M&T Bank Corporation

Welcome to the M&T Bank Fourth Quarter and Full Year 2018 Earnings Conference Call. It is now my pleasure to turn the floor over to Don McLeod, Director of Investor Relations. Please go ahead, sir.

Thank you, Laurie, and good morning, everyone. I'd like to thank you all for participating in M&T's Fourth Quarter and Full Year 2018 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 comments made during this call might contain forward-looking statements relating to the banking industry and to M&T Bank Corporation. M&T encourages participants to refer to our SEC filings, including those found on Forms 8K, 10K, and 10Q, for a complete discussion of forward-looking statements. Now I'd like to introduce our Chief Financial Officer, Darren King.

Thanks, Don, and good morning, everyone. As noted in this morning's earnings release, M&T's results for the fourth quarter were characterized by a continuation of the trends we've been seeing over the first three quarters of 2018. These include... Further expansion of the net interest margin, growth in net interest income, growth in non-interest revenues with trust fees remaining a highlight, expenses that continue to be well controlled, and a credit environment that remains solid. One positive aspect of the fourth quarter's results was a notable pickup in commercial and industrial lending, which contributed to aggregate net loan growth for the quarter. Highlights for the full year of 2018 include Seven percent growth in taxable equivalent net interest income driven by rising asset yields coming as the result of further increases in short-term interest rates initiated by the Federal Reserve combined with a manageable pace of deposit price increases. Credit improved from the already strong levels seen over the past three years with net charge-offs as a percentage of loans the lowest since 1987. While loan growth did not meet our expectations, that subdued growth enabled us to return the excess capital we generated back to our shareholders. For the year, M&T repurchased $2.2 billion of common stock and paid $508 million of common dividends to our shareholders. That resulted in a 146% payout ratio for the year. The repurchase program resulted in a 5.5% decline in average diluted shares for the full year of 2018 when compared with 2017. Now let's look at the specifics for the fourth quarter. Diluted GAAP earnings per common share were $3.76 for the fourth quarter of 2018, improved from $3.53 in the third quarter of 2018 and $2.01 in the fourth quarter of 2017. Net income for the quarter was $546 million. compared with $526 million in the linked quarter and $322 million in the year-ago quarter. On a gap basis, M&T's fourth quarter results produced an annualized rate of return on average assets of 1.84% and an annualized return on average common equity of 14.8%. This compares with rates of 1.8% and 14.08%, respectively, in the previous quarter. Included in the GAAP results in the recent quarter were after-tax expenses from the amortization of intangible assets amounting to $4 million, or 3 cents per common share, down slightly from the prior quarter. Consistent with our long-term practice, M&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 of amortization of intangible assets as well as any gains or expenses associated with mergers and acquisitions when they occur. M&T's net operating income for the fourth quarter, which excludes intangible amortization, was $550 million, compared with $531 million in the linked quarter and $327 million in 2017's fourth quarter. Diluted net operating earnings per common share were $3.79 in the recent quarter, compared with $3.56 in the third quarter of 2018 and $2.04 in the fourth quarter of 2017. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 1.93% and 22.16% in the recent quarter. The comparable returns were 1.89% and 21% in the third quarter of 2018. In accordance with the SEC's guidelines, this morning's press release contains a tabular reconciliation of GAAP and non-GAAP results, including tangible assets and equity. Both GAAP and net operating earnings for the fourth quarters of 2018 and 2017 were impacted by certain noteworthy items. Included in the fourth quarter 2018 results was a $20 million contribution to the M&T Charitable Foundation. That amounted to $15 million after tax effect or 11 cents per common share. Also included in 2018's fourth quarter was a $15 million reduction in M&T's provision for income taxes arising from an IRS-approved change in tax treatment of certain loan fees, which was retroactive to 2017. This also amounted to 11 cents per common share. Included in the fourth quarter of 2017's results were $21 million of realized gains on investment securities, which amounted to $14 million after tax effect, or 9 cents per common share. Also reflected in the fourth quarter 2017 results was a contribution to the M&T Charitable Foundation of $44 million. which amounted to $27 million after tax effect or 18 cents per common share. M&T's effective tax rate for 2017's fourth quarter was impacted by the changes to the federal corporate income tax rates. M&T's provision for income taxes for that quarter was increased by approximately $85 million, amounting to 56 cents per common share as a result of those tax law changes. As a reminder, The year-over-year comparisons for both GAAP and net operating earnings were impacted by the reduction in federal corporate income taxes for 2018. Turning to the balance sheet and the income statement, taxable equivalent net interest income was $1.65 billion in the fourth quarter of 2018, up $30 million from the linked quarter. The net interest margin improved to 3.92%, up four basis points, from 3.88% in the linked quarter. We estimate that higher short-term interest rates following the Fed's September and December rate actions added a benefit to the margin of as much as six basis points. Cash interest received on acquired loans combined with a slightly higher level of prepayment fees added an estimated two basis points to the fourth quarter margin. A higher average balance of funds placed on deposit with the Fed had an estimated four basis point dilutive effect on the margin. The higher cash balances were primarily the result of increased trust demand deposits and the continued slow pace of reinvestment of cash flows from investment securities. Average loans increased less than 1% compared with the previous quarter. The ongoing runoff of residential real estate loans primarily acquired Hudson City mortgage loans, was more than offset by growth in other loan categories, which increased $754 million, or 1.1%, from the third quarter. Looking at the loans by category on an average basis compared with the linked quarter, commercial and industrial loans were about 3% higher than in the prior quarter. This included a $275 million seasonal increase in loans to auto dealers to finance their inventories, combined with a $411 million increase in other C&I loans. Commercial real estate loans were down less than 1% compared with the third quarter, with modest growth in construction loans offset by a lower level of commercial mortgage loans as a result of paydowns and a decline in loans held for sale. residential real estate loans, which are largely comprised of mortgage loans acquired in the Hudson City transaction, continued the expected pace of paydowns. The portfolio declined about 3%, consistent with previous quarters. Consumer loans were up 2%, with growth in indirect auto and recreation finance loans outpacing continuing declines in home equity lines and loans. Regionally, in addition to the multi-region seasonal rebound in floor plan lending, Pennsylvania and our metro region, which includes New York City, Philadelphia, and Tarrytown, realized the strongest growth in CNI loans. New Jersey was the bright spot for CRE loans. Average core customer deposits, which exclude deposits received at M&T's Cayman Islands office and CDs over $250,000, were up about 4% annualized compared with the third quarter. The higher levels of trust demand deposits I mentioned previously were the primary driver of the increase. Turning to non-interest income. Non-interest income totaled $481 million in the fourth quarter, compared with $459 million in the prior quarter. The quarter's results included $4 million of security valuation gains on our remaining portfolio of GSE preferred stock, compared with a $3 million loss in the third quarter. Mortgage banking revenues were $92 million in the recent quarter, compared with $88 million in the link quarter. Residential mortgage loans originated for sale were $412 million in the quarter, down about 24% compared with the third quarter. A decline in origination revenues was partially offset by higher residential servicing fees attributable to a subservicing portfolio we onboarded during the third quarter. Total residential mortgage banking revenues, including both origination and servicing activities, were $57 million, compared with $59 million in the prior quarter. Commercial mortgage banking revenues were $35 million in the fourth quarter, up from $29 million in the linked quarter. Trust income was $135 million in the recent quarter, up slightly from $134 million in the previous quarter, and up 4% from $130 million in 2017's fourth quarter. New business generation continues to be strong, while the weakness in equity markets during the quarter was a modest headwind. Service charges on deposit accounts were $109 million, essentially unchanged from the prior quarter. Trading and FX gains were $17 million, improved by $11 million from the prior quarter, largely reflecting customer interest rate swap activity coming as a result of the improved pace of commercial lending. Turning to expenses. Operating expenses for the fourth quarter, which exclude the amortization of intangible assets, were $797 million. As I mentioned earlier, the fourth quarter's operating expenses reflected a $20 million contribution to the M&T Charitable Foundation. Excluding the contribution, operating expenses increased by $7 million from $770 million in 2018's third quarter. That increase reflects higher salaries and benefits attributable to one additional working day during the quarter and increased incentive compensation expense arising from last year's solid financial performance. The remaining expense categories in aggregate were essentially flat with the prior quarter with the elimination of the FDIC's large bank surcharge being partially offset by higher other costs of operations. The efficiency ratio, which excludes intangible amortization from the numerator and securities gains or losses from the denominator, but which does include the charitable contribution, was 51.7% in the recent quarter, increased slightly from 51.4% in the previous quarter. The ratio was 54.7% in 2017's fourth quarter. Next, let's turn to credit. Our credit quality continues to be largely in line with the trends seen over the past few quarters. Indeed, consistent with the trends seen over the past few years. Annualized net charge-offs as a percentage of total loans were 17 basis points for the fourth quarter of 2018, compared with seven basis points in the third quarter. Recall that the third quarter's results included a sizable $13 million recovery on a previously charged-off CRE loan. The provision for credit losses was $38 million in the recent quarter, essentially matching net charge-offs. The allowance for credit losses was $1 billion at the end of December, and the ratio of the allowance to total loans was 1.15% at the end of 2018. Non-accrual loans increased by $23 million at December 31st, compared with the end of the prior quarter. The ratio of non-accrual loans to total loans increased by one basis point, ending the quarter at 1.01%. We did see a rise in criticized loans during the quarter, primarily driven by a couple of large loans with unique circumstances. Loans 90 days past due, on which we continue to accrue interest, excluding acquired loans, that had been marked to a fair value discounted acquisition were $223 million at the end of the quarter. Of these loans, $192 million, or 86%, are guaranteed by government-related entities. Turning to capital, M&T's common equity Tier 1 ratio was an estimated 10.13% compared with 10.46% at the end of the third quarter. The decline reflects retention, or the decline reflects earnings retention during the fourth quarter, share repurchases, and the impact of the improved loan growth, which in turn led to higher end-of-period risk-weighted assets. M&T repurchased $500 million of its common stock during the quarter. As noted earlier, for the full year of 2018, M&T repurchased 12.3 million shares of its common stock valued at $2.2 billion and paid $508 million of common dividends to our shareholders. This resulted in a 146% payout ratio for the year. Next, I'd like to take a moment to cover the key highlights of 2018's full year results. Gap-based diluted earnings per common share were $12.74, up 46% from $8.70 in 2017. Net income was $1.92 billion, improved from $1.41 billion in the prior year. These results produced returns on average assets and average common equity of 1.64% and 12.82% respectively. Net operating income, which excludes intangible amortization, was $1.94 billion, improved from $1.43 billion in the prior year. diluted net operating income per common share was $12.86, also up 46% from $8.82 in 2017. Net operating income for 2018 expressed as a rate of return on average tangible assets and average tangible common shareholders' equity was 1.72% and 19.09% respectively. We note that that the full-year improvement in GAAP and net operating earnings included a sizable benefit from lower U.S. corporate tax rates. However, the year-over-year improvement, notwithstanding lower taxes, was significant. Pre-tax GAAP and net operating income both improved by 8%, while diluted common shares outstanding declined by 5.5% as a result of the repurchase activity. Now, turning to the outlook. Looking forward into 2019, our outlook is fairly consistent with the one we shared on this call last January. While GDP growth may slow from the pace seen in 2018, we still expect it to be at a level consistent with the average annual rate of growth seen since the last recession ended. Unemployment remains very low and both consumer and commercial customers' financial positions are healthy. Consumer confidence remains relatively high although commercial customers are slightly more cautious. In addition, there continues to be measurable progress toward a regulatory approach tailored for banks like M&T. However, with the usual caveat that events never unfold entirely in the manner you expect, here are a few thoughts for the upcoming year. Loans outstanding declined on a full-year average basis in 2018. but were up at the end of 2018 by about one-half of 1% from the end of 2017. This reflected a 13% decline in residential mortgage loans, offset by 4% aggregate growth in the other loan portfolios. Average total loans for the fourth quarter of 2018 were down about one-half of 1% from the fourth quarter of 2017 average, with a 13% decline in residential real estate loans offset by aggregate 3% growth in the other portfolios. While, as noted, commercial and industrial loan growth in the past quarter was notably stronger than any quarter over the past two years, paydowns continue to be a wild card. Our pipeline as we enter 2019 is consistent with or perhaps slightly better than it was at this point last year. The CRE market remains somewhat active, most notably in the multifamily and healthcare sectors. As was the case in 2018, CRE loan growth for the coming year will be dictated by the rate at which existing construction projects are funded, demand for new construction financing, as well as for permanent financing as construction projects reach completion. We expect continued runoff of the residential real estate portfolio, likely at a consistent low double-digit pace although the dollar amount of the decline will continue to lessen as that portfolio gets smaller. And we continue to see attractive pricing and underwriting standards in the consumer area. Given these trends, our expectation for 2019 is that average total loans will grow on a full-year basis at a low single-digit pace. If the improved pace of C&I lending that M&T experienced in the fourth quarter continues, including slower paydowns, we could exceed that rate. As has been the case since the Fed began to raise interest rates in late 2015, our outlook for the net interest margin is dependent on further rate actions. A flat scenario should still lead to some expansion of the margin from 3.92% in the fourth quarter as the benefit from last year's September and December Fed actions extend over a full calendar year. Any future rate actions by the Fed in 2019, should they occur, will potentially offer further moderate upside. Deposit pricing reactivity remains an area of focus and appears likely to be somewhat higher than in the past. As the Fed slows or halts its pace of short-term rate increases, there is a likelihood that deposit pricing pressures will continue for a period of time. That outlook excludes the potential impact from cash balances brought in through Wilmington Trust, which usually have an impact on the reported margin but would have a lesser incremental effect on revenue. The level of cash on deposit at the Fed was higher at year-end than the average for the fourth quarter. Based on the current level of interest rates and reflecting the impact of the interest rate hedges we entered into last year, Our estimate for a hypothetical future 25 basis point increase in short-term interest rates will bring a more modest benefit to the net interest margin than we've seen previously, perhaps in the area of two to four basis points. This embeds a series of assumptions on resultant deposit pricing reactivity. Based on those balance and margin assumptions, we expect year-over-year growth in net interest income. The higher interest rate environment will likely continue to challenge residential mortgage banking in 2018, specifically with respect to residential mortgage loan originations. As we've noted previously, we have the capacity and appetite for additional owned MSR servicing or subservicing business. This could offer a potential offset to slow originations. The outlook for the remaining fee businesses remains consistent with our experience in with growth in the low single digit range, with the exception of trust revenues, which have been growing in a mid single digit or better pace. Excluding the $135 million addition to the litigation reserve from full year 2018's operating expenses, we expect low nominal growth in total operating expenses for 2019 over last year. As is our usual practice, We budget for modest, positive operating leverage based on our revenue outlook. This includes the full-year benefit, approximately $40 million, from the elimination of the FDIC surcharge. We'd remind you that we expect our usual seasonal increase in salaries and benefits in the first quarter of 2019, which primarily reflects annual equity incentive compensation, as well as a handful of other items. Last year, that increase was approximately $56 million. In each of the first quarters of 2017 and 2018, we realized a benefit to our provision for income taxes when prior year equity grants vested at stock prices higher than the price at the grant date. At current levels, unless there is a meaningful rally in our stock price, we wouldn't expect a similar benefit in 2019's first quarter. Our outlook for credit remains balanced. which has completed our fifth consecutive year of net charge-off experience below 20 basis points. For each of the past four years, we've cautioned that the trend can't continue and that losses will tick upward, although not approaching long-term averages. I'll reiterate that outlook this year. Eventually, I'll get this right. There continue to be some modest pressures on non-performing and criticized loans, but there are no apparent weaknesses in particular industries or geographies. Regarding taxes, our outlook for the effective tax rate for 2018 in the range of 25% to 26% proved to be conservative. An approximate rate of 25% is more appropriate for 2019 unless some discrete items occur during the coming year. As to capital, while the Fed implements its amended capital and stress testing rules for banks of our size, we'll continue to execute our 2018 capital plan through the end of this year's second quarter. We expect final rules from the Fed in time for our 2019 capital plan. We expect to continue to manage our capital levels toward the lower end of our peer group, as we believe our consistent approach to underwriting credit and the resultant low earnings volatility argues for maintaining our capital levels toward the lower end of that range maintained by our peers. Of course, as you're aware, Our projections are subject to a number of uncertainties and various assumptions regarding national and regional economic growth, changes in interest rates, political events, and other macroeconomic factors which may differ materially from what actually unfolds in the future. Now, let's open the call to questions, before which Laurie will briefly review the instructions.