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 and T Bank Q2 2019 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer 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 and T's Q2 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. Mtv.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
Thanks, Don, and good morning, everyone. As noted in this morning's press release, M and T's results for the Q2 include the 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 charge offs just over half of our long term average, Notwithstanding an increase from the unusually low level we saw in the Q1.
We continue to return excess capital Beyond what is needed to support growth of the balance sheet, including $402,000,000 of common share repurchases And paying $135,000,000 of common stock dividends. During the quarter, we successfully completed the onboarding of $13,000,000,000 of owned mortgage servicing as well as $17,000,000,000 of subservicing. These portfolios added to mortgage fee revenue, non interest expenses, servicing related purchases of mortgage loans and non maturity interest bearing deposits. At the same time, the interest rate environment has become more volatile than at any point in recent memory, impacting our outlook for net interest margin 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 per common share were $3.34 for the Q2 of 2019 compared with 3.35 segment in the Q1 of 2019 and $3.26 in the Q2 of 2018. Net income for the quarter was $473,000,000 compared with $483,000,000 in the linked quarter and $493,000,000 in the year ago quarter. On a GAAP basis, M and T's 2nd quarter results produced an annualized rate of return on average assets of 1.60% and annualized return on average common equity of 12.68%. This compares with rates of 1.68% in the recent quarter where the after tax expenses from the amortization of intangible assets amounting to $4,000,000 or $0.03 per common share, little change from the prior quarter. Consistent with our long term practice, M and T provides supplemental reporting of its results on a net operating or tangible basis from which we have only ever excluded the after tax effect of amortization of intangible assets as well as any gains or expenses associated with mergers and acquisitions when they occur.
M and T's net operating income for the 2nd quarter, which includes intangible amortization, Was $477,000,000 compared with $486,000,000 in the linked quarter and $498,000,000 in last year's Q2. Diluted net operating earnings per common share were $3.37 for the recent quarter compared with $3.38 in 20 nineteen's Q1 and $3.29 in the Q2 of 2018. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 1.68% 18.83% in the recent quarter. The comparable returns were 1.76 percent 19.56 percent in the Q1 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 equity.
Both GAAP and net operating earnings for the 1st and second quarters of 2019 were impacted by certain noteworthy items. Our results for the Q1 of 2019 included a $37,000,000 cash distribution from Baby Lending Group reflected in other revenues from operations. This amounted to $28,000,000 after tax effect for $0.20 per diluted common share. Also affecting results for the Q1 was in addition to our legal reserves of $50,000,000 relating to a subsidiary's role as trustee for customers' employee stock ownership plans. This amounted to $37,000,000 after tax effect or $0.27 per diluted common share.
Reflected in the Q2 of 20 nineteen's results Was a $48,000,000 write down of M and T's investment in an asset manager, which is accounted for using the equity method of accounting. That amounted to $36,000,000 after tax effect or $0.27 per common share. In July 2019, M and T agreed to sell its investment in the asset manager, which had been obtained in the 2011 acquisition of the Wilmington Trust Corporation. Turning to the balance sheet and the income statement. Taxable equivalent net interest income was $1,050,000,000 in the Q2 of 2019, down by $9,000,000 or 1% from 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 3 basis points of the decline in margin The higher day count in the quarter compared to the Q1, 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 2 basis points of the decline, Which this 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 accounted for approximately 7 basis points of the decline.
Sharply higher mortgage escrow deposits in conjunction with our growth in mortgage servicing, much of which Our index to a mix of Fed funds and LIBOR are the primary driver of that increase. The expected continued migration of deposits into higher yielding categories, Notably commercial deposits into interest checking and on balance sheet suite as well as a higher cost of time deposits as new certificates that are issued at Higher rates than maturing ones were also factors. Average loans grew by 1% compared with the previous quarter. Originations remain solid, while payoffs and paydowns picked up a little compared to the Q1, but remained below our experience in the second half of twenty eighteen. Looking at the loans by category on an average basis compared with the linked quarter, Commercial and industrial loans increased 1% compared with the linked quarter.
Commercial real estate loans also grew 1% compared to the 1st quarter with a slightly lower proportion of construction loans compared with permanent financing. Residential real estate loans declined by about 1% compared with the linked quarter. The continued comparatively steady pace of planned paydowns of mortgage loans acquired in the Hudson City transaction was partially offset by the purchase of government guaranteed mortgage loans out of the recently acquired servicing pools. While that practice will continue, it was somewhat elevated this quarter in connection with the onboarding of the mortgage servicing we acquired. We expect the aggregate portfolio to resume its low double digit rate of principal amortization in future quarters.
Consumer loans were up about 2%. Growth in recreation finance loans continue to outpace declines in home equity lines and loans. Regionally, 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. Average Core customer deposits, which exclude deposits received at M and T's Cayman Islands office and certificates of deposit over $250,000 Grew an estimated 2% compared with the Q1.
This primarily reflects the escrow deposits we referenced earlier. Deposits received at the Cayman Islands office increased by $275,000,000 As noted last quarter, commercial customers continue to seek a higher yield on excess funds in demand accounts and often achieve that by sweeping them into short term interest bearing deposits. Turning to non interest income. Non interest income totaled $512,000,000 in the 2nd quarter compared with $501,000,000 in the prior quarter. Mortgage banking revenues were $107,000,000 in the recent quarter compared with $95,000,000 in the linked quarter.
Residential mortgage loans originated for sale were $723,000,000 in the quarter, up substantially from $422,000,000 in the Q1, reflecting the lower long term interest rate environment as well as seasonal strength. Total residential mortgage banking revenues, including origination and servicing activities, We're $72,000,000 in the 2nd quarter, improved from $66,000,000 in the prior quarter. The increase is primarily the result of the additional residential loan servicing and subservicing that we acquired combined with higher gain on sale revenues. Commercial mortgage banking revenues were $35,000,000 in the 2nd quarter compared to $29,000,000 in the linked quarter, reflecting seasonally stronger origination activity. Trust income was $144,000,000 in the recent quarter, improved from $133,000,000 in the previous quarter.
This quarter's results include $4,000,000 of seasonal fees earned in assisting clients with their tax filing. The rebound in the equity markets from the sell off in the Q4 of 2018 also contributed to the linked quarter growth. Service charges on deposit accounts were $108,000,000 up from $103,000,000 in the Q1, reflecting higher levels of activity from what is usually a seasonally slower Q1. The recent quarter also included $9,000,000 in securities gains, representing the valuation gains on equity securities, while the Q1 of 2019 included $12,000,000 of similar valuation gains. Turning to expenses.
Operating expenses for the Q2, which exclude the amortization of intangible assets for $868,000,000 As previously noted, the recent quarter's results include a $48,000,000 write down of our and an asset manager acquired in the Wilmington Trust merger. Also included in the quarter's results was a $9,000,000 valuation reserve on our mortgage servicing rates, reflecting the recent decline in long term interest rates. Salaries and benefits were $456,000,000 in the quarter, down $44,000,000 from the seasonally high level in the prior quarter. The year over year increase reflects annual meridan increases, the salary adjustments we made in connection with the Tax Cuts and Jobs Act as well as further adds to staff as we expand our pool of IT talent. We continue to expect to offset this hiring over time by reducing our use of consultants and contractors.
The efficiency ratio, which excludes Intangible amortization from the numerator and securities gains or losses from the denominator was 56% in the recent quarter compared with 57.6 percent in 20 nineteen's Q1. Those ratios reflect legal related accrual and write down we noted earlier. Next, let's turn to credit. Overall, credit quality remains in line with our expectations. Annualized net charge offs as a percentage of total loans were 20 basis points for the 2nd quarter compared with 10 basis points in the 1st quarter.
That reflects higher net charge offs in our commercial loan portfolios. The provision for credit losses was $55,000,000 in the recent quarter exceeding net charge offs by $11,000,000 The excess provision primarily reflects loan growth. The allowance for credit losses Increased to $1,030,000,000 at the end of June compared to $1,020,000,000 at the end of the previous quarter. The ratio of the allowance to total loans was unchanged at 1.15%. Non accrual loans declined by $16,000,000 at June 30 compared with the end of March.
The ratio of non accrual loans to total loans improved by 3 basis points, ending the quarter at 0.96%. 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 $349,000,000 at the end of the recent quarter. Of those loans, dollars 320,000,000 or 92% were guaranteed by government related entities.
Turning to capital.
M and T's common equity Tier 1 ratio was The 19 basis point decline reflects the impact of higher loan balances, earnings retention and capital distributions. During the Q2, M and T repurchased 2,500,000 shares of common stock at an aggregate cost of $402,000,000 The 2019 capital plan announced late last month contemplates net capital distributions of $1,900,000,000 over the 4 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 noted at the beginning of the call, The interest rate outlook has changed materially over the past 90 days, impacting the outlook for M and 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 and other loan categories. 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's December action to raise rates, We took further steps to hedge our asset liability position by layering on additional received fixed pace loading interest rate swaps. 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 thought. At this point, we estimate that all else being equal and holding aside volatility In certain deposit categories, each hypothetical reduction of 25 basis points in the Fed funds target Should result in 5 to 8 basis points of margin pressure over the ensuing 12 months.
With these changes in mind, We still expect year over year growth in net interest income for 2019. The previously announced Servicing and subservicing acquisitions have increased our mortgage banking revenues above the outlook we shared 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 additions. Our outlook for the remaining fee categories remains unchanged The write down of the investment in the asset manager Obviously not contemplated in our earlier expense guidance. As we noted earlier, the acquisition of Onpayroll IT Talent reflected in salaries and benefits over the first half should be offset by lower contractor and consulting expenses over the coming quarters.
Beyond that, With the revenue outlook being more subdued than we previously thought, we are examining our spending as we look forward. Our outlook Credit remains little changed. Credit costs moved from an unsustainably low level in the Q1 to a level still well below long term averages during the Q2. We're watching criticized loans, which look like they'll be down this quarter from the end of March. M and T'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 at the start point, which were some 86 basis points lower than year end 2017. Combined with stress test losses calculated by the Fed for the 2018 CCAR exercise. As noted earlier, The 2019 plan contemplates net capital distributions of some $1,900,000,000 with gross distributions potentially higher as we examine the non common components of our regulatory capital and monitor growth in loans and risk weighted 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 plans beyond 2019. Of course, as you're aware, our projections are subject 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 questions, before which Samantha will briefly review the instructions.
Your first question comes from the line of John Pancari with Evercore.
Good morning. Good morning, John.
Just a little
bit of to get a little bit of color around the other expense line. I know you indicated that had originally included The $48,000,000 Bayview and then was the legal charge also that $50,000,000 is that also in that line item?
Yes. In the Q1, other expense included the addition to the litigation reserve. And in the second quarter, It included the write down of the asset manager as well as there was $9,000,000 of the mortgage servicing reserve as well.
Right. Okay. So excluding that, how should we think about a good basis to grow off of as we go into the second half on that line?
I guess if you look at the other expense line and you look at it over the last 5 quarters, Excluding kind of what I would describe as the specials, so the litigation addition In the write down of the equity investment, you'll see that, that line is relatively consistent Around 165, 170, moves up and down a little bit. And that's the place where over time, We'll expect to see some decrease in the professional services related to our IT spend. And that will start to come into play over the last half of twenty nineteen and into 2020. But it will take a little bit of time for those expenses to ramp down as we bring on new staff, train them and deploy them on the projects. There's a bit of a tail effect where it takes a while for the outside IT professionals to finish the work that they're doing.
It doesn't make sense to replace them midstream. And so that's where you'll see some of that. And also while we added to the litigation reserve in the Q1, There's still some ongoing expense for that case and some of that will show up in the professional services or in that other cost of operations line as well. So it Shubh, if you exclude those things, look at kind of where the average has been for the last few quarters And use that as a start point and start to decline it probably more in 2020 than in 2019. That's the way I think about it.
Okay. All right. That's helpful. And then also on the expense front, as we look out into 2020 And given the backdrop that you acknowledged around the rate environment, can you how do you think about operating leverage For 2020, is that still a high expectation that you'll be able to achieve that? Or is there risk to that given the great backdrop?
It's a great question, John. We're in the process of going through forecasting 2020 and starting to look at where we think revenue will be and what that might mean for expense growth. Probably a little early to handicap where 2020 looks, but obviously given a slower net interest income growth picture. That makes the positive operating leverage a little tougher to achieve. And we're obviously we're also not going to Short change the investments we need to make in the business for the sake of a couple of quarters of positive operating leverage.
I don't think it will be wildly negative if it is, but we got work to do before we comment on what 2020 will be we'll give you guys an update obviously in January on that.
Okay, got it. Thanks, Darren.
Your next question comes from the line of Ken Usdin from Jefferies.
Thanks. Hey, Darren, just to follow-up on your comments on the rates. Thanks for the commentary about what each 25 basis point means. If I'm doing the math right, I guess, 5 to 8 basis points on a 25 cut. That's what, like $50,000,000 to $80,000,000 depending on annually.
Yes. I guess the question is what's baked into your forecast then in terms of that Have you built forecast into that cuts into that forecast formally? And if so, how many? Thank you.
Yes. I mean, we usually run our ALCO models And off of the forward curves. And so we will look at the forward curves at the end of June and use that as the basis for Forecasting our NII for the rest of the year. You could kind of see in where LIBOR has moved that Some of that's already started to happen. So I guess the question is, how much incremental movement there is in LIBOR when and as The Fed actually moved.
So I think a little bit of it's already kind of happened, and then we'll see where things end up. But The direct answer to your question is based off the forward curves and run at the end of June.
Okay. Understood. That's what that is what I was getting at. Thanks. And then On the ability to control deposit costs and anticipate the mix shift, what are you seeing in terms of customers and what are you deciding in ALCO about how you're pricing deposits relative to that view of the curve?
Thanks.
Yes. So when we when you look underneath the 2nd quarter activity on deposit pricing, There's really two things. So one is the addition of the escrow balances that came with the servicing that we did. And actually, Those grew through the quarter, and we actually expect them to grow into the Q3 as well. When you hold that to the side, what we saw in the second quarter was a continuation of the trends that we saw in the first, where we still see some commercial excess balances moving into interest checking and into on balance sheet suite.
And we continue to see some consumer migration Into time, although that slowed down a little bit and really the time increases in the second quarter were driven by renewals of CDs that were actually coming off at a lower rate than where rates were and still in the 1 to 2 year and greater than 2 year space. If we look at the increase in time deposits in the Q2, it was less than it was in the first and looked a lot more like what it did in the Q4. And so Most of the reactivity in deposit pricing that happened early on was in the commercial space and in the institutional space and in the wealth space. And many of those accounts are tied to an index. And so as the index comes down, those will move down faster.
On the consumer side, it will probably be a little bit slower just because the cycle, the repricing cycle never fully matured. And the way it tends to work is people move money into CDs first. And then once those rates stabilize, they tend to look for liquidity and they move back into money market. That second step didn't happen. And so a lot of the consumer money that sits in certificates of deposit will be there for a while and it will take renewals for that to for those rates to come down.
I guess the good news is that they shouldn't probably go up much from here either.
Your next question comes from the line of Erika Najarian with Bank of America.
Hi, good morning.
Good morning, Erika.
If I could follow-up on Ken's question, as we thank you for giving us some of the assumptions that you have for the 5 to 8 basis points of compression. I'm wondering for each 25 basis points, what is the reverse beta that you're assuming specifically on the deposit side. And does it is it naturally wider, for the let's say, the 3rd cut versus the 1st cut?
Sure. So when we disclosed in the Q Our ALCO runs, they're obviously in 100 basis point increments. When we do our work, we do it in 2025. And What we expect to see is the continued lag effect of deposit repricing continue into the Q3. It usually takes 2 or 3 quarters for that to slow down after the Fed stops.
So even if they decrease rates at the end of July. We're likely still to see a little bit of movement in deposit rates. And then as we go from there, we'll start to see them come down. The rate of decrease in the deposits will be kind of consistent with what I mentioned before with Ken. And that for the indexed deposits, Obviously, they'll be 100% reactive.
And then for our other customer deposits, Movement out of sweep back into DDA, I think, will be a function of customers' businesses and cash flow. Not sure how quickly that will change, But we'll obviously be paying attention to the pricing there. And then on the consumer side, I think we'll continue to see a slowdown of the remixing. The pressure will be as older CDs mature and Come on to the books at a slightly higher rate, which is why we'll see a little bit of repricing there. I think as it relates to The Q3 and deposit costs specifically, I'll just remind you again that we're expecting continued increase in escrow balances, And those are linked to an index, either to LIBOR or to Fed funds.
There's a little bit of different pricing depending on which portfolio. And so those will have an impact on deposit pricing specifically or deposit costs in the 3rd
Got it. And just as a follow-up, could you give us a sense of how much of your interest bearing deposits are indexed and would reprice immediately. And could you please remind us the size of your swap book and the average life, please. The total new notional since you added some swaps on in the quarter. Thank you.
Sure. So the swap book the swaps that are currently in effect It's about $13,500,000,000 $14,000,000,000 of notional. And if you look at the remainder that's out there, Which I think will show around $39,000,000,000 in the queue is all forward starting. And so That should give you a sense of where the swaps are, and those should go out approximately 2 to 2.25 years Based on where we are right now, I should have wrote down your first question. Remind me again your first question.
Apologies. What percent of your interest bearing deposits are tied to an index and therefore would reprice immediately when Fed funds goes down?
It's approximately 12%
Got it. Thank you.
Of total deposits.
Got it. Thank you.
Of total deposits. Obviously, that's quite a bigger percent of interest checking.
Thank you.
Your next question comes from the line of Frank Schiraldi with Sandler O'Neill.
Good morning. Just wondering, Darren, on the just one more on the margin on the 5 basis points to 8 basis points. It seems like that's baking in The expectation that this drag in deposit pricing is going to be is going to continue here for a little bit. If we don't get a rate hike Our rate cut rather. I'm just wondering what the margin would look Clay, can your expectation of sort of margin outlook without those baked in rate hikes Rate cuts going forward.
Sure. So within the margin, and in the go forward, There's a couple of things that are important to keep in mind. So when we talk about the 5 to 8, we were specific about saying Holding some other deposit categories constant that creates volatility in the margin. So obviously, cash balances, we've talked about They were worth 5 basis points of expansion. The decrease in cash balances in the Q1 expanded the margin by 5 basis They contracted the margin by 3 basis points this past quarter.
And so those, we kind of hold aside and because they can move around and they affect the margin, but not so much the net interest income. The other thing that's moving around right now is just the mortgage escrow balances. And as those roll on and we get to what we think is a more stable balance, we'll be able to give a little bit better guidance on our expectations on the impact of escrow. So if nothing changed In the Q2, Q3, there's probably some margin compression because of those escrow balances. And so Any movement would be on top of that excluding what's already been priced in.
If we We didn't have the escrow balances and we held cash balances constant and you didn't see a change In rates from the Fed, I think we'd see pretty stable margin, might be plus or minus 2 to 3 basis points, Some because of the natural extension of deposit pricing and then some just because of roll on, roll off margins in the loan book.
Got you. Okay. And then there's been some recent reports out in the media talking about Some branch reduction in the Philadelphia area, some consolidation and reinvesting into tech and I guess modernizing The remaining branches. Just kind of curious if you could talk maybe a little bit about that, but more generally just your branch strategy here more
broadly. Sure. So, Noel, I'll talk specifically about Philadelphia. So if you look at our market position in Philadelphia, I think we have about 1% deposit share and a fairly similar branch share, Which even as things move electronic, we find that customers still value branches as a place that They can go and get advice and solve problems as well as it provides a sense of security that you're there for a long period of time. And our focus in Philadelphia, by shrinking isn't to ignore those things, but more to recognize that Our strength there has really been in the commercial space and in particular with small business customers.
And we're aggregating or concentrating our efforts in Philadelphia In the markets where there's a concentration of small business customers and where we've had some success there and we'll really orient the branch and the activities there to support the activities of our small business and commercial customers. Our experience has been that Small business customers tend to use only one branch, and that one tends to be close to their business. So we think that that's a better way for us to compete there. And as we reduce the footprint, we'll take some of the savings and invest it in the remaining branches. When you look more broadly, we have markets where we have really high share, both in terms of deposits and branches and markets where we have A little bit less.
We're going to be looking at what we do in Philadelphia and how that works in combination with the investments we're making in digital To learn from that and see how that works and we'll depending on how that goes, we'll adjust our strategy there. If we like it, we'll probably see it roll out into a and then when you look at the markets where we're a little bit more dense, I would describe our branch thoughts as consistent with our prior practices whereby we look at the total network each year. We look at which locations, both branches and ATMs are favored by our customers. And then we make adjustments to the network Each year, given that information, we're always trying to make sure that we provide convenience and access to our customers and while managing our cost structure so that we can be competitive. The nice part is In banking, customers vote with their feet every day, and we get to use the results of that vote to help us shape the network.
And That's the way we've always thought about distribution and we'll continue to.
Got you. But this is more thought of as a reinvestment opportunity as opposed to cost cutting initiative. Is that fair or maybe both?
Yes. I think it's really both. We will clearly over time have some safe, but for all of our colleagues in that geography, They will be placed in one of the branches that remains open. Usually, there is turnover in those offices and over time whether that Is replaced or not will be a function of how busy the locations are, but we will be saving some of the occupancy expense. We'll reinvest a little bit of that into the existing locations and some of that we'll save.
Great. Thank you.
Your next question comes from the line of Saul Martinez with UBS.
Hey, good morning. Couple of questions, more clarifications than anything. First, on the net interest income guide, I forget the exact terms you used, but you said you expect to see some growth in 2019 full year versus 2018. By my calculations that you're basically baking in I think something in the neighborhood of $1,000,000,000 and change in net interest income run rates in the second half of the year quarterly. Is that in my obviously, implies some reduction in the run rate, but is that more or less correct that math?
Yes, that's correct. It's probably based on the current forward curves, it probably comes down a little bit Each quarter, but would be a little bit over $1,000,000,000 yes.
Okay. And then again, a clarification, great color on all the moving Parts on deposit costs and why you think it could be stickier even as the Fed cuts. I guess putting all of that together, would you expect deposit cost to actually rise in the Q3 versus the Q2, if I'm Looking at your overall cost of interest bearing deposits, that wasn't clear if that's what to me at least, is that if that's what you're basically saying.
Sure. So the short answer is yes, and I'll give you color on that. It's yes because of the growth in the mortgage escrow balances that we anticipate. If those weren't there, we would expect a little bit of increase in our deposit costs Just because of the last little bit of remixing that tends to happen for 2 to 3 quarters after the Fed stops. When you look at that when you look at just that effect, it was lower in the second quarter than in the first quarter, And we anticipate that the Q3 would be lower still, and then it would kind of be done by the time we get to the Q4.
Will it Slow more quickly to 0 in the 3rd quarter if the Fed reduces. Hard to handicap, just given some of the repricing of CDs and the fact that they're rolling off at a lower rate than they will roll on to. There's probably still a little bit of push there. But that's those are the two elements, and I want to make sure I'm explicit about what's driving it because One of the things is kind of in the 5% to 8% and the other one is kind of not.
Okay. So if we were to see 2 cuts, Say 1 in July and I don't know September, October, when would you think you would actually start to see deposit costs Start to come down, is it sort of late year or early part of next year? And how do you think about that lag in this cycle?
Yes. I guess, So again, with the nuance of the escrow balances, I think holding that to the side, You would see a modest increase in deposit costs in the Q3, and I think you'd start to see them either flatten out or decrease In the Q4, just because of the fact that there are several categories that are indexed, those would give you a benefit right away with the cuts. And it's those other categories like the time deposits as well as just people shifting Still from interest non interest bearing into interest bearing or sweep, I put modest upward pressure on it. But I would expect that you see a little bit in the Q3. And by the time you get to the Q4, you'll probably start to see it level out or decrease.
Your next question comes from the line of Kevin Saint Pierre with KSP Research.
Good morning. Thanks for taking my question. Just circling back to expenses in conjunction with overall strategy, Darren, you and both you and Renee Have characterized M and T as being somewhat behind from a tech perspective and needing to catch up. Maybe you could characterize for us Where you think you are from that perspective along the timeline in catching up to competitors from A mobile and digital perspective.
Sure. So, I think over the last 18 months. We've made some really great strides in our technical environment. Our mobile app continues to get updated on a regular basis with new feature functionality coming Basically every 6 months, if not sooner. And it's in a pretty good spot.
When we look at the feature functionality that is most used by customers. We feel pretty good about what we have. I think the next focus is In there is on security features and more self-service on security features. When we look at the commercial part of the bank, We've just gone into production with our loan origination system. And so we're getting that up and running and The team up to speed.
We continue to make investments in our treasury management platform, Which will make things easier both for our employees and for our customers and should bring us a lot closer to parity with our peer group, if not towards some of the larger players. And we're making investments in our merchant capabilities. Within the bank, we continue to invest in infrastructure. We invest in securities, things like cybersecurity and How we protect the bank and our customers as well as in data. So we're investing along all of those categories, And we continue to make progress.
But I think as you know and we all know that it's a bit of a moving target too. So each time you catch up, someone does something to get a little bit ahead. And I think that's the nature of Renee's comments and my comments about You're never really there because the bar is always moving and you're continually investing. And we just kind of think about our tech spend is We've got to spend to keep in the game, to stay competitive and to react to the changes that are happening in all of our businesses, whether it's in the commercial business, the consumer business, the wealth and private banking business or the institutional business. And that's just going to be a way of life.
And because of that, that's why we're making the investments we are in the tech hub And in adding IT professionals to our on staff team, because as technology continues to become a bigger part of banking, Then you want to control that resource And not have a walk out the door and into someone else's operations the next day because they're an outside contractor. Yes, a contractor can help you get there quickly, and maybe bring a skill set that you don't have in the short term. But over the long term, we Such a strategic asset that we would rather control it, and that's why you see us making those investments.
Great. And so as we think about The impact on the income statement, we can expect that the salaries and benefits is going to have this natural upward drift
Yes, you'll see that happen. We'll see some From the first half to the second half, just because of that as well as the full effect of mortgage servicing that we brought on and the people that help with that. The offset over time will be in that other cost of operations line that we talked about. The trick is and the thing to keep in mind is just the timing of that, right? And that we have to add the new facility and build it out and get people there before we can consolidate other space.
So we have some double counting, if you will, in that time period. As you bring on new folks to the team and train them up with sometimes they're experienced professionals and they come up to speed faster or they could be new recruits And they take a little bit longer that you've got that overlap in time period where you get the new ones up to speed Before you can reduce the expense on the other side. We don't expect that this is 100 of 1,000,000 of dollars by any stretch because we'll take it in increments. We think that's also a better way to manage The change as well as the cost, but it's going to be something that will be consistent over the next several quarters.
Got it. Thanks.
Your next question comes from the line of Gerard Cassidy with RBC.
Hi, Darren.
Good morning, Gerard. How are you? Good. Thank you.
A couple of questions. As We see some of the smaller banks report numbers this quarter. The trend of these one off credit events seem to be popping up again. Are you guys seeing now that the margin pressure is picking up for everyone, is there any evidence yet of more aggressive Loan underwriting by banks to grow their balance sheets to offset this margin pressure?
It's an interesting question. And when we look at payoffs and paydowns and we talk about that, we track it by what the source of the payoffs and paydown was. And kind of to your point, what's been interesting this year so far is other banks have been a bigger source of payoffs and paydowns for us Then it has been private equity or funds or insurance. So there might be a little bit to that. I guess, when we compete in the market from our perspective, we always feel like others are looser on structure and lower on price We would want to be, so it's hard for me to say that there's a specific change, but it was notable when we were going through the numbers that we did see a little bit higher proportion Other banks, as a source of payoff and pay down, in the first half of this year.
Very good. And then Based on your experience, you pointed out that you guys have used the forward curves to where rates actually go at the in this kind of new rate environment we're in, when you have to forecast out 12 months, I would think they're very accurate over the very short period, 30 days or so. But how about if you go out into 6 12 months, in your experience, Are they very accurate?
I don't know, Gerard. That sounds like a loaded question to me. I think we've all seen The charts that have been put together that always show the forward curves at the moment in time against the actuals. And I guess what my experience has been that the forward curves are not very good predictors Of the actuals, but they're good predictors in the direction. Yes.
I agree. Yes. And so we obviously we use in the absence of a better way to forecast, but also that's why we use the hedges, right, is that we look at Where the margin is and how that compares to the long term average and we take into account some of the deposit reactivity and just the shape of the balance sheet. And that's why we use the hedging to try and take that volatility out of our earnings. And that's what gives us the wherewithal when things get a little volatile like they've been lately Do not have to be overly, draconian on expenses and allows us to make sure that we can maintain the investments.
Back to The question that Kevin was asking in particular about our ability to invest in technology.
Very good. Thank you.
Your next question comes from the line of Brian Klock with Keefe, Brea and Woods.
Hey, good morning, Darren. Good morning, Brian. One real quick question. I know there's a lot of conversation around the expenses. So I was trying I'm trying to keep up with everything, but I mean directionally, if you want to take that operating expense base from the 2nd quarter, Does it sound like that's going to be higher in the 3rd Q4 before you start to see, like you said, some of the double spend that you have come out in 2020.
Is that the right way to think about it?
Yes. I guess, so the way that I would look at the second half is if you look at our expenses in the first half And you take out the big things, the write down in the asset manager and the litigation reserve. Yes. That's probably a good guide for where the second half will show up. It Should be pretty similar to that.
That takes into account the investments that we're making in the tech hub, the full year The cost of the mortgage servicing colleagues that we added and some of the other expenses that we foresee in the second half.
Okay, great. That's helpful. And then just another follow-up on the capital discussion. It does It sounds like when you look at the $1,900,000,000 net that you talked about having in the capital plan and now yesterday the Board approved up preferred issuance possible in the future. Is that what you're thinking?
Yes. That's in the ballpark of where our thought process was. I think The logic there is when you look over the last several years of CCAR, Tier 1 Capital has become our binding constraint as much as CET1. And so as we contemplated the plan this year, We're looking at the mix and the ratios of Tier 1 to CET1 and think there's an opportunity for us to Just restack the capital a little bit to make sure that we're in good shape going into CCAR 2020.
Okay. Thank you for your time. Very helpful.
There are no further questions at this time.
Again, thank you all for participating today. And as always, if any clarification of any of the items on the call or news release is necessary, please reach out to our Investor Relations department at 716 842-5138.