M&T Bank Corp (MTB) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the M&T Bank second-quarter 2016 earnings call.

(Operator Instructions)

Thank you. I would now like to turn the conference over to Mr. Don MacLeod, Director of Investor Relations. Please go ahead, sir.

Thank you, Paula, and good morning.

I would like to thank everyone for participating in M&T's second-quarter 2016 earnings conference call, both by telephone and through the webcast. If you have not yet read the earnings release we issued this morning, you may access it, along with financial tables and schedules, from our website, www.MTB.com, and by clicking on the investor relations link.

Also before we start, I would like to mention that comments made during this call might contain forward-looking statements relating to the banking industry and to M&T Bank Corporation. M&T encourages participants to refer to our SEC filings, including those found on Forms 8-K, 10-K and 10-Q, for a complete discussion of forward-looking statements.

Now I would like to introduce our Chief Financial Officer, Darren King.

Thank you, Don, and good morning, everyone.

Since this is my first conference call as Chief Financial Officer, I will ask you to bear with me. Rene Jones most recently, and Mike Pinto before him, set a high bar for CFOs in general, and for M&T Bank in particular. I certainly have big shoes to fill.

Before I start, I would like to take a moment and thank Rene for the advice and guidance that he has provided to the Company and to me personally over the time that we have worked together, particularly during the last 90 days. I am looking forward to working with many of you as well over the coming months and years.

Let's get started. In the second quarter, we generated $1.3 billion of revenue, net income of $336 million, and diluted earnings per share of $1.98. Return on assets were 1.09%, and return on common equity was 8.38%. Looking at the second quarter results on a net operating basis, which excludes the after-tax effect of merger-related expenses and amortization of intangible assets, earnings per share equaled $2.07. Return on tangible assets was 1.18%, and return on tangible common equity was 12.68%.

Every measure noted above, both on a GAAP and net operating basis, improved from the first quarter. The efficiency ratio also improved to 55.1% in the second quarter, down from 57% in the first quarter and 58.2% in the year-ago quarter. We were able to deliver these results against the headwinds that we and our clients faced, including an uneven economic recovery and growth, persistent low interest rates and volatile financial markets.

There are many highlights from the second quarter that characterized the state of the Bank, and before we review the details, I would like to take a minute to review a few of the more noteworthy developments. Probably the biggest highlight of the quarter was receiving a non-objection from the Federal Reserve to our 2016 CCAR capital plan. While we learned our results in the second quarter, the non-objection was the favorable result of four months of hard work by many of our colleagues around the Bank, as well as the payback on the investments we have made over the past several years in our risk management governance, processes and technology. We know, however, that the CCAR bar keeps rising. And so this quarter, we will begin the preparations for CCAR 2017.

Another highlight of the second quarter is the continued growth of our loan portfolio. While on the surface, 3% annualized loan growth isn't particularly exciting, a look at the details reveals that lending to commercial customers increased at an annualized rate of 11% against a decline in the residential mortgage book of an annualized 16% -- largely the result of expected runoff in the Hudson City mortgage portfolio. This is a pretty typical pattern when you're converting a thrift to a commercial bank. Against this backdrop, credit quality, an M&T hallmark, remains strong.

In the second quarter, as noted on prior calls, we have been reinvesting a portion of the savings from the merger and the BSA/AML savings to position the Bank for the future. We launched a brand campaign in New Jersey to introduce ourselves to the new market. We reminded our legacy markets who we are in the face of changing competition, and we continued to invest in our technological infrastructure along several dimensions.

For instance, in foundational elements like data, in employee tools like teller cash recyclers, and in customer convenience and security that will be seen in the form of our upcoming new and improved MTB.com website and enhanced security at our ATMs through the upcoming deployment of the MB protocols. So while unique unto itself, this quarter reflects the continuous cycle of invest and harvest that has characterized M&T Bank for many years. Overall, we would describe it as a solid quarter.

Let's take a look at the details. Diluted GAAP earnings per common share were $1.98 for the second quarter of 2016, improved from $1.73 in the first quarter, and equal to last year's second quarter. Net income for the quarter was $336 million, up 13% from $299 million in the linked quarter, and up 17% from $287 million in the year-ago quarter. After-tax expense from the amortization of intangible assets was $7 million, or $0.04 per common share in the recent quarter, compared to $7 million and $0.05 per common share in the first quarter.

Also included in the second-quarter results were $13 million of pre-tax merger-related charges incurred in connection with the Hudson City acquisition. This equates to $8 million after-tax effect, or $0.05 per common share. Merger-related expenses in the first quarter totaled $23 million pre-tax. That amounted to $14 million after-tax effect, or $0.09 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 exclude the after-tax effect of amortization of intangible assets, as well as any expenses associated with mergers and acquisitions.

M&T's net operating income for the second quarter, which excludes intangible amortization and merger-related expenses, was $351 million, compared with $290 million in last year's second quarter, and $320 million in the linked quarter. Diluted net operating earnings per common share were $2.07 for the recent quarter, improved from $2.01 in the year-ago quarter, and that figure was $1.87 in this year's first quarter.

Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders equity of 1.18% and 12.68% for the recent quarter. The comparable returns were 1.09% and 11.62% in the first quarter of 2016. 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.

If we turn our attention to the balance sheet and income statement, taxable equivalent net interest income was $870 million in the second quarter of 2016, down $8 million from the linked quarter. The decline reflected the combination of a narrowing of the net interest market and a change in the mix of interest-earning assets.

Let's look at the specifics. Net interest margin declined to 3.13%, down 5 basis points from 3.18% in the linked quarter. What we consider to be core margin pressure accounted for about 3 basis points of the decline. That includes the impact of a slightly more costly mix of deposits, including the impact of the Hudson City time deposits, as well as growth and savings deposits associated with our mortgage servicing operations.

On the non-core side, interest-bearing deposits with banks, which primarily reflect cash on deposit at the New York Fed, averaged $8.7 billion during the second quarter, up by over $500 million from the prior quarter. That increase, the result of higher balances of trust deposits, decreased the margin by approximately 1 basis point. Average investment securities declined, reflecting normal principal amortization, as well as a step up in prepayments.

Those prepayments of higher-yielding securities and a limited amount of re-investment into lower-yielding LCR-compliant securities reduced the yield on the portfolio. We estimate these factors diminished the margin by an additional basis point. The cost of deposits reflects in part our decision, which we have previously discussed, to maintain pricing for customers in the Greater New York area whose accounts were formally held at Hudson City Savings Bank. We will offer more thoughts with respect to that pricing in a few moments.

Average loans increased by about 3% annualized over $572 million compared to the linked quarter. Looking at the loans by category, on an average basis compared with the linked quarter, commercial and industrial loans increased an annualized 14%. Commercial real estate loans increased by about 10% annualized. As noted earlier, those two categories combined grew an annualized 11%. Also as noted, residential mortgage loans declined at an annualized 15% rate. Consumer loans grew an annualized 5%, with growth and indirect loans, including auto loans, partly offset by a decline in home equity lines of credit.

Loan growth was consistent across most of our footprint, including upstate New York, Pennsylvania, Greater New York City and New Jersey. Growth in the mid-Atlantic region was a slightly softer. Average core customer deposits, which exclude deposits received at M&T's Cayman Islands office and CDs over $250,000, increased at an annualized 8% from the first quarter, reflecting the higher level of trust and savings deposits that I mentioned earlier.

Turning to noninterest income, noninterest income totaled $448 million in the second quarter, compared to $421 million in the prior quarter. Mortgage banking revenues were $89 million in the recent quarter, compared with $82 million in the linked quarter. Residential mortgage loans originated for sale were $858 million in the quarter, up some 30% compared with the first quarter, while the gain on sale margin was relatively stable. Our commercial mortgage banking operation had a strong quarter as well, with a slight increase in multifamily commercial mortgages originated for sale, combined with a favorable mix of higher-margin loans that prior quarter.

Trust fees improved to $120 million in the recent quarter, up from $111 million in the previous quarter. That increase reflects about $3 million of seasonal tax-preparation fees that usually occur in the second quarter, as well as fees from net new business, particularly on the institutional side. Service charges on deposit accounts and commercial loan fees also improved from the first quarter.

Turning to expenses, operating expenses for the second quarter, which exclude merger-related expenses and the amortization of intangible assets, were $726 million, improved from $741 million in the prior quarter. On that same operating basis, salary and benefits declined by $28 million from the seasonably high level in the first quarter. Partially offsetting that decline was a $16 million increase in other costs of operations, including higher professional services expenses. The operating efficiency ratio improved to 55.1% in the quarter, down from 57% in the first quarter and 58.2% in last year's second quarter.

Next, let's turn to credit. Our credit quality remains in line with our expectations, which is to say, strong, with continuing low levels of nonaccrual loans and net charge-offs. Nonaccrual loans declined to $849 million, and the ratio of nonaccrual loans to total loans was 0.96%, improved from 1% at the end of the first quarter.

Net charge-offs for the second quarter were $24 million, compared with $42 million in the first quarter. Recall that the first quarter's results included $14 million of charge-offs associated with consumer loan customers who are either deceased or filed bankruptcy, compared with just $5 million in the recent quarter. In addition, the results for the second quarter included a $7 million recovery on a previously charged-off commercial loan. Reflecting that recovery, annualized net charge-offs as a percentage of total loans were 11 basis points for the second quarter, while the comparable figure was 19 basis points in the previous quarter.

The provision for credit losses was $32 million in the recent quarter, exceeding net charge-offs by $8 million, reflecting overall loan growth, as well as the ongoing shift to a higher proportion of commercial loans as the Hudson City mortgage portfolio pays down. The allowance for credit losses was $970 million at the end of June. The ratio of the allowance to total loans was 1.10%, unchanged from the end of the first quarter. Loans 90 days past due on which we continue to accrue interest, excluding acquired loans that had been marked to fair value discount at acquisition, were $298 million at the end of the recent quarter. Of these loans, $270 million, or 91%, are guaranteed by government-related entities.

Turning to capital, M&T's Common Equity Tier 1 ratio under the current transitional Basil III capital rules was an estimated 11.01%, compared with 11.06% at the end of the first quarter, which reflects earnings retention, less $154 million of share repurchases during the second quarter, as well as net loan growth. I will offer our thoughts on our 2016 capital plan, which received no objection from the Federal Reserve, in a few moments.

Next, I would like to give you an update on several of the projects we have been working on. As previously announced, we completed the conversion of Hudson City during the first quarter, in which we converted them to our systems and operations, including loan and deposit accounting, mortgage servicing and other core applications. All the Hudson City facilities were rebranded to M&T at that time.

Speaking of branding, those of you who work and live in the Greater New York-New Jersey market have undoubtedly seen a step up in our advertising as part of this process. More recently, we have been working on the longer-term initiative of converting Hudson City from a thrift culture to M&T's commercial bank culture.

We are continuing to hire in the New Jersey market, including commercial lenders, business bankers and wealth advisors. We have hired some 49 customer-facing employees since the beginning of 2016. To complement our commercial hiring, we have begun an accelerated business banking training initiative for some 30 Hudson City branch managers, who are on a fast track to learn M&T's branch sales practices. Training also continues for other branch-based colleagues, increasing their familiarity with our entire suite of commercial bank products and services.

Our investments in technology include continuing to enhance our ability to capture and organize data for risk management and capital planning requirements, as well as for improving customer service. These investments paid a dividend in the form of our 2016 CCAR results. But as noted earlier, the bar rises every year, requiring continuous improvement in our risk management practices.

Beyond our data initiative, you should see some tangible results from our technology investments shortly, including a major update to our website within the next several weeks, and an updated mobile app that we anticipate rolling out later this year. We are also working on enhancing the tools we give to our employees to improve our interactions with customers, by simplifying the processes employees must follow to complete their work. These projects are still in the early stages.

Lastly, we have discussed in a general way the opportunities presented to us by the changing competitive environment occurring or about to occur in our footprint. We know from first-hand experience that change brings uncertainty. Whether it is with their personal banking or business banking, customers seek stability when considering their banking options. We are here to help customers in our communities, as we have been for over 160 years. To offer one example, using checking account acquisition as a proxy for new customer acquisition, year-over-year growth in Greater Buffalo is nearly 19%, almost twice as large as the average across the remainder of the footprint.

Now, let's turn to the outlook. As is our usual practice, without giving specific earnings guidance, we would like to offer our thoughts as to how we are tracking against the outlook for the full year that we gave you on the January call. While our outlook is mostly unchanged from the previous calls, one factor that has changed is the outlook for increases in the Fed funds rate. At the time of our January call, the forward rate curve was implying two actions by the Fed in calendar year 2016. There now appears to be little prospect for even one increase this year, and perhaps not even until mid to late next year.

But even without any Fed action, the curve has flattened, with the yield on 10-year treasuries touching an all-time low recently. Our ability to maintain a stable year-over-year margin will be impacted by that changed interest rate outlook. But that could be somewhat offset by our ability to reposition the balance sheet, particularly with respect to trust deposits and the pricing on Hudson City time deposits.

Loan growth this past quarter was largely in line with or slightly better than our expectations, with solid growth in commercial loans, both commercial and industrial, and commercial real estate. Partially offset by slower growth in consumer loans and the expected decline in residential real estate. Absent rises in interest rates, we don't expect the pace of repayments to slow. Fee revenues remain in line with our expectations, given the normal seasonal affects.

On expenses, our outlook for the second half of 2016 is to be somewhat consistent with the first half. This includes the FDIC surcharge imposed on banks over $50 billion in size, which will add about $5 million per quarter to our FDIC assessment, as well as our ongoing investment program. We remain focused on producing modest positive operating leverage on a year-over-year basis. We don't expect any additional merger-related expenses in connection with Hudson City.

Our outlook for credit is little-changed over the short term. We are still not seeing pressures on credit, either nonaccrual loans or charge-offs. Regarding our capital plan, we were delighted to receive no objection from our regulators to the plan we submitted in connection with the 2016 CCAR process. As you know, we plan to repurchase $1.15 billion of M&T common stock over the four-quarter period beginning July 1. In addition, the plan contemplates our Board considering an increase in the common stock dividend to $0.75 per quarter in January of 2017.

While there is no reason to expect we won't execute on this plan as proposed, I would remind you that all of these capital actions are subject to our normal capital governors policies, and unexpected adverse macroeconomic events could impact our actions. Of course, as you are aware, our projections are subject to a number of uncertainties and various assumptions regarding national and regional economic growth, changes in interest rates, political events and other macroeconomic factors which may differ materially from what actually unfolds in the future.

Now let's open up the call to questions, before which Paula will briefly review the instructions.

(Operator Instructions)

Your first question comes from Matt O'Connor of Deutsche Bank.

Good morning.

Good morning, Matt.

To follow up on the expense outlook of the back half of the year similar to the first half, I guess, first, just to clarify, is that on a reported basis or ex-merger charges?

Ex-merger charges, because we think we are finished with those one-times as of the second quarter. So if you take those out and look at what our total expenses were in the first half, it's probably close to where we will be in the second half of the year.

Okay, that helps. But I guess still, if I think about the back half, normally you have seasonality working in your favor, since Q1 is high, and you should still have some cost saves coming in, I think, from Hudson City. So I guess why flat versus down?

Sure. I think there's a few factors going on there, Matt, which affect things. First of all, we have got the FDIC assessment going up $5.25 million right there. What you will see is that, when we look at our other cost of operations, which is really where we are focused, legal expenses are up in the second quarter. And will likely continue at that pace in the third and fourth quarter, and possibly increase slightly as we go through our defense with some of the Wilmington Trust indictments that are out there. And we will be continuing to make the investments that we have been talking about in the franchise, especially continuing on the path with technology. So those are probably the big things that you will see in there.

Oh, and the other thing, of course, which I should mention is, we will be right in the throes of some of the changes that will be happening in our marketplace in the third quarter. And we will probably spend a little more on advertising as we try to take advantage of the changes that are happening. So some of those things are kind of more permanent in nature -- more permanent is probably a bad description. Some of those things will run their course over the rest of this year, and some of them will probably take a little longer.

Okay. And how much was the litigation this quarter?

I think it was roughly an increase of $4 million from what it was in the first quarter of the year.

Okay. Sorry, do you have that number handy, or is it in the 10-Q and I can look it up -- the first-quarter level?

I think it is about $14 million -- was what it was for the first quarter.

Okay. That will probably stay elevated for maybe the near-medium term, but obviously longer term, it would hopefully come down then?

That is how we are thinking about it.

Okay, thank you very much.

Yes.

(Operator Instructions)

Your next question comes from Geoffrey Elliott of Autonomous Research.

Oh, hello there. Thank you for taking the question. On the increase in deposit costs in the quarter coming, I think you said after Hudson City, could you remind us first of all the mechanics of why that is coming through now in 2Q, when the deposits have been on the balance sheet for a couple of quarters?

Yes, sure. I think really what you are seeing there is kind of what I would describe as a timing mismatch. That the rate of decrease in the Hudson City mortgage portfolio is about $900 million a quarter, and the rate of decrease in the time deposits has been, you know, closer to $100 million in the quarter. And that has been a conscious decision on our part, to maintain that pricing while we get the branch staff ready to have a different conversation with those customers than they have had in the past. So because the mortgages are running off a little faster -- or a lot faster, in this case -- than the time deposits are, the impact of those deposits on the margin is exaggerated.

And when do you think you start having some of those discussions and figuring out whether the relationships with those deposit customers makes sense? And if they don't make sense, to rid yourselves of some of the interest expense that comes through from them?

That process is going to begin this quarter, and will play itself out over the course of the third and fourth quarter this year. If you look at the book, it is relatively short. I think 75% of it is 12 months or less. So that is kind of the timeframe over which these discussions will happen, and it is something we will be focused on obviously over the course of the coming quarters.

Thank you.

Your next question comes from David Eads of UBS.

Hi, good morning.

Good morning.

You guys had really good growth on the series side this quarter. That's been a hot topic recently, with the concentration limits of smaller banks and OCC's outlook on risk in the market. So I am just kind of curious your view on the competitive environment there, whether you are seeing other banks pull back, whether you are seeing irrational pricing or irrational terms in some markets, and just where you think we are there?

Sure. You know, I guess I will offer a couple of thoughts as it relates to CRE. First, when we look at where our growth has come from, it has been fairly broad-based across our geographies and across property types. So we are not seeing any concentrations or things that we would point to that we would get worried about. When we look at pricing, I wouldn't say that it is going up, but it seems to have stabilized somewhat.

So we feel better about that. And when we look at the amount of equity that's in the deals, it is still at or above where things were back in 2006, 2007. So I think the market has learned its lesson, as far as that goes.

When we look in the markets and where we are winning business, it doesn't seem to be at the moment coming from any particular competitor that might have reached concentration limits. But I know that is an issue that is out there. I think when we do see things that look a little crazy to us, either in terms of pricing or structure, it tends to be the non-bank lenders that are in that space. And we would tend to shy away from that and keep our powder dry.

Great, that is helpful. And can you give any color on where the commercial pipelines are this quarter compared to last quarter? Or how things are shaping up for the rest of the year?

Yes, sure. When we look at the commercial pipeline and where it stands right now, it is pretty similar to where it was at the end of the first quarter. So when we look forward, I guess, I don't have reason to believe right now that we will see a meaningful decrease in the production levels. But we are also not anticipating any crazy upticks either.

Great, thanks so much.

No problem, thank you.

Our next question comes from Ken Usdin of Jefferies.

Thanks, good morning. One more follow-up on the net interest side. To your point earlier about not potentially having the rate hikes, the loan growth and the remixing into securities seems to be a support. But underlying it, you mentioned the 3 basis points of the core pressure. Is that, on an ex-rates basis how we should expect things to go from here, which is, that you are able to fight off the NIM pressure with the balance sheet growth?

I guess, I think when we look at the NIM pressure and the ways that we fight it off, it is primarily with the deposit pricing, and primarily with that CD book. You know, obviously we will use some of the proceeds, if you will, from the mortgage pay-down to fund loan growth, but we will need to supplement that on the deposit side. We think we have got ample funding, between money that we have at the Fed, as well as money that we have in a savings account, that we don't need to rely on that CD funding for growth. And as we can change that mix and bring the percentage of CDs on the balance sheet down somewhat, and/or bring down the average rate that we are paying. That is the biggest lever that we have to fight off that margin compression.

Right. So we might not see a lot of earning asset growth, but you might be able to offset the core pressure with the remixing?

I think that is probably a true statement. You know, I think the challenge will be, at least in the near term over the next couple of quarters, just making sure we can outrun the net interest income impact of the runoff or the payoffs in the residential mortgage book from Hudson City.

Okay. And on the fee side, just one quick question. The wealth business had a good quarter. I know some of that is seasonal. Are we are seeing a bit more stability in that business now? And was there any help from fee-waiver recovery in that line as well?

I guess the way I tend to think about that business is -- you have got the seasonality part right. When you take that out, we still had a nice quarter. We had some good growth in the institutional part of the wealth business. We saw some customer balance acquisition. The financial markets looked like they were going to hurt us a little bit with Brexit, but in the end, have been okay.

And then on the waiver recovery, there is always waiver recovery, but there is always offsets too, right? That there is some new business, that you might do some pricing actions to get a customer to join the business. So I think, net, you could say that there was some waiver recovery, but it would be modest. It wouldn't be a big driver of the increase.

Okay, understood. Thank you.

Yes.

Your next question comes from John Pancari of Evercore.

Good morning.

Good morning.

I wanted to see if you could talk a little bit about your plans for reinvestment of liquidity on the balance sheet, and how you look at the securities book now, particularly given what we are looking at on the longer end of the curve? Thanks.

Yes, sure. You know, I guess we are at an interesting point, you know, given where rates are and where the book sits today. I guess when we look at what some of the options are of where and how we can invest, the current yields on some of the investment options don't look particularly compelling. And I guess as the book pays down, we probably look to reinvest the pay-downs back into the market, either in Ginnie Mae's or Fannie Mae securities.

But I don't think we are looking to really grow that book right now, just given where interest rates are. We would rather put the cash to work in the loan business rather than in the securities book, and try and keep that relatively flat, unless we see a move in rates.

Okay, all right. That's helpful, thank you. And then separately on the capital front, just wanted to get your updated thoughts in terms of, you know, where you stand in the -- really, where you stand on the regulatory obligation still tied to the Hudson City merger? And then also how soon you could be out there with some potential interest in bank M&A again? Thanks.

Sure. As it relates to bank M&A -- and obviously, we continue to do our work to build our risk infrastructure. Of particular note was AML/BSA. But we continue to make great progress on the aspects of the written agreement that we are obligated to, and we are nearing completion of those activities. But we have to finish our work so that the Fed can come in and do their work., and hopefully remove the written agreement from us. We don't have a timeline on when that might happen, but we are always hopeful that it will be soon. But you can't really control that. You know, I guess -- could you repeat the question on Hudson City?

It was just the regulatory obligations around that. You just answered that with that answer. I guess my second question was really just, once you clear those hurdles, could you be back out there looking at potential bank M&A, particularly given some of the headwinds some of the smaller banks in your markets could be facing?

Yes, I think if you have watched us through the years, you know that we have always been a bank that grows through acquisition, but we do complement it with organic growth. I think for all the reasons that we talked about when we did the Hudson City merger, we think that New Jersey is an attractive footprint for us, in terms of customers that are there, both business customers as well as consumers. And it is a natural fit with our franchise. That said -- and obviously with our capital levels, we are in a good capital position to do deals.

All that said, we are not interested in doing a deal for a deal's sake. We are interested in doing things that are positive for our shareholders. And to us, that means accretive to earnings and capital. And we will be patient.

Great, thank you.

Yes, no problem.

Your next question comes from Bob Ramsey of FBR.

Hi, good morning.

Good morning.

Just wondered if you could talk about with the CCAR authorization. You know, I understand it is all sort of dependent on economic outlook. But is the idea that you sort of start off doing a quarter of the total authorization a quarter, and then adjust as necessary as you go through the next 12 months? Or do you start off a little more cautious, are the buybacks a little more front-end loaded? How should we think about the pace of activity?

Probably the best way to think about it is, split evenly over the course of the four quarters.

Great, okay. And then I wonder, now that Hudson City is done and closed and you have had a little bit of time with it sort of under your belt, just curious if there have been any surprises, what the biggest takeaways are, and where you see the greatest opportunity from here?

I guess there hasn't really been a lot of surprises that we would note, at least anything that stands out. I think we feel that the spot we are at with Hudson City is about where we expected to be at this point, 120 days post the system conversion. There is work to be done to get the branch teams up to speed -- especially from a [thrift] -- up to speed on the breadth of products that we offer, as well as learning the system and then getting used to a sales environment. So that is kind of proceeding as we would expect. And as we mentioned, that is why we feel comfortable, that now we are ready to start taking the step that we are ready to take on the deposit pricing.

And then for the commercial and business parts of the Bank, we have been there actually with M&T bankers pretty much since shortly after the announcement date. So really, our focus there has been to keep that group of people engaged. And since we got the deal done, they have been excited, and have the ability now to work with the branches and offer more confidently the deposit side of the relationship.

And then we have been out recruiting, and we are trying to grow that business through people editions. I think, you know, the thing that we pay a lot of attention to is -- just like we pay a lot of attention to credit and we want to grow in that footprint. We are going to grow under the kind of terms and structure that we know is good business. So we are not going to rush it. And the same thing kind of applies to people, that we know that finding and adding to our teams people that fit our culture and understand how we do business, and think about relationship and think about good structure -- it is more important to us that we get the right people on the teams, rather than fill the spots quickly.

So you know, I feel really good about where we are. I think we are tracking to where we would expect to be. And you know, we have just got to manage the pace that we talked about a little bit earlier on. Which is the pace at which those mortgages run off and the pace at which we grow the commercial balances to offset that. But overall, we are very pleased with where things are.

Great, thank you.

No problem.

Your next question comes from Matt Burnell of Wells Fargo Securities.

Good morning, thanks for taking my question. Just a question on terms of the commercial pipelines. You were saying they were largely unchanged quarter over quarter. I guess I am curious how much of the commercial growth, if you break it out this way, has come from, you know, legacy Hudson City markets, and how much of that is coming from legacy M&T markets?

It would seem to me that with the recent conversion, one would have thought that you might have had a somewhat stronger pipeline in the second quarter. And we have also heard from a couple of other banks that commercial demand has slowed a little bit from the start of the year. So maybe just a little more color on the commercial demand?

Sure. Well, as you would expect, when you look at the New Jersey markets, the growth rates there on commercial loans are actually slightly higher than what you would see in the rest of the footprint. You know, we kind of averaged -- let me just get the number here -- 38% growth in CNI this quarter annualized -- that is an annualized number. And 18% in commercial real estate in the quarter. Which, those are higher than what you would see in the footprint. But it is off a small base, right?

So I think when you look at the total loan growth, we are pleased with how things are going in New Jersey. We are building the pipeline there and we are getting growth rates that are faster than what you would see across the rest of the footprint. But as it takes time for the dollars to build, right? So the percentage of dollars of growth that New Jersey represents is still small and growing compared to the size of the legacy balances and footprint.

Okay, thanks very much.

No problem.

Your next question comes from Doug Doucette of KBW.

Hi, Darren, this is Brian Klock. I had some technical difficulty there. So can you hear me okay?

You changed your name.

(Laughter) No, it is me. Thanks for taking my call. I just wanted to follow up on the margin side. It looks like the CNI loan yields, after the fourth quarter, the December hike, you have seen a positive carry-through into the first quarter. And then you had another 8 basis points expansion in the second quarter. So is there still repricing going on, or was there any sort of recovery that impacted the second quarter? Or what do you expect to see from the CNI loan yields going forward then?

There was a couple of big recoveries early in the second quarter. But I think when we look at pricing and loan yields, I guess I go back to what I mentioned before, that it feels like things are stabilizing. And when we look at the yields of the new businesses that have been originated, the yields bounce around a little bit, but really have been pretty stable for about the last four to six months.

And obviously, a lot of that is tied to LIBOR. So you have got to watch what is happening with LIBOR, which moves around a little bit. But overall, pricing is pretty stable. And I wouldn't expect to see big movements over the course of the coming quarters, either direction.

So is the sort of core CNI loan yields, is it closer to the 339 from the first quarter, if you adjust for those recoveries, or is there still something else?

It is probably is around that range, yes.

Okay, all right, thanks. I will get back in the queue, thanks.

Yes, no problem.

Your next question comes from Gerard Cassidy of RBC.

Thank you, good morning.

Good morning.

Can you guys share with us -- you pointed out in your quarterly numbers that your return on average common shareholders equity was 8.38%, which generally is believed to be below most banks' cost of capital of around 9% to 10%. This Company, pre-financial crisis, used to deliver ROEs of around 15%. Can you share with us how you expect -- I know we're not expecting it to go back to 15% because of the increased capital levels. But can you share with us what you think you can do to get that above your cost of capital?

I guess, I'd offer a couple of thoughts. We spend a lot of time thinking about return on tangible common, because that is one of the key binding constraints in CCAR, and we focus a lot on that. When you look at the capital levels of where we were pre-crisis and where we are now, they are at least double.

Correct.

So two elements to managing or thinking about returns as we go forward. One obviously starts with the capital we carry to run the Bank. And so that was part of our CCAR announcement and our CCAR ask. And we will be continuing to look at, you know, the volatility of our earnings and our charge-off levels, and continue to work on our capital policies to make sure that we are adequately capitalized, but not overly capitalized. And that will help.

The other thing that I guess we think about when we look at our return versus our cost to capital, when you look at the volatility of our charge-offs and you look at the volatility of our earnings, we would kind of think that our cost to capital would be towards the bottom end of the industry, because our beta is lower. So when you look at that, we think our cost to capital would be below the average in the industry. And we would think that over time, you know, as we continue to make the changes to the business to improve profitability as well as return capital, that those would be the factors that we would be thinking about as we move the needle on returns up in a positive direction.

Great. Following up on your comments on CCAR, I congratulate you for using the mulligan. We wish more banks would do that. I noticed that, if I recall correctly, the amount of capital that was reduced because of the CCAR process was considerably higher this year than last year. I think it was over 600 basis points this year. Last year it was just under 300 basis points, if I recall. What caused that to be so much greater this time? And second, if it was totally due to the Hudson City deal, should we expect as you integrate that further that, that kind of reduction in capital should be reduced on a go-forward basis?

Yes, I guess a couple of thoughts on that. I will be honest with you, I am not as familiar with the 300 and 600 basis points that you are mentioning. But I guess a couple of things that I think about. First off, if you think about the mulligan, you know, and how people use that, I guess I feel the need to kind of address that; that we didn't go into the process with the intention of using the mulligan. We followed our process and did our analysis of our PPNR and our capital levels under stress, and we set our ask based on what we think is the target that we need to run the Bank.

I think what we saw is that there were some differences between our analysis and the Feds', and they built a process that gave people a chance to make an adjustment. Because they can see that they are looking at things differently than we are. They get to see the industry and we don't. And they built a process that I think is sound in allowing you to make that change. So we were fortunate that it was in place, and we used it.

I think, when you think about our returns over the last three years, if you add in this year and the prior two, we would still be towards the bottom end of returns in the industry. And you know, we were cautious leading into the Hudson City acquisition because there is always uncertainty when you're doing a deal, and we didn't want to have any issues. I think if you look going forward, you know, we kind of see where our earnings are going, where our PPNR is going. We continue to make progress on our models and in our loss rates.

And I think looking at the balance sheet, and as the balance sheet changes, we feel like our capital levels, even with this buyback, will be pretty good. And depending on what happens over the course of the next year, you know, we will be looking to continue to bring those levels down closer to what our targets are, and/or where we were when we passed CCAR over the prior couple years.

Great, thank you.

Yes.

Your next question comes from Jill Shea of Credit Suisse.

Good morning, thanks. Credit quality continues to be very strong, and the provision run rate was down this quarter, with a lower net charge-off. Can you just touch on how you think about the total allowance percentage as you shift towards a more commercial loan mix over time? And how we can think about the pace of reserve builds as we look out?

Yes, sure. I think if you look at the Bank pre-Hudson City, where the mix of earning assets was more commercially oriented, as the Hudson City mortgages run off, which tend to have a lower loss rate than the portfolio shifts, to be a little more commercially oriented -- both CNI and CRE -- that, over time, will shift. And the allowance for losses will likely shift as the mix shifts.

I think, if you look at the quarter, charge-offs were very low for the quarter, because we had a big recovery. I think if you look at how we feel about things going forward, the first quarter was probably a little high, and the second quarter was probably a little low. And we would expect to be somewhere in the middle of that as we go through at least, you know, the next couple of quarters.

Great, thanks.

Your next question comes from Erika Najarian of Bank of America.

Hi, good morning. I had a quick follow-up to Ken's line of questioning. Given your comments about modest earning asset growth and what you're doing on the liability side to defend the margin, can we see stability to maybe modest growth from that $863.8 million net interest income number, ex any change in the yield curve? And also maybe some more color on how you can manage the trust deposit volumes, which is clearly bloating your cash. I think you alluded to that in your prepared remarks.

Yes. So I guess starting with the net interest income, over the next couple quarters, it is probably going to be tough to see any growth there, just because of the expected rate of decrease in the residential mortgage portfolio from Hudson City. So that is a big hill for us to climb to get back to flat or positive. I think when you look at the margin itself, we think we have got some opportunity there, that's in our control, from the Hudson City time deposit book, to bring that down, to reduce the cost of funding the assets on the balance sheet. And obviously, we are seeing and expecting to see some continued growth on the commercial loan side.

You know, as it relates to trust deposits, I guess we could do something to turn those deposits away. But when we look at it, it is a good deal for us, because it requires no equity and we park the money at the Fed. And I think Rene had mentioned on prior calls but I will just remind you that, with some of our business in the trust side, we get paid either in fees or in deposits. And in the current environment, many people are choosing to pay us in deposits. So while it reduces the margin in the short term, it's positive for net interest income and for earnings. So we don't get to fussed about where the margin prints, because of what is going on with trusts and deposits.

Got it, thank you.

No problem.

Your next question comes from Ken Zerbe of Morgan Stanley.

Thank you, good morning.

Good morning.

A question on expenses. The guides that you gave -- the second half is going to be roughly equal to the first half, ex the merger charges -- I'm going to go out on a limb and say that's probably a fair bit higher than what I was building in, maybe consensus was building in, for the second half. But when we think about 2017, obviously you get some further cost savings related to Hudson City, but are we also looking at sort of a more parallel shift, higher in expenses in 2017? Or -- just trying to think if there's any offsets to the increase. Thanks.

Yes, I guess here is how I think about it. When you look at the expense increases that are going on, I will bucket them into a couple of categories. So if we start with the savings from Hudson City, we've largely achieved that. There is maybe a little bit to come through the back half of the year, but it might take a little longer on some of those pieces, as we work through ORE and expenses like that.

When you look at the run rate for the rest of the year, there is a change in the deposit charge, the FDIC charge. And that will go up in the third quarter. We think it will start to move a little bit down in time, as we change the mix of assets and liabilities on the balance sheet. We have got some increases for events, I would call them, one of them being the change that we see happening in our marketplaces, and what we will spend on some advertising dollars to take advantage of that. And then we have got the other event that is going on, and will through the end of the year, which is the legal things that are happening.

So those will elevate expenses for the back half of this year. I wouldn't expect them to carry on all through 2017. So the advertising, we know pretty certain what will happen with that, because there is a time limit to that. With the legal stuff, we know we have a trial date in January, but those dates can change, so I don't want to get too crazy on that. But that is part of what is driving some of that expense.

When you look at the other places where we are investing, it continues to be in technology, and that will move around a little bit quarter to quarter. But that is some of where the increase was in this quarter, and some of that will be continuing on through 2016 and 2017.

All right, thank you. I appreciate it.

Your final question comes from Frank Schiraldi of Sandler O'Neill.

Hello, thank you for taking the question. Just one quick one. I'm just trying to get a sense on the potential for repricing deposits from Hudson City customers. How do we think about in terms of, if the customer you look at you want to retain, do you expect you're going to continue to sort of operate this two-tier payment or pricing model? Or do you think it is going to be a much tougher conversation in terms of, if you remain an M&T customer, you accept M&T CD pricing? I'm wondering just how far over the next 12 months we could see that repricing? And how front-loaded that would be over the next 2 quarters versus the next 12 months?

Sure. So, I guess if you think about the conversation with these customers, it probably goes and ends one of three ways. One way is, we say to someone who is a CD-holding customer, here is the rate we are offering to people that only have CDs with us. That rate will be lower than what they are earning today and would be more in line with what we are likely offering in our existing markets. The customer can choose that, or they can choose another alternative, which would be to broaden their relationship, maybe bring a checking account relationship with them where they have their paycheck deposited. And if they bring that to us, then their rate would stay roughly where it is.

But we would get the benefit if we add the low-cost deposit from the checking account. And that really opens up some fee income opportunities, you know, through debit card interchange that goes with checking accounts, or other maintenance fees that go with those accounts.

And then the last option is, if they don't like the rate that we are offering them standalone, and they choose not to broaden their relationship with us, they may choose to leave and go elsewhere, looking for a yield that suits their needs. So what we will see over time is, we will see probably a combination of two things. We will see a decrease in the rate that we are paying, and we will also see a decrease in the balances that sit within those time accounts. And the combination of those two things is what will help reduce the interest expense, and help manage some of that margin compression that we were talking about.

Like I said before, I don't have the exact numbers in front of me, but when you look at the book, the vast majority of it -- I think it is about a $12 billion book, and 3/4 of it will re-price over the course of the next 12 months. So there you are talking about $9 billion that will re-price over the course of the next 12 months, and I think there is a little bit front-loaded to the third quarter, based on my recollection. But if you think about it, fairly evenly split across those quarters. That would be a good way to think about it.

Okay. And is the vast -- well, I don't want to say -- is the majority of that money, that $12 million, is that CD-only customers right now? Or is that not the case?

I guess it is a good chunk of it. You know, when we look at that portfolio, it is probably 75% to 80% single-service, and would CD-oriented. I'm just trying to think about imbalances and reflect on some of the numbers I have seen, but I don't have that exact information off the top of my head, so I don't want to misquote.

Okay, all right, great. Thank you.

Yes, no problem.

This concludes today's question-and-answer session. I will now turn the floor back over to Mr. Don MacLeod for any additional or closing remarks.

Again, thank you all for participating today. And as always, if clarification of any of the items on the call or news release are necessary, please contact our Investor Relations Department at area code 716-842-5138.

Thank you. This concludes your program. You may now disconnect.