peoples United merger.

Speaker 2

Tangible common equity per share amounted to $85.78 per share, Down $3.55 or 4% from the end of the Q1. As previously noted, the Board of Directors authorized a new Repurchase program for up to $3,000,000,000 of common stock, which replaces the previous $800,000,000 repurchase program, under which $600,000,000 of M and T shares were purchased in the 2nd quarter. Now let's turn to the outlook. Interest rate expectations continue to be volatile and can have a material impact on our outlook for full year 2022. Similar to last quarter, the outlook that follows reflects the combined balance sheet with 3 quarters of operations from People's United as well as a more recent forward curve and is on a full year basis.

Speaker 2

First, let's talk about our outlook for the balance sheet. We continue to expect to grow the investment securities portfolio By $2,000,000,000 per quarter for the remainder of the year. However, that cadence could accelerate or slow depending on market conditions as well as customer loan demand. Now turning to the outlook for average loans. When compared to standalone M and T full year 2021, Average loan balances of $97,000,000,000 We continue to expect average loan growth for our combined franchise to be in the 24% to 26% range.

Speaker 2

However, growth may come in near the lower end of that range. Note that the updated average growth rates for C and I and CRE loans Reflect the reclassification of C and I loans into CRE loans in the former People's United loan book that we mentioned earlier. On a combined and full year average basis, we expect average C and I growth in the 37% to 39% range. We expect average CRE growth in the 17% to 19% range, Average residential mortgage growth in the 28% to 30% range and average consumer loan growth in the 10% to 12% range. As we look at the combined income statement, Hertz standalone M and T operations from 2021, We believe we're well positioned to benefit from higher rates and to manage through the macro challenges we noted earlier on this call.

Speaker 2

Our outlook for net interest income for the combined franchise is for 56% full year growth compared with the $3,800,000,000 in 2021. This reflects the forward yield curve from the beginning of the month. Given the speed of interest rate hikes by the Fed, the reactivity of deposit pricing and the deployment of excess liquidity and loan growth, The full year and net interest income could be plus or minus 2%. Turning to the fee businesses. We still expect strong trust income growth driven by new business and the recapture of money market fee waivers, but albeit lower than previous expectations as a result of the lower equity valuations from the 2nd quarter.

Speaker 2

In addition, higher interest rates are expected to continue to pressure mortgage originations and gain on sale margins. We have completed the sales of Ginnie Mae repulled mortgages and we will continue with the retention of almost all originations for the rest of the year. With this in mind, we expect the gain on sale from residential mortgages to be minimal in the second half of the year. We therefore now expect non interest income to grow in the 5% to 7% range for the full year compared to $2,200,000,000 in 2021. Next, our outlook for full year 2022 operating non interest expense is impacted by the timing of the Peoples United We continue to anticipate 24% to 26% growth in combined Operating non interest expenses when compared to the $3,600,000,000 in 2021.

Speaker 2

However, expenses are likely to be near the higher end of the range, reflecting inflationary pressures on wages and improved bank performance. As a reminder, these operating non interest expenses do not include pre tax merger related charges. We do not expect these charges to be materially different than our initial estimates. Turning to credit. We continue to expect credit losses to remain well below M and T's long term average of 33 basis points.

Speaker 2

For 2022, we conservatively estimate that net charge offs for the combined company will be in the 20 basis point range. Finally, turning to capital. We believe the current level of core capital is higher than what is needed To safely run the combined organization and to support lending in our communities, we plan to return excess capital to shareholders at a measured pace. Late in June, the Federal Reserve released the results of its stress test, also known as the DFAST. Based on these DFAST results, M and T's preliminary stress capital buffer or SCB is estimated at 4.7%.

Speaker 2

As a result, we will be subject to a 9.2 percent common equity Tier 1 ratio threshold under the SCB regulation, which is in effect from October 1, 2022 through September 30, 2023. M and T's Common Equity Tier 1 ratio of 10.9 percent at June 30 comfortably exceeds the threshold below which capital distributions could be limited by that regulation. We continue to anticipate ending 2022 with a CET1 ratio in the 10.5% range. With a solid started capital starting capital position and the potential to generate significant additional amounts of capital over the next few years, We don't anticipate a material change to our capital distribution plans. Our objective as always is to bring our CET1 ratio down gradually to a level that is near the high end of the lower quartile of our peer group.

Speaker 2

We anticipate continuing to repurchase Common shares under the new $3,000,000,000 repurchase program. So now let's open up the call to questions, before which Gretchen will briefly review the instructions.

Operator

We do ask that you limit yourself to one question and one follow-up in the interest of others. Thank you. The first question we'll take is Betsy Graseck

Speaker 3

This is Brian on for Betsy. I was wondering if you could give us an update on your rate sensitivity today Now that we're a little bit further into the rate hike cycle and assuming that the current forward curve plays out, where do you expect that to trend over time? Thanks.

Speaker 2

Sure, Brian. Good morning. Obviously, the Fed is hiking at a lot faster pace than what any of us I anticipated when we started the quarter and started the year. When we look at the mix of deposits On our balance sheet and some of the actions that we've taken this quarter to move out of some high cost funding. When we look at The next several hikes, and think about what the impact of a 25 basis point increase might be, where we look more towards 7 to 10 basis points Increase in net interest margin for each 25, that's on an annualized basis and net interest income growth In the $140,000,000 to $190,000,000 range.

Speaker 2

And looking at that, the kind of range of reactivities that We've sensitized this 15% to 35%, just kind of how we're thinking about it and what we're seeing, again, based on the mix of deposits on our portfolio.

Speaker 3

That's really helpful though. Thank you. And in light of the changes you made to some of your high cost Funding sources, I was wondering if you could just talk about your overall deposit growth expectations through year end.

Speaker 2

Well, when you look at M and T and our funding, we have one of the higher, What I would call core funding portfolios amongst our peers and amongst the banks. And so, a significant portion is in non interest bearing DDA as well as interest checking, which tend to be operational accounts. And so when we look at those accounts, whether it's consumers, small business or commercial customers, we do expect that there will be some decline as People continue to spend given the rate of inflation. But so far, the decline we've been watching has been fairly gradual. We have seen some commercial customers use some of the excess cash to pay down loans.

Speaker 2

That's part of when you see some of the loan declines. We're seeing that offset By payoffs or by them using the cash, and really the place where you start to see the most Price sensitivity in the short term, tends to be, as we mentioned earlier, in the municipal deposit space as well as in the wealth Customer space, and so we'll expect to see some movement there. And typically what happens, Brian, is There are some instances where the actual pricing goes up on interest checking or savings and money market. But generally, what happens first, Particularly in the consumer space as you start to see balances migrate towards time deposits. And so part of what we'll See, for us and we would expect for the industry is the migration towards time deposits and that Will be what kind of drives the overall beta for deposit costs, more so than any one particular category of deposits moving up in a rapid pace.

Speaker 2

And so just given the nature of our deposit base, we expect some decline, but we don't expect it to be Excessive from here. It will be maybe in the 1% to 2% range, but really not that much.

Speaker 3

Thank you.

Operator

Our next question comes from John Pancari, Evercore ISI.

Speaker 4

Good morning.

Speaker 2

Hey, John.

Speaker 4

On the just on the loan growth front, I appreciate the guide for the 24% to 20 6% on average total balances. Just want to see if you could maybe give a little color in terms of The trajectory of the commercial real estate portfolio, is it fair to assume that declines are going to continue? I know you kind of alluded to that and would it be outright declines in the balances or just a shrinking in the overall mix, but you could actually see growth there? Thanks.

Speaker 2

So looking at commercial in aggregate, I think it's important to look at the 2 in aggregate. We think they'll be relatively close to flat. The growth in C and I ex PPP We'll offset what's likely to be a decline in CRE. And when we look at the CRE balances and what's happening there, There's really 2 things going on. The first, which we've been talking about for a while, is construction loans are on the decline.

Speaker 2

And so we had back in 2018 2019, some real growth in construction lines that over the course of 2020 2021 And 2022 have been drawn down as projects have been underway. You did see a little delay In the pandemic, but projects got back on track. And as those come to completion, they'll follow their normal course where They will get converted into permanent mortgages and that often happens off of our balance sheet. And so we continue to expect some decline in construction balances. On the permanent side, as I mentioned, we have seen some payoffs from customers using cash.

Speaker 2

We haven't using their cash, their excess cash and And declining their balances, the level of activity that you typically see in the CRE space continues to be low. With rates moving, it's affecting cap rates and asset values. And so you're starting you're not seeing the turnover in properties Like you might have under normal circumstances and that will affect the pace of decline and or growth In permanent CRE. And so what we saw this quarter, if I look at loan originations in the quarter across C and I and CRE, it was actually our best post pandemic non 4th quarter, lots of qualifiers there. Increase in originations, which I thought was a very positive sign.

Speaker 2

And it was a little bit weighted towards the back end of the quarter. And so I guess to think about permanent mortgages down slightly, construction mortgages Down a little bit more over the course of the year, which probably takes in dollars, maybe $1,000,000,000 down, Call it 1%, 1% to 2%, offset by growth in C and I.

Speaker 4

Got it. Okay. Thanks, Darren. And then separately, just on the buyback front, it was good to see the new $3,000,000,000 authorization. How should we think about the pace of buybacks here?

Speaker 4

Is it fair to assume a similar pace as what you saw in The Q2 of the $600,000,000 or could you actually get some acceleration in the pace of repurchases in coming quarters?

Speaker 2

Yes, sure. The best way to think about it, John, is to think about that $600,000,000 is a good pace. It could accelerate depending on How fast rates move and what's happening with net interest income growth and capital generation. We've got 1 quarter to go through With some of the merger expenses coming through, which will affect capital, so we could move it up a little bit or down a little bit off that $600,000,000 But I think For purposes of looking forward, that's a good pace to think about.

Speaker 5

Great.

Speaker 4

All right. Thanks, Dan.

Operator

We'll take our next question from Ebrahim Poonawala from Bank of America.

Speaker 6

Good morning.

Speaker 1

Good morning.

Speaker 6

I guess, one, wanted to follow-up on the NII guide for up 56%. Just wanted to make sure, Given all the moving pieces around the balance sheet, we have this right. It implies exit 4th quarter run rate north of $1,900,000,000 Just want to make sure, Darryl, that sounds reasonable in terms of how we think about what the jumping off point is for 2023. And if you don't mind reminding us how much of purchase accounting accretion do you expect in the back half and maybe if you have an updated number for next year as well?

Speaker 2

Sure. So to answer your first question, the $1,900,000,000 run rate at the end of the year It's a good number to use. Obviously, I'll caveat that and keep in mind that that's based on the forward curve And lots of assumptions on as we mentioned about deposit betas, but I think that's a reasonable number. And then The second question, remind me again what that was. I'm sorry, I'm losing my mind already.

Speaker 6

Just in terms of how much of purchase accounting accretion is there in the numbers for

Speaker 2

Yes. Purchase accounting, the number that you saw in the Q2 that we talked about, the $35,000,000 is a good start point. I mean, obviously, over time That winds its way down. And so, as you think about 2023, think about 4 quarters of purchase accounting Accretion versus 3 this year, but kind of the $30,000,000 to $35,000,000 a quarter run rate is a good place to be there.

Speaker 6

Got it. And I guess just a separate follow-up on the CRE side. As you think about, obviously, you've talked about in the past in terms of Just thinking about how much to balance sheet versus not, and I think you had an announcement of some appointments within The CRE business a couple of days ago, I would love to hear your updated thoughts. 1, coming out of the stress test, Any surprises, anything that you think you would tweak as a function of the stress test? And then just where are we in terms of the evolution of the New strategy around CRE as you think about that business?

Speaker 2

Yes. I think the short answer is The path that we're on and our thought process around CRE hasn't changed. When we look at I guess a couple of comments on the stress test. We were pleased to see the decline in loss rates from the pandemic stress test in CRE, Down to 11% from 16%. However, if you look at even earlier stress tests, They kind of averaged around 6% or 7% for CRE.

Speaker 2

So it's still pretty elevated from that. And when we look at Our own performance over time in the CRE space, we can't get anywhere near that number. And what's really interesting is when you look over the last two years at the pandemic, that was pretty much a real live stress test On CRE, without much support from the government and the losses there were pretty minimal. And so when we think about our underwriting, We're really comfortable with the underwriting. I mean, think about our experience in the space.

Speaker 2

We think we've got a really talented group of individuals that operate there and that we can use those skill sets to continue to support our customers, and maybe use others' balance sheets, Who are actually looking for the kind of skill sets that we have in underwriting. And so there's a great match there where we can take advantage of our skill set. We can Provide funding and capital for our customers and be there for them and maybe even offer them a broader range of alternatives, and make it more capital efficient over time Where we can convert some of those loan balances and dollars into fee income, which will free up capital. And so the path that we've been on, we We feel really good about as you noted, we've added some folks. We added some folks in what we call our innovation office.

Speaker 2

We've also added A couple of players in our CRE Capital Markets area of the bank. You probably hear a little bit more about that in the coming weeks. And we slowly start to build out the team and slowly increase the mix or the percentage that ends up on balance sheet and off. Now it's still Not quite at a point where you can see it in the non interest income numbers, but that will build as we go through the rest of this year and into 2023. And so, I guess, long winded way of saying no change in the strategy, but hopefully some of that color Helps give context to why we're on the path that we're on.

Speaker 6

That's helpful. Thanks for taking my question.

Operator

Our next question comes from Matt O'Connor from Deutsche Bank.

Speaker 7

Good morning. Sorry about that. Pretty explicit expense guidance this year and obviously cost saves coming in over the next several quarters. As we think about Next year and kind of just underlying expense growth, given some of the puts and takes with inflation and there's always Some kind of expense component tied to credit, which might normalize a little bit. But just the bottom line is how do you think about

Speaker 2

But once we get through let's start with 2022 and the path that we're on. The guide that we gave It was on a net operating basis, so it excludes the merger expenses and should start to give you an idea of what the run rate might look like as we exit 2022, what I would suggest to you is as we go through the system conversion this third quarter, That's a key moment in some of the final pieces of expense reduction. And so there will be systems, contracts and decommissioning expenses that will go on and those don't happen immediately. Sometimes that takes a month or 2. There will be folks that we will retain From the acquired institution that can be systems conversion plus 30 days plus 60 plus 90.

Speaker 2

And so some of the expenses will Lead a little bit into the Q4 and maybe slightly into the first, but we should be getting towards the real run rate by the end of the Q1 should And it shouldn't be much different from where we exit the 4th. Outside of that, when you get Our philosophy about expenses and the investments that we're making, our history has always been to pay close attention To the efficiency ratio and the expenses, to make sure that the technology investments that we're making Improve productivity, which provide an expense save. And historically, we've been in the kind of 2% to 3% growth rate in expenses on a normalized basis. It might be at the higher end of that because of inflation. Sometimes you can end up at the lower end of that if Inflation is 0, but it's not something where we expect to see mid single digits numbers like we've seen over the last couple of years.

Speaker 2

I think there's some Extenuating circumstances that led us there, but over the long run, that's kind of how we expect to run the bank and we do it to achieve positive operating leverage. And over the long run, that's our goal.

Speaker 7

That's helpful. And then just following up on some of the capital questions, Kind of longer term, how much buffer do you want over the regulatory minimum? I mean, it's pretty clear you're hoping to drive down the regulatory minimum over time. Obviously, ending this year at 10.5% is a big buffer, but what's the thought on how much you'd want to hold over the regulatory minimum? Thank you.

Speaker 2

Yes, sure, Matt. I mean, when we look at our capital targets, we take into account our own internal stress Test analysis and losses under stress, as well as the insight we get from the CCAR and the stress test. And the thing to keep in mind with the SCB is every 2 years that number can change. And so we got to be careful about setting The place we want our capital ratio to be based on any 1 year's test. The other part that I think is important to keep in mind, especially with the test of the last couple of years is how the Fed models, take into account balance sheet size And what that does for expense growth in PPNR and operational risk.

Speaker 2

And so within that stress capital buffer, there's credit losses And then there's these other factors that drive that up. And so those will also change as we go through time. And so you think about the work that we're doing to deploy The cash and the securities, which will help in the next CCAR, the work we're doing on construction, lending balances and the impact that can have on Loss rates in CRE as well as just the reduction in CRE, many of the factors and things that we're focused on will are intended to help Reduce losses and PPNR negative impact in the stress test, which should help bring that capital buffer down over time. And so the 10.5 that we talked about for this year is really as we enter into January of 2023, when we'll go through the stress test again, which normally that's an off year for a Category 4 bank, But it will be the 1st year we go through on a combined basis. Now we actually think the Peoples portfolio is helpful to our losses under stress, Because they their CRE portfolio is a little more skewed towards permanent mortgages, which tend to have a higher or sorry, excuse me, a lower Loss under stress.

Speaker 2

And so that we also think will be helpful, for the SCB next year. And We've always talked about operating at the low end of the peer range in the bottom quartile, the top end of the bottom quartile in terms of CET1 ratio. Given our underwriting history and our loss history, we expect to move in that direction. But we want to get through the end of this year and through that first test On a combined basis, with some buffer and then continue to bring things down, into the range that we talked about.

Speaker 7

Okay. Thank you.

Operator

Our next question comes from Gerard Cassidy from RBC Capital Markets.

Speaker 2

Darrin. Good morning Gerard.

Speaker 3

Just sticking with capital for

Speaker 5

a minute, Obviously, your stress capital buffer this year was extraordinarily high. It didn't seem to be the right number compared to You're risking your organization. I hope it's not any retribution to one of Bob's letters back in 2016 in the annual report about the regulators. But anyway, Aside from that, can you share with us what strategies you may try to Implement to show the regulators next year when you go through the stress exam, as you just pointed out, how to bring that number down to more reasonable level?

Speaker 2

Yes, sure, Gerard. I guess just starting with the test. The thing to keep in mind is I think that the stress tests were put in place, by the Fed at a very unique time in the history of the country And some challenges that the banks were having and was put in place to give people confidence in the system and it's a good process. It's never going to be perfect. And each year, the Fed stresses certain parts of the asset base Based on what's going on in the country and the last couple of years, it's been focused on commercial real estate.

Speaker 2

And so as an organization that has historically had a concentration in commercial real estate, when that's the focus, The pain is felt a little disproportionately at banks like M and T. We as I mentioned earlier, if we look at our history Of underwriting and actual losses, we're very comfortable with the asset class, but it's clear that we're going to we can't operate with The size of portfolio relative to the peers that we have in the past. And so that's why we talk about the work we're doing To continue to support our customers, which is the most important thing that we're going to be there for them, but that we're going to think about different ways To do that, and so construction loans, our construction portfolio probably got a little big, and that will come down naturally as we've talked about. And then As we go forward, we'll look to move towards a slightly better balance of C and I and consumer loans In addition to commercial real estate. And so that should help, overall in the test, just because construction loans are one of the higher loss categories.

Speaker 2

What part of the portfolio could be stressed next year? It could be something else. It It could be C and I or it could be mortgage and that will lead to a different outcome. The other thing though that I think is important to keep in mind is As quantitative tightening happens and deposits come out of the system, that's going to reduce balance sheets. Reduce balance sheets will reduce that expense growth that I mentioned earlier In the test and we'll reduce operational losses and those will also have the effect of reducing The size of the SCB and for M and T in particular, keep in mind that when we went through the test this year, We had the highest level of cash on our balance sheet of anyone in the system.

Speaker 2

And in the test, the cash value at the Fed when because The test always drops Fed funds to 0, produces 0 net interest income. And so you have the benefit of the earning assets driving the expense, But not the benefit of any income that comes with them. And so as we see those balances shrink and we start to invest a little bit more in Securities and those fixed rate securities that will help generate a little bit more PPNR over the through the test. And so All of these things are pieces of the puzzle and actions that we're taking to help Improve that capital buffer and bring it down closer to where we all might expect it to be. And it will take time, but that's we're on a path.

Speaker 2

We've talked about the path we're on to bring down the capital ratios, While maintaining an appropriate cushion to where the SCB suggests we need to be and we'll continue to work on the balance sheet to help Drive that SCB number down, which will continue to give us the opportunity to Generate capital invested in growth in the franchise and if not, distribute it to shareholders in a friendly way.

Speaker 5

Very good. Thank you for the thorough answer. As a follow-up question, on credit, obviously, your Credit metrics on net charge offs are through the cycle amongst the best, if not the best of the regionals. The equity markets have Seem to have discounted the bank stocks in anticipation of rising credit losses and problems, coming from the tightening policies of the Fed. Can you share with us, are you guys seeing any evidence yet of early stage delinquency starting to creep up in certain parts of your franchise or Certain product types that there is some weakness that are developing or is it no, it's still clear All clear and maybe it's something next year that we have to anticipate.

Speaker 2

When we look at credit, if I look at the various portfolios, I start with the consumer portfolios. Consumer delinquency, whether it's in mortgage, indirect auto, rectify, credit card, home equity, Delinquency rates still are below pre pandemic levels. And when I look at the M and T portfolio in particular, We've never been a place that does subprime and the percentage of near prime customers is also very low. And the last thing we see Across all of those portfolios is LTVs are also at lows. With the increase in value of automobiles as well as home price Inflation over the last couple of years, LTVs are very low.

Speaker 2

And so, so far not a lot of delinquency and good collateral coverage. And so nothing that we're seeing signs in that in those portfolios. Within the C and I and CRE space, It's nuanced and it's a function of in C and I, what's happening with input costs for C and I customers and how Strong is their ability to pass on price increases to their end customer. And so we've seen some instances where we've moved Some credits onto our watch list where input costs have risen faster than pricing, and That's led to some decreases in debt service coverage, and so we've moved some people onto our watch list. Within the real estate portfolio, What's interesting is it's a bit of a remixing.

Speaker 2

And so we've seen a real strong improvement in hotel NOI, we're seeing people travel again. In fact, in one of the things in our expenses, I could see our travel and entertainment expense was up As an organization, I think that's a true statement for many organizations across the country, which is a positive sign for our urban hotel And we're seeing that in the numbers. And so as those get better, we're seeing some still continue to see some challenges In the healthcare sector, which is you think about assisted living, acute care, and elective surgery, there's still Some lower occupancy levels, they're up off of the pandemic lows, but they're better. And office continues to be a watch For us, as people come back to the office, again, when we look at our own staff, we're seeing more people in the office, but It's not back to pre pandemic levels, and I think that's also true across the country. So we're seeing no improved performance in retail And hotel within the real estate space and still some challenges in the healthcare and office space.

Speaker 2

And so not really a change in aggregate, but a shift in where our focus is. So I wouldn't give the all clear signal, that would be very un M and T like. We're always worried and looking for Where the next issue could be, but there's nothing that's flashing red right now that says that There's a big crisis coming in the next several quarters.

Speaker 5

And Darren, in the C and I portfolio, do you is there much leverage finance? Obviously, spreads have widened in that category in particular.

Speaker 2

We have leveraged finance in there, but it's a small percentage of the portfolio. I think on a combined basis, it's, call it, in the $2,000,000,000 of outstandings, $3,000,000,000 of commitments, maybe $2,500,000,000 to $3,500,000,000 in that space, Which given the size of the bank now, is a pretty small percentage of our total assets. And when we look at What the grading on those is, still pretty strong even with rates where they are.

Speaker 5

Great. Thank you so much.

Operator

We'll take our next question from Erika Najarian from UBS.

Speaker 8

Hi. Just one follow-up for me. Actually, a follow-up to the first question. You're expecting some declines, it sounds like, in your Four accounts given inflationary pressures. And what's interesting is pretty much all of your peers have talked about growing deposits I guess, a 2 part question.

Speaker 8

Number 1, how much more in surge deposits do you have left? I guess I'm trying to figure out how conservative the underlying deposit growth assumptions are Underneath that 56% guide for an AI.

Speaker 2

Yes. I guess as you look through the deposit portfolio, go back to the comments from before, the bulk of our deposit base What we refer to as operational accounts. And so it's where our business banking customers, our commercial customers and our consumers are running their daily lives From those accounts, there are surge balances in there. We're not seeing them run out Really in a dramatic pace. The reason we kind of went through the painstaking task of explaining all the deposit changes Was to get to this point that we're not seeing dramatic runoff in our core accounts.

Speaker 2

There is A challenge that we see for many of our consumers where the pace of inflation is running faster than the pace of wage growth, But they still have lots of deposits from the various stimulus programs and things that happened during the crisis. And so we believe that those balances will come down and but they'll come down gradually. And really the question on deposit decline is for customers who have excess balances beyond what they can use, Some will get deployed to pay down debt like we talked about with some of our commercial customers using some cash to pay down loans. And then the other thing will be How many folks will look for a rate for excess balances? And given our excess liquidity position, relative to the peers, How much do we want to pay out and for what types of customers?

Speaker 2

And so what we tend to do is we look at the depth of the relationship. And if you have a broader relationship with the bank, we would be willing to do more for you on your loan pricing or on your deposit pricing. And if you're A single service time account looking for a rate given the excess liquidity, we probably won't match some of the rates that are out there and And cash versus the peers that might cause that difference, but we're not anticipating, by any stretch, any rapid depletion of those core accounts.

Speaker 8

I understand. So just to interpret that, Darren, just making sure I'm thinking about You have so much cash that your sensitivity is greater for those that are seeking higher yield. Is that a good way to think about it?

Speaker 2

Yes. I guess I would say we will be relationship oriented And total relationship focused on the places where we will give rate for people that are seeking it and that will keep those balances on our balance sheet. And for folks that are just kind of what I would describe as renting our balance sheet, we'll be a little bit less sensitive and those balances could well run off. And we're We're in the fortunate position of being able to have that selectivity, because of the excess cash that we have.

Speaker 8

Got it. Thank you.

Operator

Our next question comes from Frank Schiraldi from Piper Sandler.

Speaker 2

Good morning, Darren. Good morning, Frank.

Speaker 4

Just wondering, I hate to beat a dead horse on the capital and the stress test side, but even if you set aside The relatively larger pre balances, it looks like M and T has assumed loan losses in the severely adverse scenario is basically Higher than the median almost across categories, despite what you pointed to and what is obviously A stronger credit history overall. Just wondering if you've been able to gather any more Color on is it a regional thing? What the Fed is sort of thinking that makes their loss assumption so much more punitive than you guys would assume?

Speaker 2

Yes. Frank, when you look under the hood, the most important thing to remember is there's no loss rate applied to any M and T portfolio by the Fed that's different from what they apply to anyone else with a similar portfolio, right? And so all of this is a function of mix. And what I think the Fed found, if I remember this correctly, over the course of the last couple of years And the difference between the pandemic test where the results came out in December 2020 versus this most recent one was that The loss rates that were being assumed in some categories, notably hotel and retail, was nuanced. And in the first test, It was a little bit more blunt that there was more trauma in that whole sector and that would lead to much lower asset values.

Speaker 2

And so you couldn't rely on the collateral. In this last test, what I think the Fed did was they were more nuanced and they could see that Suburban hotels, ones that you could drive to resort oriented hotel properties had seen increases in occupancy As people started to travel again and that led to better asset values and collateral values under stress. And where they tended to apply more was in the urban areas where it was still we still hadn't seen the recovery in Business travel and conventions and weddings in those large properties, and so the loss rates were applied there. And when you look at M and T and some of our real estate portfolio, particularly in the hotel, we obviously have New York City. We had some in Boston.

Speaker 2

We have some in Philadelphia and Washington. And so those properties at M and T would have faced a little bit more stress and that would help lead to that higher loss rate. And that seemed to be in place. I think there was still a little bit of stress on retail and some beginning on office. I think they were looking a little bit more with a little bit more scrutiny at what we consider B and C grade office Bill, thanks, and apply a little bit tougher, test to the asset values in those categories.

Speaker 2

It gives us more insight into how the Fed thinks about things, gives us More questions for us to think about it, how we consider those property types. But again, to me, the positive is When you look at even with those loss rates, in our capital levels, we were still about 300 basis points above the minimum under that stress and with the other Comments I made about impact of PPNR. And so when we look at the capital ratios of the bank, and where we sit, we feel really good. And the Fed just helped us confirm that we can withstand a pretty severe downturn in some of these asset classes and still be in great shape. And We continue to learn through the process and make the adjustments that we talked about before to the balance sheet to be as capital efficient as we can be.

Speaker 4

Great. Thanks for all the color. That's all I have.

Operator

And it appears we have no further questions at this time. I will now turn the program back over to our speakers.

Speaker 1

Great. Thank you. And again, thank you all for participating today. And as always, if any clarification of any items on the call or a news release is necessary, Please contact our Investor Relations department at area code 716-842-5138. Have a good day.

Operator

This does conclude today's program. Thank you for your participation. You may now disconnect. Have a great day.

Powered by Quartr
Earnings Conference Call
M&T Bank Q2 2022
00:00 / 00:00