7/23/2020

speaker
Lorraine
Operator

Ladies and gentlemen, thank you for standing by, and welcome to the M&T Bank second quarter 2020 earnings conference call. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that while posing your question that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero. I will now turn the call over to Don McLeod, Director of Investor Relations.

speaker
Don McLeod
Director of Investor Relations

Thank you, Lorraine. Good morning. I'd like to thank everyone for participating in M&T's second quarter 2020 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, on Forms 8K, 10K, and 10Q for a complete discussion of forward-looking statements and risk factors. Now, I'd like to introduce our Chief Financial Officer, Darren Kaye.

speaker
Darren Kaye
Chief Financial Officer

Darren Kaye Thanks, Don, and good morning, everyone. As we noted in this morning's press release, M&T's results continue to be impacted by the economic slowdown brought on by the COVID-19 epidemic and the return to a zero interest rate policy by the Federal Reserve. Our clients, both consumer and commercial, have adjusted to the new economic reality, which is reflected on our balance sheet by a slowdown in some loan categories and notably higher levels of deposits. In light of the challenging economic environment, our focus has shifted somewhat from capital distribution to capital strength. As far as the impact on M&T goes, the low interest rate environment resulted in a decline in our net interest income. Payment related fees suffered from the reduced level of economic activity due to the pandemic related lockdowns. However, lower rates also led to a 13% improvement in mortgage banking revenue compared to the first quarter. Trust income remained solid and operating expenses were well controlled. The net result provided a solid foundation to support expected credit costs while also improving our capital ratios. In connection with the CECL loan loss accounting standard, which reflects our assessment of the future economic conditions as of the end of the quarter, we added $254 million to our allowance for credit losses. The common equity tier one ratio improved by 32 basis points to 9.51%, indicating that M&T is well positioned to meet the needs of our customers and our communities. Now let's review the results for the quarter. Diluted GAAP earnings per common share were $1.74 for the second quarter of 2020, compared with $1.93 in the first quarter of 2020 and $3.34 in the second quarter of 2019. Net income for the quarter was $241 million, compared with $269 million in the linked quarter and $473 million in the year-ago quarter. On a GAAP basis, M&T's second quarter results produced an annualized rate of return on average assets of 0.71% and an annualized return on average common equity of 6.13%. This compares with rates of 0.9% and 7% 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 $3 million or 2 cents per common share. little change 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 second quarter, which excludes intangible amortization, was $244 million compared with $272 million in the linked quarter and $477 million in last year's second quarter. Diluted net operating earnings per common share were $1.76 for the recent quarter compared with $1.95 in 2020's first quarter and $3.37 in the second quarter of 2019. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 0.74% and 9.04% for the recent quarter. The comparable returns were 0.94% and 10.39% in the first quarter of 2020. 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. Turning to the balance sheet and the income statement. Taxable equivalent net interest income was $961 million in the second quarter of 2020, down by $20 million from the linked quarter. This primarily reflects the lower interest rate environment following the Federal Reserve's emergency reduction to its Fed funds target late in March. These cuts led in turn to a 105 basis point decline in average one month LIBOR compared to the first quarter. Overall, average interest earning assets increased by $15 billion to $123 billion, while the net interest margin declined by 52 basis points to 3.13% compared with 3.65% in the linked quarter. The government's fiscal and monetary policy actions were the primary drivers of our significant balance sheet growth in the quarter. First, loans made through the Paycheck Protection Program, or PPP, added $4.8 billion to average loans for the quarter. A significant portion of PPP funds currently sit in customer deposit accounts waiting to be deployed. Those PPP derived deposits in combination with other stimulus programs, led in turn to a $10 billion or 170% increase in our placement of cash at the Federal Reserve Bank of New York. Those large balance sheet movements had a similarly large impact on the net interest margin. Cash held at the Federal Reserve reduced the margin by an estimated 25 basis points, while having little effect on net interest income. The PPP loan portfolio was additive to net interest income during the quarter, but the combined impact of income and balances diluted the margin by about three basis points. The lower interest rate environment caused an estimated 22 basis points of pressure to the margin. The net impact of lower rates was somewhat mitigated by a 38 basis point decrease in the cost of interest-bearing deposits. All other factors amounted to another two basis points of margin pressure. Average total loans increased by $6 billion, or 7%, compared with the previous quarter. Looking at loans by category on an average basis compared with the linked quarter, commercial and industrial loans increased by $5.4 billion, or 22%, including the $4.8 billion of average PPP loans. CNI loans grew by nearly $600 million, excluding the PPP activity, largely the result of having line draws on the balance sheet for a full quarter net of repayments. We saw a somewhat unusual decline in dealer floor plan balances as customers returned to showrooms faster than manufacturer inventory could be shipped. Commercial real estate loans grew by 3% compared to the first quarter. Residential real estate loans declined by just over 2%, or $332 million, which primarily reflects the continuing measured rate of paydowns on acquired mortgages. Loans purchased from servicing pools, pending resolution, partially offset those paydowns. Consumer loans were up less than half a percent, reflecting higher indirect recreation finance loans partially offset by lower auto loans and home equity lines of credit. On an end-of-period basis, the PPP portfolio more than offset a net contraction of other commercial and industrial loans, reflecting paydowns of about half of the line draws that occurred late in the first quarter and a $1.3 billion decline in floor plan loans. CRE and consumer loans each grew a little over 1%, while consumer real estate loans declined slightly. Average core customer deposits, which exclude deposits received at M&T's Cayman Islands office and CD's over $250,000, grew 17% or over $15 billion compared with the first quarter. That figure includes $10 billion of non-interest-bearing deposits. The factors driving the change included cash from the government stimulus programs held in both commercial and consumer accounts and higher levels of mortgage servicing escrow deposits. These in turn led to the higher placement of cash at the Fed. On an end of period basis, core deposits were up $14 billion or 15% reflecting those same factors. Foreign office deposits decreased 39% on an average basis and 29% on an end of period basis as on-balance sheet sweep rates return to historic lows. Turning to non-interest income. Non-interest income totaled $487 million in the second quarter, compared with $529 million in the prior quarter. The recent quarter included $7 million of valuation gains on equity securities, largely on our remaining holdings of GSE preferred stock, while the first quarter included $21 million of losses. Also, recall that during the first quarter of 2020, M&T received cash distribution of $23 million from Bayview Lending Group. There was no such distribution in the second quarter. Mortgage banking revenues were $45 million in the recent quarter, compared with $128 million in the linked quarter. Residential mortgage loans originated for sale were $1.1 billion in the quarter, up 25% from $919 million in the first quarter. Total residential mortgage banking revenues, including origination and servicing activities, were $111 million in the second quarter, improved from $98 million in the prior quarter. The increase reflects the higher volume of loans originated for sale, combined with stronger gain on sale margin, partially offset by lower servicing income. Commercial mortgage banking revenues were $34 million in the second quarter, was $36 million. Trust income was $152 million in the recent quarter, up slightly from $149 million in the previous quarter. The rebound in equity markets from first quarter lows, good capital markets activity, and $5 million of seasonal tax preparation fees were all factors during the quarter, more than offsetting the emerging impact of money market fund fee waivers in the zero interest rate environment. Service charges on deposit accounts were $77 million compared with $106 million in the first quarter. COVID-19 related waivers of many of the consumer service charge categories and a slowdown in overall payments activity were the primary factors contributing to the decline. The $46 million linked quarter decline in other revenues from operations reflects the Bayview Lending Group distribution I mentioned earlier, as well as lower payments revenues that are not included in service charges, such as credit card interchange and merchant discount. Loan-related fees, including syndication fees, also declined given the reduced pace of non-PPP commercial loan origination activity. Operating expenses for the second quarter, which exclude the amortization of intangible assets, were $803 million, down some $100 million from $903 million in the first quarter. Recall that operating expenses for the first quarter included approximately $67 million of seasonally higher compensation and benefits costs, the largest of which related to accelerated recognition of equity compensation expense for certain retirement eligible employees. As usual, those seasonal factors declined during the second quarter. In addition, we reduced our level of incentive accruals to reflect lower levels of new business activity following the pandemic-related lockdowns. The impact of the pandemic also led to a noticeable decline in certain other expense categories. Advertising and marketing costs declined by $13 million compared with the prior quarter to under $10 million. Other costs of operations for the second quarter included a $10 million addition to the valuation allowance on our capitalized mortgage servicing rights. A similar sized addition was made during the first quarter. In addition, travel and entertainment expense of $12 million. The efficiency ratio, which excludes intangible amortization from the numerator and securities gains or losses from the denominator, was 55.7% in the recent quarter, compared with 58.9% in 2020's first quarter and 56% in the second quarter of 2019. Next, let's turn to credit. Net charge-offs for the recent quarter amounted to $71 million. Annualized net charge-offs as a percentage of total loans were 29 basis points for the second quarter compared to 22 basis points in the first quarter. The increased charge-off activity largely relates to problem loans identified at the end of 2019 but whose deterioration was likely accelerated by the pandemic-induced economic slowdown. The provision for credit losses in the second quarter amounted to $325 million exceeding net charge-offs by $254 million and increasing the allowance for credit losses to $1.6 billion or 1.68% of loans. The allowance currently reflects an updated series of assumptions reflecting a somewhat more adverse economic scenario than either of the scenarios used at January 1st or March 31st, 2020, as well as the impact of proactive risk rating changes within our portfolio to reflect the current economic environment. Our macroeconomic forecast uses a number of variables, with the largest drivers being the unemployment rate and GDP. Our forecast assumes the quarterly unemployment rate falls to 9% in the third quarter of this year from a peak at 13% in the second quarter, followed by a sustained high single-digit unemployment rate through 2022. The forecast assumes GDP contracts 6.7% during 2020 and recovers to pre-recession levels by the second quarter of 2022. Non-accrual loans as of June 30th amounted to $1.2 billion, an increase of $95 million from the end of March. At the end of the quarter, non-accrual loans as a percentage of loans was 1.18%. It's important to keep in mind that some of the usual credit metrics which are zero risk weighted and carry little or no credit risk. Excluding the impact of PPP loans, the ratio of allowance for credit losses to loans would be 1.79%. Similarly, the ratio of non-accrual loans to total loans would be 1.27%. Annualized net charge-offs as a percentage of total loans would be 31 basis points. Loans 90 days past due, on which we continue to accrue interest were $536 million at the end of the recent quarter, and of those loans, $454 million, or 85%, were guaranteed by government-related entities. Consistent with agency guidance, loans that have received some sort of relief, whether payment deferrals, covenant modifications, or other form of relief as a result of COVID-19-related stress, are not reflected in our non-accrual or delinquency numbers. As the virus spread in mid-March to early April, our customers reached out for relief actions and support from the bank. From that peak period, requests for relief from both commercial and consumer customers are down by about 95%. M&T's booked relief actions in the commercial portfolios have been heavily influenced by auto and recreation finance dealers. Those dealer relationships the vast majority of which are floor plan inventory, account for $4.4 billion of relief requests amounting to nearly 80% of total dealer balances. High levels of forbearance for dealers has been seen industry-wide, and given the strength in sales activity towards the end of the quarter, we expect further extensions of relief to be limited. Excluding dealer relationships, relief provided to commercial customers totaled $9.8 billion, comprising some 16% of balances. For the consumer portfolios, we provided assistance to approximately 30,000 accounts representing $3 billion in balances of our combined mortgage, home equity line of credit, and indirect recreation finance or auto portfolios, amounting to about 9% of total balances. Of interest, Approximately 30 percent of that population made a payment in the month of June. For mortgage loans that we don't own and that we service for others, relief was provided to approximately 70,000 accounts, totaling $13.2 billion. Turning to capital, M&T's common equity Tier 1 ratio was an estimated 9.51 percent as of June 30th, compared with 9.19 percent at the end of the first quarter. This reflects the impact of earnings in excess of dividends paid and lower risk-weighted assets. M&T did not repurchase shares during the second quarter and will not be doing so in the third quarter. Turning to the outlook. As we sit here today, our outlook is somewhat clearer than it was 90 days ago. However, there's still a fair amount of uncertainty. As far as the balance sheet goes, our liquidity assets, short-term investments, and deposits at the Fed rose somewhat beyond our expectations with both a rate and volume-driven impact on the net interest margin. This was driven by inflows of deposits from the PPP loans and other government stimulus programs. While the pace is uncertain, we believe that recipients will use these funds and excess reserves will trend downward somewhat as we go forward. Any additional on those assumptions. Excluding the impact from cash and PPP loans, the net interest margin experienced a 22 basis point rate-driven decline following a 105 basis point decline in LIBOR. We expect average LIBOR in the third quarter to fall a little further, as will deposit rates. Given all factors, we expect the printed margin will improve somewhat in the coming quarter. We expect average PPP loans will increase from the $4.8 billion average in the quarter toward the $6.5 billion outstanding at June 30th. Beyond that, the rate of prepayment and forgiveness will significantly impact the balance retained. As you know, forgiveness under the program is not currently automatic and is subject to review by the SBA. While we expect significant numbers of forgiveness requests before the end of the year, It's difficult to handicap how much will occur in the third quarter versus the fourth quarter. Commercial loan growth, which is to say excluding PPP loans, has slowed and we expect those balances to remain flat to slightly down over the remainder of 2020 compared to where we ended the quarter. In a normal environment, we'd expect to see a seasonal slowdown in inventories and a corresponding decline in our floor plan loan balances during the third quarter. Recent vehicle sales volumes might necessitate dealers adding inventory against a backdrop of constrained production that the manufacturers and the upcoming model year changes. Residential real estate loans should continue to experience a measured pace of runoff as the vast majority of our loans are originated for sale. However, as I touched on earlier, there are circumstances under which we can pursue buying delinquent loans or loans under forbearance out of the MBS pools we service. As a result, we have stepped up buyouts from the Ginnie Mae pools, which will lead to temporary growth in our residential mortgage loan portfolio. These are government-guaranteed loans, so our credit risk is extremely limited. We'd expect to see some improvement in the growth of consumer loans compared with the recent quarter, as recent indirect originations are on the balance sheet for a full quarter. Our outlook for net interest income is also somewhat dependent on the eventual resolution of the PPP loans. While we expect net interest income to improve in the third quarter from the second, the rate of improvement is also heavily dependent on the pace of forgiveness or prepayments on the PPP loans. Turning to fees, residential mortgage applications continue to be very strong with rates as low as they are and purchase activity has held up well. Waivers of money market mutual fund management fees. environment persists. We'll see a larger impact in the coming quarter than we did in the second quarter. Service charge income was impacted by lower levels of customer activity, higher balances, and state-mandated waivers of certain consumer fees. Payments activity recovered by the end of the quarter. However, certain categories of retail fees continue to be waived. In addition, higher commercial deposit balances have enabled those customers to offset the hard dollar fees arising from their treasury management obligations through the use of earnings credit. As we noted, the seasonal increase in salaries and benefits we experienced in the first quarter largely normalized during the second quarter. We have curtailed hiring and have been redeploying team members around the bank to address shifting business needs. We're in a similar situation to last year, as the first half, excluding the first quarter seasonal salaries and benefits figure. The third quarter is often higher than the fourth quarter from an expense perspective. In the CECL loan loss accounting environment, our allowance for credit losses at the end of the quarter reflects the macroeconomic variables I referenced earlier, the impact of the government stimulus, and the characteristics specific to our portfolio. As GAAP requires, we will reassess the allowance at the end of the third quarter based upon updated macroeconomic scenarios and M&T's specific credit data. Finally, regarding capital, as noted at the beginning of the call, we're focused on capital strength. Consistent with the CCAR results, we don't expect to repurchase any shares during the third quarter, and we continue to meet the Federal Reserve earnings threshold for dividend distributions. 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 up the call to questions before which Laurie will briefly review the instructions.

speaker
Lorraine
Operator

Thank you. As a reminder, if you would like to ask a question, please press star, then the number one on your telephone keypad. Your first question comes from the line of Gerard Cassidy of RBC.

speaker
Gerard Cassidy
RBC

Good morning, Darren. Good morning, Gerard.

speaker
Gerard Cassidy
RBC

Question for you on the net interest margin. Obviously, you've cited the reasons why the margin came down so much this quarter. And the PPP loans and the excess deposits certainly were the contributing factors, as you pointed out. When you look at your asset yields, the loan yields in particular, they came down quite steeply. Your cost of funding, not as much. As we go forward, do you sense that the asset yields in the loan portfolio, the decline will start to diminish, but you still see continued reductions in the cost of funding?

speaker
Darren Kaye
Chief Financial Officer

Yeah. George, when we look through the composition of the balance sheet, I think you saw that the yield on the CNI loans in particular came down. With the CRE loans, that tends to be where the hedging impacts those, and we'll see those come down through time. We also did see a nice decrease in the deposit costs. A significant portion of our deposit costs now are linked to the index, and so they came down proportionally. And so when we look forward, you know, if you hold the cash and the PPP aside and look at, you know, what we would consider to be the core margin, we think we wouldn't expect to see a drop like the 22 that we saw this past quarter, that it would be more tied to movements in LIBOR, which given, you know, how close we are to zero, we would expect to be pretty minimal. And so we would see relatively small movements in the yield on loans and a similarly small yield in the deposit costs. with probably the notable exception of some of the managed costs where time deposits are still repricing and there will be some of that go on through the second half of the year, as well as some of the other managed deposit costs like some of the money markets and the like. So probably all else equal, we follow LIBOR and maybe trickle down a couple basis points in the core margin. But as we kind of pointed out, the printed margin will bounce around depending on how the cash balances move in the quarter as well as the PPP funding.

speaker
Gerard Cassidy
RBC

Very good. And then as the follow-up question, you obviously built up your reserves this quarter. M&T has distinguished itself as one of the best banks through a full cycle on credit. If the economic outlook does not deteriorate from the period that you just came through in which you made your assumptions for the reserve buildup, and granted you'll have some reserves for any loan growth, should we anticipate provisions for loan losses coming down in third or fourth quarters, assuming this economic outlook doesn't deteriorate from this quarter under CECL accounting?

speaker
Darren Kaye
Chief Financial Officer

Well, I guess, you know, the math would say if the economic assumptions are identical, then the provision wouldn't really change with the exception of reflecting loan growth. you would see an increase, but all else equal, as you point out, you'd probably see the provision not moving much and that the action would be predominantly actual charge-offs.

speaker
Gerard Cassidy
RBC

But would the provision still be at this level, though?

speaker
Darren Kaye
Chief Financial Officer

I mean, because you built up reserves so much, assuming life of loan loss... Yes, the provision would only be impacted by net loan growth if the macroeconomic assumptions were unchanged.

speaker
Gerard Cassidy
RBC

Okay, thank you.

speaker
Lorraine
Operator

Your next question comes from the line of Dave Rochester of Compass Point.

speaker
Dave Rochester
Analyst, Compass Point

Hey, good morning, guys. Good morning. I appreciated the detail on the deferrals and some of those loan buckets. I was just wondering what the total amount was at the end of the quarter, if you happen to have that, or the current total in terms of total amount of loans and deferral. And then if you happen to have the criticized or classified asset trends for the quarter, that would be good to hear as well.

speaker
Darren Kaye
Chief Financial Officer

So we'll get you the sum of the loans in forbearance or with some kind of payment relief. When you look at the non-accrual loans, the non-accrual loans bumped up by $95 million for the quarter. More action was in the criticized space, and a lot of that was related to some of the forbearance activity. And so as we went through the portfolios and we looked at – loans that were in forbearance. We took them down a grade or two depending on where they started, and that was really the primary driver of an increase in criticized, but most of them are just over the threshold that we would start to consider criticized. Back to the balance figure of what's in forbearance in aggregate. For loans that we own, it's about $17 billion, about 14 commercial and about $3 billion for consumer, which would include the mortgage portfolio that we own. And then if you add in what we service for others, there's another $13-odd billion, but that's not our credit risk. And, you know, I guess it's important to point out that as we come to the end of the quarter, we're getting close to the end of some of the 90-day forbearance periods. And within that commercial portfolio, there's a large amount, you know, $4.4 billion or around there of commercial or dealer floor plan balances. And we are not seeing a lot of activity in extension requests. And so we would expect that number to start to come down as we go into the third quarter.

speaker
Dave Rochester
Analyst, Compass Point

Okay. And then for the total amount of criticized loans you have at the end of the quarter, what were those?

speaker
Don McLeod
Director of Investor Relations

We typically don't disclose that until the 10 Q comes out.

speaker
Dave Rochester
Analyst, Compass Point

Okay. Gotcha. But it sounds like those were up, I guess, commensurate with some of the other deterioration that you guys. Yeah. Yeah. Yeah.

speaker
Darren Kaye
Chief Financial Officer

Yeah.

speaker
Dave Rochester
Analyst, Compass Point

Yeah.

speaker
Darren Kaye
Chief Financial Officer

Probably because of those, the damn rates that we talked about.

speaker
Dave Rochester
Analyst, Compass Point

Yep. Got it. And then just switching to the NEM quickly, just so I understand you're saying that the core NEM moves a little bit lower, but the reported NEM with all the impacts on cash and whatnot could actually be higher. if cash does actually decline in the next quarter or two. Is that what you're saying?

speaker
Darren Kaye
Chief Financial Officer

That's right.

speaker
Dave Rochester
Analyst, Compass Point

Yeah. Okay. I was just curious, just looking at the balance sheet, you have a decent amount of borrowings there. Your cash grew more than your entire borrowing balance this quarter. Are there any opportunities where you can whittle away at that balance over time? I realize you may have some built-in prepayment penalties that you have to run into, but any opportunities on that side?

speaker
Darren Kaye
Chief Financial Officer

Yeah, I guess if you look around, we probably, given where rates are, you know, we wouldn't be taking on any duration risk at this point with converting it into mortgage-backed securities, but we'd prefer to stay short. You know, we'll have some long-term debt that will mature and roll over, and we won't replace that in the short term. We can take advantage of those balances for funding. And then we'll probably use some of it, as we mentioned, in balances in the mortgage servicing business where we would buy out some of the loans that are being modified and take them out of the pools and we'll use some of the excess cash to fund those in the short term.

speaker
Dave Rochester
Analyst, Compass Point

And going back to the roll-off of the borrowings, what's the schedule for that look like over the next year? Do you have any lumpy roll-offs that could really help the NIM in any of these quarters?

speaker
Don McLeod
Director of Investor Relations

There's... Everything is swapped, so the savings is not materially large.

speaker
Dave Rochester
Analyst, Compass Point

Okay. Got it. Great. Thanks, guys. Appreciate it.

speaker
Lorraine
Operator

Our next question comes from the lineup, John Pancari of Evercore ISI.

speaker
John Pancari
Analyst, Evercore ISI

Morning. Morning, John. On the reserve, actually on your loss expectation, have you run your internal company-run stress test yet for 2020 DFAS, or have you disclosed it?

speaker
Darren Kaye
Chief Financial Officer

We don't run a company stress anymore as part of being a Category 4 bank.

speaker
John Pancari
Analyst, Evercore ISI

Okay. All right. So I guess I just want to see if you could help – think about the reserve level now at the 1.68% that's about half of the last time you did run the publicly disclosed company run stress test in 2018 and so how should we, can you help us kind of triangulate that reserve coverage where it stands now versus the stress loss estimate is it really the macro assumptions behind it and the dialing in of stimulus that you can attribute to that difference

speaker
Darren Kaye
Chief Financial Officer

Well, I guess there's a number of factors, John, to think about when looking at that level of allowance. I guess the first place that I start is, you know, we think about it more as 1.8 as opposed to 1.7, which is, I know, splitting hairs, but just because of the PPP loans and the fact that there's no credit risk there or very little. And then when you compare the CCAR process to the CECL process, there are a couple of key differences. One is the assumptions that you mentioned. The stress test is specifically designed to really put the bank under stress. And so when you look at some of the assumptions, the depth of the decline in GDP and the length of time it stays at those depths, the drop in unemployment, while we saw a bigger drop in unemployment In the short term, when you look at where that trends out over the last four to six quarters of the projection, it's actually not as bad as what CCAR would have. And so there are some parts of the macroeconomic assumptions that are different. A key difference would be HPI. and that we've seen HPI hold up really strong right now and the decrease in HPI is a lot different in our economic assessment today than what it would be under stress. Another really key difference is within CCAR you assume that all or we assume that all non-accrual loans charge off and we know that's not our experience in the CECL allowance recovering or curing those customers that are in non-accrual. And so those are some of the differences between the two. I guess the thing that we look back to, too, is how the portfolio and the underwriting performed under the great financial crisis and what the actual losses were during that and what the peak losses were. And when we compare the portfolio to what we saw in that crisis, which was more financial-driven We look at where our reserving ratios are relative to what happened then. And, you know, so CECL more so reflects our underwriting experience than CCAR might, where you use a little bit more of industry information and industry-level losses. And so those are a bunch of the things that go on underneath. And, you know, we're doing work. I think, you know, we talked about it during the quarter. Renee talked about it. of the portfolios where we see the forbearance the highest, really literally going bottoms up and credit by credit to understand what we think their cash flow is and their ability to sustain revenue shortfalls for periods of time and looking at the values of the collateral and how they might hold up under stress and all of those different It's thorough, but it reflects both the economic environment and the view we have of our portfolio.

speaker
John Pancari
Analyst, Evercore ISI

That's very helpful. Thanks for all that color. And then separately, just wanted to see if I could get a little bit more granularity around the underlying commercial demand that you're seeing on the loan book. It sounds like, you know, understandably, given that they – you expect commercial balances to remain flat to slightly down. Sounds like not a lot of underlying commercial demand, but just wanted to get your updated view on what you're seeing live in terms of borrower demand, given where we stand right now in the pandemic.

speaker
Darren Kaye
Chief Financial Officer

Yeah, we've definitely seen a slowdown in demand. I think PPP helped create some of that slowdown because the customers were able to take advantage of those programs. But really what's encouraging to us that we've seen is a really rapid reaction by the customers to the new operating environment. And we've seen them make changes to their business to manage the burn rate of expenses. And so when you look at how they're running their business, part of this you see reflected in the deposit balances. The pace of turnover in their operating accounts isn't what it was pre-pandemic. And so when you factor that in along with some of the PPP funds and their ability to manage, they're very liquid. And that's a great thing from a credit perspective because they can withstand a longer slowdown in economic activity, but it doesn't necessarily lead to a lot of loan demand in the short term. And so that's really what's going on there. But from our perspective, when we look at the how the customer base has actually responded. We're quite pleased with what we see. And the customers, you know, I would say are quite sanguine about what's going on. You know, I think we're in that period right now where for our part of the country, we got through the hard hit that happened in April and May. We're starting to see a rebound and our customers are are guardedly optimistic about how things are, how they will unfold, but, you know, cautious, and all of that is what's leading to that forecast.

speaker
John Pancari
Analyst, Evercore ISI

Got it. Thank you.

speaker
Lorraine
Operator

Our next question comes from the line of Stephen Alexopoulos of J.P. Morgan.

speaker
Stephen Alexopoulos
J.P. Morgan

Hi. Good morning, Darren. Good morning. Just to follow up on the reserve, how much of the reserve bill this quarter was tied to the change in economic forecasts as opposed to portfolio-specific changes? And were qualitative overlays a material factor this quarter?

speaker
Darren Kaye
Chief Financial Officer

So if you look at the allowance, the biggest driver of the increase or the provision was the economic forecast. When you look at the moves in the grades, in some cases the grades move by one or two, and those aren't generally – the PD, the loss assumptions under those changes aren't big enough swings to cause a meaningful move in what you think your loss rates would be. It's really as you get up into the criticized and even beyond the criticized and the non-accrual where you really start to see an uptick in those rates. You know, I would describe it as the grading that happened this quarter kind of caught up a little bit to the macroeconomic assumptions that were in the model at the end of the first quarter. And so... those are the drivers there. And when you look at the qualitative overlays, we really didn't change the overlays from an economic perspective in terms of the impact of the stimulus. That was pretty consistent from quarter over quarter. I would say the place where if there was a qualitative overlay was looking at some of the instances in the models where they haven't seen these types of inputs in terms of GDP changes and unemployment. And in worse economic conditions, tend to overpredict losses. And so for certain portfolios where we went through bottoms up and looked at what we thought our loss was, we kind of took that into account and made an overlay. But really, not much change quarter over quarter and not tremendously significant.

speaker
Stephen Alexopoulos
J.P. Morgan

Okay, that's helpful. And then one of the areas that as a focal point for you guys, is New York City commercial real estate exposure, as you know. Could you give us what's the balance today? What are you seeing there? What are deferral requests in that bucket? I think that would be helpful. Thanks.

speaker
Darren Kaye
Chief Financial Officer

Sure. So, you know, within New York City, I think when you look in the 10K, including construction, the balances are right around $9 billion. Actually, sorry, a little bit high, $7 billion. And when we look at the requests for forbearance, they haven't increased since what we saw in the first quarter. And when you walk down the portfolios by category, if we look at the industrial type of space It's really quite small, and that's the least impacted segment. You know, we're still seeing rent collection rates of 95 percent plus there and low levels of forbearance. With the multi-family portfolio, which in total exposure, including construction, is about $2.5 billion, we're still seeing rent receipts above 90 percent. In fact, you know, they went up slightly in July compared to what they were in April. and we haven't seen any increases in requests for forbearance there. The office space continues to also see some slight upticks in rent being collected, slightly over 90%, which is up from what it was in April, although not totally meaningfully. Hotel is probably one of the more challenged portfolios in aggregate, at least in terms of the economic impact. although the ability of the clients to handle things has been quite strong. And so the forbearance rates there are the highest, upwards of 70% plus. But what's interesting is when we look at the forbearance rates across the whole hotel portfolio, they aren't materially higher in New York City than they are across all other geographies. And we have seen through our card activity that people are going back to hotels. In the retail world, which is another relatively large portfolio, and where there's probably the next highest level of forbearance activity after the hotel portfolio, it's about $1.3 billion. And interesting, that's probably where we've seen the biggest increase in rents being paid since April. and now is up over 50% from being slightly above 30% before. And so the New York City portfolio is so far holding up well. We're seeing some trends that are positive in terms of payments ultimately to the landlords. And then I guess the other thing that we keep an eye on is what the loan-to-values are in that portfolio versus any other. And the loan-to-values across all those categories in New York City tend to be 5 to 10 percentage points lower than what the LTVs might look like in a similar asset class in the rest of the footprint. And so, you know, it's still early days and so far too early to declare victory, but the trends and the change in the trends from early in the quarter to the end of the quarter haven't deteriorated and arguably are slightly more positive.

speaker
Stephen Alexopoulos
J.P. Morgan

All right. There's more color than I was hoping for. Thanks for taking my questions.

speaker
Darren Kaye
Chief Financial Officer

Sure thing.

speaker
Lorraine
Operator

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

speaker
Matt O'Connor
Deutsche Bank

Hey, guys. Morning, Matt. Hey. The PPP loans are a pretty big part of your loan portfolio. bigger than, I think, a lot of your peers. And if we just think about the origination fee that you'll get on that, it seems like a pretty decent chunk relative to earning capital reserves. Can you just give us an estimate on what you think the blended origination fee is on the $6.5 billion and how much you think will be forgiven or repaid the next few quarters in aggregate?

speaker
Darren Kaye
Chief Financial Officer

Yeah, so... The blended fee on the loans is probably somewhere between 270 and 280. And the pace of forgiveness is, as we said, a little bit tough to handicap. Although, you know, as we think about it, Matt, there's a couple things. The change to the program rules extended the time that the customers had to actually use the money and so that pushes out the time period for the forgiveness. We thought a bunch of it originally, and we in the industry, that it would be starting even as early as late in the second quarter. Now that could push all the way into the fourth quarter, and so we expect forgiveness in the second half of the year, probably in the range of 60% to 70%. But how much is in the loaded in the fourth quarter than the third, but it remains to be seen. And the other thing that's still just kind of hanging out there is the rules for forgiveness are still in consideration, and will there be any automatic forgiveness or not for the small loans? I think those things will impact the timing. that the longer it takes for the rules to be clear on forgiveness, I think that will have two impacts. It will slow down when that actually happens and when those fees get accelerated. And then the second thing that will happen is I think customers are being cautious about when they use the money, and so that sits on the balance sheet. While they want to make sure that they spend it appropriately, And so it's a little bit fluid in there. What's relatively certain is that that amount of origination fee or processing fee will come in over the next couple years. The timing of when that shows up is a little bit uncertain.

speaker
Matt O'Connor
Deutsche Bank

Gotcha. And then just separately, the expenses were very well managed this quarter. The guidance for second half to be similar to first half kind of implies 1Q expenses might have been bloated, 2Q expenses might have been unusually low. Is that a reasonable way to frame it? Because the cost came in a lot lower, I think, than anyone would have expected in 2Q. And it doesn't seem like that's sustainable. So I just want to make sure I'm framing that right.

speaker
Darren Kaye
Chief Financial Officer

Yeah, I think you're in the right ballpark there. You know, we think that it's closer to Q2, obviously, than it was to Q1. But, you know, this is M&T. And when we see movements in revenue and headwinds, then we take action on the expense side. third quarter versus fourth. But if you average them out, you know, you're in the ballpark, you know, maybe slightly higher than Q2 on average for each of those last two quarters with a bit of a mixed difference between third and fourth.

speaker
Matt O'Connor
Deutsche Bank

Gotcha. Okay, that's helpful. Thank you.

speaker
Lorraine
Operator

Our next question comes from the line of Ken Houston of Jefferies.

speaker
Ken Houston
Analyst, Jefferies

Thanks. Good morning. Question on the fee side of things. Darren, just wondering if you can help us understand. Some of the lines were better. Some of the lines were worse. And as you look out, can you just talk about, you know, can those service charges rebound? What do you see for mortgage? And just, you know, what were the fee waivers this quarter? And then what do they turn into? Thanks.

speaker
Darren Kaye
Chief Financial Officer

Sure. Sure. So just kind of going category by category, if you look at the mortgage business, second quarter was a bang-up quarter for us and for most of the industry. Whether we continue at that pace in the consumer space is difficult to say, but seems unlikely. But I don't think we go all the way down to where we were in the first quarter. I would expect we're somewhere in between. We should continue to see Some gain on sale just from where rates are and from some of the portfolios that we're servicing where people will refi, which will be offset a little bit by slightly lower servicing fees. But net-net, I would expect us to be in the range between where we were in the first and the second. Trust income, you start to see a little bit of pressure on that line item just because of the the fees that are associated with the money market mutual fund and the management fees. And so we might see a little bit of pressure there. And then the service charge line is really the one that was impacted this quarter. And it's interesting when you look at it that the payment related fees, so interchange, have come back to where they were and up year over year. The biggest The impacts are on some of the other line items, some of the ATM-related fees where we're from some of the government programs, state-related programs. We're not allowed to charge for those, and so those will be off the table until that changes. And then one of the other big categories is NSF, and NSF is lower, mainly for two reasons. There's less transaction activity and also higher average balances in customer accounts. and then commercial account balances. So I think in a long-winded way of saying, I think we start to see service charges come back up through time, but probably takes a couple of quarters to get back to the run rate we were at in the first quarter. And then in some of the other income, again, you've got payment fees. That's where the credit card-related fees are, just because they're not associated with deposit accounts. And so interchange and merchant should come back with business activity. And then that's where some of the loan origination fees are, like syndications. And, again, as those markets pick up, we'll see those fees come back.

speaker
Ken Houston
Analyst, Jefferies

Got it. And just to follow up on the fee waivers, I think you talked last time that they could get to around $10 million. Do you have any different view there, and what were they this quarter? Thanks.

speaker
Darren Kaye
Chief Financial Officer

They were, well, they were slightly higher than that this quarter, and I would expect them to be in that range in the third quarter. And then we'll see how things unfold to the fourth. It's just because they're more policy-related. You know, I'm hesitant to comment on what they might go beyond the third quarter.

speaker
Ken Houston
Analyst, Jefferies

Oh, and I'm sorry, Darren. I meant the trust, the waivers with the money market fee waiver side.

speaker
Darren Kaye
Chief Financial Officer

Oh, okay. Okay. They were small in the second quarter. I mean, really not that significant, and we'll start to see them go up as we go forward, maybe in the neighborhood of $10 million a quarter, something like that.

speaker
Ken Houston
Analyst, Jefferies

Okay, got it. Thanks very much.

speaker
Darren Kaye
Chief Financial Officer

Yep.

speaker
Lorraine
Operator

Our next question comes from the line of Saul Martinez of UBS. Sorry, your line is open. Please state your question. If your phone is on mute, please unmute it. Hello.

speaker
Gerard Cassidy
RBC

Hi. Can you hear me? Sorry about that. We got you now. I thought you were using sign language. Yeah. No. Sorry about that. So just wanted to make sure I understood the guidance on expenses and have my numbers straight. So I think, I mean, you mentioned it would be similar in the second half versus the first half. And you know, stripping out some, I guess, a small amount of non-core items in the first quarter. By my calculations, that gets you a little under $1.7 billion or let's just call it $845, $850 million a quarter, which seems a little bit high versus, you know, what you kind of implied in your answer to Matt. So I just want to sharpen the pencil a little bit and make sure, you know, I kind of have the you know, a little bit tighter range in terms of the outlook going in the second half of the year?

speaker
Darren Kaye
Chief Financial Officer

Yeah, sure. I think the difference might be the comment about first and second is it's the same excluding the seasonal salary impact or similar excluding the seasonal salary impact. And, you know, that by itself would be about $60 million that you'd exclude. And if you were including that in the first equal second, then you'd get that higher run rate. I think if you take The run rate that we saw in the second quarter and bump it up by $10 or $15 million and think about that on average for the second half of the year, you're probably in a better run rate.

speaker
Gerard Cassidy
RBC

Okay, got it. So basically second half normalizing for the seasonality is basically what you're saying. Okay, got it. I misunderstood that. Okay, and I guess on the NII, another more of a clarification question as well. I mean, you gave a ton of color on the moving parts around net interest margin and probably got lost in all of it. But I think the punchline was you do expect some uptick in net interest income in the third quarter versus the second. And first, I think, you know, just wanted to make sure that was right. And... Is that outlook incorporating any of the PPP deferral gains that you talked about, 60% to 70% in the second half, fully realizing it's completely uncertain and more fourth quarter tilted, but is that view that you will have some NII growth dependent on some realization of PPP forgiveness gains?

speaker
Darren Kaye
Chief Financial Officer

Yes, that's If you go in the third quarter, we expect slight uptick in NII, and that's because some small amount of forgiveness starts to come in, and then you'll have a full quarter of the PPP loans outstanding and the amortization of the fee, and then really you start to see more of that weighted to the fourth quarter.

speaker
Gerard Cassidy
RBC

Okay. But that view that there is some uptick is incorporating some some forgiveness. And I guess the 60 to 70%, is that, I mean, if we could just clarify on that, do you have a view of what percentage of the loans will be forgiven? And is the 60 to 70%, you know, based on the percentage of the forgiveness, in other words, of those loans that are forgiven, you think 60 to 70% will be in the second half? Is that the right interpretation of what you said?

speaker
Darren Kaye
Chief Financial Officer

Yeah, I guess so at the highest level, when you look at the PPP loans, you know, you're probably up to 75% over time. You know, I guess I'm kind of hedging my bets a little bit and thinking that maybe it's more like 60 or 70. What we know is just, again, because of the rules about when the funds are supposed to be dispersed, that it needs to happen by and large by the end of the year. by the end of the year. And then the question on timing is when the customers go and seek forgiveness and then how quickly the SBA processes it. It's, you know, it's likely to be concentrated in the next three quarters and then there will be some, you know, the rest of it will hang on and show up, you know, kind of over the normal course of those two-year loans and normal amortization. But that's kind of how we're thinking about it. And as I said, a little bit of that is, quarter, which helps. And then, you know, obviously whatever doesn't show up in the third quarter starts to show up in the fourth and the first of 2021. Got it.

speaker
Gerard Cassidy
RBC

I fully realize it's a very imprecise science, but appreciate that. That's helpful. Okay.

speaker
Lorraine
Operator

Our next question comes from the line of Erica Najarian of Bank of America.

speaker
Erica Najarian
Analyst, Bank of America

Hi, I just had a one follow-up question on the NIM. Darren, you said earlier that the net interest margin was impacted 25 basis points by excess cash and three basis points by PPP. I think investors thought it was helpful when one of your peers said this morning what normalized NIM could stabilize as we look at your earnings power post all the PPP noise. So if I exclude that, I would get to net interest margin in the 340 range. And as I think about your outlook for LIBOR decreasing but potentially offset by deposit costs, as you think about second quarter, third quarter of 2021, is high 3.3s a good starting point for the margin?

speaker
Darren Kaye
Chief Financial Officer

Yeah, I think that's a good way to think about it. We talked about that. We look at the core earnings power of the bank, and that 22 basis points gets you down to where we would be absent those large increases in cash balances at the Fed as well as PPP. And you probably see that move down small amounts per quarter just as the different hedge markets activity rolls on and rolls off, that the way the hedges were constructed through time, that the receive fixed rate on the hedges will slowly come down and that will create some headwind. The flip side is the loan activity that is happening, we've seen some increases in the margin on that and so that will help offset. I think you're thinking about it right. You're in the ballpark of how we would see it without those factors. You know, really the, one of the big questions in the printed margin, and I would just kind of hold this to the side, is just where the cash settles out.

speaker
Lorraine
Operator

Got it. Thank you. Thank you. Oh, now we're trying to call to Don McLeod for any additional or closing comments.

speaker
Don McLeod
Director of Investor Relations

Again, thank you all for participating today. And as always, if any clarification of any of the items on the call, the news release is necessary. please contact our Investor Relations Department at 716-842-5138.

speaker
Lorraine
Operator

Thank you for participating in the M&T Bank Second Quarter 2020 Earnings Conference Call. You may now disconnect.

Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

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