M&T Bank Q1 2022 Earnings Call Transcript

Quartr
Provided by Quartr
April 20, 2022

There are 7 speakers on the call.

Operator

Welcome to the M&T Bank First 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 Clock, 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 M and D's Q1 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.mtz.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 And we encourage the 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 Now I'd like to turn the call over to our Chief Financial Officer, Darren King.

Speaker 2

Thank you, Brian, and good morning, everyone. As we reflect on the past quarter, it was an eventful one. First off, we were pleased to have closed the acquisition of Peoples United Financial on April 1st And to welcome our new colleagues, customers and shareholders to the M and T family. We're excited to turn our complete focus To successfully integrating People's United, of course, not losing sight of the tenants that define M and T, Delivering superior customer service, offering rewarding careers for our colleagues, engaging in the communities we call home and providing top quartile long term returns to shareholders. We plan on completing the systems conversion in the Q3 of this year.

Speaker 2

Subsequent to our January earnings call, the outlook for interest rates has changed materially. Low levels of unemployment And continued supply chain disruptions exacerbated by the situation in Ukraine have pushed inflation to levels not seen since the early 1980s. Interest rates began to rise even before the Federal Reserve raised its Fed Funds target in late March and the forward curve anticipates additional hikes coming more quickly than we anticipated in January. The changing rate environment created an opportunity for us to deploy excess cash into investment securities at a faster pace than we previously outlined and to restart our interest rate hedging program. While we're beginning to see the tailwinds from rising interest rates positively impacting our net interest income, those same higher rates have prompted headwinds to our mortgage banking business, both for origination volumes and for gain on sale margins.

Speaker 2

We expect these headwinds to persist. Despite these macro challenges, credit quality remains strong and expense growth has been well managed. We're well positioned for the future and excited about the opportunity to integrate the People's United franchise as well as to deploy our excess cash and excess capital. Now let's review our results for the Q1. Diluted GAAP earnings per common share We're $2.62 for the Q1 of 2022 compared to $3.37 in the Q4 of 2021.

Speaker 2

Net income for the quarter was $362,000,000 compared with $458,000,000 in the linked quarter. On a GAAP basis, M and T's 1st quarter results produced an annualized rate of return on assets just shy of 1% at 0.97% and an annualized return on average common equity of 8.55%. This compares with rates of 1.15% and 10.91% 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 $1,000,000,000 or $0.01 per common share, down slightly from the prior quarter. Also included in this quarter's results For merger related expenses of $17,000,000 related to the Peoples United acquisition.

Speaker 2

This amounted to $13,000,000 after tax or $0.10 Consistent with our long term practice, M and T provides supplemental reporting of its results On a net operating or tangible basis, from which we have only ever excluded the after tax effect 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 Q1, which excludes intangible amortization and the merger related expenses, Was $376,000,000 compared with $475,000,000 in the linked quarters. Diluted net operating earnings per common share were $2.73 for the recent quarter compared to $3.50 in 20 21's Q4. Net operating income yielded annualized rates of return on average tangible assets and Average tangible common shareholders' equity of 1.04 percent 12.44 percent for the recent quarter. The comparable returns 1.23% 15.98% in the Q4 of 2021.

Speaker 2

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. Included in the recent quarters, GAAP and net operating results was a $30,000,000 distribution from Bayview Lending Group. This amounted to $23,000,000 after tax effect and $0.17 per common share. We received a light distribution in the Q4 of 2020 as well as the Q4 of 2021. Next, we'll look a little deeper into the underlying trends that generated these results.

Speaker 2

Taxable equivalent net interest income was $907,000,000 in the Q1 of 2022, a decrease of $30,000,000 or 3% from the linked quarter. The primary drivers of the decline were $20,000,000 in lower interest income and fees from PPP loans, as well as the $16,000,000 reduction of interest accrued on earning assets, reflecting the 2 day shorter calendar quarter. Those factors were partially offset by higher rates on interest earning assets and cash interest received on non accrual loans. The net interest margin for the past quarter was 2.65 percent, up 7 basis points from 2.58% in the linked quarter. The primary driver of the increase to the margin was a reduced level of cash held on deposit with the Federal Reserve, which we estimate boosted the margin by 10 basis points.

Speaker 2

That was partially offset By a 4 basis point decline resulting from the lower income from PPP loans. Rising interest rates had a modest one basis Point benefit to the margin as the Fed's action on the Fed funds target came relatively late in the quarter. All other factors including day count and interest received on non accrual loans had a negligible impact on the margin. Compared with the Q4 of 2021, average interest earning assets decreased by some 4% or $5,800,000,000 Reflecting a $5,600,000,000 decline in money market placements including cash on deposit at the Fed, partially offset by a $920,000,000 increase in investment securities. Average loans outstanding Decreased by about 1% compared with the previous quarter.

Speaker 2

Looking at the loans by category, on an average basis compared with the linked quarter, Commercial and industrial loans increased by $976,000,000 or about 4%. That figure includes a decrease of approximately $780,000,000 in PPP loans. That decrease was more than offset By $361,000,000 growth in dealer floorplan balances and a $1,400,000,000 increase in all other C and I loans. Commercial real estate loans declined by 5% compared with the 4th quarter. Three factors contributed to that decline.

Speaker 2

Elevated payoff activity was the primary driver, including several criticized and non accrual loans assumed by other lenders. The quarter also saw construction loans converted into permanent off balance sheet financing often facilitated by our M and T Realty Capital Corporation subsidiary. And finally, new origination activity remains subdued compared to prior years. Real estate loans declined by residential real estate loans excuse me declined by 3% consistent with our expectations. The change reflects new loans originated and retained for investment, which were more than offset by normal runoff combined with the sale of Ginnie Mae buyouts as they became eligible for repooling into new RMBS.

Speaker 2

Consumer loans We're up nearly 1%. Activity was consistent with recent quarters where growth in indirect auto and recreational finance loans has been outpacing declines in home equity lines and loans. On an end of period basis, PPP loans amounted to just $592,000,000 Average core customer deposits, which excludes CDs over $250,000 decreased about 5% or some $6,000,000,000 compared with the 4th quarter. That figure was roughly evenly divided between non interest bearing and interest checking. Trust demand deposits Drove the decline in demand deposits following lower levels of capital markets activity compared with the 4th quarter.

Speaker 2

The decline in interest checking reflects our ongoing program to manage deposit pricing downward, while our liquidity profile remains so strong. Some higher cost escrow deposits were moved off our balance sheet to other institutions willing to pay higher rates. Turning to non interest income. Non interest income totaled $541,000,000 in the Q1 compared with $579,000,000 in the linked quarter. As noted, M and T received a $30,000,000 distribution from Baby Lending Group in each of the past two quarters.

Speaker 2

Mortgage Banking revenues were $109,000,000 in the recent quarter compared with $139,000,000 in the linked Revenues from our residential mortgage banking business were $76,000,000 in the Q1 compared with $91,000,000 in the prior quarter. Residential mortgage loans originated for sale were $161,000,000 in the recent quarter compared with $191,000,000 in the 4th quarter. Both figures reflect our decision to retain a substantial majority of mortgage originations for investment on our balance sheet. The primary driver of the linked quarter revenue decline is the higher interest rate environment as pressured gain on sale margins for loans previously purchased from Ginnie Mae servicing pools and which have become eligible for resale or repooling. Although these loans typically have Higher rates than new originations that difference has been narrowing.

Speaker 2

Residential gain on sale totaled $14,000,000 in the recent quarter compared with $26,000,000 in the prior quarter. Commercial Banking revenues were $33,000,000 in the 1st quarter, Reflecting a decline from $49,000,000 in the linked quarter. That figure was $32,000,000 in the year ago quarter. As a reminder, the commercial mortgage banking business tends to show seasonal swings. Revenues totaled $66,000,000 in the first half of twenty twenty one compared with $99,000,000 in the second half, which also included an elevated level of prepayment fees.

Speaker 2

Trust income was $169,000,000 in the recent quarter, little change from the previous quarter, but up 8% from the year ago quarter. Service charges on deposit accounts were $102,000,000 compared with $105,000,000 in the 4th quarter. That decline primarily reflects seasonal factors. The previously announced repricing of our consumer checking products did not have a significant impact on the Q1, but we expect foregone revenues from the program to reach a run rate of $15,000,000 per quarter by the second half of the year. Turning to expenses.

Speaker 2

Operating expenses for the Q1, which exclude the amortization of intangible assets And merger related expenses were $941,000,000 The comparable figures were $904,000,000 in the linked quarter and $907,000,000 in the year ago quarter. As is typical for M and T's Q1 results, operating expenses for the recent quarter, which Included approximately $74,000,000 of seasonally higher compensation costs relating to the accelerated recognition of Equity compensation expense for certain retirement eligible employees like domicloud. Also it reflects the HSA contribution, The impact of annual incentive compensation payouts on the 401 match and FICA payments as well as the annual reset in FICA payments and unemployment insurance. Those same items amounted to an increase in salaries and benefits of approximately $69,000,000 in last year's Q1. As usual, we expect those seasonal factors to decline significantly as we enter the 2nd quarter.

Speaker 2

Aside from these seasonal factors that flow through salaries and benefits, operating expenses declined by $38,000,000 compared with the 4th quarter. Lower professional services costs as well as lower pension related costs drove that decline. The efficiency ratio, which excludes intangible amortization and merger related expenses from the numerator and Securities gains or losses from the denominator was 64.9% in the recent quarter, compared with 59.7% in 20 21's 4th quarter 60.3 percent in the Q1 of 2021. Those ratios in the first Quarters of 2021 2022 each reflect the seasonally elevated compensation expenses. Next, let's turn to credit.

Speaker 2

Despite the challenges of the pandemic and its variance, Supply chain disruptions, labor shortages and persistent inflation. Credit is stable to improving. The allowance for credit losses amounted to $1,500,000,000 at the end of the Q1, little change from the end of 2021. We recorded a provision for credit losses of $10,000,000 in the Q1, which was partially offset by just $7,000,000 of net charge offs. As the COVID-nineteen pandemic eases, Forecasted economic indicators continue to show improvement from the prior period.

Speaker 2

Fund inflation remains persistently high with upward pressure from energy prices constrained supply chains, which have been impacted by Russia's invasion of Ukraine. The Q1's baseline macroeconomic forecast These developments, although there was little difference in the forecast 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 consumer real estate values. The result of these considerations is an allowance for credit losses that is consistent with our prior estimate. Non accrual loans increased very slightly amounting to $2,100,000,000 that equaled 2.3% of loans at the end of March, Up slightly from 2.2% at the end of last year. When we file our Q1 10 Q in a few weeks, We expect to report a modest decline in criticized loans.

Speaker 2

As noted, net charge offs for the recent quarter amounted to $7,000,000 Annualized net charge offs as a percentage of total loans were just 3 basis points for the Q1, which we believe is an all time low. That figure was 13 basis points in the 4th quarter. Loans 90 days past due On which we continue to accrue interest were $777,000,000 at the end of the recent quarter. In total, 89% of these 90 days past due loans were guaranteed by government related entities. Turning to capital.

Speaker 2

M and T's common equity tier 1 ratio was an estimated 11.6% compared with 11.4% at the end of the 4th quarter. This ratio reflects earnings net of dividends combined with a slight reduction in risk weighted assets. Tangible common equity totaled 11.5 1,000,000,000 down just 0.3 percent from the end of the prior quarter. Tangible common equity per share amounted $89.33 down $0.47 or 1 half of a percentage point from the end of Q4. This very moderate decline reflects our patience in deploying excess liquidity into long duration investments until the interest rate outlook became clear.

Speaker 2

As previously announced, we expect to resume the repurchase of M and T common shares shortly, Starting with the $800,000,000 buyback program recently reauthorized by our Board. Now turning to the outlook. On April 1, we closed the Peoples United acquisition. That development combined with the rapid change in interest rate expectations have had a material impact on our outlook for full year 2022. The information that follows reflects the combined balance sheet, a more recent forward curve and includes 3 quarters of operations from People's United.

Speaker 2

First, let's talk about our outlook for the balance sheet. Excluding the impact of acquisition Adjustments at closing. We acquired $63,000,000,000 in total assets, including Investment securities totaling $12,000,000,000 cash placed at the Federal Reserve totaling $9,000,000,000 Loans of $36,000,000,000 and other assets of $6,000,000,000 Deposits totaled $53,000,000,000 Borrowings and other liabilities totaled about $1,000,000,000 each and equity totaled $7,500,000,000 The purchase consideration was approximately $8,400,000,000 With the increase in rates, The deal is now expected to be slightly dilutive to tangible book value per share. However, this also means that future earnings will benefit from additional Acquisition Accounting Accretion. Let's go into a little more detail on our outlook for growth in the combined balance sheet.

Speaker 2

First, the interest earning cash position at the beginning of the second quarter, totaled just over $45,000,000,000 We expect these balances to decline to slightly under $30,000,000,000 by the end of 2022, Due to a combination of growth in the securities portfolio, loan growth as well as a reduction in wholesale funding, Investment securities for the combined company totaled $21,000,000,000 at the beginning of the second quarter and we expect To grow the portfolio by $2,000,000,000 per quarter. This cadence could accelerate or slow depending on market conditions. We start this quarter with $40,000,000,000 in C and I loans, including just over $800,000,000 in PPP loans. CRE, residential mortgage and consumer loan portfolios are $46,000,000,000 $22,000,000,000 $20,000,000,000 respectively. In order to provide more details on our outlook for loan growth, Let's first look at our expectations for spot or end of period loan growth from the beginning of the second quarter through the end of 2022.

Speaker 2

Total combined loans are expected to grow in the 3% to 5% range from the beginning of the second quarter. Excluding PPP and Ginnie Mae buyout loan balances, total combined loans are expected to grow in the 4% to 6% range. The outlook for C and I loan growth excluding PPP loans is in that same 4% to 6% range With solid growth, excuse me, in dealer floorplan balances, PPP loans are expected to continue to pay down over the course of the year and not have a material impact on loan growth. For CRE loans, we expect the heightened level of payoffs to have largely run their course and thus The outlook for total combined CRE loans is essentially flat for the rest of this year. The tailwinds from our mortgage retention strategy are expected to help drive 7% to 8% loan growth in residential mortgage balances over the course of this year.

Speaker 2

And excluding the impact of the re pooling of Ginnie Mae buyouts, growth is expected to be in the 12% to 14% range. Of course, mortgage rates and home supply will ultimately affect that pace of growth. Finally, we're pleased with the momentum In our consumer loan portfolio and expect this growth to continue to be strong over the remainder of the year, we anticipate growth in the 7% to 9% range in this portfolio. To help you understand the outlook for end of period growth or how the outlook for end of period loan growth Ties into growth in average the average balance sheet when compared to standalone M and T 2021 average balances. We expect average loans for the combined franchise to grow in the 24% to 26% range When compared to standalone M and T full year 2021 average balances of $97,000,000,000 On a combined and full year average basis, we expect average C and I growth in the 43% to 45% range.

Speaker 2

We expect average CRE growth in the 15% to 16% range and average residential mortgage growth in the 26% to 28% range. And finally, we expect average consumer loan growth in the 16% to 18% range. As we look at the outlook for the combined income statement compared to standalone M and T operations from 2021, we believe we are well positioned to benefit from higher rates and to manage through the macro challenges we noted earlier on this call. This outlook includes the impact From preliminary estimates of acquisition accounting marks that are expected to be finalized later in the quarter. Our outlook for Net interest income for the combined franchise is for 50% full year growth compared to the $3,800,000,000 in 2021.

Speaker 2

We expect that 50% growth to be plus or minus 2%, depending on the speed of interest rate hikes by the Fed and the pace of the deployment of excess liquidity as well as loan growth. This outlook reflects the forward yield curve from the beginning of this month. Turning to the fee businesses. While higher rates are expected to pressure mortgage originations and gain on sale margins, Growth in trust revenue should benefit from the recapture of money market fee waivers sooner than previously anticipated. We expect non interest income to grow in the 11% to 13% range for the full year compared to $2,200,000,000 in 2021.

Speaker 2

Next, our outlook for full year 2022 operating non interest expenses is impacted by the timing of the We anticipate 23% to 26% growth in combined operating non interest expenses when compared to $3,600,000,000 in 2021. As a reminder, these operating non interest expenses do not include pre tax merger related Charges. At the time of the merger announcement, one time pre tax merger charges were estimated at $740,000,000 including $93,000,000 of capitalized expenditures. These merger charges are not expected to be materially different than these initial estimates. We expect the majority of these merger charges to be incurred in the 2nd 3rd quarters of this year.

Speaker 2

Turning to credit. We continue to expect credit losses to remain well below M and T's legacy long term average of 33 basis points. For 2022, we conservatively estimate that net charge offs for the combined company will be in the 20 basis point range. As a reminder, the provision for credit losses in this year's Q2 will include provision related to the non purchase Credit deteriorated loans from People's United. We are still finalizing the acquisition accounting marks, But given the improvement in economic conditions over the past year, this provision will likely be lower than the $352,000,000 pretax provision Estimated at the time of the announcement, the so called double count.

Speaker 2

Finally, turning to capital. Due to the delay and growth in capital at both firms, the preliminary combined CET1 ratio at closing Should be over 11%. We believe this level of core capital is higher than what is needed to safely run the combined company and to support lending We plan to return excess capital to shareholders at a measured pace. We will be participating in the DFAST This year and again in 2023. Normally, next year would have been an off year for a Category 4 bank like M and T.

Speaker 2

However, The Federal Reserve has reasonably requested that we participate again next year, so that our stress test and stress capital buffer can be assessed, including the balance sheet and operations of People's United. With a solid start in capital position 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. Based on that objective, we anticipate ending 2022 with the CET1 ratio In the 10.5 percent range. As noted earlier, we anticipate restarting the currently authorized $800,000,000 comment share repurchase program now that the acquisition is closed. Now let's open up the call to questions,

Operator

We'll take our first question from Betsy Graseck from Morgan Stanley.

Speaker 3

Hi, good morning.

Speaker 2

Good morning, Betsy.

Speaker 3

I just wanted to drill down a little bit on your comment around the returning excess capital to shareholders at a measured pace.

Speaker 4

Maybe you can give us

Speaker 3

a sense as to how you're thinking about that, because obviously with loan growth coming in, there'll be a little bit of composition, but not that much. So I guess really the underlying question is how measured is measured in your mind?

Speaker 2

Yes. So as we think about it Bethune, we're going to go through the next couple of quarters and the Impact of some of the one time expenses associated with the deal will have an impact on capital in addition to the buybacks. And so as we think about it, it might be a little bit lumpy in a couple of these quarters. But if you think about it over the course of the next three It's moving down in maybe the 20 to 30 basis point per quarter range. That's probably a good starting point.

Speaker 2

The a bit of the wildcard Obviously, it's also the pace of increase in the Fed funds rates, because of the combined bank's asset sensitivity That will have a meaningful impact on net income and capital generation. So we'll need to be monitoring that In addition to the pace of buybacks to hit that kind of 20 to 30 basis point target. So it might bounce around a bit, but that's kind of when we think about it, how we tend to think about

Speaker 3

Okay. And then just as a follow-up, the expense savings, could you just Remind us the pace of the realization of those that you're anticipating?

Speaker 2

Yes. So if We go back to the due diligence. We were and continue to target about a 30% decrease In the Peoples United Expense space. And when you look at when that really starts to come in, it really is in the 4th quarter of this year and will probably leak a little bit into the Q1 of next year just given the timing. Most of the Reduction in expenses is tied to the system conversion event.

Speaker 2

And so typically after that, you will have some folks who will stay on That time plus 30 plus 60 plus 90 days just as we stabilize the operations and then those expenses will start to go away. So It will really be as we get to maybe the December time frame of this year that we'll hit that run rate and really into the Q1 of 20

Speaker 3

Thank you.

Operator

Our next question comes from Ebrahim Poonawala from Bank of America.

Speaker 3

Good morning.

Speaker 2

Good morning.

Speaker 3

I was wondering if you could just go back to your NII guide. I think you mentioned 50% up year over year All in with the deal. Just talk to us around thought process around pace of cash deployment, what you're buying And where do you expect to keep excess cash maybe as we end 2022?

Speaker 2

Sure. So I guess a couple of things on what's going on there in that. Just looking at the cash and the cash deployment, Some of it will be into securities. We talked about a pace of an incremental $2,000,000,000 a quarter In growth in the securities portfolio, net of runoff, when you look at the securities portfolio and where we've been focused Of late, it's been in the shorter end of the curve, typically in the 2 to 3 year space. I think if you look at how that curve Look, you see that it kind of flattens out once you get to 5 years.

Speaker 2

And so we don't see a benefit to that extra duration. But part of the way we're getting some of that duration is through the retention of the mortgages we're originating through our retail channels. And so part of the cash then is deployed into the residential mortgage balances that will sit on our balance sheet, and then obviously the other loan growth that we Talked about. And those are the things that we think help bring the cash levels from the pace the place we are Combined, in April of around $45,000,000,000 down to $30,000,000 The other part that I didn't mention was there is Some wholesale funding that is coming through the merger and as we look at our cash position, we think we can bring those Wholesale balance is down and fund them with the liquidity position that we have.

Speaker 3

Understood. And just tied to that on the funding side, we saw some deposits runoff you've talked about this last quarter. Remind us in terms of when you think about deposit balances, Where you expect them to trend? And are there other kind of more rate sensitive index type deposits that you expect to leave the balance sheet over the coming quarters?

Speaker 2

Yeah. I guess, we're not anticipating additional runoff in the deposit portfolio right now. We'll go through, I think, the first 100 basis points, I think, for us and generally for the industry, given the loan to deposit ratios in the industry, Those deposits are likely to be sticky and we won't see much movement due to rates. As we go through the cycle, there's a cadence that happens with these. The deposits that tend to be the most rate sensitive Are usually those in the wealth business as well as in the municipal or government space And you'll tend to see betas move there a little bit faster.

Speaker 2

In consumer land, it takes a little bit longer for Rates to start to drive behavior. And over time, you'll see some movement in out of checking accounts and into money market savings and time accounts. But that will all be based on the pace at which the industry starts to move up rates. Just on time deposits, There is a slightly higher time deposit portfolio at Peoples than there has been at M and T. And you might see a little bit of runoff in the time deposits Early on, but as rates move, assuming they move as anticipated, at some point you'll see those lines cross and That portfolio will stop shrinking.

Speaker 2

And then on a combined basis, it will start to grow. But that's probably not The growth part is probably not until late this year, early next year would be my guess just based on our past experience and where the forward curves are.

Speaker 3

Got it. Thanks for taking my questions.

Operator

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

Speaker 5

Hi. I was hoping you could flush out the 10.5% CET1 target. And I guess just keep one Why it's so high? I think it's above where most of your peers are targeting and can appreciate you're converting a deal and you got key thoughts that you want to see. But Is that kind of the intermediate target?

Speaker 5

And over time, you'll bring it down maybe closer to the 9%, 9.5% that we Your peers or how do you live at the 10.5% and how long term is that?

Speaker 2

Yes. Happy to answer the question, Matt. The 10.5% is a stepping stone along the way. We haven't changed our thought process About how we manage capital, that we're always looking to deploy it into the franchise first and always looking to support customers and loan growth within our And to the extent that that's not there at a reasonable return, then we look to get it back to shareholders. We always think about the dividend It's an important element of that and we try to make sure we target as we've talked about before right around a third of Earnings is a dividend payout target.

Speaker 2

We think that gives us a good flexibility To make sure that we can maintain that payment through the economic cycles and then we tend to favor using buybacks as the rest of it. And the 10.5 percent when you look at where we're starting and you look at What we believe is going to be the capital generation of the combined organization. It's and with against the backdrop of an asset sensitive franchise In a rising rate environment, the capital generation, we think becomes pretty compelling. And so the pace of Deployment against the pace of capital generation makes it tough to bring that ratio down very quickly. And as you pointed out, It's an intermediate step that next year will be the 1st year we go through the stress test with our combined balance sheet.

Speaker 2

And what history has taught us is when you go through that first time, there can be surprises in how the portfolios Are treated or react under the Fed stress test models. And sometimes in those situations, there can be data gaps that you need And so we understand those issues and challenges, but we're we think that going into that test At that level, it's just a safer place to be and then they know we'll have more information when we come out the other side and Expect to continue on our path down to the target that we've always talked about. We'll obviously have to look at that target as we take into account the new balance sheet and the combined Bank that we have, because we are getting some new portfolios and we'll want to run them through our own stress test models to understand how they perform under stress. But Consider the 10.5% as a stop along the journey towards our more typical target.

Speaker 5

Okay. That's helpful. And then on the liquidity, I'm probably missing some sort of liquidity rule on this. But Why can't you and other banks that have tons of cash just dump it in short term treasuries? We've Seeing very unusual moves in the treasury market.

Speaker 5

So you could basically accelerate all that rate leverage and not really take any risk, right? Like 6 month treasury is about $130,000,000 12 month is 2%, doesn't impact the CET1 I don't think. So just remind us like what liquidity rule is out there that's preventing you from doing that? And if it's not a rule, why wouldn't you consider that?

Speaker 2

Yeah. There's not a rule Matt. I mean, when you're going through for banks that are subject to the liquidity coverage ratio, There's an expectation about what percentage of their liquidity is held in high quality liquid assets. I think the treasuries count, but cash is one of the And so shorter duration cash oriented instruments would affect banks that are LCR banks, which are category 3 banks. For a bank like MSC, we're not subject to that.

Speaker 2

But when we look at the benefit of Locking in now a 2 year treasury versus where we see the forward curve going, we think we're going to get a lot of that Just with the rate modes without having to lock it in, but yes, we maintain the flexibility of that cash and we keep the marks Off the balance sheet. And so you can see we're starting to buy in and we'll continue to build a portfolio that does take advantage of some of that, While trying to protect the flexibility that we have and we'll still expect to benefit from the increase in rates. We're trying to dollar cost to average in a little bit into that position. And really the focus for us I can't speak for others, but the focus for us is Over the course of the next couple of years rebuilding the mix of the balance sheet between what's in cash, what's in securities Within the securities portfolio, what's the duration of it? How are we thinking about that with what is the duration of the whole portfolio as we talked about with what's in mortgages?

Speaker 2

And then the other thing that's really important is how much cash and what's your deposit runoff assumption, Because if you get too far into the securities portfolio and all of a sudden you see some migration in deposits and you've got to go out and fund those Or you got to react to outflows with rate. If you go too far too fast, you can get yourself upside down. And so, obviously, at 2 years, When we think about the pace at which we want to deploy that cash into something that might over the course of the next couple of quarters Provide a higher yield, but based on as I mentioned where it looks like the Fed is moving, you might catch up pretty quickly there in the cash.

Speaker 5

And just to squeeze in, what would be the longer term target of call it securities to assets or maybe it's securities plus residential mortgages Is the way you think about it, but you said rebuild and kind of remix next couple of years and what would be the end state as you think about?

Speaker 2

Yeah. I guess, a way to think about it Matt is to look at the combination of our securities portfolio plus our on balance sheet mortgages And look at that as a percentage of assets and then look at where the peers sit. And if you think about The peers who have the lower percentage of those, so the bottom quartile of the peers when you add up Securities and Mortgages as a percentage of assets. I think that kind of range for us. Our as we talked about before, our goal is always to deploy our liquidity into lending, while making sure that we're not taking on crazy asset sensitivity.

Speaker 2

And so we'll look to bring that close that asset sensitivity down. And those would be the some of the primary

Operator

Our next question comes from John Pancari from Evercore. John, your line is open. You might be on mute.

Speaker 2

Well, after 2 years of the pandemic, we still got mute.

Operator

And we'll take our next question from Ken Usdin from Jefferies.

Speaker 5

Hey, thanks a lot. Good morning, guys. Hey, Darren, just wondering if you could just drill down to a couple more pieces of NII. First of all, can you help us understand that You mentioned the accretion. Can you help us understand how much accretion you're expecting either in dollar terms ideally or Can you help us understand the percentage that adds to growth?

Speaker 1

Yes, sure. When you look at the NII,

Speaker 2

like I mentioned, we're still finalizing what the marks are. But when you look at the forecast for the year and the coming years, the impact of the accretion will be positive Compared to where we thought it would be when we announced, obviously, because of the change in the interest rate environment. But when you look at the percentage, It could move what we guided. It's maybe a couple of percentage points in either direction, More likely to be accretive than not. Really the bigger driver of the growth in NII is Just the composition of obviously of our balance sheet and our asset sensitivity and the new rate curve, which It's the biggest part of that driver.

Speaker 5

Okay. So there is accretion in there, but you're saying it could be more than What you have in there, but you're not going to until you finalize the marks, you're not going to update us on just what the amount of the accretion is in there?

Speaker 2

We'll give you all of the information once we finalize it. But I guess what I'm saying is, it's not going to change the outcome in a meaningful way.

Speaker 5

Okay. Got it. And then just second question just on you talked about some of the moving parts within the betas. But can you just talk us about What you're expecting for deposit betas? And how that might have changed given the faster pace of expected hikes that we're now seeing from the Fed?

Speaker 5

Thanks.

Speaker 2

Yeah. No problem. I guess, we talked a little bit about deposit betas earlier on. And it's really When we disclose the sensitivity in the Q, What we'll see there is the first 100. And the first 100, we really don't think there's a lot of reactivity.

Speaker 2

And really when we look at the 100, we look at each 25 and then we'll look at the subsequent 25. But really we think the first 100 has relatively low deposit betas probably in the 10% to 15% range, probably towards the bottom end of that. It's skewed by portfolio. When you look, as I mentioned before, at some of the Government and municipal deposits, they tend to be a lot more rate sensitive as do the wealth balances. And so those would drive up The deposit beta and for our smaller business customers and our consumer customers, the betas are a little bit lower.

Speaker 2

Clearly, as you get higher in the absolute level of Fed funds, you start to get a little bit more attention. One of the things that I think is different this cycle from others, not just for us, but for the industry for all of us to There's now an ability to pay interest on commercial checking accounts, which there hadn't been before. And you would look at the impact on commercial balances historically would be on earnings credit and then the offset on fees. And from an interest perspective, it was typically in sweep accounts and was either on or off balance sheet. Now much of that will happen in those commercial checking accounts, where clients will have to decide between earnings credit against fees or between earning an actual interest income Based on the rate on those products.

Speaker 2

And so it's something we haven't seen how reactive those Specific products will be because we haven't really been through a tightening cycle that's looking like the one that's in front of us. But again, big picture. If you just go back to where loan to deposit ratio sit and all the liquidity that sits, not just on our balance sheet, but on others, Unless there's a meaningful change in that position or meaningful loan growth, you probably have deposit betas that are at the lower end Of what we saw in the last tightening cycle.

Speaker 5

Yes. Got it. Thanks a lot, Aaron. Makes sense.

Operator

Our next question comes from Steven Alexopoulos from JPMorgan.

Speaker 2

Hey, Darren. How's everything? Doing great. Good morning. How you been?

Speaker 2

Good morning. Good. On asset sensitivity, Could

Speaker 4

you give

Speaker 2

color you said you restarted the hedging program in the quarter. Could you give color on what you're doing there? And now that Peoples has closed, what's The new level of asset sensitivity versus what you guys last disclosed? So I'll go in reverse order. The new level of asset sensitivity is slightly less than what it is M and T standalone.

Speaker 2

If you look at the 2 balance sheets, both were asset sensitive. And on a combined basis, the asset sensitivity drops Maybe a percentage point, half a point in that range. We saw in the Peoples portfolio over the course The last year similar phenomenon that we did and that there has been some loan declines certainly PPP loans That paid off and turned into cash. And so they were looking and managing their portfolio In a very similar fashion to how we were. And so there really wasn't a big change in the combined asset sensitivity.

Speaker 2

And then when you look at the hedging program, what we've been trying to do is since we see the curve that is forecast, We can use some forward starting swaps much like we had done in the prior cycle to lock in those increases So in effect, if you see where we are today, 9 increases In Fed funds, you can lock that in with a forward starting position and then you'd have to see 10 or 11 before you thought that was a bad decision. And given the fact that you're still asset sensitive, you'd be pretty happy if that was the case. But being able to lock in some of these Today, you can protect in case the pace isn't at that level. And so it's really with some of those cash flow hedges, Very similar to how we built the portfolio last time, we try to, leg into it a little bit and Build it out each month as we go forward. Got it.

Speaker 2

Okay. That's helpful. And then for my follow-up question, I want to go back to your response to Betsy's question on the Class A phase. And are you still assuming 85% in 2022 and is the number still $330,000,000 So I am Trying to think about 85%. That's not a number that's oh, I know what you're thinking about.

Speaker 2

I got it 1st year. I'm with you now. Yeah. Just given the timing of When the deals happen, we'll start to see that run rate achieved Towards the end of the year. Was it 85% this year?

Speaker 2

We're not going to see 85% in actuality In calendar year 2022 just because we're not doing the conversion until the Q3, right? And so In reality, we'll start to get to the run rate as we come out of the year. And so really the way to think about it is, it's It will really kick in full year in 2023. And then it's we're still in the range of thinking that we're around 30 But keep in mind that the Peoples expense base has changed. So the dollars will be slightly different.

Speaker 2

They're they've seen the same thing we have with expense growth and wage inflation. And so The good news is in dollar terms, the savings are probably a little bit higher because the cost went up, but the reality is the Okay. So the dollar is up a bit. And basically by the end of the Q4, you'll be at the run rate, Yes, the Q4. Not the Q4.

Speaker 2

Yes. We really like I mentioned, there's a lot of it's going to come out in the Q3, But there's always some residual some folks that are 60 or 90 days past conversion. And if we're doing the conversion In around the early part of September, a little bit of that leaks into the Q4. And so by the time we get out of this year, We should be pretty close to the run rate as we jump off into 2023. The 100% run rate?

Speaker 2

Yes. Okay. Okay. Got it. Thanks a lot.

Operator

Our next question comes from Gerald Cassidy from RBC.

Speaker 6

Hi, Darren. How are you?

Speaker 2

Good morning, Gerard.

Speaker 1

How are you doing?

Speaker 6

Good. Thank you. The question I have has to do with, I think you said that you were able to see some of your criticized loans Taken off your balance sheet from competitors, I was wondering if you can elaborate I'm not going to ask the names of who did this, but Could you elaborate the underwriting standards that you were holding these customers to that made it more enticing for them to Go to another competitor assuming they got better terms and conditions. And do you see that continuing in the second or third quarter of this year? Yeah.

Speaker 2

We've seen a fairly as we mentioned, fairly substantial amount of payoff activity this quarter. A bunch of it was in and around New York City Real Estate and in many cases in the leisure and hospitality industry AKA hotel. And it's a variety of players Gerard that are coming in. Sometimes it's private equity and sometimes it's the funds. We have seen a couple refinanced by other banks.

Speaker 2

And it might not necessarily be the credit per se. And what I mean by that is, when you've got a company on your books and you've been watching their performance Over time and you downgrade them, you want to see a few quarters of reperformance before you upgrade them. And they get classified as a troubled debt restructuring potentially depending on what happens. And someone who comes in new, it's not a troubled it's not a TDR for them. It's a new loan.

Speaker 2

They can structure it the way they want. In some cases, we saw us get refinanced out and then Additional dollars were added. And so it's a new loan in someone else's eyes. And so the treatment from Accounting in a capital perspective is a little bit different. And they're not waiting for a little bit longer history of performance Before they re grade it and change it, right?

Speaker 2

They might look more prospectively than we might typically look where you're wanting to see a few months Maybe even a couple of quarters of sustained performance before you change the grade. And so for those reasons that's why you tend to see this stuff. I think and I would humbly say that a lot of times people look at our underwriting And know our history of it and so are willing to take us out because they know these credits are strong. And a lot of times that proves out. When you look at Charge offs this quarter at 3 basis points, the reason that was so strong was as much because of recoveries, Because of things that we had previously charged off where it turned out that the collateral values were where we thought they would be and we were able to recover what we had So there's a number of things that happen when others take us out.

Speaker 2

And it's It's not something that we necessarily love, but it's part of the cycle.

Speaker 6

Very good. And if you're at the time, I'll just leave it at one question. Thank you.

Speaker 2

Okay.

Operator

Our next question comes from John Pancari from Evercore.

Speaker 4

Good morning. Thanks for taking my question. Just one for me on the credit I mean on the commercial real estate front, I know you had indicated that the book should be relatively flat here going forward. Can you

Speaker 3

just maybe talk about what

Speaker 4

gives you confidence In that front, I know you mentioned that pay downs were impacting the balances for the Q1. I don't know if you have the amount of those pay downs and what gives you confidence that they could abate? And then lastly, do you expect any of the potential securitization that you mentioned of the Peoples' permanent financing portfolio to come into play here? Thanks.

Speaker 2

Yes. So I think there's a couple of things that are behind that, John. So Over time, when we look at our portfolio, we tend to see growth In our portfolio when there's activity in the market and there hasn't been as much activity until recently with properties starting And so part of what we were just talking about some of the pay downs is property starting to change hands. And so that typically is a benefit for us. The other thing is when we look at some of the payoffs and we mentioned that many were in our non accrual or criticized space And in the hotel part of our portfolio, we've seen a number of upgrades and we continue to expect more upgrades to come, Because we are seeing a definite improvement in that portfolio.

Speaker 2

And so for those reasons, we expect to see a little bit less Payoff and paydown activity there. I mentioned a little bit about the construction loans and those paying off. In a lot of cases, what you were seeing is some folks trying to lock in where they could a fixed rate rather than the construction line is a variable rate. And so people are trying to lock in some of the financing in the face of rising rates, which of course Can still happen, but loans have to be at a certain place along the way, meaning the construction loans have to be far enough along that you can convert some of it into permanent. And then I guess the other part of it is just the utilization rate of those lines and where they stand that As the projects near completion, they'll continue to grow towards 100%.

Speaker 2

And when we look at where that utilization is today, We're it's higher than it's been since well in our history that I'm looking at, but Certainly from the low point in December of 2019. And so when you open up a bunch of construction lines and the projects start to move forward, You see those lines slowly build and grow and from a low of maybe 50 odd percent in 2019, We're now in the call it 68% to 70% range. And so at that point, the construction has got to go to completion For the developer to get paid out and so those lines will continue to grow which will be a bit of an offset. And so for a bunch of those reasons that's why when we look forward, We think that there will be enough growth to offset some of the pay downs that are natural and expected. And the other thing which we shouldn't discount From just loan growth in general is now that there's certainty around the deal and the merger, There's that anxiety goes away for our employees and for our customers who are waiting.

Speaker 2

And I think that that's a we shouldn't discount that that does have an impact on the psyche. And that as folks feel that certainty understand the credit window that we'll start to see the activity ramp up and so that's also part of that forecast.

Speaker 4

Okay. And anything on the potential securitization of the permanent financing book at Peoples?

Speaker 2

We have it's too early John to go through that. I mean, we still we talked about it. You're 100% right. We talked about it at Merger announcement and it's something that we think is an opportunity. We still see that as a great way to be able Provide capital for our clients and it's something that we'll look at and more to come as we go Through the Q2 and Q3.

Speaker 2

Just give us a second to integrate these 2 banks and I promise we'll come back.

Speaker 4

Got it. Thanks, Aaron.

Operator

Our next question comes from Frank Sher Aldey, your line is open from Piper Sandler.

Speaker 4

Hi, Darren. Good morning, Craig. Just a quick follow-up on asset sensitivity. I recognize that deposit beta is going to start lower and trend higher at some point. But Just to simplify things, I wondered if you had any updated thoughts with Peoples in tow, what a given 25 bps hike Should do for the NIM, at least at the beginning of the cycle.

Speaker 2

Yes. Early on, Just to give an update on where we had been before, we talked about standalone. I think it was maybe 9 to 12 basis points before combined that's a with the change in the portfolio, it's a little bit higher. We would estimate kind of 10 to 14. Obviously, as you mentioned deposit betas are the driver of the range from 10 to 14.

Speaker 2

And on a combined basis, 25 basis points on a full year annualized basis that $10,000,000 to $14,000,000 we think Equates to about $165,000,000 to $225,000,000 in incremental NII.

Speaker 4

Great. Okay. I'll leave it there. Thank you.

Speaker 2

No problem.

Operator

And our next question comes from Bill Quicashi, your line from Wolfe Research. Your line is open.

Speaker 4

Thank you. Hi. Good afternoon, Darren. Thanks for taking my question. So how are you thinking about Growing the securities portfolio versus putting on swaps from here and separately, how are you thinking about what level of liquidity you should view as excess right now against the backdrop Of a more aggressive Fed balance sheet runoff this cycle?

Speaker 2

Yeah. It's a great question. It's something that we spend a lot of time talking about as a management team and our treasurer and treasury team spends That's obviously all day every day thinking about it. We have a long ways to go clearly before we're liquidity We mentioned we start the combined bank with $45,000,000,000 in cash. And so as we think about the mix How much we put in the securities portfolio and how we think about the hedges.

Speaker 2

What we like about the hedges It's a nice offset obviously to the loan book, but it's capital friendly,

Speaker 1

right? And so if you

Speaker 2

think about what we've seen in the last Quarter with if you try to cover asset sensitivity and reduce it solely through the securities portfolio and fixed Rate product, to the extent that it's held and available for sale then you have equity risk, as rates continue to rise whereas when we do it through the hedging, It's more equity efficient. What we recognize though is that just given some of the changes that are happening between LIBOR and SOFR on the rate that loans are on the books and the changes that to move the position down, we won't be able to do it solely with hedging. And so that's when we start to look Some of the other instruments and we look at and make a trade off decision between mortgage backed securities versus just the mortgages that we can hold on our balance sheet. When we look at the flow that we think is coming today out of our retail production, we think that provides us a nice opportunity to manage down some of We need to manage down some of that asset sensitivity and deploy that liquidity. And then think about securities for the rest.

Speaker 2

And we'll and I think we'll continue for now to focus at the shorter end of The curve there, just because we've got some of the longer part covered in the mortgage book. And The thing that we always just kind of keep an eye on is what's happening in that deposit book. And really that's the trick, right? As you liquidity and cash, just for part of our liquidity coverage and liquidity management is under stress, But go at a pace where if you've got the excess you can always deploy it. But if you find yourself short that's a little bit of a problem.

Speaker 2

So we'd rather kind of work our way down slowly to take that away. And ultimately, as we mentioned before, get to a position where That securities plus mortgage balances as a percentage of the total balance sheet is kind of in the range of The top end of the the bottom quartile of the peers.

Speaker 4

Understood. Very helpful. Thank you.

Operator

And our next question comes from Brent Arentissol from Portfolio Partners. Your line is open.

Speaker 4

I think this is pretty clear, but it looks like net interest income is going to go up by 100 of 1,000,000 of dollars in subsequent quarters. Am I missing something?

Speaker 2

That's how we see it. The caveat, of course, is the Fed curve actually has to come true. So far, we've got 25 basis points, but

Speaker 4

What's the final share count? Because I need to make sure I understand this straight.

Speaker 2

Post deal, it's in the 170 $6,000,000,000 $1,000,000,000

Speaker 1

$1,000,000,000 $1,000,000,000 Congratulations

Speaker 4

you guys. Well done.

Speaker 2

Thank you. Thank you.

Operator

And our last question comes from Christopher Spire from Wells Fargo. Your line is open.

Speaker 1

Thanks for squeezing me in. I'm just wondering what you think the organic growth rate for the portfolio, but more specifically the loan book will be In 2023? Thank you.

Speaker 2

Yes. We're still going through and doing the work there. I don't have any reason to believe that it will go Much below the kind of 2% to 3% rate that we've been seeing or expect this year. I mean, this year is a little bit high because we had some runoff And this pause that we talked about while there was uncertainty. But in general, it's hard to outgrow GDP.

Speaker 2

And Owen, GDP might be a little bit high, but we're expecting that that will start to come down. When I think about the puts and takes, CRE is probably going to stay a little bit lower as we talk about and complete the portfolio repositioning That we've talked about for a while. C and I, we think we've seen some really strong growth already this year and expect that to continue. There's clearly a question about the pace of recovery in the floor plan business. When you look at a lot of the growth, it was early in the quarter, late in the year.

Speaker 2

And at the end of the quarter, You started to see a little bit of a slowdown in production again and supply chains. And so if that gets resolved, You could see a higher growth rate in C and I without it, it might not be quite as robust. And obviously, that spills over To the indirect consumer rectify. And then mortgages, I think mortgage activity will be a function obviously of how high the 30 year goes And what's happening with people changing homes, which has been when we look around many of our geographies, the biggest issue seems The just availability of homes to buy versus desire to actually purchase At least right now. We'll see whether that shifts as I mentioned when rates go up.

Speaker 2

But I would be thinking as a starting point In that 2% to 3% range for the whole portfolio.

Speaker 5

Thank you.

Operator

It appears we have no more questions at this time. I will now turn the program back over to Brian Kwok.

Speaker 1

Great. Thank you all for participating today. And As always, if clarification of any of the items in the call or news release is necessary, please contact our Investor Relations department

Operator

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

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Earnings Conference Call
M&T Bank Q1 2022
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