Welcome to the M&T Bank first quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, the call will be open for questions. If you would like to ask a question at that time, please press star one on your telephone keypad. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Brian Klock, Head of Markets and Investor Relations. Please go ahead.
Thank you, Gretchen, and good morning. I'd like to thank everyone for participating in M&T's first quarter 2022 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. 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 today's presentation may contain forward-looking information. Cautionary statements about this information, as well as reconciliations of non-GAAP financial measures, are included in today's earnings release materials, as well as our SEC filings and other investor materials. These materials are all available on our investor relations webpage, and we encourage the participants to refer to them for a complete discussion of forward-looking statements and risk factors.
These statements speak only as of the date made, and M&T undertakes no obligation to update them. Now I'd like to turn the call over to our Chief Financial Officer, Darren King.
Thank you, Brian, and good morning, everyone. As we reflect on the past quarter, it was an eventful one. First off, we were pleased to have closed the acquisition of People's United Financial on April first, and to welcome our new colleagues, customers and shareholders to the M&T family. We're excited to turn our complete focus to successfully integrating People's United, of course, not losing sight of the tenets that define M&T. Delivering superior customer service, offering rewarding careers for our colleagues, engaging in the communities we call home, and providing top-quartile long-term returns to shareholders. We plan on completing the systems conversion in the third quarter of this year. Subsequent to our January earnings call, the outlook for interest rates has changed materially.
Low levels of unemployment and continued supply chain disruptions, exacerbated by the situation in Ukraine, have pushed inflation to levels not seen since the early 1980s. Interest rates began to rise even before the Federal Reserve raised its Fed funds target in late March, and the forward curve anticipates additional hikes coming more quickly than we anticipated in January. The changing rate environment created an opportunity for us to deploy excess cash into investment securities at a faster pace than we previously outlined and to restart our interest rate hedging program. While we're beginning to see the tailwinds from rising interest rates positively impacting our net interest income, those same higher rates have prompted headwinds to our mortgage banking business, both for origination volumes and for gain on sale margins. We expect these headwinds to persist.
Despite these macro challenges, credit quality remains strong and expense growth has been well managed. We're well positioned for the future and excited about the opportunity to integrate the People's United franchise, as well as to deploy our excess cash and excess capital. Now let's review our results for the first quarter. Diluted GAAP earnings per common share were $2.62 for the first quarter of 2022, compared to $3.37 in the fourth quarter of 2021. Net income for the quarter was $362 million, compared with $458 million in the linked quarter. On a GAAP basis, M&T's first quarter results produced an annualized rate of return on assets just shy of 1%, at 0.97%, and an annualized return on average common equity of 8.55%.
This compares with rates of 1.15% and 10.91%, 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 $1 million or $0.01 per common share, down slightly from the prior quarter. Also included in this quarter's results were merger-related expenses of $17 million related to the People's United acquisition. This amounted to $13 million after tax, or $0.10 per common share. 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.
M&T's net operating income for the first quarter, which excludes intangible amortization and the merger-related expenses, was $376 million, compared with $475 million in the linked quarter. Diluted net operating earnings per common share were $2.73 for the recent quarter, compared to $3.50 in 2021's fourth quarter. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders equity of 1.04% and 12.44% for the recent quarter. The comparable returns were 1.23% and 15.98% in the fourth quarter of 2021. In accordance with the SEC's guidelines, this morning's press release contains a reconciliation of GAAP and non-GAAP results, including tangible assets and equity.
Included in the recent quarter's GAAP and net operating results was a $30 million distribution from Bayview Lending Group. This amounted to $23 million after-tax effect and $0.17 per common share. We received a like distribution in the fourth quarter of 2020, as well as the fourth quarter of 2021. Next, we'll look a little deeper into the underlying trends that generated these results. Tax-equivalent net interest income was $907 million in the first quarter of 2022, a decrease of $30 million or 3% from the linked quarter. The primary drivers of the decline were $20 million in lower interest income and fees from PPP loans, as well as a $16 million reduction of interest accrued on earning assets, reflecting the two-day shorter calendar quarter.
Those factors were partially offset by higher rates on interest-earning assets and cash interest received on non-accrual loans. The net interest margin for the past quarter was 2.65%, up 7 basis points from 2.58% in the linked quarter. The primary driver of the increase to the margin was a reduced level of cash held on deposit with the Federal Reserve, which we estimate boosted the margin by 10 basis points. That was partially offset by a 4 basis point decline resulting from the lower income from PPP loans. Rising interest rates had a modest 1 basis point benefit to the margin as the Fed action on the Fed funds target came relatively late in the quarter. All other factors, including day count and interest received on non-accrual loans, had a negligible impact on the margin.
Compared with the fourth quarter of 2021, average interest to earning assets decreased by some 4% or $5.8 billion, reflecting a $5.6 billion decline in money market placements, including cash on deposit at the Fed, partially offset by a $920 million increase in investment securities. Average loans outstanding decreased by about 1% compared with the previous quarter. Looking at the loans by category on an average basis compared with the linked quarter, commercial and industrial loans increased by $976 million or about 4%. That figure includes a decrease of approximately $780 million in PPP loans. That decrease was more than offset by $361 million growth in dealer floor plan balances and a $1.4 billion increase in all other C&I loans.
Commercial real estate loans declined by 5% compared with the fourth quarter. Three factors contributed to that decline. Elevated payoff activity was the primary driver, including several criticized and non-accrual loans assumed by other lenders. The quarter also saw construction loans converted into permanent off-balance sheet financing, often facilitated by our M&T Realty Capital Corporation subsidiary. Finally, new origination activity remained subdued compared to prior years. Residential real estate loans, excuse me, declined by 3%, consistent with our expectations. The change reflects new loans originated and retained for investment, which were more than offset by normal runoff, combined with the sale of Ginnie Mae buyouts as they become eligible for re-pooling into new RMBS. Consumer loans were up nearly 1%.
Activity was consistent with recent quarters, where growth in indirect auto and Recreational Finance loans has been outpacing declines in home equity lines and loans. On an end of period basis, PPP loans amounted to just $592 million. Average core customer deposits, which excludes CDs over $250,000, decreased about 5% or some $6 billion compared with the fourth quarter. That figure was roughly evenly divided between non-interest bearing and interest checking. Trust demand deposits drove the decline in demand deposits following lower levels of capital markets activity compared with the fourth quarter. The decline in interest checking reflects our ongoing program to manage deposit pricing downward while our liquidity profile remains so strong. Some higher cost escrow deposits were moved off our balance sheet to other institutions willing to pay higher rates. Turning to non-interest income.
Non-interest income totaled $541 million in the first quarter, compared with $579 million in the linked quarter. As noted, M&T received a $30 million distribution from Bayview Lending Group in each of the past two quarters. Mortgage banking revenues were $109 million in the recent quarter, compared with $139 million in the linked quarter. Revenues from our residential mortgage banking business were $76 million in the first quarter, compared with $91 million in the prior quarter. Residential mortgage loans originated for sale were $161 million in the recent quarter, compared with $191 million in the fourth quarter. Both figures reflect our decision to retain a substantial majority of mortgage originations for investment on our balance sheet.
The primary driver of the linked quarter revenue decline is that the higher interest rate environment has pressured gain on sale margins for loans previously purchased from Ginnie Mae servicing pools and which have become eligible for resale or re-pooling. Although these loans typically have higher rates than new originations, that difference has been narrowing. Residential gain on sale totaled $14 million in the recent quarter, compared with $26 million in the prior quarter. Commercial banking revenues were $33 million in the first quarter, reflecting a decline from $49 million in the linked quarter. That figure was $32 million in the year ago quarter. As a reminder, the commercial mortgage banking business tends to show seasonal swings.
Revenues totaled $66 million in the first half of 2021, compared with $99 million in the second half, which also included an elevated level of prepayment fees. Trust income was $169 million in the recent quarter, little change from the previous quarter, but up 8% from the year ago quarter. Service charges on deposit accounts were $102 million, compared with $105 million in the fourth quarter. That decline primarily reflects seasonal factors. The previously announced repricing of our consumer checking products did not have a significant impact on the first quarter, but we expect foregone revenues from the program to reach a run rate of $15 million per quarter by the second half of the year. Turning to expenses.
Operating expenses for the first quarter, which exclude the amortization of intangible assets and merger related expenses, were $941 million. The comparable figures were $904 million in the linked quarter and $907 million in the year ago quarter. As is typical for M&T's first quarter results, operating expenses for the recent quarter, which included approximately $74 million of seasonally higher compensation costs relating to the accelerated recognition of equity compensation expense for certain retirement eligible employees like Don MacLeod. It reflects the HSA contribution, the impact of annual incentive compensation payouts on the 401 match and FICA payments, as well as the annual reset in FICA payments and unemployment insurance. Those same items amounted to an increase in salaries and benefits of approximately $69 million in last year's first quarter.
As usual, we expect those seasonal factors to decline significantly as we enter the second quarter. Aside from these seasonal factors that flow through salaries and benefits, operating expenses declined by $38 million compared with the fourth quarter. Lower professional services costs as well as lower pension related costs drove that decline. The efficiency ratio, which excludes intangible amortization and merger related expenses from the numerator and securities gains or losses from the denominator, was 64.9% in the recent quarter, compared with 59.7% in 2021's fourth quarter and 60.3% in the first quarter of 2021. Those ratios in the first quarters of 2021 and 2022 each reflect the seasonally elevated compensation expenses. Next, let's turn to credit.
Despite the challenges of the pandemic and its variants, supply chain disruptions, labor shortages, and persistent inflation, credit is stable to improving. The allowance for credit losses amounted to $1.5 billion at the end of the first quarter, little change from the end of 2021. We recorded a provision for credit losses of $10 million in the first quarter, which was partially offset by just $7 million of net charge-offs. As the COVID-19 pandemic eases, forecasted economic indicators continue to show improvement from the prior period. Inflation remains persistently high, with upward pressure from energy prices and constrained supply chains, which have been impacted by Russia's invasion of Ukraine.
The first quarter's baseline macroeconomic forecast considered these developments, although there was little difference in the forecast from the prior quarter for those indicators that have a significant impact on our CECL modeling results, including the unemployment rate, GDP growth, and residential and consumer real estate values. The result of these considerations is an allowance for credit losses that is consistent with our prior estimate. Non-accrual loans increased very slightly, amounting to $2.1 billion. That equaled 2.3% of loans at the end of March, up slightly from 2.2% at the end of last year. When we file our first quarter 10-Q in a few weeks, we expect to report a modest decline in criticized loans. As noted, net charge-offs for the recent quarter amounted to $7 million.
Annualized net charge-offs as a percentage of total loans were just 3 basis points for the first quarter, which we believe is an all-time low. That figure was 13 basis points in the fourth quarter. Loans 90 days past due, on which we continue to accrue interest, were $777 million at the end of the recent quarter. In total, 89% of these 90 days past due loans were guaranteed by government related entities. Turning to capital. M&T's common equity Tier-one ratio was an estimated 11.6% compared with 11.4% at the end of the fourth quarter. This ratio reflects earnings, net of dividends, combined with a slight reduction in risk-weighted assets. Tangible common equity totaled $11.5 billion, down just 0.3% from the end of the prior quarter.
Tangible common equity per share amounted to $89.33, down $0.47 or 0.5 percentage point from the end of the fourth quarter. This very moderate decline reflects our patience in deploying excess liquidity into long duration investments until the interest rate outlook became clearer. As previously announced, we expect to resume the repurchase of M&T common shares shortly, starting with the $800 million buyback program recently reauthorized by our Board. Now, turning to the outlook. On April 1st, we closed the People's United acquisition. That development, combined with the rapid change in interest rate expectations, have had a material impact on our outlook for full year 2022. The information that follows reflects the combined balance sheet, a more recent forward curve, and includes three-quarters of operations from People's United. First, let's talk about our outlook for the balance sheet.
Excluding the impact of acquisition accounting adjustments at closing, we acquired $63 billion in total assets, including investment securities totaling $12 billion, cash placed at the Federal Reserve totaling $9 billion, loans of $36 billion, and other assets of $6 billion. Deposits totaled $53 billion, borrowings and other liabilities totaled about $1 billion each, and equity totaled $7.5 billion. The purchase consideration was approximately $8.4 billion. With the increase in rates, the deal is now expected to be slightly dilutive to tangible book value per share. However, this also means that future earnings will benefit from additional acquisition accounting accretion. Let's go into a little more detail on our outlook for growth in the combined balance sheet. First, the interest earning cash position at the beginning of the second quarter totals just over $45 billion.
We expect these balances to decline to slightly under $30 billion by the end of 2022 due to a combination of growth in the securities portfolio, loan growth, as well as a reduction in wholesale funding. Investment securities for the combined company totaled $21 billion at the beginning of the second quarter, and we expect to grow the portfolio by $2 billion per quarter. This cadence could accelerate or slow depending on market conditions. We start this quarter with $40 billion in C&I loans, including just over $800 million in PPP loans. The CRE, residential mortgage, and consumer loan portfolios are $46 billion, $22 billion, and $20 billion respectively.
In order to provide more details on our outlook for loan growth, let's first look at our expectations for spot or end of period loan growth from the beginning of the second quarter through the end of 2022. Total combined loans are expected to grow in the 3%-5% range from the beginning of the second quarter. Excluding PPP and Ginnie Mae buyout loan balances, total combined loans are expected to grow in the 4%-6% range. The outlook for C&I loan growth, excluding PPP loans, is in that same 4%-6% range with solid growth excuse me, in dealer floor plan balances. PPP loans are expected to continue to pay down over the course of the year and not have a material impact on loan growth.
For CRE loans, we expect the heightened level of payoffs to have largely run their course, and thus the outlook for total combined CRE loans is essentially flat for the rest of this year. The tailwinds from our mortgage retention strategy are expected to help drive 7%-8% loan growth in residential mortgage balances over the course of this year. Excluding the impact of the repooling of Ginnie Mae buyouts, growth is expected to be in the 12%-14% range. Of course, mortgage rates and home supply will ultimately affect that pace of growth. Finally, we're pleased with the momentum in our consumer loan portfolio and expect this growth to continue to be strong over the remainder of the year. We anticipate growth in the 7%-9% range in this portfolio.
To help you understand the outlook for end of period growth or how the outlook for end of period loan growth ties into growth in the average balance sheet when compared to standalone M&T 2021 average balances. We expect average loans for the combined franchise to grow in the 24%-26% range when compared to standalone M&T full year 2021 average balances of $97 billion. On a combined and full year average basis, we expect average C&I growth in the 43%-45% range. We expect average CRE growth in the 15%-16% range and average residential mortgage growth in the 26%-28% range. Finally, we expect average consumer loan growth in the 16%-18% range.
As we look at the outlook for the combined income statement compared to standalone M&T operations from 2021, we believe we are well-positioned to benefit from higher rates and to manage through the macro challenges we noted earlier on this call. This outlook includes the impact from preliminary estimates of acquisition accounting marks that are expected to be finalized later in the quarter. Our outlook for net interest income for the combined franchise is for 50% full year growth compared to the $3.8 billion in 2021. We expect that 50% growth to be ±2% depending on the speed of interest rate hikes by the Fed and the pace of the deployment of excess liquidity as well as loan growth. This outlook reflects the forward yield curve from the beginning of this month. Turning to the fee businesses.
While higher rates are expected to pressure mortgage originations and gain on sale margins, growth in trust revenue should benefit from the recapture of money market fee waivers sooner than previously anticipated. We expect non-interest income to grow in the 11%-13% range for the full year compared to $2.2 billion in 2021. Next, our outlook for full year 2022 operating non-interest expenses is impacted by the timing of the People's United system conversion and subsequent realization of expense synergies. We anticipate 23%-26% growth in combined operating non-interest expenses when compared to $3.6 billion in 2021. As a reminder, these operating non-interest expenses do not include pre-tax merger related charges.
At the time of the merger announcement, one-time pre-tax merger charges were estimated at $740 million, including $93 million of capitalized expenditures. These merger charges are not expected to be materially different than these initial estimates. We expect the majority of these merger charges to be incurred in the second and third quarters of this year. Turning to credit. We continue to expect credit losses to remain well below M&T's legacy long-term average of 33 basis points. For 2022, we conservatively estimate that net charge-offs for the combined company will be in the 20 basis point range. As a reminder, the provision for credit losses in this year's second quarter will include provision related to the non-purchase credit deteriorated loans from People's United.
We are still finalizing the acquisition accounting marks, but given the improvement in economic conditions over the past year, this provision will likely be lower than the $352 million pre-tax provision estimated at the time of the announcement, the so-called double count. Finally, turning to capital. Due to the delay and growth in capital at both firms, the preliminary combined CET1 ratio at closing should be over 11%. We believe this level of core capital is higher than what is needed to safely run the combined company and to support lending in our communities. We plan to return excess capital to shareholders at a measured pace. We will be participating in the DFAST this year and again in 2023. Normally, next year would have been an off year for a category four bank like M&T.
However, the Federal Reserve has reasonably requested that we participate again next year so that our stress test and stress capital buffer can be assessed, including the balance sheet and operations of People's United. With a solid starting capital position and the potential to generate significant amounts of capital over the next few years, we don't anticipate the test results causing a material change to our capital distribution plans. Our objective, as always, is to bring our CET1 ratio down gradually to a level that is near the high end of the lower quartile of our peer group. Based on that objective, we anticipate ending 2022 with a CET1 ratio in the 10.5% range. As noted earlier, we anticipate restarting the currently authorized $800 million common share repurchase program now that the acquisition is closed.
Now let's open up the call to questions, before which Gretchen will briefly review the instructions.
We'll take our first question from Betsy Graseck from Morgan Stanley.
Hi. Good morning.
Morning, Betsy.
I just wanted to drill down a little bit on your comment around the returning excess capital to shareholders at a measured pace. Maybe you could give us a sense as to how you're thinking about that? Because obviously with loan growth coming in, there'll be a little bit of a competition, but not that much. I guess, really the underlying question is how measured is measured in your mind?
Yeah. So as we think about it, Betsy, we're gonna go through the next couple quarters and the impact of some of the one-time expenses associated with the deal will have an impact on capital in addition to the buybacks. As we think about it might be a little bit lumpy in a couple of these quarters, but if you think about it over the course of the next three as moving down and maybe the 20 basis points-30 basis points per quarter range, that's probably a good starting point.
You know, a bit of the wild card obviously is also the pace of increase in the Fed funds rates, because of the combined banks asset sensitivity, that will have a meaningful impact on net income and capital generation. It will need to be monitoring that in addition to the pace of buybacks to hit that kind of 20 basis points-30 basis points target. It might bounce around a bit, but that's kind of when we think about it, how we tend to think about it.
Okay. Just as a follow-up, the expense savings, can you just remind us the pace of the realization of those that you're anticipating?
Yeah. If we go back to the due diligence, we had and continue to target about a 30% decrease in the People's United expense base. When you look at when that really starts to come in, it really is in the fourth quarter of this year and will probably leak a little bit into the first quarter of next year, just given the timing. You know, most of the reduction in expenses is tied to the system conversion event. Typically after that, you'll have some folks who will stay on, you know, that time +30, + 60, + 90 days just as we stabilize the operations. Then those expenses will start to go away.
It'll really be as we get to, you know, maybe the December timeframe of this year that we'll hit that run rate and really into the first quarter of 2023.
Thank you.
My next question comes from Ebrahim Poonawala from Bank of America.
Good morning.
Good morning.
I was wondering if you could just go back to your NII guide. I think you mentioned 50% up year-over-year all in with the deal. Just talk to us about the thought process around the pace of cash deployment, what you're buying, and where do you expect to keep excess cash maybe at the end of 2024?
Sure. I guess, you know, a couple things on what's going on there in that. Just looking at the cash and the cash deployment, some of it will be into securities. You know, we talked about a pace of an incremental $2 billion a quarter in growth in the securities portfolio, you know, net of runoff. When you look at the securities portfolio and where we've been focused of late, it's been in the shorter end of the curve, typically in the two-three-year space. I think if you look at how that curve looks, you see that it kind of flattens out once you get to five years. We don't see a benefit to that extra duration.
Part of the way we're getting some of that duration is through the retention of the mortgages we're originating through our retail channels. Part of the cash then is deployed into the residential mortgage balances that will sit on our balance sheet. Obviously the other loan growth that we talked about. Those are the things that we think help bring the cash levels from, you know, the place we are combined in April of around $45 billion down to $30. The other part that I didn't mention was there is some wholesale funding that is coming through the merger.
As we look at our cash position, we think we can bring those wholesale balances down, and fund them with the liquidity position that we have.
Understood. Just, tied to that on the funding side, we saw some deposits runoff you've talked about this last quarter. Remind us in terms of when you think about deposit balances, where you expect them to trend, and are they other kind of more rate sensitive index type deposits that you expect to leave the balance sheet over the coming quarters?
Yeah. I guess we're not anticipating additional runoff in the deposit portfolio right now. You know, we'll go through, I think the first 100 basis points, I think for us and generally for the industry, given the loan to deposit ratios in the industry, the deposits are likely to be sticky and we won't see much movement due to rates. As we go through the cycle, you know, there's a cadence that happens with these. The deposits that tend to be the most rate sensitive are usually those in the wealth business as well as in the municipal or government space. You'll tend to see betas move there a little bit faster.
You know, in consumer land, it takes a little bit longer for rates to start to drive behavior. Over time, you'll see some movement out of checking accounts and into money market savings and time accounts. But that'll all be based on the pace at which the industry starts to move up. You know, just on time deposits, there is a slightly higher time deposit portfolio at People's than there has been at M&T. You know, you might see a little bit of runoff in the time deposits early on, but as rates move, assuming they move as anticipated, at some point you'll see those lines cross and that portfolio will stop shrinking. Excuse me. Then on a combined basis, it'll start to grow.
The growth part is probably not until late this year or early next year, would be my guess, just based on our past experience and where the forward curves are.
Got it. Thanks for taking my questions.
The next question comes from Matthew O'Connor from Deutsche Bank.
Hi. I was hoping you could flesh out the 10.5% CET1 target and I guess just be blunt, like, why so high? I think it's above where most of your peers are targeting. I appreciate you're converting a deal and you got DFAST that you want to see. Is that kind of the intermediate target? Over time you'll bring it down maybe closer to the 9%-9.5% that we see from your peers? How'd you arrive at a 10.5%, and how long term is that?
Yep. Happy to answer the question, Matt. The 10.5%, you know, is a stepping stone along the way. You know, we haven't changed our thought process about how we manage capital, that you know, we're always looking to deploy it into the franchise first and always looking to support customers and loan growth within our markets. To the extent that that's not there at a reasonable return, then we look to get it back to shareholders. You know, we always think about the dividend as an important element of that, and we try to make sure we target, as we've talked about before, right around a third of earnings as a dividend payout target.
We think that gives us a good flexibility to make sure that we can maintain that payment through the economic cycles. You know, we tend to favor using buybacks as the rest of it. You know, the 10.5 when you look at where we're starting and you look at what we believe is going to be the capital generation of the combined organization. It is, and against the backdrop of an asset sensitive franchise in a rising rate environment, the capital generation we think becomes pretty compelling. The pace of deployment against the pace of capital generation makes it tough to bring that ratio down very quickly.
As you pointed out, it's an intermediate step that next year will be the first year we go through the stress test with our combined balance sheet. What history has taught us is when you go through that first time, you know, there can be surprises in how the portfolios are treated or react under the Fed's stress test models. Sometimes in those situations, there can be data gaps that you need to remediate. We understand those issues and challenges, but we're, you know, we think that going into that test at that level is just a safer place to be.
I know we'll have more information when we come out the other side and expect to continue on our path down to the target that we've always talked about. You know, we'll obviously have to look at that target, as we take into account the new balance sheet and the combined bank that we have, because we are getting some new portfolios, and we'll want to run them through our own stress test models, to understand how they perform under stress. But, you know, consider the 10-five as a stop, along the journey, towards our more typical target.
Okay. That's helpful. On the liquidity, I'm probably missing some sort of liquidity rule on this, but why can't you and other banks that have tons of cash just dump it in short-term Treasuries? You know, we've seen very unusual moves in the Treasury market, so, you know, you could basically accelerate all that rate leverage, and not really take any risk, right? Like the six-month Treasury is about 1.30, 12 months is 2%. Doesn't impact the CET1, I don't think. Just remind us, like what liquidity rule is out there that's preventing you from doing that? If it's not a rule, why wouldn't you consider that? Thank you.
Yeah. There's not a rule, Matt. I mean, when you're going through for banks that are subject to the liquidity coverage ratio, there's an expectation about what percentage of their liquidity is held in high quality liquid assets. I think the treasuries count, but cash is one of the preferred. Shorter duration cash-oriented instruments would affect banks that are LCR banks, which are Category three banks. For a bank like M&T, we're not subject to that. But when we look at the benefit of locking in now a two-year treasury versus where we see the forward curve going, we think we're going to get a lot of that just with the rate moves without having to lock it in.
We maintain the flexibility of that cash and we keep the marks off the balance sheet. You know, you can see we're starting to buy in, and we'll continue to build a portfolio that does take advantage of some of that, while trying to protect the flexibility that we have. We'll still expect to benefit from the increase in rates. You know, we're trying to dollar cost average in a little bit into that position. Really the focus for us, you know, I can't speak for others, but the focus for us is over the course of the next couple of years rebuilding. You know, the mix of the balance sheet between what's in cash, what's in securities.
Within the securities portfolio, what's the duration of it? How are we thinking about that with what is the duration of the whole portfolio? You know, as we talked about with what's in mortgages. The other thing that's really important is how much cash and what's your deposit runoff assumption, right? Because if you get too far into the securities portfolio and all of a sudden you see some migration in deposits, then you've got to go out and fund those or you've got to react to outflows with rate. If you go too far too fast, you can get yourself upside down. You know, obviously at two years, there's a lot less risk of that.
Those are the kind of things that we're always thinking about and debating internally when we think about the pace at which we want to deploy that cash into something that might, you know, over the course of the next couple quarters, provide a higher yield. Based on, you know, as I mentioned, where it looks like the Fed is moving, you might catch up pretty quickly there in the cash.
Just to squeeze in, what would be the longer term target of, call it securities to assets or maybe it's securities plus residential mortgages, is the way you think about it. You said, you know, rebuild and kind of remix the next couple of years and what would be the end state, as you think about?
Yeah, I guess it, a way to think about it, Matt, is to look at the combination of our securities portfolio plus our on balance sheet mortgages and look at that as a percentage of assets and then look at where the peers sit. If you think about the peers who have the lower percentage of those, so the bottom quartile of the peers when you add up securities and mortgages as a percentage of assets. Think that kind of range for us. You know, as we've talked about before, our goal is always to deploy our liquidity into lending while making sure that we're not taking on crazy asset sensitivity. We look to bring that asset sensitivity down.
Those would be some of the primary categories in which we would look to do that.
Okay. Thanks for taking all my questions.
Our next question comes from John Pancari from Evercore. John, your line is open. You might be on mute.
Boy, after two years of the pandemic, you're still muted.
We'll take our next question from Ken Usdin from Jefferies.
Hey, thanks a lot. Good morning, guys. Hey, Darrin, just wondering if you could just drill down to a couple more pieces of NII. First of all, can you help us understand that you mentioned the accretion. Can you help us understand how much accretion you're expecting, either in dollar terms, ideally, or can you help us understand the percentage that adds to growth?
Yeah, sure. When you look at the NII, like you mentioned, we're still finalizing what the marks are. But when you look at the forecast for the year and in the coming years, the impact of the accretion will be positive compared to where we thought it would be when we announced, obviously because of the change in the interest rate environment. But when you look at the percentage, it could move what we guided. It's maybe a couple of percentage points in either direction, you know, more likely to be accretive than not.
Really, the bigger driver of the growth in NII is just the composition, obviously, of our balance sheet and our asset sensitivity and the new rate curve, which is the biggest part of that driver.
Okay. There is accretion in there, but you're saying it could be more than what you have in there, but until you finalize the marks, you're not going to update us on just what the amount of the accretion is in there?
We'll give you all of the information once we finalize it. I guess what I'm saying is.
Okay.
It's not going to change the outcome in a meaningful way.
Okay. Got it. Just second question just on, you talked about some of the moving parts within the betas. Can you just talk to us about, like, what you're expecting for deposit betas and how that might have changed given, the faster pace of expected hikes that we're now seeing from the Fed? Thanks.
Yep, no problem. You know, I guess we talked a little bit about deposit betas earlier on. You know, it's really when we disclose the sensitivity in the Q, what we'll see there is the first 100. The first 100, we really don't think there's a lot of reactivity. Really, when we look at the 100, we look at each 25, and then we'll look at the subsequent 25. Really, you know, we think the first 100 has relatively low deposit betas. You know, it's probably in the 10%-15% range, probably towards the bottom end of that. You know, it skews by portfolio.
When you look, as I mentioned before, at some of the government and municipal deposits, they tend to be a lot more rate sensitive, as do the wealth balances. You know, those would drive up the deposit beta. For you know, our smaller business customers and our consumer customers, you know, the betas are a little bit lower. Clearly, as you get higher in the absolute level of Fed funds, you start to get a little bit more attention. You know, one of the things that I think is different this cycle from others, not just for us, but for the industry, for all of us to keep in mind is there's now an ability to pay interest on commercial checking accounts, which there hadn't been before.
You know, you would look at the impact on commercial balances historically would be on earnings credit and then the offset on fees. From an interest perspective, it was typically sweep accounts and, you know, it was either on or off balance sheet. Well, now much of that will happen in those commercial checking accounts where clients will have to decide between earnings credit against fees or between earning an actual interest income based on the rate on those products. It's something we haven't seen how reactive those specific products will be because we haven't really been through a tightening cycle that's looking like the one that's in front of us.
You know, again, big picture, if you just go back to where loan to deposit ratios sit and all the liquidity that sits, you know, not just on our balance sheet, but on others, unless there's a meaningful change in that position or meaningful loan growth, you probably have deposit betas that are, you know, at the lower end of what we saw in the last tightening cycle.
Yes. Got it. Thanks a lot, Darren. Makes sense.
Our next question comes from Steven Alexopoulos from JP Morgan.
Hey, Darren. How's everything?
Doing great. Good morning. How you been?
Morning. Good. On asset sensitivity, could you give color? You said you restarted the hedging program in the quarter. Can you give color on what you're doing there? Now that People's has closed, what's the new level of asset sensitivity versus what you guys last disclosed?
I'll go in reverse order. The new level of asset sensitivity is slightly less than what it is M&T standalone. If you look at the two balance sheets, both were asset sensitive. On a combined basis, the asset sensitivity drops, you know, maybe a percentage point, half a point, in that range. We saw in the People's portfolio over the course of the last year, similar phenomenon that we did and that there had been some loan declines, certainly PPP loans that paid off and turned into cash. They were looking at and managing their portfolio in a very similar fashion to how we were. There really wasn't a big change in the combined asset sensitivity.
When you look at the hedging program, you know, what we've been trying to do is, since we see the curve that is forecast, you know, we can use some forward-starting swaps, much like we had done in the prior cycle to lock in those increases before they happen. You know, in effect, if you see where were we today, you know, nine increases in Fed funds, you can lock that in with a forward-starting position, and then, you know, you'd have to see 10 or 11 before you thought that was a bad decision. Given the fact that you're still asset sensitive, you'd be pretty happy if that was the case.
Being able to lock in some of these today, you can protect in case the pace isn't at that level. It's really with some of those cash flow hedges, very similar to how we built the portfolio last time, where we try to leg into it a little bit and build it out each month, as we go forward.
Got it. Okay. That's helpful. For my follow-up question, I want to go back to your response to Betsy's question on the cost savings phase-in. Are you still assuming 85% in 2022? Is the number still $330 million?
I'm trying to think about 85%. That's not a number that's. Oh, I know what you're thinking about. I got it. First year. I'm with you now.
Yeah.
You know, just given the timing of when the deals happen, we'll start to see that run rate achieved, towards the end of the year. You know, with an 85% this year, we're not going to see 85% in actuality in calendar year 2022, just because we're not doing the conversion until the third quarter, right? In reality, we'll start to get to the run rate as we come out of the year. Really the way to think about it is it'll really kick in full year in 2023. You know, we're still in the range of thinking that we're around 30% cost saves. Keep in mind that the People's expense base has changed.
You know, the dollars will be slightly different. You know, they've seen the same thing we have with expense growth and wage inflation. You know, the good news is in dollar terms, the savings are probably a little bit higher because the costs went up. The reality is the percentage save has really not changed much.
Okay. The dollar's up a bit and basically by the end of the fourth quarter you'll be at the run rate.
Yeah.
Not the fourth quarter.
Not the fourth quarter. Yeah.
Yeah.
You really-
By the end of the year.
You know, like I mentioned, there's a lot of it's going to come out in the third quarter, but there's always some residual. You know, some folks that are, you know, 60 or 90 days past conversion. If we're doing the conversion, you know, in around the early part of September, a little bit of that leaks into the fourth quarter. By the time we get out of this year, we should be pretty close to the run rate as we jump off into 2023.
The 100% run rate?
Yeah.
Okay. Got it. Thanks a lot.
Our next question comes from Gerard Cassidy from RBC.
Hi, Darren. How are you?
Good morning, Gerard. How are you doing?
Good, thank you. The question I have has to do with, I think you said that you were able to see some of your criticized loans taken off your balance sheet from competitors. I was wondering if you can elaborate. And I'm not gonna ask the names of who did this, but could you elaborate, you know, the underwriting standards that you were holding these customers to that made it more enticing for them to go to another competitor, assuming they got, you know, better terms and conditions? Do you see that continuing in the second or third quarter of this year?
Yeah. You know, we've seen a fairly, as we mentioned, fairly substantial amount of payoff activity this quarter. A bunch of it was in and around New York City real estate and in many cases in the leisure and hospitality industry, AKA hotel. It's a variety of players, Gerard, that are coming in. Sometimes it's private equity, and sometimes it's the funds. We have seen a couple refinanced by other banks. It might not necessarily be the credit per se. What I mean by that is when you've got a company on your books and you've been watching their performance over time and you downgrade them, you wanna see a few quarters of re-performance before you upgrade them.
They get classified as a troubled debt restructuring, and potentially, depending on what happens. Someone who comes in new, it's not a TDR for them. It's a new loan. They can structure it the way they want. In some cases, we saw us get refinanced out, and then, additional dollars were added. It's a new loan in someone else's eyes. The treatment from an accounting and a capital perspective is a little bit different. They're not, you know, waiting for a little bit longer history of performance before they regrade it and change it, right?
They might look more prospectively than we might typically look, where you're wanting to see a few months, maybe even a couple quarters, of sustained performance before you change the grade. For those reasons, that's why you tend to see this stuff. You know, I think I would humbly say that a lot of times people look at our underwriting and know our history of it, and so are willing to take us out because they know these credits are strong. A lot of times, you know, that proves out when you look at the charge-offs this quarter at 3 basis points.
The reason that was so strong was as much because of recoveries, because of things that we had previously charged off, where it turned out that, you know, the collateral values were where we thought they would be, and we were able to recover what we had previously charged off. There's a number of things that happen, when others take us out. You know, it's not something that we necessarily love, but it's part of the cycle.
Very good. In view of the time, I'll just leave it at one question. Thank you.
Okay.
Our next question comes from John Pancari from Evercore.
Morning. Thanks for taking my question. Just one for me on the credit, I mean on the commercial real estate front. I know you had indicated that the book should be relatively flat here going forward. Can you just maybe talk about what gives you confidence in that front? I know you mentioned that pay downs were impacting the balances for the first quarter. I don't know if you have the amount of those pay downs and what gives you confidence that they could abate. Lastly, do you expect any of the potential securitization that you mentioned of the People's permanent financing portfolio to come into play here? Thanks.
I think there's a couple things that are behind that, John. Over time, when we look at our portfolio, we tend to see growth in our portfolio when there's activity in the market. There hasn't been as much activity until recently with properties starting to change hands. Part of what we were just talking about some of the pay downs is property starting to change hands. That typically is a benefit for us. The other thing is when we look at some of the payoffs, and we mentioned that many were in our non-accrual or criticized space and in the hotel part of our portfolio.
We've seen a number of upgrades, and we continue to expect more upgrades to come, because we are seeing a definite improvement in that portfolio. For those reasons, we expect to see a little bit less payoff and pay down activity there. It mentioned a little bit about the construction loans and those paying off. In a lot of cases, what you were seeing is some folks trying to lock in where they could a fixed rate rather than, you know, the construction line is a variable rate. People are trying to lock in some of the financing in the face of rising rates, which of course, you know, can still happen.
Loans have to be at a certain place along the way, meaning the construction loans have to be far enough along that you can convert some of it into permanent. You know, then I guess the other part of it is just the utilization rate of those lines and where they stand. That as the project's near completion, they'll continue to grow towards 100%. When we look at where that utilization is today, you know, it's higher than it's been since well, in our history that I'm looking at. Certainly from the low point in December of 2019.
You know, when you open up a bunch of construction lines and the projects start to move forward, you see those lines slowly build and grow. From a low of maybe 50-odd% in 2019, you know, we're now in the call it 68%-70% range. At that point the construction's got to go to completion for the developer to get paid out. Those lines will continue to grow, which will be a bit of an offset. For a bunch of those reasons, that's why when we look forward, we think that there'll be enough growth to offset some of the pay downs that are natural and expected.
You know, and the other thing which we shouldn't discount from just loan growth in general is now that there's certainty around the deal and the merger, you know, that anxiety goes away for our employees and for our customers who are waiting. I think, you know, we shouldn't discount that does have an impact on the psyche. That as folks feel that certainty and understand the credit window, that we'll start to see the activity ramp up. So that's also part of that forecast.
Okay. Anything on the potential securitization of the permanent financing book at People's?
It's too early, John, to go through that. I mean, we still talked about it. You're 100% right. We talked about it at the merger announcement into something that we think is an opportunity. We still see that as a great way to be able to provide capital for our clients. It's something that we'll look at and, you know, more to come as we go through the second quarter and third quarter. You know, just give us a second to integrate these two banks, and I promise we'll come back.
Got it. Thanks, Darren.
Our next question comes from Frank Schiraldi. Your line's open from Piper Sandler.
Hi, Darren.
Morning, Frank.
Just a quick follow-up on asset sensitivity. I recognize that deposit betas are, you know, going to start lower and trend higher at some point. Just to simplify things, I wondered if you had any updated thoughts, you know, with People's in tow, what a given 25 bp hike should do for the NIM, at least, you know, at the beginning of this cycle.
Yeah, early on, you know, just to give an update on where we had been before. You know, we talked about standalone, I think it was maybe 9 basis points-12 basis points before, combined. You know, with the change in the portfolio, it's a little bit higher. You know, we would estimate kind of 10-14. Obviously, as you mentioned, deposit betas are the driver of the range from 10-14. On a combined basis, 25 basis points on a full year annualized basis, that 10-14 we think equates to about $165 million-$225 million in incremental NII.
Great. Okay, I'll leave it there. Thank you.
No problem.
Our next question comes from Bill Carcache. Your line from Wolfe Research. Your line is open.
Thank you. Hi, good afternoon, Darren. Thanks for taking my question.
Morning.
How are you thinking about growing the securities portfolio versus putting on swaps from here? Separately, how are you thinking about what level of liquidity you should view as excess right now against the backdrop of a more aggressive balance sheet runoff this cycle?
Yeah, it's a great question. It's something that we spend a lot of time talking about as a management team and our treasurer and treasury team spends obviously all day, every day thinking about it. We have a long ways to go, clearly, before we're liquidity constrained. You know, when we mentioned we start the combined bank with $45 billion in cash. As we think about the mix between how much we put in the securities portfolio and how we think about the hedges, what we like about the hedges is it's a nice offset, obviously, to the loan book. It's capital friendly, right?
If you think about what we've seen in the last quarter with if you try to cover asset sensitivity and reduce it solely through the securities portfolio and, you know, fixed rate product, to the extent that it's held and available for sale, then you have equity risk as rates continue to rise. Whereas when we do it through the hedging, it's more equity efficient. What we recognize though is that, you know, just given some of the changes that are happening between LIBOR and SOFR on the rate that loans are coming on the books and the changes that to move the position down, we won't be able to do it solely with hedging.
That's when we start to look at some of the other instruments and we look at and make a trade-off decision between mortgage-backed securities versus, you know, just the mortgages that we can hold on our balance sheet. When we look at the flow that we think is coming today out of our retail production, we think that provides us a nice opportunity to manage down some of that asset sensitivity and deploy that liquidity. Then, you know, when we think about securities for the rest. We'll, you know, I think we'll continue for now to focus at the shorter end of the curve there, just because we've got some of the longer part covered in the mortgage book.
You know, the thing that you know, we always just kinda keep an eye on is what's happening in that deposit book. Really that's the trick, right? As you look at what's happening with those deposit balances, they look pretty sticky based on what we see right now. We'll wanna hold a certain amount of liquidity and cash just for part of our liquidity coverage and liquidity management in under stress, but go at a pace where if you've got the excess, you can always deploy it. If you find yourself short, that's a little bit of a problem. We'd rather kind of work our way down slowly to take that away.
Ultimately, as we mentioned before, get to a position where that, you know, securities plus mortgage balances as a percentage of the total balance sheet, you know, is kind of in the range of the top end of the bottom quartile of the peers.
Understood. Very helpful. Thank you.
Our next question comes from Brent Erensel from Portales Partners. Your line is open.
Thanks. I think this is pretty clear, but it looks like net interest income is gonna go up by hundreds of millions of dollars in subsequent quarters. Am I missing something?
That's how we see it. You know, but, you know, the caveat, of course, is the Fed curve actually has to come true. So far, we've got 25 basis points, but.
What's the final share count? 'Cause I need to make sure I understand this straight.
Post deal. It's in the $176 million-$177 million range.
I'll use $177 million.
Million.
Thank you very much.
million shares.
Congratulations, you guys. Well done.
Thank you.
Cheers.
Thank you.
Our last question comes from Christopher Spahr from Wells Fargo. Your line is open.
Thanks for squeezing me in. I'm just wondering what you think the organic growth rate for the portfolio, more specifically the loan book, will be in 2023. Thank you.
Yeah, we're still, you know, going through and doing the work there. You know, I don't have any reason to believe that it will go much below the kinda 2%-3% rate that we've been seeing or expect this year. I mean, this year's a little bit high because we had some runoff and, you know, this pause that we talked about while there was uncertainty. In general, you know, it's hard to outgrow GDP, you know, and GDP might be a little bit high, but we're expecting that will start to come down.
You know, when I think about the puts and takes, you know, CRE is probably gonna stay a little bit lower as we talk about and complete the portfolio repositioning that we've talked about for a while. C&I, we think, you know, we've seen some really strong growth already this year and expect that to continue. There's clearly a question about the pace of recovery in the floor plan business. You know, when you look at a lot of the growth, it was early in the quarter, late in the year, and at the end of the quarter, you started to see a little bit of a slowdown in production again and supply chains. You know, if that gets resolved, you could see a higher growth rate in C&I.
Without it might not be quite as robust. Obviously, that spills over into the indirect consumer Recreational Finance. You know, mortgages, I think mortgage activity will be a function obviously of how high the 30-year goes and what's happening with people changing homes, which has been, you know, when we look around many of our geographies, the biggest issue seems to be just availability of homes to buy versus desire to actually purchase at least right now. You know, we'll see whether that shifts, as I mentioned, when rates go up. You know, I would be thinking as a starting point in that 2%-3% range for the whole portfolio.
Thank you.
Okay.
It appears we have no more questions at this time. I will now turn the program back over to Brian Klock.
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This does conclude today's program. Thank you for your participation. You may disconnect at this time. Have a great day.