Good day. Thank you for standing by. Welcome to the M&T Bank second quarter 2021 earnings conference call. Today's call, at this time, all participants are in the listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to Don MacLeod. Thank you. Please go ahead.
Thank you, Erica. Good morning. I'd like to thank everyone for participating in M&T's second quarter 2021 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. 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 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. I'm happy to say that our Chief Financial Officer, Darren King, will be leading the call today. Joining us today is Brian Klock, who started with M&T in May and who will take over as the Head of market and Investor Relations at the end of this year. Darren?
Thanks, Don. Good morning, everyone. Welcome back, Brian. After a 17-year hiatus, welcome to the other side of the table. I have a rhetorical question for you. Where would you rather be than right here, right now?
You got it, Marv. I mean, Darren.
All right. Let's jump into the business of the day. As we noted in this morning's press release, we were pleased with the continued rebound in the economy from the pandemic-induced slowdown. We continue to see improved customer activity across all sectors of the economy. Notably, while not back to pre-pandemic levels, we're seeing improvements in the leisure and hospitality sectors. While non-accrual and criticized loans increased from prior quarter, loss emergence remains subdued, leading us to recognize a further moderate release from the allowance for credit losses. The balance sheet continues to strengthen as both capital and liquidity grew from already elevated levels, positioning the bank to continue to be a source of strength for our customers. We continue to make progress towards a fourth quarter close of the People's United merger, and we were pleased with the overwhelming shareholder support of the combination.
Looking at the results for the quarter. Diluted GAAP earnings per common share were $3.41 for the second quarter of 2021, improved from $3.33 in the first quarter of 2021, and $1.74 in the second quarter of 2020. Net income for the quarter was $458 million compared with $447 million in the linked quarter and $241 million in the year-ago quarter. On a GAAP basis, M&T's second quarter results produced an annualized rate of return on average assets of 1.22% and an annualized rate of return on average common equity of 11.55%. This compares with rates of 1.22% and 11.57%, 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 $2 million, or $0.02 per common share, little changed from the prior quarter.
Included in the quarter's results were merger-related charges of $4 million related to M&T's proposed acquisition of People's United Financial. This amounted to $3 million after tax or $0.02 per common share. Results for this year's first quarter included $10 million of such charges, amounting to $8 million after-tax effect or $0.06 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 second quarter, which excludes intangible amortization and the merger-related expenses, was $463 million, compared with $457 million in the linked quarter and $244 million in last year's second quarter.
Diluted net operating earnings per common share were $3.45 for the recent quarter, up from $3.41 in 2021's first quarter and up from $1.76 in the second quarter of 2020. Net operating income yielded annualized rates of return on average tangible assets, an average tangible common shareholder's equity of 1.27% and 16.68% for the recent quarter. Comparable returns were 1.29% and 17.05% in the first quarter of 2021. 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. Let's take a look at some of the underlying details in our results. Taxable equivalent net interest income was $946 million in the second quarter of 2021, compared with $985 million in the linked quarter.
A decrease in PPP related income accounted for approximately half of the quarter-over-quarter decrease in net interest income, as the first round of PPP loans continues to wind down. The net interest margin for the past quarter was 2.77%, down 20 basis points from 2.97% in the linked quarter. Higher levels of cash on deposit at the Federal Reserve continued to contribute pressure to the margin, which we estimate accounted for seven basis points of the decline from the first quarter. Lower fee amortization from the PPP loan portfolio, both scheduled amortization and accelerated recognition from forgiven loans, contributed about six basis points of the margin pressure. The impact of interest rates, primarily lower income from our hedge program, partially offset by a lower cost of deposits, accounted for about three basis points of the decline. All other factors accounted for some four basis points of margin pressure.
Compared with the first quarter of 2021, average earning assets increased by some 2%, reflecting a 13% increase in money market placements, primarily cash on deposit at the Fed, and a 6% decline in investable securities. Average loans outstanding declined just under 1% compared with the previous quarter. Looking at the loans by category on an average basis compared with the linked quarter, overall commercial and industrial loans declined by $668 million or 2.4%. Dealer floor plan loans declined by $859 million, reflecting the well-documented auto production and inventory issues experienced by the industry. Due to the late first quarter timing of round 2 originations and delays in forgiveness of loans over $2 million in size, average PPP loans declined by less than $50 million from the prior quarter. All other C&I loan categories grew slightly over 1%.
Commercial real estate loans declined by about half a percent, similar to what we saw in the first quarter. We continue to see very low levels of customer activity. Residential real estate loans declined by 2%. We've seen little opportunity for additional buyouts of loans from Ginnie Mae servicing pools as delinquency and payment trends continue to improve. Absent those, the ongoing runoff of acquired Hudson City mortgage loans continues at a moderate pace. Consumer loans were up 3%, consistent with recent quarters as growth in indirect auto and recreation finance loans has been outpacing declines in home equity lines and loans. On an end of period basis, total loans were down 2%, reflecting the same factors I just mentioned. PPP loans totaled $4.3 billion at June 30th, compared with $6.2 billion at the end of the first quarter.
Average core customer deposits, which exclude deposits received at M&T's Cayman Islands office and CDs over $250,000, increased over 3% or $4 billion compared with the first quarter. That figure includes $2.6 billion of non-interest-bearing deposits. On an end of period basis, core deposits were up by just under $700 million. I'll note here that the repeal of the prohibition of paying interest on commercial checking deposits has led us to reconsider the need for a Cayman Islands office. It held no deposits at the end of the quarter. Turning to non-interest income. Non-interest income totaled $514 million in the second quarter, compared with $506 million in the linked quarter. The recent quarter included $11 million of valuation losses on equity securities, largely on our remaining holdings of GSE preferred stock, while the prior quarter included $12 million of such valuation losses.
Mortgage banking revenues were $133 million in the recent quarter, compared with $139 million in the linked quarter. Revenues for our residential mortgage business, including both origination and servicing activities, were $98 million in the second quarter, compared with $107 million in the prior quarter. Lower gain on sale margins were the primary driver of the decline. In addition, residential mortgage loans originated for sale were down about 5% to $1.2 billion compared with the first quarter. Commercial mortgage banking revenues were $35 million in the second quarter, compared with $32 million in the linked quarter. Trust income rose to $163 million in the recent quarter, improved from $156 million in the previous quarter. This quarter's results included $4 million of seasonal fees arising from tax preparation work we undertake for clients, as well as the result of growth in assets under management in the wealth and institutional businesses.
Service charges on deposit accounts were $99 million, compared with $93 million in the first quarter. The primary driver of the increase was customer payments related activity. Turning to expenses. Operating expenses for the second quarter, which exclude the amortization of intangible assets and merger-related expenses, were $859 million. The comparable figure was $907 million in the linked quarter. Salaries and benefits declined by $62 million to $479 million from the prior quarter. Recall that the first quarter's results included $69 million of seasonal salary and benefit costs. Our deposit insurance increased by $4 million to $18 million during the quarter, primarily reflecting higher levels of criticized loans, which factor into the FDIC's assessment calculation. Other costs of operations for the past quarter included an $8 million addition to the valuation allowance on our capitalized mortgage servicing rights.
Recall, there was a $9 million reversal from the allowance in 2021's first quarter. The efficiency ratio, which excludes intangible amortization from the numerator and securities gains or losses from the denominator, was 58.4% in the recent quarter, compared with 60.3% in 2021's first quarter, which included the seasonally elevated compensation cost. Let's turn to credit. As I noted at the start of the call, we're pleased with the signs of spending and revenue trends for our customers as the overall economy continues to improve. That said, some industries are improving more rapidly than others, and the supply chain issues and pressures on costs go beyond just the automotive sector. The allowance for credit losses declined by $61 million to $1.6 billion at the end of the second quarter.
That reflects a $15 million recapture of previous provisions for credit losses, combined with $46 million of net charge-offs in the quarter. The allowance for credit losses as a percentage of loans outstanding declined to 1.6%, 1.62%, excuse me. That ratio is little change from 1.65% of loans at the end of the prior quarter. Annualized net charge-offs as a percentage of loans were 19 basis points for the second quarter, compared with 31 basis points in the first quarter. The allowance for credit losses at the end of the quarter reflects our assessment of credit losses in the portfolio under the CECL loss measurement methodology, which includes our macroeconomic forecast. As we've previously indicated, our macroeconomic forecast uses a number of economic variables, with the largest drivers being the unemployment rate and GDP.
Our forecast assumes the national unemployment rate continues to be at elevated levels, on average 5.4%, through 2021, followed by a gradual improvement reaching 3.5% by mid-2023. The forecast assumes that GDP grows at a 7.4% annual rate during 2021, resulting in GDP returning to pre-pandemic levels during 2022. Non-accrual loans increased by $285 million to $2.2 billion or 2.31% of loans at the end of June. This was up from 1.97% at the end of March. We expect to disclose an increase in criticized loans with our second quarter 10-Q filing. This reflects the prolonged recovery in certain sectors of the economy, notably hospitality and healthcare. M&T's commercial loan grades reflect the performance of individual properties with limited consideration of property values or guarantor ability to sustain cash flows from other sources. Notwithstanding those increases, loss emergence on troubled loans continues to be moderate.
Interest reserves are healthy, sponsors remain supportive, and collateral values are well within our underwriting assumptions. The allowance for credit losses continues to reflect our ultimate loss expectations. Loans 90 days past due, on which we continue to accrue interest, were $1.1 billion at the end of the recent quarter, and 96% of these loans were guaranteed by government-related entities. Turning to capital. M&T's Common Equity Tier 1 ratio was an estimated 10.7%, compared with 10.4% at the end of the first quarter, and which reflects lower risk-weighted assets and earnings net of dividends. As previously noted, while the People's United merger is pending, we don't plan to engage in any stock repurchase activity. Now, turning to the outlook. As we reach the halfway point of the year, the cautious outlook we conveyed on the January and April earnings calls has been well-aligned with what we're actually seeing.
The fiscal and monetary stimulus programs, along with the vaccination programs, have clearly brought a turnaround in economic growth and employment. The downside effects from these actions continues. Excess liquidity in the system has suppressed loan growth, particularly commercial loans for M&T in the broader industry. Customer deposits are at all-time highs and grew faster than our ability to deploy them into assets that earn above our cost of capital. The fundamental aspects of our outlook haven't changed. Total loan growth roughly flat on a year-over-year basis, excluding the PPP loans, with pressure on C&I, especially dealer floor plan and CRE loans being offset by growth in consumer loans. Net interest income down low single-digit percentage from full year 2020. Low single-digit growth in total fees.
We see the potential for a slowdown in mortgage banking in the second half, offset by stronger trust income, payments-related fees, and commercial loan fees. Expenses for the first half of the year have been mostly in line with our expectations, with year-over-year growth largely attributable to expenses directly tied to revenue growth, such as in trust, and to higher corporate incentive accruals coming as a result of improved overall profitability compared to last year. As these trends continue, together with costs associated with the reopening of the economy and costs incurred in preparation for the People's United merger, we expect there to be a little more pressure on expenses in the second half of 2021. The credit environment continues to improve along with the overall economy, but some segments are recovering more slowly than others.
We're encouraged by the progress we're seeing in our hospitality portfolio with respect to bookings and cash flows, that sector's return to normal will lag the overall economy. Lastly, the planned merger with People's United remains on track, our estimated timeline for approval by the regulators, closing, and integration remains unchanged. 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 the call to questions, before which Erica will briefly review the instructions.
As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the queue and the roster. Your first question comes from the line of Ebrahim Poonawala with Bank of America.
Good morning.
Morning.
I guess if you could just follow up on the outlook for expenses being pressured in the back half. When I look at second quarter, we grew about 7% year-over-year. Give us a sense of how we should think about it. Should the back half be higher than first half levels in terms of what we saw in expenses? Any color around that would be helpful.
Yeah, sure. I guess when you look at the quarter comparison in second quarter versus second quarter last year, that was when the economy shut down and everything stopped. You're in for a larger expense increase there in that quarter, looking at a year-over-year basis. When we think about the whole year and where we go for the second half, the things that we're looking at is we're looking at some increase in fee-related expenses as we continue to see those fee categories grow. We're looking at, as I mentioned before, continued increase in our incentive accrual based on the performance of the bank. You recall that last year, we reduced the incentive pay to our senior folks based on the performance of the bank.
The other place where you'll see some growth is as we continue to make our investments in technology and prepare for the People's integration. We'll probably see some expense pressure in the third quarter. We'll call out what's related specifically to the merger. Some of those will either be one-times or they could in fact be expenses that will start maybe a quarter earlier than we might have thought as we prepare for legal day one and for the conversion. Overall, the expense growth that we saw this quarter, we wouldn't be running at that high of a rate for the whole year. Certainly not excluding the impact of the People's merger. I'd be thinking more in the 3%-5%, taking into account the corporate incentives as well as the growth in some of the fee businesses.
Got it.
Got it.
Okay. That's helpful. I guess just on a separate topic, Darren, last quarter you provided some color around the hospitality book. I'm just wondering if you've seen any improvement in terms of the debt servicing for these borrowers. I understand you don't expect credit losses stemming from this portfolio, but how will that inform your ability to get back to season on reserve levels as you think about the next few quarters? Thank you.
Yeah, sure. I guess the way we're looking at it and thinking about it is when we look at the criticized portfolio, we're really focusing on the standalone cash flows of each of the properties and each of those specific, I guess, call it pieces of collateral. Because with many of our relationships, our clients will have multiple properties. So we look at each property and we assess its ability to cash flow. That's what affects the criticized balances. When you look at actual losses, just because they're struggling, many of them are actually still earning interest and accruing interest because the sponsors have outside sources that they're bringing to support the deals. Then the other thing we're looking at is we keep getting updated appraisals on loans and properties that we have both in criticized and in particularly in non-accrual.
What's been a pleasant surprise is when we look at the recent appraisals that have come in, they've been very strong. We've seen valuations, I believe we're on a fully on an as is basis that are well above our loan costs and on a stabilized basis that are maybe down 10% from the original appraisals. So when we think about the loss content in the portfolio, which is reflected in our allowance, we feel quite comfortable with what's there. The question obviously will be the timing on when the cash flows get to a point where we would see them as not criticized any longer. We are seeing improvements in occupancy rates in the hotel portfolio across the board. We're not quite back to pre-pandemic levels there, mainly because business travel hasn't resumed.
We're seeing good performance in leisure travel, but not as strong yet in business. As those vacancy rates come down, and revenue per available night or per available room comes up, we'll see those assets go from criticized back into performing, and then that will support further reductions in the allowance.
Got it. Thank you.
Your next question comes from the line of Ken Zerbe with Morgan Stanley.
All right. Thanks. Good morning.
Morning, Ken.
Actually, would love to stay on the whole reserve topic for just a second more.
Okay.
Obviously, the amount of reserves that you released this quarter is very small, certainly relative to what we've seen at a number of other banks. I know you can't necessarily comment on how you differ from other banks, but I am kind of curious any color you have on what assumptions that you're making that might explain the differences in your limited reserve release versus everyone else. Or maybe it's not assumptions at all. It really is this big criticized portfolio that you're talking about. Any color would be helpful. Thank you.
Sure. No, happy to go into some of the details there. I guess a couple of broad thoughts to start. The CECL methodology is a lot more penal on consumer books than on commercial books because they tend to be longer dated, and our institution, as you are aware, skews more commercial. That's one. It also has a big impact on credit card portfolios. Credit card at M&T is not a huge part of our book of business. When you look at some of what was being done last year in reserving, what you saw was much larger additions to allowance than you would've seen at M&T because of those mix differences. Now when we're going in the other direction, the releases are also higher for those same reasons.
When you look inside our portfolio and just to give you a little flavor on the allowance, it's obviously a collection of these different asset classes and the loss expectations in those assets. If you think about C&I, the C&I provision, there was a little bit of a release or recapture because there was a decrease in the loans outstanding because of the auto floor plan. Right? That was as much a function of a decrease in assets as it was the loss rate on the assets. Within the real estate portfolio, we continue to have a loss assumption that's pretty much unchanged, and there was a slight uptick there because of the size of the criticized portfolio.
If you look in the mortgage book, it was a decrease, again, because of the reduction in the assets as well as the continued great performance of home prices which affect the model and the loss expectations. There was a decrease there. In the other consumer portfolios, it was actually an increase because of the growth in balances offset a little bit by strong used car prices, which brought the loss rate down a little bit. There's different pieces in each of the portfolios that will move the allowance either up or down. It could be because of economic factors, it could be because of the balance. Those are some of the dynamics that are happening underneath, and hopefully that helps give a little bit more color to what's happening with the allowance.
No, it does. That's perfect. Thank you. Just maybe a follow-up question. In terms of the securities portfolio-
Yeah
I certainly understand your rationale for not wanting to invest in very low yielding securities at this point. At what point might that change? Or, how low could the securities portfolio go before you feel like you need to invest at least something? Thanks.
Yep. Sure. Was waiting for this conversation. I got to listen to René last time on the same subject. When you look at where we sit today, I'll talk about the securities portfolio, but also just some of the other parts of the bank. We just talked about the reserve and where the reserve sits relative to CECL day one. When we look at our underwriting and our losses, our expectations, to me, we are adequately reserved, if not maybe a little bit more, and that's future potential. Look at our capital ratios at 10.7%. We're probably going to print near the high of the peers in terms of that ratio, and we'll hold onto that until we do the merger. That's untapped potential, and I see the securities portfolio the same way. We've been allowing that to run off.
I think what you'll start to see is we start to think about maintaining it where it is and then look as we prepare to merge with People's. What's on our mind as we think about how and when to deploy that excess cash, it's a combination of just replacing some of the cash with securities in our own book, but what the combined balance sheet's going to look like. People's will bring a higher percentage of securities than cash, which will balance us out a little bit. They'll also bring a bigger on-balance sheet consumer mortgage portfolio as a percentage of their assets. They've tended to be an originate and hold shop where we've been an originate and sell. The combination of those two factors when we combine the portfolios, will start to bring down some of our asset sensitivity.
Based on that combined portfolio, we'll start to think about how we want to deploy that cash into what types of securities and what type of duration we might want to add. It could be through the securities portfolio itself with mortgage backs. It could be just retaining mortgages and getting the same exposure, but having it on the balance sheet in an HTM as opposed to an AFS type of portfolio. Those are the things that we're looking at, and we'll look to do other things we can to optimize the cash. Looking to reduce borrowings. We'll continue to reduce time deposits, which we'll get some additional ones with People's.
I think as we look forward, our belief is that the deposits are probably going to stick around a little bit longer than we might have anticipated, which is affecting our thinking about deploying and the duration that we want to assume and what percentage of the cash we want to put to work. I think we're probably at a point where we start to see that securities portfolio level off, and we'll be selective about jumping in, but we'll probably keep it roughly where it is.
All right, great. Thank you.
Your next question comes from the line of John Pancari with Evercore ISI.
Good morning.
Hey, John.
Just a question on the margin front. Wanted to see if you can baked into your net interest income expectation for a low single-digit decline in 2021, how should we think about the margin trajectory underlying that going forward from here? Obviously, on an underlying basis, clearly the People's deal would impact that, but wanted to see if you could elaborate a little bit on the standalone margin expectation. Thanks.
Yeah. It's a tricky one, John. When I think about the net interest income, the reason I've been explicit, and we've been explicit about talking about that dollar number as opposed to the margin, is there's a lot of things that are going to bounce the margin around that don't affect the dollars. Right? First and foremost is cash. We're still in a place where each extra billion dollars of cash compresses the margin by two to three basis points. It actually adds a nominal amount to net interest income. The other thing that bounces the net interest margin around is just the pace of forgiveness on the PPP loans. When you look at the last four quarters, we've really seen the bulk of round one PPP loans forgiven.
When you accelerate that origination fee, obviously that affects the net interest income and the margin but isn't necessarily repeatable. When we think about the full-year guide for net interest income down low single digit, factored in there is the earning assets, which we've talked about where we think those will be. If you go underneath and look at the actual loan spreads and deposit costs, those are pretty stable. That portfolio is producing a pretty stable stream of net interest income. The movements are generally caused, certainly in the NIM by cash, by the pace of PPP, and then ultimately the hedge portfolio that we've talked about I think for several quarters now that it's out there. The notional amount outstanding hasn't changed. It's still around $17.5 billion. The effective yield is coming down each quarter.
That will put a little bit of pressure on the net interest margin and ultimately net interest income. As I at least look through the next couple of quarters on a standalone basis, I think net interest income is roughly around where it was this quarter.
Great. Thanks. That's helpful. Before I ask my second question, I have to acknowledge the Marv Levy quote.
I appreciate that.
Even though I'm not-
He's one of our favorites.
Not a Bills fan, got to acknowledge it. Just separately on the loan growth outlook for the relatively flat expectation for the year. Can you just talk about when you see an inflection in balances as we look over the next couple of quarters? Is an inflection in the near term? Can you see an inflection in the back half as consumer offsets the continued declines in C&I and CRE?
I think you'll start to see it. It's going to be nuanced and it's not going to be obvious. The reason it's going to be that way is there's two portfolios that we have that are going to cause a top-line decrease in loans. First and foremost is PPP, which is well documented, right? We know we've got now $4.3 billion at the end of the quarter that's going to run off. Will depend on the pace of forgiveness, there's reason to believe that will happen in the next three or four quarters. There's also the Ginnie Mae buyouts that we've added onto the balance sheet to use up some of that excess liquidity because we like the duration and the yield on that.
As the economy continues to improve, it's our expectation that those will become re-performing, they will get packaged and sold back as securities, that will bring down those mortgage balances, obviously, will drive some fee income. When you look underneath the portfolio, back to some of the trends that we had talked about, ex floor plan, C&I was actually up modestly, we did see a very slight uptick in utilization rates of C&I lines in the quarter. We will see production come back in the auto sector, we'll see some of those floor plan balances growing again. Just for context, our current line utilization in the auto floor plan space is about half of its long-term average. That by itself is worth a couple billion dollars. We'll see that start to come back.
We think it'll be really first quarter of next year. When you look in the real estate space, not surprisingly, there's not a lot of activity going on. Usually what drives some of the CRE growth and declines is just activity and assets changing hands. When that happens, it's both a positive and a negative. We see payoffs because some of our clients sell. We also gain assets when construction projects come online or come due and/or when our clients are out looking at assets and growing their portfolios. Right now, that's pretty subdued and expect that the CRE balances will be kind of flattish, maybe slightly down as we work our way through. The big growth is in the consumer portfolio. When I say big, that sounds more grandiose than it is.
It's consistent growth in the auto floor plan or auto indirect as well as RecFi and auto and RecFi, sorry. It's there. I like the trends that we see. The spreads are still holding up. The returns in the business we're booking are solid. We don't feel a need to chase it, but to be there to support our clients with what their activities are. It'll largely reflect the economy.
Got it. All right. Thanks. Very helpful.
Thanks, John, and thanks for the Marv Levy reference. We got room on the bandwagon for more Bills fans, okay?
Sure thing.
Your next question is from the line of Ken Usdin with Jefferies.
Thanks. Hey, good morning.
Morning, Ken.
Darren, wanted to follow up and ask to a point about the eventual re-securitizations on the Ginnie Mae's. I was wondering if you could just help us understand how big is that book in the loan book now, and if your fee guide for down low single digit contemplates getting some of that re-securitization income back into fees this year?
As we look at the Ginnie Mae portfolio, it's call it $3.5 billion to $4 billion that will ultimately get re-securitized and sold. The pace is a little bit unknown right now as the foreclosure moratoriums keep getting extended, that gets pushed out. When we gave the original guide about fee growth and low single digits, that contemplated some degree of gain on sale coming from that portfolio. That's been pushed out a little bit. One of the things that happens on the other side, though, is as long as those assets sit on our balance sheet, we're accruing interest income. That's helping with the net interest income.
When we look at the potential gain on sale, it will move the percentage growth in fee income maybe a percentage point, and it would be towards the fourth quarter of the year, not likely much before then, just given what we're seeing and the time it takes to get those securities considered re-performing and available for sale. It'll be back-end loaded and start to spill into 2022.
Yes, understood. Just a follow-up question, it's great to see the trust business continuing to rebound up another 4%. I'm just wondering, can you just talk through just some of the underlying growth drivers in trust? Do you have what the fee waivers were this quarter, and if you expect that those would have peaked and maybe we get a little bit of help back on those going forward given the IOER changes? Thank you.
Yep. Let me make sure I got all these. Start with trust, I'll talk about the waivers. We're really pleased with how things are progressing in the trust business. There's really two main drivers of the trust fee income in the last few quarters. Our wealth team has really done a great job with leveraging the changes that they made to their platform to be out and growing new customers which is very encouraging. For the existing customers plus the new ones, everybody's benefiting from the capital markets and the growth there. Another piece of our trust business is we manage assets on behalf of retirement plans. As we manage those assets It's a great business because each month, employees contribute more to their plan. We're signing up new employers, and the market's been growing.
The combination of those three things is driving growth in assets under management, which is leading to top line. Keep in mind, this is where I say we're seeing expense growth, that in many cases we're a fiduciary of those. We're not the underlying asset manager. There's a sub-adviser fee that doesn't get netted against the trust fee income. It's in the other expense line. As we grow those assets under management, we like the returns in that business, and we like the profit it adds, but it does cause expenses to go up at the same time. That's why when I say there's expense growth related to fee growth, that's one of the big drivers.
When we look at the waivers in the funds, it's in the neighborhood of, call it at the high end, $15 million a quarter, is where we are today. What it will take to get back in there, I think we need Fed funds up to probably closer to 50 basis points before you see that start to materialize, as opposed to the first 25. This would be another one of these things. When I look forward and I think about what the potential is for the bank, in addition to the things we talked about with cash and capital in the provision, obviously the waivers is another one that can turn around. Lots of latent potential. We just need to unlock it.
Yep, got it. Thank you, Darren.
Your next question is from Bill Carcache with Wolfe Research.
Good morning. Good to have you back, Darren.
Thanks, Bill. Nice to be back.
As PPP balances wind down, is there an opportunity to grow your small business lending into other markets outside of your traditional footprint, perhaps by partnering with other financial technology players or doing a bolt-on type deal like we've seen from others? The question is, I guess, just any color that you can give on the extent to which you've considered these kinds of moves across any of your business lines.
Sure. Great question. Small business is one of the cornerstones of M&T and who we've been for years in the communities that we serve. I think the number one opportunity that sits in front of us is Peoples. We mentioned it on the announcement of the deal. The more we get to know our new colleagues at Peoples and the geographies, we continue to be excited about the upside there, and that bringing our brand of small business banking to that franchise is really exciting. We have been watching with great interest what's been happening with nationwide small business lending. I have the benefit of, I used to actually run that division in a prior career here at M&T, and we've seen people come in and out of that business a lot.
One of the things that always excited me in that business was when people announced they were getting in because it's tough. One of the things that's really important to remember about small business is that small business loans are okay business. The real value is in the deposits. The small business franchise is actually self-funding. One of the tricks, and when you talk about nationwide small business lending, what we're watching is not the ability to give out money because that's easy, but the ability to make sure that you risk rate it, that you take care of fraud, which we saw some fraud in some of the PPP situations. Ultimately, your ability to win the whole relationship. If you think about M&T and our approach to banking, it's always been full relationship banking.
One of the keys is having, we've always talked about the operating account of our customers, whether it's consumers, whether it's small business or middle-market companies. That's a little bit of a tougher proposition on a nationwide and remote basis, but it's something that we watch. Fortunately, we had a very strong PPP showing, and we were able to win some new relationships in our footprint. For now, I think we'll focus primarily on capturing the upside that we see in the new markets that come with the People's combination.
Understood. Thanks for taking my question.
Eric, are we moving to the next question?
Your next question comes from the line of Gerard Cassidy with RBC.
Hi, Darren. Welcome back into the seat.
Morning, Gerard. Thanks.
I thought for a minute they just dropped me off with that long delay, but I'm glad you picked up. Couple questions for you. We all, and you referenced it in your prepared remarks about floorplan lending and what's going on in the auto industry and the supply issues and other industries as well. The question is this: autos in particular, there are some stories that have been written recently that maybe the auto dealers may follow what they're doing today into the future, meaning keeping a lower inventory and having higher margins. Maybe they sell fewer units, but the margins are higher. That may be a way to go. Are you hearing anything like that from your guys on the front line who deal with the auto dealers that the normal inventory levels and the normal floorplan lending will come back, or maybe it will not come back?
Gerard, it's a great question. It's one that comes up often. It tends to come up a little bit more in other business circles than with the dealers. Obviously, they love the situation that we're in right now because of how quickly the cars are moving off the lot. The thing that you got to keep in mind, especially as it relates to the auto business, is a lot of the production is pushed by the manufacturer. While we do a lot of floor plan with the dealers, generally the new car production is floored by the manufacturer. The manufacturer will actually have incentives and will buy back cars that don't sell. There's what's on the dealer's lot and what they'd like to do, then there's what the manufacturing industry or part of the value chain wants to do.
I think the last SAAR, if my memory is correct, printed around $15 million. It averaged about $17 million pre-pandemic. That's a lot of production that's not there right now. One of the other elements of the production that happens is it goes from the manufacturer to the dealer. Some of the unused inventory ends up in rental agencies. Obviously that was an industry that early on was hit pretty hard by the pandemic, but seems to be coming back. At least if any of you have tried to rent a car lately, you'll find, one, it's difficult, two, it's really expensive. I think as some of that production comes back, you'll see it move its way through the lots and back into the rental car company. Probably more insight or information than you wanted in the response.
I don't think it will stay this way because I think there are other forces at play that are unique to auto. It's different world in RecFi, where the manufacturers don't have that same power. The dealers themselves have more control over inventory on the lots. Obviously that sector has been through a big change through the pandemic as well. I think we will see a rebound in auto floor plan lines. Will they get a usage, I should say. Will they get all the way back to where they were? I guess that remains to be seen, but it'll be a function, I think, of the ability of the manufacturers to ramp up production.
Very good. I appreciate the insights. Coming back to your comments about your average balance sheet. You talked about deposits at the Fed, your securities, et cetera. I don't know if you're able to do this, when you look at your spread, I think in this quarter was 2.71%, your margin was of course 2.77%. You look at the different categories of asset yields, how far away is the current market, your incremental loan that you make or the incremental security that you purchase to the actual averages that you're showing in the third quarter? Is it a 10, 20, 30 basis point difference on the incremental new asset production versus what your averages are showing?
When I look at roll-on and roll-off margins, what we've seen for probably the last six to nine months is roll-on margins have been better than roll-off margins. That bodes well for the portfolio over the long run. What we've also been seeing in the last few quarters is the spread or call it abnormal spread, I don't know, is coming back closer to what it was pre-pandemic. You'll see over time the spread, which is really the piece that matters the most to us coming back to pre-pandemic levels, but hopefully not below. In the last little while, what we've seen is roll-on better than roll-off.
I'm cautioning a little bit because when I think about the press release and I think about the page in the press release that talks about yield, and particularly on C&I, there's a lot of movement in there right now because that's where all the PPP fees are rolling in and out of, that's why we're getting some wild swings in margin there. When we look at the CRE yield, that's where some of the hedge would be. When you take all that stuff away and just look at what's actually in the portfolio, the spreads over the last year have been a little bit better than what they were going into the pandemic. They're trending back there. I would think that over time, our long-term average yield or spread would be similar to what it was pre-pandemic.
As we start to deploy some of that cash, hopefully into things other than securities but into supporting customers that we continue to see a net interest margin that in the long run prints in the top quartile of the peers as has been our history.
Very good. Appreciate it. Again, welcome back.
Thanks, Gerard.
Your next question is from the line of Mike Mayo with Wells Fargo.
Good afternoon. My questions are tech related. What's your outlook for your tech budget over the next, say, three to five years? In the past you said tech cost is around low double digits of revenues, but given the challenging rate environment and pending People's, still I'm just wondering what you think it will be post-merger. What are the incremental investments in light of the comments you had for the second quarter? As a follow-up, I'll just give that now. What's the mix of this budget in terms of run versus change the bank? Before the pandemic, we kind of estimated it was around 60/40 as you focused on reducing customer friction and improving processes. Thanks.
All right. Let me make sure I got all. I'm trying to keep up with you, Mike, on the list here. Tech budget things that we're focused on and spending and kind of mix of build the bank versus run the bank. Did I miss anything there?
Correct. That's pretty much it. Thanks.
Okay. I guess I'll just start with what we saw in quarter-over-quarter. When you look in that software and data processing line, there's two elements there. One is contracts that we have where we pay a fee based on volume. As some of the data processing volumes increase, so will that fee, and that's one of the drivers. The other one in there is software licenses. What we tend to find is the first quarter is a little bit light on that, and it tends to catch up as the year goes on. Some of the licenses will grow as we prepare for People's, because we'll be buying additional licenses for the People's employees, whether it's for commercial loan RMs, whether it's for the branches or staff employees.
You might see that a little bit in advance of the merger, and those would not be considered one-time expenses, but they would've been contemplated in our due diligence. You'll see some of that. The other thing that happens is as you shift more of your technology into a ASP or cloud-based environment, that you pay more in kind of monthly or quarterly fees versus the upfront investment cost. It's a little bit of a shift. That impacts the growth of the overall tech budget, right? That you'll have a higher tech budget if you're kind of building your own software versus buying off the shelf. The difference is it costs you a little bit less upfront, you've got the tail of the ongoing software licensing costs.
When we look at our tech budget and how it's grown over the last several years, it's been high single-digit compound annual growth rates. When you look over the last five years, there's times when it moves up and we invest a little bit more, and times when it levels off. I think that's a pretty good estimate of where we've been and likely where we're going. The focus is across build the bank and run the bank. It's 60/40. I think that's a good number and way to think about it. Whether it's 60/40 run versus 60/40 improve or build can shift in time.
Some of the things that you're investing in or we're investing in include data quality, data warehousing, cybersecurity, risk management things, which I guess are build the bank, but could be considered run the bank depending on how you qualify them. They're just part of being a larger institution. As we've noted, we're spending focus on things that improve the customer experience, whether it's been the mobile app, whether it's been improving the interactions that happen in the call center, whether it's providing better technology to the branch teams. We've made some big upgrades to our cash management system. We've made big upgrades to our loan origination systems to try and help the commercial RMs and make their lives easier. It's across those types of investments that you're seeing us spend our dollars. I think tech budgets are just part of banking.
They're going to be there. It's hard to separate technology from banking these days. That doesn't mean it's the only part of banking. As we'll reemphasize that we've always been a bank in our communities where our folks and the personal touch and relationship management matters, and the technology is there to complement that approach and to make our teams that much more effective with clients.
Thank you.
Your next question is from David Rochester with Compass Point.
Hey, good morning, guys, or now good afternoon, I guess. How you doing?
Yes, good afternoon.
Yeah. A quick one on capital. I know this may be a better question for the next earnings call. Just given what you're seeing today and your higher capital levels, do you think you'll be in a good position to get a lot more aggressive with the buyback once you close the deal? The capital ratios will still be pretty robust at that point, so just curious if you're looking to get more aggressive following the close.
Yeah, I guess more aggressive gives me a little bit of agita, but we certainly will continue to be active and prudent stewards of capital. My first hope is that we go back to the conversation we were having before about loan growth, and that we continue to grow customers and grow balances, and we use that capital to deploy for in the sake of our customers. That said, when you look at the things in front of us with hopefully deploying some of that cash and seeing some releases of provision and get the synergies, the cost savings out of the merger, we're going to be creating more capital, and that gives us a great opportunity to go and do buybacks. We'll go through and put the two banks together. We'll put our forecast of loan growth together and uses of that capital.
We'll consider the dividend and where that is within our capital governance. Then what we can't deploy effectively, we'll give it back to you guys. I think just based on where I sit and where our ratios are right now, it's safe to say that capital deployment will be in our future.
Would you say that the chances are better than not that you wrap up the buyback that you have out there by CCAR next year?
Well, since we announced the buyback in January and we got approval from the board but we didn't Use it because we announced the deal.
Right.
And so I-
Yeah
I don't think we could use that whole thing up before CCAR next year because we'll be submitting that in April of next year. Between the fourth quarter and the first quarter, to be able to use up that whole allotment would be pretty difficult.
Yeah, I'm just.
Go ahead.
I was just thinking through the first half of next year.
Even through the first half, that would start to get tough. Like I said, we'll be back to you guys with some more detailed thoughts on capital deployment as we get through legal day one and get the two banks put together, at least on paper, and we can get a look at the balance sheet and confirm the forecast. I think it's definitely safe to say, as I mentioned before, that a ramp-up in the rate of capital deployment compared to certainly the last few years is in front of us.
Sounds good. Maybe just one quick one on expenses. You guys addressed this a little bit earlier, but just trying to tie this back to the guidance you gave earlier this year for flat to less than up 1% expense growth for the year ex the deal. I know you factored in some fee growth into that guidance as well. Are you still thinking that that guidance works at this point ex the deal, or has the revenue performance been better than what you thought at that point?
I think there's a couple things. Some of the revenue performance has been a little bit better, it's more overall bank performance has been better. Right? When we were contemplating our accruals for incentives at the start of the year, we were expecting not as quick a rebound in the economy and maybe a little bit higher charge-offs than what we're actually experiencing. As we work through the year and we see better performance at the bank, we tend to set our accruals as a percentage of the bank's net income. As the net income's increasing, we're accruing a higher amount for incentives. If you go back to that original guide of flat to 1%, ex the People's and the other things, we're probably more going to run 1%-2% ex the People's deal.
Okay, great. One last one on deposits. I hear you loud and clear when you say you're expecting deposits to stick around for a while. I was just curious if you've seen any increased spending, whether it's amongst consumer customers or business customers, of deposits in recent months. Thanks.
It's interesting to see the deposits, where we are seeing people spending, but it's not showing up as a decrease in the balances. What's interesting is I'm starting to get back out again as we reopen the economy and lucky for Gerard's question, I had spent some time with some of our dealers. A couple of our other customers, and they had received PPP loans. I'm going somewhere with this because it was interesting to me that they had just gotten forgiven. I said, "Well, what are you going to do with the Do you have the money left?" They said, "We have every cent still." I said, "Why? You got that to pay for these expenses." They said, "We did that out of our normal cash flow. We just adjusted our operations.
We didn't want to spend the money until we actually had the loan forgiven in case we didn't get it forgiven." That gives you a little bit of an insight into some of the mindset of the type of customers that we have, one, but two, that those dollars are still sitting there and available to be spent. I think we'll start to see those move. We need to continue to see movement in the economy. From any of the customers that I spend time with and talk to, there's obviously some supply chain challenges in certain sectors. The biggest supply issue is talent and available workers.
I think that's the next thing to go, is to get more folks back on the employment rolls, and then we'll start to see some more of that spending and demand for the cash out of both the consumer and the business deposit accounts.
All right. Great. Appreciate all the color. Thanks.
Your next question is from Peter Winter with Wedbush Securities.
Great. Thanks. Hi, Darren. Welcome back.
Hey, Peter. Thank you.
Just two quick housekeeping questions. Last quarter, René mentioned that there was about $90 million in swap income. I was just wondering what it was on the second quarter and maybe the outlook for the second half of the year.
Yep. You said you had a couple. Is that your only question, or do you have another one?
Well, just the other on PPP.
Yeah.
How much is left in terms of amortized fees?
In swap income for the quarter, it was down about $14 million. As we had mentioned, I think a couple of calls ago that the total for the year was going to be closer to for 2021 close to what it was in 2020. Kind of peaking in the fourth quarter last year, first quarter this year, and then declining each quarter from there. Looks like we'll be down kind of round numbers, call it $10 million a quarter the rest of the way. This was a bigger quarter just because of the nature of some of the swaps that went on and off, but no change to that guide. When we look at PPP, we look at PPP round one the bulk of the origination fee has now gone through and been captured in the income statement and through net interest income.
PPP round 2 while the forgiveness portals are open, we haven't really recognized any forgiveness on those yet. The whole 2nd round of balances and the origination fees associated with them are still hanging out there. Round numbers, emphasize round maybe $100 million of income to come in. Hopefully, we'll start to see it next quarter. The good news with it is it either amortizes in every month or it accelerates, but you don't lose it. That's out there, and that's also factored into our guide about net interest income being down low single digits year-over-year.
Got it. Thanks, Darren.
Sure thing.
This does end our allotted time for question and answer. I'll turn the call back over to Donald MacLeod for closing remarks.
Thank you all for participating today. As always, if clarification of any of the items on the call or news release is necessary, please contact our investor relations department at 716-842-5138. Goodbye.
This concludes today's conference call. Thank you for participating. You may now disconnect.