M&T Bank Corporation (MTB) Q3 2022 Earnings Call Transcript

Operator

[Operator Instructions] We’ll take our first question from Ebrahim Poonawala from Bank of America.

Ebrahim Poonawala

I guess just some…

Operator

I think you’re on mute, sir.

Ebrahim Poonawala

Thank you. Good morning.

A – Darren King

Good morning.

Ebrahim Poonawala

I guess maybe just, Darren, talk about NII a little bit. Obviously, I think third quarter was a little shy of expectations, fourth quarter seems in line. As we think about the outlook from 4Q onwards, how do you see NII growing from there into 2023, given your outlook on the balance sheet, should we expect a steady lift higher given tailwind from rates and your view — any question around.

A – Darren King

Sure. Let me kind of take those in sequence for — and I’ll go in reverse order. So for 2023, we’ll come back in January with the full outlook. But obviously, where we expect to end the year at about $1.9 billion, we think is a good jumping-off point for thinking about 2023. When we look at the third quarter and where we ended up versus where we might have anticipated, the difference is really in the cash balances. And as we’ve been looking forward for 2022, we’ve been talking about deploying that excess cash and managing down some of the high-cost funding. And it was our objective to get to basically the level that we’re at, at the end of the third quarter, at the end of the fourth.

And so the reason why the fourth quarter expectation is broadly in line with where we were before is because that’s the cash level that we’re at. And before we would have expected a little bit more cash on the balance sheet in the third quarter. And what I would say is when we look at what’s been happening with our client base, and I think you see broadly across the industry is the third quarter was really a big inflection point for deposit movement in deposit betas. And that we saw a number of balances move into off-balance sheet or money market funds. And I think what we see going forward is, as we talked a little bit about Barclays that we start to see deposit betas move up a little bit. And so we’ll still get some benefit from the rising rates. It might not be what we’ve seen in the prior quarters but should still be positive. And then as we get into 2023 we’ll see where the outlook is. But part of what we’ve been working on is some of the balance sheet restructuring we’ve talked about to try and help protect those margins and lock them in. And you’ll probably start to see the growth in net interest margin slow down.

And so as we get into 2023, we’ll be looking at the combined balance sheet and the various businesses that we have in there. It feels like we’re getting to a point where for the balances that are tied to interest rates and fees that are tied to rates. Think about the two mortgage fee businesses as well as the mortgage warehouse lending business that we’re getting towards bottom and that they should be at that level going forward. And then we’ll continue to work on building our presence in the new geographies and taking advantage of our new organization. And so we’ll get back to — or not deposit loan growth levels that look more like our combined firms delivered pre-pandemic. But we’ll come back with more specifics for you in the first — in the January call.

Ebrahim Poonawala

Okay. Thank you and helpful.

Operator

Our next question comes from Betsy Graseck from Morgan Stanley.

Betsy Graseck

Hi, good morning.

Darren King

Good morning, Betsy.

Betsy Graseck

I wanted to understand how you’re thinking about just the capital levels. I know you have a significant amount of excess capital. But in this environment, do you anticipate leaning into loan growth?

And then maybe you could help us understand how you’re going to be funding that loan growth, or would you be looking to do the opposite. I know you gave us the buyback amount, but does it make more sense to buy back more? And grow loans less? Just a little bit of that dynamic and how you’re thinking about it would be helpful? Thanks.

Darren King

Yeah, sure. Happy to talk about that. The way we think about lending and always have at the bank is we’re — number one, we only can provide loans that are demanded by our customers. We can’t create loan demand for them. And so we’re always there for clients and our communities to support their investment needs.

And as we work through that, we’re always trying to find the right balance between making sure that we’re providing capital that our clients need with earning a return on the capital that our shareholders have entrusted to us. And so we always start with returns. We look at those returns not just at each individual loan level, but across the whole relationship. And that is the governor that dictates the pace, at which we grow the combination of what returns look like and what demand there is in the marketplace.

And so capital is really an outcome from thinking about it that way, meaning we will hold capital to be able to support clients and their growth, and that which we don’t need to support lending. We’ll look to return to the shareholder, typically through a combination of dividends and buybacks with a little bit of an emphasis on buybacks.

The only thing that I think is a change that we’ve started to see this quarter that will all, I think, be cognizant of is the macroeconomic forecast got a little worse, which means the provision is up, but provision is capital by another name. And so we’ll be thinking about the combination of what’s sitting in the allowance and what our capital ratios are to make sure that we feel like the bank is well protected. But we’re here to support growth in our communities, and anxious to be that provider of capital. And so, over a long period of time, it’s kind of what happens with real GDP growth in the communities is generally the growth rate that you see. And so, that’s kind of how we think about it and the trade-offs that we try to make, and we’ll be back, as I said, with a little more color in January with how we feel about 2023.

Betsy Graseck

Right. That makes sense to hear how you’re thinking about it. I’m just also wondering in this higher rate environment, higher inflation environment, does that tilt at all the decisioning? And part of the question comes from how we’re fund, how you’re thinking of funding the loan growth. It’s obviously not just through capital, but also through either deposits or wholesale funds, et cetera. So, does that change the dynamic at all? Thanks.

Darren King

No. We kind of — we try to think about both sides of the balance sheet on a match-funded basis. So we think about deposits on kind of what we could sell the math, so to speak, on a match-funded basis and lending on the same — from the same perspective. When we look forward, one of the things that I think you’re seeing in the industry, and you’ll see with us as it relates to liquidity is starting to put in some longer-term funding on the balance sheet from a liquidity perspective. And so, we’ve talked about the balance sheet we had going back for the last probably three or four quarters, that we have way more cash than we think is efficient, and we’ve been working to put that to work and keep the deposit cost relatively low, which I think has been the case.

And then as we go forward, as we continue building out the balance sheet, we’ll have a different mix of cash and securities. But part of the funding will definitely be some wholesale funding in there. You could see this past quarter, we did $500 million at the holding company, and that was to replace some holding company financing that came with the Peoples merger. And then from a liquidity perspective, we’ll look to add some other wholesale funding into the balance sheet over the course of the fourth quarter and into 2023 in all likelihood.

Betsy Graseck

Got it. Thank you.

Operator

Your next question comes from Ken Usdin from Jefferies.

Ken Usdin

Thanks. Good morning. Darren, just a follow-up on the deposit side. You mentioned that we’re just kind of starting to see that change in beta. So I was just wondering, if you can just talk about — just update us on your thoughts around where betas go to incrementally from here? And also, any thoughts different in terms of where you expect them to go cumulatively over the cycle.

Darren King

Sure. I guess, as I mentioned, we’re expecting to see a little bit of a ramp up in deposit betas. We expect it to be led largely in the commercial space, as well as in the wealth and institutional space, meaning the trust demand deposits. Those tend to be the most price sensitive and start to become priced off of Fed funds. And so, we’ve seen some movement there.

As we look at what’s on balance sheet sweep, what’s off-balance sheet, I think we’ll see some more pressure on balance sheet sweep, as well as just commercial checking pricing, which will move up the total cost of interest-bearing deposits. We’re not seeing a huge pressure on consumer deposit accounts, either or now. We are starting to move a little bit and see some movement in the CD portfolio. And that you can see has been happening in the marketplace, again, not just for us but for others and so, we expect that the fourth quarter, we start to see an uptick, mainly in the interest-bearing space and checking driven by those categories that I talked about.

And we’re probably looking at deposit betas in the quarter that maybe are 50% to 100% up from where they were in the last quarter, which I think will remind you the that’s in the kind of the 10% range. And so, they’ll pop up to the 20% to 30% range, which is still really low on a cumulative basis through the cycle, right?

And we fundamentally believe that the deposit pricing will catch up as the Fed slows down and that we should expect cumulative betas through the cycle that look like the last rising rate environment. It might take a little while to get there. But as we had talked about at Barclays that we fundamentally believe that margins will not stay above 4% for a long period of time. They might get there for a few quarters but over time, obviously, the market is efficient, and those betas will catch up.

Ken Usdin

Great. And that was going to be my follow-up, Darren, is that prior point you had made at Barclays just about, your line of sight in terms of how long into next year that you think the margin can continue to go up based on what we see in the forward curve right now. Can it continue to rise throughout next year?

Darren King

I think you probably, I think there’s been a lot of talk that I’ve been reading the press about peak rates and peaks. I think you see a little bit more into next year. But I think it starts to peak in either the first or second quarter and come down a little bit.

But when you look at what the average is likely to be for 2023 versus 2022, it’s going to be up and it probably exits the year at a pretty solid level. But it will start to work its way down as we go through 2023 and into 2024. But compared to where we’ve been for the last few years and really since the great financial crisis, it’s nice to see some spread back in the business coming off of those zero Fed funds that we dealt with for so long.

Ken Usdin

Yes, absolutely. All right, thanks a lot, Darren.

Operator

The next question comes from Erika Najarian from UBS.

Erika Najarian

Hi, good morning.

Darren King

Good morning, Erika.

Erika Najarian

My first question is just going back to the dynamics of the third quarter net interest income, you mentioned a smaller balance sheet from some of the rebalancing in deposits, but also I think your commercial real estate yields are probably less – had a lower beta than investors were expecting.

Could you maybe talk a little bit about how your hedge book had impacted that loan beta in the third quarter? How we should expect that hedge book to impact the loan beta in the fourth quarter and how your hedging strategy, I believe there’s $10 billion in notional that set to expire at the end of first quarter. What’s sort of the strategy and replacement from there?

Darren King

Sure. So a bunch of things in there to unpack, when we look at the CRE loans in particular, we’ve talked a lot in the past that those loans are generally the ones where the cash flow hedges are applied.

The characteristics of those loans set them up best to get the right accounting treatment for the derivatives. And when you look at what has happened in the course of the year, we’ve started to rebuild the hedge book.

We started in the first and second quarter as we saw — excuse me some steepness in the curve. And so we started to put on some of those hedges, some spot and some forward starting. And what’s happened is, in the short-term, from when we put those original hedges on as rates moved up faster than what those curves at the time were implying.

And because the rates in the market moved up faster than what was in the forward curve when we put the hedges on, they’re actually negative right now. And so they’re impacting the margin on those commercial real estate loans in a negative way.

And if we just look kind of quarter-over-quarter, the impact of the hedges moved about $45 million, where the hedges were a positive in the second quarter, and they became a negative in the third. And given the pace of increase from the Fed, that negative probably continues into the fourth quarter as well.

Net-net, we’re happy that the rates are moving up faster, because so much of the portfolio is, is tied to those rates and not hedged. And eventually, the curve that we locked in when we put the hedges on, it will catch up to where the Fed is and the negative impact will start to go away. But that’s kind of really what’s going on there with those commercial real estate margins in the portfolio.

And if you look at the hedging and the hedges that are out there, we expect the notional amount that’s actually in place to decrease as we go into the first quarter. The fourth quarter will be down a little bit from around $21 billion to about $17 billion of notional. And that will step down to the $10 billion range through 2023.

That’s based on what we have today, as we’re watching what’s going on in the world with the Fed and the forward curves. We may well put on some additional spot and forward starting as we go through the fourth quarter and go through next year. But based on what’s on the books today, that’s kind of how things look.

Erika Najarian

Got it. My follow-up question is sort of a two-parter. Number one, just confirming the received fixed rate on the remaining book is about 1.3%. And the second question is, as a follow-up to Ken, there was a lot of debate in the marketplace in terms of what you meant about NIM peaking at four then going back down. So I wanted to sort of clarify that.

If I assume that earning assets are flat in the fourth quarter versus third quarter that will get me to a NIM of about four and 415 to get to $1.9 billion. And so if we think about, the forward curve, with the implication that the Fed stops, raising rates in February.

Are you saying to us that I think we all understand that if the Fed stops in February, then margin will peak in first quarter, second quarter and then go down. And in that case, do we have some NIM expansion in the first quarter? And then do we get back below four by year-end. I guess that’s what we’re trying to clarify do we get a three handle back in the NIM at some point in 2023?

Darren King

Right. So your thought process on the fourth quarter is pretty solid. That’s kind of in the range of where we expect things to be. And so when we look into next year, we expect that we’ll — given the is increases that are being anticipated right now in the fourth quarter and the fact that betas are moving, but they’re still not obviously 100%. We do expect to see, as you pointed out, some expansion into – into the fourth quarter and into early 2023.

And really, I think the question and the thing that we’ve been trying to point out is that unless you go back to earlier than 2000, when Fed funds stayed above 6% for a long period of time. We haven’t seen sustainably — margin sustainably above 4%. And so I guess part of what we’re trying to communicate is that we shouldn’t — we don’t expect that to be the case at M&T. And we’re not trying to set up the bank and our expense base and how we think about the bank and how we think about our capital levels assuming that 4% plus will live forever.

Will it turn? We believe it will. What’s the timing? It’s sometime, I think, and we think, in 2023, like I said, is it the second quarter, third quarter. I don’t know exactly where it goes. Some of that will depend on what the funding looks like at the bank, how quickly deposit betas move what have you. But it probably does start to reach its peak in 2023 and start to inch its way down. Does it go below four by the end of the year? It could but it’s going to move back in that direction over the long term, probably not until 2024 and beyond would be my guess.

Erika Najarian

Thank you.

Operator

Our next question comes from Bill Carcache from Wolfe Research.

Bill Carcache

Good morning. Darren, I wanted to ask if you could give us an update on your CRE exposure any concerns over potential downgrades across your different geographic regions? And any color you can give on conversations that you’re having with customers, particularly on the office side?

Darren King

Yes, sure. So in CRE in general, we’ve seen an improvement in our criticized, mainly driven by continued improvements in the hotel space as well as retail. When we look at retail, I think back in early 2020, the belief was that there would never be anyone shopping in a store, again, it would all be online. And lo and behold, here we are back to the similar mix of online and in-person sales.

And so as that has happened, rents have been paid on a steady basis. And so the cash flows for the landlords of retail customers have improved, and we’ve seen improvement in those – those real estate assets, similar experience in hotel. There has been a lot of capacity that’s come out of the system. But overall, hotel performance is very strong, and we continue to see improvements in that sector.

The places that we’ve got our eye on are twofold. One is in healthcare. And when we look at independent living and assisted living, those places are having some challenges with staffing. It’s obviously well documented the challenges in staffing in the industry in general and those in particular. And so in the short term, they’ve been doing in discussions with our clients there. They’re having to use agencies to help with some of the staffing. And so that’s increasing the cost in the short term, which is challenging their debt service coverage.

But we’re still looking at the portfolio, we feel really good about the LTVs. And so, so far, not seeing a lot in loss content. And we have seen some continuing increases in occupancy rates there. So I would describe it as stabilizing some positive trends and some that are a little concerning.

But overall, we’re feeling okay about that portfolio. And office is really the key place where, as you point out, folks are focused now. And we’re still watching to see what’s happening with return to office and the mix of kind of full-time remote — full time in the office and hybrid situations.

And so we are seeing leases being renegotiated, but not eliminated. There’s some a little bit of pricing pressure there. But when we look at our portfolio in particular, we see that much of our exposure really sits in 2024 and beyond. The percentage of our portfolio has lease expirations in 2022 and 2023 is really about 15% of the portfolio and 80% of the portfolio plus would have an expiration date on the leases 2024 plus.

And so we’re obviously actively engaged with those clients. to understand what’s going on and understand the likelihood of renewals, what the occupancy rates are, how stable the rents are per square foot and therefore, obviously, the debt service coverage and so their ability to cash flow.

But while we’ve seen some decrease in asset values in office, we haven’t seen them come down anywhere near where our current LTV sit. And so it’s a portfolio that we’ve got our eye on. I wouldn’t call it anything more than the normal lens you would expect where it’s where some of the challenge has shifted over time, and we’re actively engaged with the clients to make sure that we’re working with them to keep them in business.

Bill Carcache

That’s very helpful. And following up on the sequential increase in the reserve rate due to modestly less optimistic macro forecast. Can you give a little bit more color on how your baseline compares versus your other scenarios, how you’re weighting them and where you’d expect — or where we should expect the reserve rate to sort of settle your fund employment were to go to, say, the 5%, 5.5% range?

Darren King

So when we wait the scenarios, the baseline is the bulk of the weight. We consider a worse economic situation as well as a better one. And depending on where we are in the cycle, we kind of weight them differently. So if things are good, the likelihood that they get better, we would feel is less. And so we put a little bit more weight on the downside. The reverse would be true.

If you look at what happened this quarter and the change this quarter. There were two things that drove the $52-odd million addition. And about one-third of it was just because of the change in mix on our balance sheet and where the growth came from. We had a little bit more growth in the consumer portfolios. The consumer portfolios tend to be longer dated. And so with the CECL methodology, the amount that you put aside is more for longer-dated assets. And so, that drove about a-third of the increase. And then, the other two-thirds was really just a function of the changes in the macroeconomic assumptions.

And so, just to give you a sense, I don’t think it’s linear. But the biggest driver was an increase in the unemployment rate in our macroeconomic assumption from 3.6% to 4%. And so, 40 basis points added, call it, $50 million. I don’t think it’s linear. But if you did that math, you kind of go up by 2.5 times to get to 5%. So maybe you add another $200 million — or sorry, $150 million, if it goes that high, right?

And so, it also depends on what’s the mix of the portfolio, right? And so, there’s a bunch of factors to keep in mind. That’s one of the biggest drivers, but you’ve got GDP in there. You’ve got asset values both for mortgages, for consumers, as well as for commercial real estate. And so, there’s a number of things at play. But, obviously, the model is sensitive to changes in those factors and unemployment is one of the key ones.

Bill Carcache

Well, it’s a complex topic, but that’s very clear — very clear explanation. Thanks. Appreciate you taking my questions.

Operator

The next question comes from Gerard Cassidy from RBC Capital.

Gerard Cassidy

Hi, Darren.

Darren King

Good morning, Gerard. How are you?

Gerard Cassidy

Good. A couple of questions for you. First, coming back to your thinking on the net interest margin and you made reference to pre-2000 where the Fed funds rate was 6% for an extended period of time, which kept the margin over 4%. Is the Fed chooses a terminal rate of 5%, let’s say, but stays there well into the middle of 2024, let’s say.

So they get there in the spring of 2023, they don’t touch it for 12 to 18 months. Can you give us your thoughts after the trickle down from maybe over 4%, does the margin then stabilize, I’m not going to put you on the spot and say 390, 370, but the thinking is what I’m more interested in.

Darren King

Sure. Well, I feel like you’re putting me on the spot, Gerard, but that’s okay, I’ve never shied away from being on the spot. So to have some margin it helps to have a higher Fed funds, right? Because so much of the asset book prices off of LIBOR, well, not anymore, so for MTB, which is very, very highly correlated to Fed funds. And so, once you’ve got a spread over the reference rate, really so from a loan perspective, what — how is competition and what’s the spread over the reference rate? And so that kind of affects the yield on the asset side.

And on the deposit side, it’s really two-fold. One is, what’s your loan-to-deposit ratio, right? And so there’s still a lot of liquidity in the system and loan-to-deposit ratios are low, which takes off a little bit of pressure on deposit pricing.

The other thing that’s happened a lot in the last few years, particularly in retail banking, there’s just been a change in how customer pricing works and the mix of fees versus spread. And so, what I think you see a little bit in the industry is, as fees have come down.

Think about maintenance fees, think about overdraft fees, think about other service fees that have come down and been competed away. I think that starts to put a little pressure on how fast and how high rates might go on — at least on the new accounts and savings accounts. I think time deposits are generally viewed as almost a discretionary asset in the industry.

Our view on it is we need to provide a great checking account experience that it’s all about transactions and convenience. And that core operating account, whether it’s a consumer, whether it’s a small business, whether it’s a commercial customer, that’s the core of your bank and your funding base, and then you make decisions about some of the other interest-sensitive products based on that.

And when you’ve got that core funding base, it gives you the ability to price those other rate-sensitive products a little bit differently. And we try to make sure that we’re giving a fair rate to our clients and manage the overall relationship profitability. But one of the definite benefits in the margin, in general, is what the mix of deposits is and that core funding base is a critical element and a big part of M&T.

And so, when you look across the industry, what’s a normalized industry margin, it’s going to matter a lot what your funding mix is and what percentage of core deposits funded. But, I guess coming back to the point that’s got a lot of attention, obviously, is that we’re just in a place where we haven’t been for a long time in terms of the margin and in terms of Fed funds.

And it seemed like, if the industry in general was getting a little euphoric that things were just going to keep going up and up, and that’s just not the case. We know that, especially folks like us or you, Gerard, have been around for a long time, the sage old veteran that, that doesn’t happen in competition as pressures the margins and things normalize.

Gerard Cassidy

Flattery will get everywhere with me. And then second, as a follow-up, Darren, can you give us an update on just how the People’s deal is moving along? And if you don’t mind, can you update us on just the trend line of the one-time charges and then cost savings.

And then as part of that cost, the one-time charges, I happened to receive in my mailbox last night since you guys new to this territory, an enticement to open up an account, they would pay me, I don’t know, $450, I guess it was. But, is that an ongoing marketing expense that you talked about, or is that part of your one-time charges?

Darren King

Sure. So Gerard, you’re a very special prospect. So, $450 we only get to our most important prospects.

Gerard Cassidy

Thank you.

Darren King

Yeah. Okay. You cut my sarcasm. So, a bunch of things in there. As we’re progressing along with the integration, obviously, we completed the system conversion over Labor Day and have spent September stabilizing things. And stabilizing when I say that, is really working through with all of the clients to make sure that they have access that they understand how the tools work and they’re able to perform the basic functions that they look for on a Tape Day basis.

And whenever you go through a massive change like this, there’s always some things where there’s some confusion. But overall, we feel really good about how things have gone. We convert nearly a million customers. And while there have been some hiccups, the complaints have been less than 1%. Even with that, we’re not happy until everyone has the access that they’re looking for. And we’ve been working with those clients on a one-on-one basis to solve their individual issues.

And so, from a one-time perspective, really, when we look at the marketing, we would think of marketing expense as a one-time pretty much in the month of the conversion. And then beyond that, we would think about it as operating expense. And so when you look at those cash bonus incentives, those become part of marketing expense on an ongoing basis.

And when we talked about what we’ll do in the fourth quarter, obviously, we’ll ramp up a little bit what we’re spending on marketing, including some of those promos to introduce ourselves to those folks like you who don’t know us as well in the markets and then to our existing clients to hopefully reconfirm their purchase decision to stay with us and as well to entice them to think about other products that M&T can provide because we think our product set is very competitive as well as our pricing. And so you’ll see some of that.

And then the other thing was just be some lingering effects of stabilizing the systems or completing some of the conversions. I shouldn’t say stabilize in the systems. The systems are fine. They’ve actually worked completely exactly as expected. It’s more stabilizing the expectations of folks and doing some little cleanup that will linger into the fourth quarter.

But when you look, what you’ll start to see is you will see the impact of the acquisition and the salary and benefit line. And so we always have some dislocations at the time we closed the deal. And then we have dislocation starting after the system conversion. And those are typically the conversion date plus 30 days, 60, or 90. And so those folks, there’s no change in those decisions.

In fact, if there’s any change, some people have elected to stay when they were originally going to be where we’re going to separate. But overall, the expectation of decline is in line with what we thought it would be and that will start to show up in the salary and benefit line in the fourth quarter.

Gerard Cassidy

Great. Thank you so much.

Darren King

Thanks Gerard. We look forward to you being a customer.

Gerard Cassidy

Okay.

Operator

We have reached our allotted time. I will now turn the call back over to Brian Klock for closing remarks.

End of Q&A