M&T Bank Corp (MTB) 2006 Q3 法說會逐字稿

At this time I would like to welcome everyone to the M&T Bank third quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] Thank you. It is now my pleasure to turn the floor over to your host, Mr. Don MacLeod, Director of IR.

Thank you and good morning, everyone. This is Don MacLeod. I would like to thank everyone for participating in M&T's third quarter 2006 earnings conference call, both by telephone and through the webcast. If you have not read our earnings release, you may access it along with the financial tables from our website, www.M&Tbank.com and by clicking on the Investor Relations link. Also, before we start, I would like to mention that comments made during this call may contain forward-looking statements relating to the banking industry and to M&T Bank Corporation. M&T encourages participants to refer to our SEC filings found on Forms 8-K, 10-Q, and 10-K for a complete discussion of forward-looking statements. Now I would like to introduce our Chief Financial Officer, Rene Jones.

Thank you, Don. Good morning, everyone. Before I take questions, I would like to review a few of the financial highlights. Diluted earnings per share which reflect the amortization of core deposit and other intangible assets, as well as merger related costs were $1.85 in the third quarter of 2006, up 13% from the $1.64 reported in the third quarter of 2005. This compares to diluted earnings per share of $1.87 reported in the link quarter.

M&T's results reflect the impact of last quarter's acquisition of 21 branches in Buffalo and Rochester, including the impact of the amortization of core deposit intangible and acquisition-related expenses resulting from the transaction, diluted earnings per share were reduced by $0.04. Diluted net operating earnings per share, which exclude the amortization of core deposits and other intangible assets, as well as the merger-related costs I mentioned a moment ago were $1.96, up 14% from the $1.72 in the third quarter of 2005 and up slightly from the $1.95 in the linked quarter.

This morning's press release contains a tabular reconciliation of GAAP and non-GAAP results including tangible assets and equity. Net income for the third quarter was $210 million, up 10% from a year earlier. This compares with $213 million earned in the sequential quarter. Net operating income, which excludes the amortization of core deposit and other intangible assets and merger-related expenses was $223 million, compared to $200 million in the third quarter of 2005 -- in the third quarter of 2005, and $222 million in the linked quarter.

As you saw in our earnings release, the results from the third quarter included several items of particular interest that I would like to point out. During the first quarter, a fixed rate advance from the Federal Home Loan Bank was called at par. As a result of the unamortized purchase accounting premium related to the advance, M&T realized a gain from that call. Second, M&T received tax refunds and interest from the Internal Revenue Service arising from the final settlement of all first tax returns dating prior to the acquisition. Also impacting the third quarter results was a tax deductible cash contribution to the M&T charitable foundation. Taken together, these three items tend to offset each other and had little or no impact on the bottom line in the third quarter.

That said, return on assets -- return on average assets was 1.49% compared to 1.39% in the third quarter of 2005 and 1.54% in the second quarter of 2006. Net operating return on average tangible assets was 1.67% compared with 1.54% in the third quarter of of 2005 and 1.69% in the sequential quarter. Return on average common equity was 13.72% compared with 12.97% in the same period of 2005 and 14.35% in the linked quarter. Net operating return on average tangible common equity was 30.22% compared with 27.67% in the third quarter of 2005 and 30.02% in the linked quarter.

As compared with the recent past, our net interest margin was relatively stable. The net interest margin in the third quarter was 3.68%, up 2 basis points from the linked quarter and down 8 basis points from the similar period in 2005. The branch acquisition added 3 basis points to the margin compared with the linked quarter, but that was offset by the impact from one additional day during the quarter. Average loans for the third quarter were 41.7 billion, up an annualized 7% from the linked quarter. Average loans grew an annualized 5% excluding the loans acquired in the branch transaction.

As in past quarter, growth in C&I loans and commercial real estate loans was partially offset by declines in consumer loans. The commercial loan pipeline remains strong at 1.4 billion as of September 30, as compared with 1.5 billion at the end of last quarter and 1.1 billion at the end of 2005. As a result of loan growth and a stable net interest margin, tax equivalent net interest income was $462 million for the third quarter, up $11 million from $451 million reported in the linked quarter and up slightly from the $460 million in last year's third quarter. On the deposit side, excluding the impact of the branch acquisition, non wholesale deposit balances were flat with the linked quarter, with time deposits up slightly and nonmaturity savings deposits down slightly.

Credit quality remained strong during the third quarter. Net charge-offs for the quarter were $17 million. This represents an annualized rate of 16 basis points of average loans and compares with net charge-offs of $10 million or 10 basis points in this year's second quarter and $22 million or 21 basis points in the third quarter of 2005. The provision for credit losses for the third quarter of 2006 was also $17 million and resulted in an allowance for credit losses of 646 million or 1.54% of total loans at the end of September. This compares with allowance levels of 1.55% at the end of June 2006 and 1.58% at September 30, 2005. Nonperforming loans totaled 180 million at the end of the recent quarter, up from 156 million at the end of the second quarter and up from 166 million at the end of September 2005. The increase is almost entirely related to a single automobile dealer relationship.

The nonperforming loan ratio was 43 basis points at the end of September compared with 38 basis points at the end of the second quarter. That ratio was 41 basis points at the end of September 2005. Loans past due 90 days but still accruing were 112 million at the end of the recent quarter, up from 101 million at the end of the second quarter of 2006 and down from 131 million at the end of September 2005. At September 30, 2006, this category included 76 million in loans that are guaranteed by government-related entities.

Turning to noninterest income, service charges on deposit accounts were 100 million in the third quarter, up 5 million from the third quarter of 2005 as well as the second quarter of 2006. This was driven by linked quarter increases in both the consumer and commercial segments. Mortgage banking revenues were 37 million, up 1 million from last year's third quarter, but as I suggested three months ago, down 5 million from the linked quarter. Origination volumes for the quarter and the mortgage pipeline at the end of the quarter were both slightly improved from the second quarter levels. Revenues were -- other revenues were $81 million compared with 66 million in the third quarter of last year and 70 million in the second quarter of this year. The gain on the redemption of the FHLB advance accounts accounts for substantially all of the linked quarter and the year-over-year improvement.

Operating expenses, which do not include amortization of intangible assets and costs related to the integration of the branches acquired at the end of the second quarter were 388 million, up 34 million from the third quarter of 2005 and up 26 million from the third quarter of 2006. The third quarter figures include the $18 million contribution to the M&T charitable foundation as well as a $5 million impairment charge for residential mortgage servicing rights. There were impairment recoveries of 6 million in last year's third quarter and 8 million in this year's second quarter. Excluding those items, operating expenses were up less than 2% on a year-over-year basis and were actually down $4 million from the linked quarter despite the additional expense of operating the branches we acquired. M&T's efficiency ratio in the third quarter was 52.8% compared with 50% in the third quarter of 2005 and 50.7% in the second quarter of 2006. During the quarter, M&T repurchased 762,000 shares of common stock at an average cost of $120.44 per share. There are still 2.3 million shares remaining on the repurchase authorization announced in November of 2005.

Before we turn to questions, I'd also note some of the highlights related to the first nine months of 2006, most of these were covered in detail in the earnings release. Diluted GAAP earnings per share were $5.49 for the first nine months of 2006, up 11% in the same period last year. GAAP basis net income was 626 million, up 8%. Diluted net operating earnings per share of $5.75 up 11% from 2005. Net operating income of 656 million up 9%. Average loans were up 5% to 41.1 billion. The net interest margin of 3.69% was down 10 basis points from last year. Net charge-offs for the first nine months were 43 million for an annualized 14 basis points of average loans compared with 54 million or 18 basis points for the same period last year. Noninterest income was 789 million up 13% from 2005. Operating expenses, which exclude intangible amortization of merger-related costs was 1.1 billion, up 4%. M&T's efficiency ratio for the first nine months of 2006 was 52% compared with 51.4% for the first nine months of 2005.

Finally, our day-to-day results for the first nine months of 2006 continue to be on track with the expectations that we laid out back in January. As I noted on our earnings press release, despite the less than desirable rate environment and modest loan growth, M&T posted strong results for the third quarter. Highlights for the quarter included integration of the 21 branches in upstate New York acquired at the end of last quarter, a stable net interest margin, strong credit quality and continued success at managing operating expense levels. Our margins stabilized in the third quarter and based on what the forward rates are telling us about the future interest rates, we expect that will likely continue over the next several quarters.

We're not seeing any signs that lending activity or credit quality will be significantly different from what we've seen. That said, our future performance as always remains subject to a number of future factors, including changes in interest rates, credit performance, spreads on assets and liabilities, asset valuations, and local and national business, and economic conditions. We'll now open up the call to questions, before which Elsa will briefly review the instructions.

[OPERATOR INSTRUCTIONS] Adam Barkstrom with Stifel Nicolaus.

Was wondering, you mentioned in your opening remarks, but can you give us a little more color on the deposit fees? That number, you said was both consumer and commercial, but up 5% linked quarter given the competitive pricing out there, the shifting away from DDA to CDs. I was just surprised to see that up so much.

It's a great question, Adam. One of the things that we've been seeing is that the consumer service charges have been really steady. There's obviously -- over, let's say over the past year, there's been an increase in the amounts per account, but we've also seen some growing accounts. So that helps a bit. What's really changed this quarter is that this is the first quarter, I think of the last four, where the commercial service charges have really turned around. So we saw a $1.2 million linked quarter increase in commercial service charges, which is like a 16% annualized growth rate.

I think a lot of that has to do with the fact that we're now seeing commercial clients take down those balances. And in part, what they seem to be doing is moving into sweep accounts. And for M&T that benefits us in two ways. One, we get new sweep income, but also as the balances come down on the deposit side, you've sort of got a natural hedge there, because earnings credits are lower and then they're paying more in terms of fees. So we've slowly each quarter seen a run down in the deposits per account on the commercial side, saw a little more this quarter, and you're really beginning to see the offset in the service charges.

You mean via the earnings credit on the commercial side?

Yes. Both in terms of the earnings credit, and then of course, as people move into sweeps, you're getting additional fee income from that product as well.

Right. But now -- I mean, on the consumer side, what's driving that? Because the DDA balances -- al in, that includes commercial and consumer ut were down linked quarter. I would imagine the consumer balances were relatively flat?

Yes. That's probably -- that's about right and we were -- if you look on a year-over-year basis, we were up almost 10% in our consumer service charges. We did a couple of things. If you remember, it was just about a year ago where we changed our approach on putting in tiered pricing for the fees and we've sort of tweaked a few other things along that same nature. But really, I think you're seeing the full-year benefit of those changes.

On the tax rate, you explained why that was affected for 3Q, is that going to be a 3Q only event?

Yes, it is. Somewhere I think I mentioned that. But, yes, it's a one-time event.

Okay. And then loan yields were up nicely, up a little over 20 basis points linked quarter. Somewhat surprised to see that with the runoff in the auto portfolio. Can you give us some color on the loan yields?

Yes. I'll talk about a couple of things. You started out with a bit of surprise because of the runoff in the consumer or auto book. But think about that indirect auto, we were booking loans two or three years ago at some 400 basis point margin. Some of those loans are sort of -- how do I say this? They are a 400 basis point margin, but they were at a very, very low rate environment. Those are rolling off from a yield perspective and that gives you lift. Despite the fact that indirect auto is rolling off, we could expect to continue to see a lift in the yield on that portfolio. The bulk of what we booked was booked in a low rate environment.

On the commercial side, you saw an increase in the yields on CRE, the way I would think about that product, is it's primarily a five-year repricing product, right? So now that we're a long ways through this increase over time, the loans that stay with us will have a slow, 20% of those will go up or reprice every year. So I would expect that in the coming months, quarters we'll continue to see a little bit of asset reprice going up there.

And if I could just -- last one. You mentioned in the press release the increase in nonperforming, the $26 million auto relationship. Can you give us some color there, where it is, anything in particular with that credit? Just more color there, if you would?

Yes. I guess the credit was in the state of Pennsylvania. We've talked about for some time that we're looking closer at our floor plan portfolio. I think one of the things that we've seen in some cases is with we call out of trust situations and out of trust situation is simply that as a note pays off on one of the autos, we're supposed to take those -- those funds are supposed to come back to M&T to pay off e note. In this case, we had an out of trust situation where that didn't happen. I think this is kind of consistent with the theme that we've talked about for a while in that we're watching that portfolio closely and I would expect from time to time you'll see one of these incidents come up. But it seems to be relatively isolated to one, two, three dealers. We'll continue to watch it, but we're not concerned at all.

What's the deal with this particular line. Is this a structuring problem? You say that the car sold, those funds are supposed to come back to pay off the particular note. I don't understand. Is it -- and was this an acquired loan or is this a legacy loan?

Well, much of the -- let me start off by saying much of our floor plan relationships that we have in Pennsylvania were acquired as we went into Keystone. Having said that, I would consider them M&T loans today because we've had that portfolio for some four or five years, right. And having said that, when you think about indirect auto loan, this is probably a normal process that something would be taken to nonperforming when you see an out of trust situation. Because you're reacting proactively, but at the end of the day, it's not as if you're going to immediately take this kind of situation to charge off, because you're affecting the viability of the dealership and your ability to actually collect on that loan. Right?

Right.

You'll see this from M&T. When we start to see any sort of out of trust situation we're going to look very hard at that loan and do it in a relatively fast manner, but there's nothing unusual here.

All right. Thank you, gentlemen.

Jennifer Thompson with Oppenheimer & Company.

Hi, good morning. Just a follow-up question on the auto dealer. What part of any of that loan was impacting net charge-offs this quarter? And if not, just general trends in the net charge-off ratio, is there anything you're seeing from credit quality perspective that's concerning you at this point?

None of the -- of that auto dealer was included in charge-offs for the quarter. And no, I think what you see with the 17 million or 16 basis points is we're sort of back at our normal level. I think as I mentioned last quarter, the aberration was the 10 basis points in the second quarter. But we're not seeing any signs of any problems out there.

Okay. The merger costs, could you remind us what they were last quarter and how much was included in this quarter's number?

They're $3 million year-to-date on an after-tax basis. And this quarter was 1 million. So last quarter was 2.

And what would -- is the -- what would be expected for the remainder of the year?

Maybe 1 to 2 million, but it should be relatively negligible.

Okay, great. And just the tax rate going forward, should we expect that to go back to the level we saw in the second quarter?

Yes, I think second quarter is a good benchmark.

Okay, great. Thanks very much.

Gary Paul a Private Investor.

Hi, Rene.

Hi, Gary, how are you?

Fine. I've been reading that somewhere around a third to a half of all one to four family residential mortgages over the past couple years are really low quality, things like no down payment, interest only, negative amort, et cetera. In either the mortgage portfolio or the mortgage-backed security portfolio or via guarantee or obligation to repurchase, does M&T have any of this low quality stuff?

Well I guess to paraphrase that, much of the concern that's out there in the industry early on started with ARM portfolios. And people are concerned about, as rates rise whether there's going to be credit concerns. ARM portfolios make up about 20% of the $7 billion or so that will originate over time. To put that in perspective, when we look at what the industry does, it's probably around 40 to 45% of the industry is ARM. And I think much of that, Gary, is driven by geography. So some large percentage of the ARMs and the interest-only type of product actually is originated out of California. And because we tend to be in geographies which have much lower price, I think that's the primary reason why we have much less of that.

The other thing is, as you probably know, we don't portfolio very much. I think last year about 80, 90%, 87% of our loans were sold, that we originated were sold. And of that, of the loans that we retained, only a real small percentage of what we would term as alt A, maybe say 15% of what we retained, and only about 2% are interest-only type securities. So on the whole, we think our exposure to that is very limited.

Thank you.

You're welcome.

Jason Goldberg with Lehman Brothers.

Thank you, good morning.

Good morning, Jason.

Rene, the last several quarters I clockworked your cost of interest bearing deposits going up 30 bips on average as the Fed raised 50. This quarter obviously the Fed didn't get the full quarters impact of last quarter's actions and you were up 20 bips there. As you look forward and assuming the Fed does nothing, what do you think that number would be? I know it's a bit of an abstract question.

Yes. The number, the specific number is hard. But I guess what I would expect to see is that on our interest-bearing liabilities and our core deposit costs, that will continue to rise slightly despite the fact that the Fed is not likely to increase rates anytime soon. And I think that's simply because we're sort of doing a bit of a catch-up and I would think about it in terms of the average spread of Fed funds to the average cost of our deposit.

Having said that, that will be smaller increases and I think it will be offset by the asset repricing that I talked about and I think it's also going to be somewhat offset by our securities book, which has a yield that's below Fed funds today. As that has been running down, that's actually given us some offset. I would expect deposit costs to continue to rise for the short-term period and then stabilize somewhere in 2007, if there are no big changes in the rate environment.

That's helpful. And then secondly, at what point would we expect this consumer runoff to cease? Or this is something we should kind of just continue to model going forward?

Well, I think aside from execution, one of the things that tends to drive the indirect auto business is rates and so one of the things I might watch is the two-year LIBOR rate. As that comes down, you tend to get some improvement and pickup in volume there, because it makes the overall -- getting overall returns more viable. That's what I would watch for.

All right. And then lastly, just with respect to the MSR valuation adjustment, is that something that you do at the end of the quarter or during the quarter? Assuming a stable environment, how should we think about that?

Yes. We definitely do it at the end of the quarter. In fact, I think what you would have seen is that if you were looking maybe the week before, the impairment amount would have been higher. But rates bounce back towards the last couple of days of the month. And in fact, I think now they're up another 10 basis points or so, so you'd be going -- you'd be doing a reversal now of 1 to $2 million. But it's at the end of the month.

Okay, that's helpful. Thank you.

[OPERATOR INSTRUCTIONS] Bob Hughes with KBW.

I have a follow-up question on indirect auto. We heard more recently from some that given the movement in short-term rates here that they have seen some better pricing in indirect auto. Has pricing or competition eased to the point where you're getting closer to being a little bit more active there, or how would you characterize the environment right now?

A couple of things. I think that if you look at a given month, we've probably seen the same thing in terms of a little bit higher volume and easier ability to get -- to book loans profitably when the rates have come down, two-year LIBOR rates have come down. Having said that, those rates as you guys know have been so volatile. It's nothing you can predict will happen, will continue to happen. We've been rather cautious in talking about that.

Unlike the last cycle which might have been four or five years ago, we haven't seen a lot of people exit the business. You have seen some people exit the subprime indirect auto space, but we're not in that space, so that doesn't help us at all. People seem to be hanging in there and I'd say there's probably no change in the competition.

Okay. And just one follow-up. Within the multi-family portfolio specifically, can you talk about what type of activity you might be seeing in terms of prepayments and what level of prepayment penalty income you might have booked this quarter?

Prepayments continue to be low. I think last quarter, they were 3.3 million prepayment penalties and we are at, I think -- we were at 3.6 last quarter and we're at 3.3 this quarter. So they're very low.

Very good. Thanks Rene.

Ken Usdin, with Banc of America.

Thanks, good morning, Rene.

Good morning.

A follow-up question on the investment portfolio. Obviously you let that roll a lot more this quarter, at least on the averages. Can you just talk about how you're viewing -- you mentioned that the average yield is now below that of Fed funds, but can you just walk us through how you're thinking about reinvestment of the portfolio at this point? Do you think you'll continue to just let it run down if we remain in the environment that we're in?

The short answer is, yes. If we remain in the environment we're in, we think that's probably the best approach. So really what we're doing, is as we run that down, we're basically using that to fund loan growth today. If you look back in January, I might have said that we could put on investment securities at, say, 50 basis points spread over LIBOR and so we were doing a modest amount. We probably could have done something around 30 basis points in the second quarter and we were putting on less. And now I would say that it's really hard to find anything even near 20 basis points of overall spread.

So unless that changes, it just doesn't seem to make sense to go out and park your money in the investment securities, because the return is not there. And again, that can change. If you look -- if you take the forward curves today and look out into the second half of 2007, that all changes. But right now, we think this is the best play.

Okay. And you're--.

Just if I could, Ken, I would also point out that the reason that we have that benefit accreting into our net interest margin is because we don't -- we have not done any restructuring. You've seen a lot of folks take a charge to equity and then they get a big jump in their margin because they're reinvesting in other securities out there. Our view is that we don't do that because it's sort of a zero sum game and then as you think about today, well, you're pretty much investing in some pretty low yields and pretty low yield returning securities at this point in time. So you mean benefits to the margin -- you mean future benefit, not necessarily what you're getting today? You just mean the eventual rollover and opportunities--?. Yes. Opportunities as that rollover accretes and we take over wholesale borrowings and the security rolls off, naturally we'll get a lift to our net interest margin.

Right. Rene, can you also just give us the typical breakouts of what the mortgage originations were and then also the by geography loan breakdown?

Yeah, I can do that. The -- our -- if you look at our applications, our applications were about 3.2 billion or up 5% from the second quarter and our closings were 1.5 billion, down from 1.6 billion in the second quarter. And then the other question was on loan?

Yes, the geographic breakdown of New York, Pennsylvania, Mid-Atlantic?

Yes. Hang on one second. I'll take you through that. I'm going to give you these numbers net of the impact of city. So what you had was -- I think I'm going to give them to you. We had about 4% growth in loans in upstate New York excluding the branch transaction. Our metro grew by 12% with a fair amount of growth there in the metro region on the C&I side. Pennsylvania was up an annualized 7% and the Mid-Atlantic was up 4% on an annualized basis.

Okay. And my last follow-up was just, on the Mid-Atlantic, that's kind of the second quarter of fairly low, even lower than some of the slower growth regions as far as the sequential. Can you just give us an update, is that mostly competitive, is that just a slowing nature of the marketplace?

We'll start off by saying the market remains competitive, but I don't think there's a big change in that and I think overall we're not really worried about that at all. We don't seem to be losing customers, but what can I say? I think we'd like it to be higher and I think over the long-term it will.

Okay, thanks a lot.

You're welcome.

At this time, I would like to turn the floor back over to management for any further or closing remarks.

Thank you. Again, I would like to thank everybody for participating today and as always, if a clarification of any items on the call or the news release is necessary please call our Investor Relations department at area code 716-842-5138. Thank you and good-bye.

Thank you, this does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.