M&T Bank Corporation

Good morning. My name is Samantha, and I will be your conference operator today. At this time, I would like to welcome everyone to the M&T Bank Q2 2019 earnings call. All lines have been placed on mute to prevent any background noise. and marks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Don McLeod, Director of Investor Relations. Please go ahead.

Thank you, Smith, and good morning, everyone. I'd like to thank you all for participating in M&E's second quarter 2019 earnings conference call, both by telephone and through the webcast. If you have not read today's 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 the Energy Bank Corporation. Energy encourages participants to refer to our SEC files including those found on Form 8-K, 10-K, and 10-Q for complete distraction or forward-looking statements. Now I'd like to introduce our Chief Financial Officer, Derek Hayes.

Thanks, Don, and good morning, everyone. As noted in this morning's press release, MSU's results for the second quarter include a continuation of several favorable trends. Loan growth continues to be in line with our expectations for low single-digit aggregate growth in 2019. We saw healthy growth in fees, particularly mortgage banking and trust income, compared with both prior quarter and the year-ago quarter. Credit quality remains solid, with net starts up just over half of our long-term average, notwithstanding an increase from the unusual low level we saw in the first quarter. We continue to return excess capital beyond what is needed to support growth of the balance sheet, including $402 million of commissary purchases, and $135 million of common stock dividends. During the quarter, we successfully completed the onboarding of $13 billion of owned mortgage servicing, as well as $17 billion of subservicing. These portfolios added to mortgage fee revenue, non-interest expenses, servicing-related purchases of mortgage loans, and non-maturity interest rating deposits. At the same time, news research environments have become more volatile than at any point in recent numbers, impacting the power outlook for net interest margins and spread revenues, which we will discuss in more detail in a few moments. Now let's take a look at the specific numbers. Diluted GAAP earnings for common share were $3.34 for the second quarter of 2019, compared to $3.35 in the first quarter of 2019, and $3.26 in the second quarter of 2018. Net income for the quarter was $473 million compared to $483 million in the length quarter and $493 million in the year-over-quarter. On a gap basis, MEC's second quarter results produced an annualized rate of return on average assets of 1.60% and an annualized return on average common equities of 12.68% This compares with rates of 1.58% and 13.14% respectively in the previous quarter. Including GAAP results in the recent quarter were the after-tax expenses from the amortization of an annual asset amounting to $4 million, or 3 cents per common share, little change from the prior quarter. Consistent with our long-term practice, MSP provides supplemental reporting of its results on a net operating of 20 cases so we have only ever excluded the asset tax effect of amortization of an intangible asset, as well as any gains or expenses associated with mergers and acquisitions that may occur. M&T's net operating income for the second quarter, which includes intangible amortization, was $477 million, compared with $486 million in the late quarter and $498 million in last year's second quarter. Diluted net operating earnings for common share were $3.37 for the recent quarter compared to $3.38 in 2019's first quarter and $3.29 in the second quarter of 2018. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholder's equity of 1.68% and deep 10.83% in the recent quarter. The comparable returns were 1.76% and 19.56% in the first quarter of 2019. 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 equities. Both gaps in net operating earnings for the first and second quarters of 2019 were impacted by certain noteworthy items. Our results for the first quarter of 2019 included a $37 million tax distribution from Bayview Lending Group reflected in other revenues from operations. This amounted to $28 million after-tax effect, or 20 cents for diluted common share. Also affecting results for the first quarter was in addition to our legal reserve of $15 million relating to a subsidiary's role as trustee for customers' employee stock ownership plan. This amount is a $37 million after-tax effect, or $0.27 per diluted common share. Reflected in the second quarter of 2019's results was a $48 million write-down of M&T's investment in an asset manager, which is accounted for using the equity method of accounts. That amounted to $36 million after tax effect, or 27 cents per common share. In July 2019, MSU's self-investment in the asset manager was paid for the pain in the 2011 acquisition of the Wilmington Trust Corporation. Turning to the balance sheet and the income statement, taxable equivalent net income was $1.05 billion in the second quarter of 2019, down by $9 million, or 1% on the linked quarter. This reflects a narrower net interest margin, partially offset by growth in both loans and total earning assets. The margin for the quarter was 3.91%, down 13 basis points from 4.04% in the linked quarter. Factors contributing to that decline include a higher level of cash on deposit at the Fed which accounted for an estimated three basis points of the decline in margins. The higher day count in the quarter compared to the first quarter, which accounted for one basis point of that decline. We estimate that market rates, primarily from LIBOR, moving lower in advance of an anticipated cut in short-term rates by the Federal Reserve accounted for some two basis points of the decline. has been consistent with our recent experience where LIBOR moves in advance of Fed funds, only now it is in the opposite direction. A higher cost of interest-bearing deposits account for approximately seven basis points of the decline. Slightly higher mortgage and escrow deposits in conjunction with our growth in mortgage servicing, much of which are indexed to a mix of Fed funds and LIBOR, are the primary drivers of that increase. the expected continued migration of deposits into higher-yielding categories, notably commercial deposits into interest-deflating and on-balance sheets, as well as a higher cost of time deposits, as new certificates that are issued at higher rates than returning ones were also factored. Average loans grew by 1% compared to the previous quarter. Originations remained solid, while payoffs and paydowns picked up a little compared to the first quarter, Looking at the loan size category on an average basis compared with the mid-quarter, commercial and industrial loans increased 1% compared with the mid-quarter. Commercial real estate loans also grew 1% compared with the first quarter with a slightly lower proportion of construction loans compared with permanent financing. Residential real estate loans declined by about 1% compared with the mid-quarter. The continued, comparatively steady pace of planned paydowns of mortgage loans acquired in the Hudson City transactions was partially offset by the purchase of government-guaranteed mortgage loans out of the recently acquired servicing pools. While that process will continue, it was somewhat elevated this quarter in connection with the onboarding of the mortgage servicing reacquired. We expect the aggregate portfolio to resume consumer loans were up about 2%. Growth in recreation finance loans continued to outpace declines in home equity lines and loans. Recently, loan growth was somewhat stronger in our metro region, which includes New York and Philadelphia, as well as in the Mid-Atlantic. New Jersey continues to show solid growth off a low base. compared to the first quarter. This primarily reflects the escrow deposits we referenced earlier. Deposits received at the Plano Islands office increased by $275 million. As noted last quarter, commercial customers continue to seek a higher yield on excess funds in demand accounts and often achieve that by increasing them in the short term interest-bearing deposits. Turning to non-interest income. Non-interest income totaled $512 million in the second quarter compared with $501 million in the prior quarter. Mortgage banking revenues were $107 million in the recent quarter compared with $95 million in the late quarter. Residential mortgage loans originated for sale were $727 million in the quarter up substantially from $422 million in the first quarter, reflecting the lower long-term synthesis environment as well as seasonal strength. Total residential mortgage-pending revenues, including origination and servicing activities, were $72 million in the second quarter, improved from $56 million in the prior quarter. The increase is primarily the result of the additional residential loan servicing and subservicing that we acquired, combined with higher pin-on-tail revenues. Commercial mortgage banking revenues were $35 million in the second quarter compared to $29 million in the late quarter, reflecting seasonally stronger originating activity. Trust income was $144 million in the recent quarter, improved from $133 million in the previous quarter. This quarter's results include $4 million of seasonal fees earned in assisting clients with their tax filing. The equity markets from the sell-off in the fourth quarter of 2018 also contributed to the one-quarter build. Service charges on deposit accounts were $108 million, up from $103 million in the first quarter, reflecting higher levels of activity than what is usually a seasonally slower first quarter. The recent quarter also included $9 million in security gains, representing the valuation gains on equity securities while the first quarter of 2019 included $12 million of similar valuation gains. Turn to expenses. Property expenses for the second quarter, which exclude the amortization of intangible assets, were $868 million. As previously noted, the recent quarter's results include a $48 million write-down of our investments in an asset manager acquired in the Wilmington Trust Merchant. Also included in the quarter's results was a $9 million valuation reserve on our mortgage servicing rate, reflecting the recent decline in long-term interest rates. Salaries and benefits were $456 million in the quarter, down $44 million from the season-high level in the prior quarter. The year-over-year increase reflects annual merit increases use of consultants and contractors. The efficiency ratio, which excludes intangible organizations from the numerator and securities gains or losses from the denominator, was 56% in the recent quarter, compared to 57.6% in 2019's third quarter. Those ratios reflect legal-related accrual and write-downs we noted earlier. Next, let's turn to credit. Overall, credit quality remains in line with our expectations. Annualized net charge-off as a percentage of total loans were 20 basis points for the second quarter, compared with 10 basis points in the first quarter. That reflects higher net charge-off in our commercial loan portfolio. The provision for credit losses was $55 million in the recent quarter, exceeding net charge-off by $11 million. The excess provision primarily reflects loan growth. The allowance for credit losses increased to $1.03 billion at the end of June compared to $1.02 billion at the end of the previous quarter. The ratio of the allowance total loans was unchanged at 1.15%. Non-accrual loans declined by $16 million at June 30th compared with the end of March. The ratio of non-accrual loans to total loans Loans nine days past due, on which we continue to accrue interest, excluding acquired loans that had been marked to a fair value discounted acquisition, were $349 million at the end of the recent quarter. Of those loans, $320 million, or 92%, were guaranteed by government-related entities. Current capital. compared with 10.03% at the end of the first quarter. The 19 basis point decline reflects the impact of higher loan balances, earnings retention, and capital distribution. During the second quarter, MSU re-purchased 2.5 million shares of common stock at an aggregate cost of $402 million. The 2019 capital plan, announced late last month, contemplates over the four-quarter period beginning this month. Our reference to net distributions reflects our intention to examine the current non-common equity components of our regulatory capital structure in the coming months. Now, turning to the outlook. As we noticed at the beginning of the call, yield up for M&T as well. We continue to expect growth in total loans in 2019 to be at a low single digit pace with continued runoff in residential mortgages more than offset by aggregate growth in other loan templates. The forward curve is implying reductions in short-term interest rates possibly starting as early as the end of this month and continuing over the next few quarters. Recall that following the Fed by layering on additional received fixed, face-loading interest rates slots. While our balance sheet is much less asset sensitive than it was previously, we expect lower rates to result in less growth in net interest income than we previously saw. At this point, we estimate that all else being equal and holding aside volatility and With these changes in mind, we still expect year-over-year growth in managed income for 2019. The previously announced servicing and subservicing acquisitions have increased our mortgage banking revenues above the outlook we feared on the January call. Lower long-term interest rates have led to a pickup in residential mortgage loan originations but not enough to further change that outlook beyond the impact of the servicing addition. Our outlook for the remaining C categories within 10 teams with growth in the low single digit range except for trust income, which should be in the mid single digit range, but remains vulnerable to market volatility. The breakdown of the investment in the asset manager is obviously not contemplated in our earlier expense guidance. As we noted earlier, the acquisition of on payroll IT talent reflected in salaries and benefits over the first half could be offset by lower contractor and consulting expenses over the coming quarter. Beyond that, with the revenue outlook being more subdued than we previously thought, we are examining our spending as we look forward. Our outlook for credit remains little changed. Credit costs moved from levels still well below long-term averages during the second quarter. We're watching for the size loans, which look like they'll be down this quarter from the end of March. MIT's capital allocation philosophy and policies remain consistent with our previous thoughts. To summarize, we believe that our current capital levels are higher than what is necessary to operate in a safe and sound manner given our history of solid credit underwriting and low earnings volatility. As such, our intention remains to manage our capital to a more appropriate level over time. The 2019 capital plan is lower than the plan for 2018, basically reflecting the fact that the Fed's template used year-end 2018 capital levels as a start point, which were some 36 basis points lower than year-end 2017, combined with stress test losses calculated by the Fed for the 2018 CCR exercise. As noted earlier, the 2019 plan contemplates net capital distributions of some $1.9 billion, with growth distributions potentially higher as we examine the non-common components of our regulatory capital and monitor growth in loans and regulated assets. Lastly, we'll continue to watch the Fed's rulemaking on stress testing capital levels, including stress capital buffer and the liquidity coverage ratio as we develop our capital plan beyond 2019. Of course, as you're aware, our perceptions are subject to a number of uncertainties and various assumptions regarding national and regional economic growth, changes in interest, political events, and other macroeconomic factors which may differ materially from what actually unfolds in the future.