Welcome to the M&T Bank Third Quarter 2018 Earnings Conference Call. It is now my pleasure to turn the floor over to Don McCloud, Director of Investor Relations. Please go ahead,
sir. Thank you, Maria, and good morning, everyone. I'd like to
thank you all for participating in M and T's Q3 2018 earnings conference call, Both by telephone and through the webcast.
If you have not read the earnings release we issued
this morning, you may access it along with the financial tables and schedules from our website, www.mtb.com and by clicking on the Investor Relations link and then on the Events and Presentations link. Also before we start, I'd like to mention that comments made during this call might contain forward looking statements relating to the banking industry and to M&T Bank Corporation. M and T encourages participants to refer to our SEC filings, including those found on Forms 8 ks, 10 ks and 10 Q for a complete discussion of forward looking statements.
Now I'd like to introduce our Chief Financial Officer, Darren King. Thank you, Don, and good morning, everyone. We were quite pleased with M and T's results for the Q3, which we characterized as strong in this morning's press release. Some highlights from the quarter include continued growth in net interest income, both on a linked quarter and a year over year basis Fee revenues that remain steady with softness in mortgage banking and trust income seasonality being offset by higher commercial loan fees, Well controlled expenses, notwithstanding the steps we're taking to invest some of the savings from tax reform into higher compensation for certain employees And credit performance that is stable to a point beyond our expectations with the current run rate of credit losses Benefiting from a sizable recovery this quarter. These higher levels of profitability, both pre provision and after tax, Afford M and T many opportunities to deploy capital, including through the return of capital to our shareholders.
During the quarter, We increased the quarterly common stock dividend by 25 percent to $1 per share per quarter and repurchased nearly $500,000,000 of M and T common stock. Now let's look at the specific numbers. Diluted GAAP earnings per common share For $3.53 for the Q3 of 2018, improved from $3.26 in the Q2 of 2018 and $2.21 in the Q3 of 2017. Net income for the quarter It was $526,000,000 up from $493,000,000 in the linked quarter $356,000,000 in the year ago quarter. On a GAAP basis, M and T's 3rd quarter results produced an annualized rate of return on average assets of 1.8% And an annualized return on average common equity of 14.08%.
This compares with rates of 1.70 and 13.32%, respectively, in the previous quarter. Included in GAAP results In the recent quarter, we're after tax expenses from the amortization of intangible assets amounting to $5,000,000 or $0.03 per common share, Little changed 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 Q3, which excludes intangible amortization, was $531,000,000 Up from $498,000,000 in the linked quarter $361,000,000 in last year's Q3. Diluted net operating earnings per common share were $3.56 for the recent quarter, Up from $3.29 in 2018 Q2 and $2.24 in the Q3 of 2017.
Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 1.89% 21% for the recent quarter. The comparable returns were 1.79% and 19.91 percent in the Q2 of 2018. In accordance with the SEC's guidelines, This morning's press release contains a tabular reconciliation of GAAP and non GAAP results, including tangible assets and equity. As a reminder, the year over year comparisons for both GAAP and net operating earnings are impacted by the reduction in the federal income tax rates for 2018 and beyond. With M and T's effective tax rate for the 1st 3 quarters of 2018, some 12 percentage points lower than in 2017.
Recall that both GAAP and net operating earnings for the Q3 of 2017 We're impacted by a non deductible $44,000,000 payment to the U. S. Department of Justice that related to matters at Wilmington Trust Corporation Prior to its acquisition by M and T and a $50,000,000 addition to M and T's reserve for litigation matters. Net of tax impacts, these actions reduced net income by $48,000,000 or $0.31 of diluted earnings per common share in that quarter. GAAP pretax income in the recent quarter improved by 10% from the year ago quarter, excluding the prior year's increase Turning to the balance sheet and income statement.
Taxable equivalent net interest income was $1,030,000,000 in the Q3 of 2018, Up $20,000,000 from the previous quarter. The comparison with the prior quarter reflects an expansion of Net interest margin to 3.88 percent, up 5 basis points from 3.83% in the linked quarter. Combined with the impact from one additional accrual date in the recent quarter, The primary driver of the wider net interest margin was the further increase in short term interest rates arising from the Fed's June September rate actions, lifting overall asset yields. A big difference between this quarter and the prior 2 was the relationship between the Fed funds rate and Short Term LIBOR. That spread widened to a lesser extent than in recent quarters, resulting in a margin improvement consistent with our Previous estimates.
Average loans declined by $274,000,000 Or less than 0.5% compared with the previous quarter. As has been the case for the past several quarters, The continued planned runoff of the mortgage loan portfolio acquired with Hudson City was the main factor. The other higher yielding loan categories grew about 1.5% in the aggregate. Looking at the loans by category, on an average basis compared with the linked quarter, commercial And industrial loans were essentially flat compared with the linked quarter, with the usual seasonal third quarter slowdown in dealer floorplan balances Offsetting growth in other C and I loans. Commercial real estate loans were also effectively flat compared with the Q2.
As noted, residential real estate loans continued the expected pace of pay down. Our portfolio declined by some 3% or approximately 14% annualized, consistent with previous quarters. Consumer loans were up about 2%. Continued strength in recreation finance loans Complemented modest growth in indirect auto loans. The ongoing longer term trend of softness in home equity lines and loans Continue to offset the gains in the indirect portfolios.
Regionally, The pace of commercial loan growth is fairly consistent with no particular region standing out either positively or negatively. The notable exception is New Jersey, where we're seeing decent growth over what remains a modest base. On an end of period basis, Loans declined some $1,100,000,000 or just over 1% compared to the previous quarter. Excluding residential mortgage loans, The other loan categories declined by about $500,000,000 in the aggregate, which was almost entirely due to a decline in commercial mortgage loans Held for sale at September 30 compared with June 30. Average earning assets also declined by about 1.5% Or about $376,000,000 which includes the $274,000,000 decline in average loans.
Average investment securities declined by $425,000,000 notwithstanding the fact that we did purchase some short duration treasury securities during the quarter. Average core customer deposits, which exclude deposits received at M and T's Cayman Islands office, CDs over $250,000 and brokered deposits declined an estimated 2% compared to the 2nd quarter. This primarily reflects the decline in commercial escrow deposits as noted in prior quarters as well as the seasonal decline and municipal money market balances. Average time deposit balances declined by 3%, a slower pace than in recent years. The increase in market rates has contributed to higher growth in long duration CDs, while the runoff of acquired Hudson City time deposit balances continues to slow.
Turning to noninterest income. Noninterest income totaled $459,000,000 in the 3rd quarter compared with $457,000,000 in the prior quarter. Mortgage banking revenues were $88,000,000 in the recent quarter compared with $92,000,000 in the linked quarter. Residential mortgage loans originated for sale We're $545,000,000 in the quarter, down about 15% from the 2nd quarter. Total residential mortgage banking revenues, Including origination and servicing activities were $59,000,000 down very slightly from $61,000,000 in the prior quarter.
During the Q3, we entered into a subservicing contract, which brought an additional $9,000,000,000 of servicing assets. We expect to see the full run rate benefit to mortgage banking revenues from this contract during the Q4. Commercial mortgage banking revenues were $29,000,000 in the 3rd quarter compared with $31,000,000 in the linked quarter, reflecting some of the same pressures on loan margins That balance sheet lenders are seeing. Trust income was $134,000,000 in the recent quarter Compared with $138,000,000 in the previous quarter and 7% above the $125,000,000 earned in last year's Q3. Recall that results for the Q2 included some $4,000,000 of seasonal fees earned for assisting clients in preparing their tax returns, which did not recur in the Q3.
Service charges on deposit accounts We're $109,000,000 improved from $107,000,000 in the 2nd quarter, largely the result of seasonal factors. Losses on investment securities were $3,000,000 in the quarter compared with a $2,000,000 gain in the 2nd quarter. As we've noted previously, this volatility comes as a result of changes in the fair value of our GSE preferred stock, which prior to 2018 had been recorded and accumulated other comprehensive income. Included in other revenues Our certain categories of commercial loan fees, including letter of credit and loan syndication fees, which improved sharply compared to what we saw in both the first and 2nd quarters. Turning to expenses.
Operating expenses for the 3rd quarter, Which exclude the amortization of intangible assets were $770,000,000 unchanged from the previous quarter. Salaries and benefits increased by $13,000,000 to $431,000,000 reflecting in part The impact from our plan to invest a portion of the savings from the lower federal income tax rate towards higher wages for certain employees as well as a modest headcount increase. Other costs of operations declined by approximately $18,000,000 from the 2nd quarter, reflecting in part lower legal related expenses. The efficiency ratio, which excludes intangible amortization from the numerator and securities gains or losses from the denominator was 51.4% in the recent quarter. That ratio was 52.4% in the previous quarter and 56% in 20 seventeen's Q3.
Next, let's turn to credit. Credit quality has largely been in line with our expectations. However, this past quarter's results Exceeded even our expectations due to a sizable $13,000,000 recovery on a previously charged off commercial loan. Annualized net charge offs as a percentage of total loans were 7 basis points for the 3rd quarter, down from 16 basis points in the 2nd quarter. The provision for credit losses was $16,000,000 in the recent quarter, which matched net charge offs.
The allowance for credit losses was unchanged at $1,020,000,000 at the end of September. The ratio of the allowance to total loans increased slightly to 1.18%, reflecting the lower level of loans at the end of the quarter as well as the ongoing mix shift in the balance sheet. Non accrual loans were $871,000,000 at September 30, Up from $820,000,000 at the end of the second quarter and remaining within the range seen over the past several quarters. The ratio of non accrual loans to total loans increased by 7 basis points ending the quarter at exactly 1%, Also impacted by lower quarter end loan balances. 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 For $254,000,000 at the end of the recent quarter.
Of these loans, dollars 195,000,000 or 77% We're guaranteed by government related entities. Turning to capital. M and T's common equity Tier 1 ratio was an estimated 10.44% at the end of the 3rd quarter Compared with 10.52% at the end of the 2nd quarter, reflecting strong capital generation during the 3rd quarter, Net of share repurchases as well as the impact from a modest end of period decline in risk weighted assets. During the Q3, M and T repurchased 2,800,000 shares of common stock at an aggregate cost of $498,000,000 Now turning to the outlook. Going into the final quarter of 2018, our outlook for the year remains consistent with the commentary we've offered previously.
As we highlighted at a recent investor conference, the soft commercial lending environment combined with our mortgage loan portfolio runoff Makes it difficult to grow loans on a full year average basis. That said, we do see the potential for growth in the coming quarter compared with the last, aided by seasonal strength in the dealer floorplan loans. We continue to anticipate improvement And the net interest margin for the remainder of 2018, consistent with our prior guidance. Throughout 2018, We have seen the margin improvement from each Fed funds type gradually decrease as markets normalize and deposits become more expensive, Behaving in a manner more consistent with prior cycles. We will offer our updated thoughts on the net interest margin and the outlook for growth and net interest income on the January call after we report our full year results.
Residential mortgage origination activity will remain challenged by higher long term interest rates, but the mortgage subservicing contract I mentioned previously Will provide a partial offset to the revenue pressures that come with the natural aging of the servicing book. The outlook for the remaining fee businesses remains little changed. The expense outlook is also unchanged. We continue to expect low nominal annual growth in total operating expenses, excluding the Q1's $135,000,000 addition to the reserve for the Wilmington Trust Corporation shareholder litigation. The growth rates of the individual expense categories May vary from quarter to quarter as we continue to manage across the bank's total expense base.
As a reminder, Our outlook does reflect our view that the FDI surcharge on large banks will end in the Q4 of 2018. Our outlook for credit also remains little changed. The sizable recovery that benefited the 3rd quarter results Was indeed a positive event, but one that we don't anticipate repeating next quarter. We also anticipate continuing Our 2018 capital plan given our strong profitability and capital ratios. Of course, as you are 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 Maria will briefly review the instructions.
Thank you. Our first question comes from the line of Ken Zerbe of Morgan Stanley.
Thanks. Good morning.
Good morning, Ken.
I guess maybe just starting with deposit costs a little bit. I understand
you guys have a really low deposit data relative to many other banks that we're seeing. So But I was hoping you could just talk about like where are you seeing pressures? And if you are, whether it's specific markets, certain products, Is there anywhere that's getting incrementally more challenging on the margins? Thanks.
Sure, Ken. I think when we look at our deposit costs And the change quarter to quarter, it's not any one region in particular, but the place where we see movement varies by segment. So in our commercial portfolio, sorry, yes, we'll start with commercial. In the commercial portfolio, it's really been in interest checking And in non interest checking in the form of earnings credit rates. And so we started to See some pressure there.
We have some balances in commercial that are linked to an index. So as the index moves up, the price moves up there. But we continue to see corporate treasurers paying a lot more attention to their excess balances and considering moving them to interest checking. Sometimes they do on balance sheet sweep and in the end to off balance sheet sweep as well. But we've been very active with our customers, making sure we're out working with them to help them put their excess balances to effective use.
In the consumer space, we're seeing behavior that's fairly typical as you work your way through a rising rate cycle. The main event so far has been balances moving from money market savings accounts into time accounts. And as we mentioned in the, I guess, prepared comments that And within the CD book, we're starting to see people lengthen out the terms that they're signing up for. So early on, if you probably looked about a year ago, We would have said most of the action was in the 1 year CD space. And with changes in the curve a little bit of late, we've seen A little more activity in the 18 24 month space.
And so you're seeing a little bit of remixing where Balances are shifting from money market in this time. But generally, both of those are pretty consistent with What our prior experience has been, as well as what we tend to model When we do our ALCO runs and we put in our asset sensitivity in the K and the Q. The one thing that's probably a little bit unique To us, perhaps compared to some of the others, it's just the percentage of our deposit base that sits in non interest bearing in operating accounts, be they business or consumer. And Obviously, that helps mitigate to some extent the impact of rising rates.
Okay. That helps. And then last question. Just in terms of,
I guess, capital returns, given that your loan growth has, Let's say, incrementally gotten a little bit slower, hence your sort of revised guidance that it's hard to grow the average balances. At what point would you go or can you go back to the Fed and ask for maybe a revision to your capital return Approval or is that even an option or something
that you guys would consider? Thanks.
So technically, the option always exists, but you can go back to the Fed and do a resubmission After you've gone through and done your initial CCAR ask and been approved as well as An update like we did last year after mid cycle. When we look at where things are right now, this is 1 quarter that It was maybe a little bit slower than we anticipated. 4th quarter things usually pick up, and we're not materially off where our capital plan was. And when you combine that with still waiting for a little bit of clarity on how the regulations might change, I would suggest that it's probably a low Probability that we would go back this year as we did last year. All right.
Thank you very much.
Our next question comes from the line of Matt O'Connor with Deutsche Bank.
Good morning.
Good morning, Matt. You guys talked a
little bit about kind of the loan growth outlook on a near term basis here, and it seems like most of the optimism is based on maybe seasonality. As you kind of look more medium term, can you talk about your confidence in growing loans and maybe just the overall balance sheet? Because obviously, the securities balances have come down. You've got some capacity to buy there if you wanted to and also to expand. So Maybe just talk about the medium term outlook for loan and balance sheet growth and then if there's any kind of added thoughts on the securities portfolio that are worth mentioning.
Sure. I'll start with the securities portfolio and then work to loan growth because the securities portfolio, Really, our preference is to invest our deposits into loans with our customers. The securities portfolio really is meant To help with our liquidity coverage ratio. And so depending on the deposit balances as well as the mix of loans that will impact Our liquidity coverage ratio requirements and we'll set our securities accordingly. And when we think about what we need for the liquidity coverage ratio, we think about not just what's in the securities portfolio, but what's in cash.
And the combination of those two It's what we look at. And the securities portfolio, a little bit more of it of late is sitting in cash than in securities Just because when we look at the overnight rate compared to the 1 year treasuries, there's not enough of a premium to make it worth stepping in. If you go to the loan book, when we think about the loan book, it's really important To take our portfolio and separate out the residential real estate portfolio from the other, asset categories. So we expect to continue to see runoff in the residential real estate portfolio. Given its characteristics, We don't see any reason to believe that the pay down rate that we've been seeing for the last several years It is likely to change and that's kind of been around 13% to 14% annualized.
The only thing that will happen obviously is that, that portfolio gets smaller, The dollar amount of decrease will also get smaller. And therefore, the amount of growth needed in the other Portfolios to create absolute loan growth will get a little bit easier. In consumer loans, we've been pretty consistent With our positioning in indirect auto as well as rectify and anticipate That will continue, obviously, depending on the strength of the consumer. But right now, I have no reason to believe that, that will slow materially. And then in Commercial Real Estate and C and I, they've been relatively flattish the last Couple of quarters actually, and I think that performance is a little bit masked by the overall loan decreases.
And really the challenge there has been payoffs and paydowns and they're in the place those are Coming from differs by the portfolio. So our commercial real estate portfolio, we're seeing some pay downs of Construction balances where construction projects are coming to completion, and then we see some permanent financing going into the insurance companies. Now we have seen a little bit of movement in our construction commitments, which gives us a little bit of optimism For the next 6 to 12 months, but those balances obviously build as projects move through their completion cycle. And so we'll be watching that. In the C and I portfolio, obviously, we talked about the seasonal factors, but we continue Be active in the floor plan business.
We see some activity in healthcare, in certain segments of healthcare, And we've seen some increases in commitments. So there's some there are some reasons to be optimistic as we look forward. And really the wild card is some of the things that are a little bit outside of our control and that's activities Around private equity, which has really kind of been the issue in C and I lending, where we see private equity coming in And buying out some of our customers and checking equity and or Coming in and putting debt on top of ours with their loan funds. And so that's a phenomenon that's likely to continue for a little while longer. But What we've learned through time is to be patient and to not reach and to be there for our customers.
And that's what We've been doing for the last 12 to 24 months and what we'll continue to do.
Our next question comes from the line of John Pancari of Evercore.
Good morning.
Good morning, John.
Related to that loan growth commentary you just gave, that's helpful. Just wondering how would you view the 2019 Trajectory in terms of growth. I know you implied it's tough to grow 2018, but are we looking at something that could be in the GDP range for 'nineteen excluding the runoff remaining in the resi book?
John, we're going through right now finalizing our thoughts on 2019 and putting our plan together. We'll be back in January with more specifics about how we see 2019 unfolding. So I think it's a little premature to comment. We'll also our thoughts on 2019 will be impacted to some extent by the Q4 that we've seen And years go by, some substantial movements can happen in the Q4 and can Have a big impact on your start point for 2019. So I'm going to defer that my thoughts on that until January.
Okay. All right.
Got it. And then on the margin, just a couple of quick things there. What is The impact to the margin that you expect from the incremental moves by the Fed. So Faris, For the next 25 basis point Fed move, what does that equate to by your latest math in terms of margin benefit? And then separately, curious About your updated thoughts on the loan to deposit ratio, I know it's around 97.5% here, it moved up a little bit.
Where do you think that could go just as you Leverage other parts of your loan book to fund new loan originations. Thanks.
So for net interest margin, We're not changing our expectations that for a 25 basis point increase, That it would be outside of the 5 to 8 basis point range. That number when we talked about that at the start of the year was an average For the year, for each 25, what's been true is it started out at the higher end of that and in fact above Early on in the year, it has come down towards the lower end of that, more recently as we start to see deposit pricing look more like prior cycles. And so for the rest of the year, that's kind of where we see things going. As we go into 2019, again, we'll be updating our models and looking through our thoughts on, in particular, Deposit reactivity and we'll give you new guidance at that point. I should have wrote down the other question.
The loan to deposit ratio, right. Thanks, sorry. So the loan to deposit ratio is kind of hovered around 97%, 98%, 99% each quarter for the last 3 depending on combination of Some of the held for sale balances at the end of the quarter or what happens during the quarter as well as the pace of loan runoff and originations. And kind of the combination of those factors, we expect to be in play for the coming several quarters. Hard to foresee us getting down to a 95% ratio, although you never say never.
Equally hard to see us going meaningfully over 100%. I expect we'll be in this range For the foreseeable few quarters, that's something else that we'll look to update over the in January.
Got it. Thanks, Dan.
Our next question comes from the line of Frank Schulte of Sandler O'Neill.
Good morning. Just a couple of questions. I wanted to ask about the rate of runoff in resi. I mean, I believe most of that Hudson City production is variable rate, so I'm not sure rates are doing anything to it. But just wondering if you could remind us on your thoughts How that rate of runoff changes, if at all, in coming quarters?
Sure, Frank. There's a mix of different things within that Hudson City book. There are some 5.1s and 7.1s and as you pointed out, rates aren't impacting them. There are some jumbles in there as well as a small A portion actually of good old all day. And what we've seen over the hikes since 2015 It's really not much of a change in the prepayment speed or payoff ratios in that book.
And so we're not anticipating a material decrease. It's probably down slightly, maybe a point 2018 over 2017 and if rates continue on their trajectory, maybe another point reduction In 2019, the bigger factor there really is just the size of the portfolio and what How much in dollars runs off each quarter as much as the rate of decline?
Got you. Okay. And then just you already mentioned, you talked about on the deposit side about the amount of balances sitting in non interest bearing. I think that's Seems to be a focus of investors this quarter is non interest bearing and some contraction we've seen at other banks. It looks like your balances were pretty flat linked quarter.
So I'm just wondering if there's any noise there or just if you could talk a little bit about the ability To defend those balances, or if you're starting to see pressure there.
So for the non interest bearing deposits, It's a keen area of focus for us, whether that's within our consumer portfolio, where we actually did see some Checking account growth in the Q3, which was nice to see, as well as in our small business and in our commercial customers. And that's the number one thing we focus on every day in our calling activity, because that's really the anchor Relationship product, no matter which business we're in. And so in the commercial space, our teams have been out talking To customers helping them optimize their cash, which obviously will mean some of that will move into interest bearing, be it on balance sheet Sweep on balance sheet interest checking, but also some remains in the operating account. For our small business customers, that tends to be a place where Operating balances tend to stay, and is a category where deposit balances typically exceed loan balances, and that continues to be the case in a place where we're strong. And when you look at our Market share in SBA, across our footprint, we tend to be a 1, 2 or 3 position in most of those markets, and It's an area of focus that we'll continue to spend time on.
And then as we mentioned in consumer, there's obviously some excess balances in checking accounts today. And some of that you might start to see move, but not likely until there's more movement in savings rates and money market savings rates. We've seen a little bit of that in the banks, but not much. Most of that action has been in the non bank space in the online Savings account space. So we see a little bit of migration, but we're keenly focused on it.
We expect that it will Decrease slowly over time just as rates move, which is pretty normal, but we're not expecting a mass exodus of funds.
Thank you.
Our next question comes from the line of Ken Usdin of Jefferies.
Hey, thanks. Good morning, Darren. It was nice to see the flattish trajectory on the expenses this quarter. Just wondering if you can give us a little bit more color 1st on just what led the increase in salaries and benefits on one side and the other you mentioned that I think the legal and professional These came down in other and if this is a more kind of normal starting point for that, as that has looks like started to tail off.
Sure, Ken. Happy to discuss those. For salaries and benefits, there's really Two main drivers that are of the increase