M&T Bank Corp (MTB) 2018 Q1 法說會逐字稿

Welcome to the M&T Bank First Quarter 2018 Earnings Conference Call. It is now my pleasure to turn the floor over to Don MacLeod, Director of Investor Relations. Please go ahead, sir.

Thank you, Lori, and good morning. I'd like to thank everyone for participating in M&T's First Quarter 2018 Earnings Conference Call, both by telephone and through the webcast. If you have not read the earnings release we issued this morning, you may access it along with the financial tables and schedules from our website, www.mtb.com, and by clicking on the Investor Relations link and then on the Events & Presentations link.

Also, before we start, I'd 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'd like to introduce our Chief Financial Officer, Darren King.

Thank you, Don, and good morning, everyone. M&T's results for the first quarter largely reflect the continuation of the economic environment we've been operating in over the past 5 or 6 quarters and the financial trends that have emerged. The results are characterized by the following: strong year-over-year growth in net interest income, reflecting continued expansion of the net interest margin combined with modestly lower loan balances as growth in commercial and consumer loans was offset by our continued runoff of the residential mortgage portfolio acquired in the merger with Hudson City. Fee revenues were comparatively stable with trust fees continuing to be a highlight. We experienced our usual seasonal uptick in compensation-related expenses during the first quarter associated with equity compensation and employee benefits costs. Aside from that, expenses continue to be well controlled.

The credit environment remains very good to excellent. As announced in early February, M&T amended its capital plan for the 2017 CCAR cycle. After receiving no objection from the Federal Reserve, M&T's Board of Directors authorized an additional $745 million of share repurchases to be completed by the end of this year's second quarter.

Let's look at the specific numbers for the quarter. Diluted GAAP earnings per common share were $2.23 for the first quarter of 2018 compared with $2.01 in the fourth quarter of 2017 and $2.12 in the first quarter of 2017. Net income for the quarter was $353 million compared with $322 million in the linked quarter and $349 million in the year-ago quarter.

On a GAAP basis, M&T's first quarter results produced an annualized rate of return on average assets of 1.22% and an annualized rate of return on average common equity of 9.15%. This compares with rates of 1.06% and 8.03%, respectively, in the previous quarter.

Included in GAAP results in the recent quarter were after-tax expenses from the amortization of intangible assets amounting to $5 million or $0.03 per common share, little change from the prior quarter. Consistent with our long-term practice, M&T provides supplemental reporting on its results on a net operating or tangible basis, from which we have only ever excluded the after-tax effect of amortization of intangible assets as well as any gains or expenses associated with mergers and acquisitions when they occur.

M&T's net operating income for the first quarter, which excludes intangible amortization, was $357 million compared with $327 million in the linked quarter and $354 million in last year's first quarter. Diluted net operating earnings per common share were $2.26 for the recent quarter compared with $2.04 in 2017's fourth quarter and $2.15 in the first quarter of 2017. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders equity of 1.28% and 13.51% for the recent quarter. The comparable returns were 1.12% and 11.77% in the fourth quarter of 2017. 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.

Both GAAP and net operating earnings for the first and fourth quarters of 2017 as well as the first quarter of 2018 were impacted by certain noteworthy items. Included in the first quarter of 2017's results was an $18 million tax benefit that arose from revised accounting guidance for equity compensation. This amounted to $0.12 per common share.

Included in last year's fourth quarter results was a contribution to The M&T Charitable Foundation amounting to $44 million. That contribution equaled $27 million of after-tax effect or $0.18 per common share. The contribution exceeded the $21 million of realized securities gains recognized during the fourth quarter.

M&T's effective tax rate for the fourth quarter was also impacted by changes to U.S. corporate tax rates. M&T's provision for income taxes for the quarter was increased by approximately $85 million as a result of the tax law changes reflecting a revaluation of the corporation's net deferred tax assets. This amounted to approximately $0.56 per common share. In aggregate, these items lowered net income for the fourth quarter by $98 million or $0.65 per diluted common share.

During the recent quarter, M&T increased its reserve for litigation matters by $135 million to reflect the status of preexisting litigation. That increase, on an after-tax basis, reduced net income by $102 million or $0.68 of diluted earnings per common share. Also during the first quarter of 2018, M&T received a cash distribution of $23 million from Bayview Lending Group, which is reflected in other revenues from operations. This amounted to $17 million after-tax effect or $0.12 per diluted common share.

Similar to last year, M&T's results for the first quarter included a $9 million tax benefit relating to the new accounting guidance for equity compensation. That amounted to $0.06 per diluted common share. That benefit, coupled with the lower corporate income tax rate, reduced M&T's effective tax rate for the quarter to just shy of 23%.

Earlier, I noted $21 million of realized security gains in last year's fourth quarter, which arose primarily from the sale of a current -- of a portion of our GSE-preferred stockholdings. Our results for the first quarter reflect a $9 million unrealized loss on our portfolio of equity securities primarily comprised of our remaining holdings of GSE-preferred stock. New accounting guidance requires equity securities to be revalued through the income statement instead of through other comprehensive income. Looking ahead, the impact from this accounting change on holdings of equity securities could result in some volatility in securities gains or losses.

Turning to the balance sheet and to the income statement. Taxable-equivalent net interest income was $980 million in the first quarter of 2018, little change from the linked quarter. The comparison with the prior quarter reflects the impact from 2 fewer days in the recent quarter, partially offset by expansion of the net interest margin to 3.71%, up 15 basis points from 3.56% in the linked quarter. The increase in short-term interest rates resulting from the Fed's December and March rate actions added a benefit to the margin of as much as 9 basis points in 2018's first quarter. This was in excess of our projections as the LIBOR rate rose more rapidly than the Fed funds target rate. A lower level of average balances of funds placed on deposit with the Fed had an estimated 4 basis point positive effect on the margin. The lower cash balances were primarily the result of some seasonal volatility in commercial deposits as well as fluctuations in trust-related deposits. As is usual, the 2-day shorter first quarter compared with the previous quarter reflected an estimated 2 basis point benefit to the margin arising from the impact of 30 over 360 interest basis assets.

Average loans declined by less than 1% compared with the previous quarter. Customer sentiment appears to be stronger, while paydown activity seems to be slowing. Commercial real estate activity is picking up slightly.

Looking at loans by category. On an average basis compared with the linked quarter, commercial and industrial loans were roughly flat compared with the linked quarter. Commercial real estate loans were up approximately 2% or roughly 6% annualized compared with the fourth quarter. Funding of new construction loans was the primary driver.

As noted, residential real estate loans, which are largely comprised of mortgage loans acquired in the Hudson City transaction, continued the planned rate of paydown. The portfolio declined by some 4% or approximately 14% annualized, consistent with previous quarters.

Consumer loans were up 1%. Growth in indirect and recreation finance loans continued to outpace declines in home equity lines and loans. Regionally, growth in floor plan balances was offset by softness in C&I activity elsewhere and which was fairly uniform across our footprint, while CRE demand was a little better in New Jersey, Upstate New York and our metro region, which includes New York City. Average core customer deposits, which exclude deposits received at M&T's Cayman Islands office and CDs over $250,000, declined an estimated 3% compared with the fourth quarter.

Turning to noninterest income. Noninterest income totaled $459 million in the first quarter compared with $484 million in the prior quarter. As noted, the recent quarter included $9 million of unrealized securities losses, while 2017's final quarter included $21 million of realized securities gains. As I noted, included in other revenue from operations for the recent quarter is a $23 million distribution from Bayview Lending Group.

Mortgage banking revenues were $87 million in the recent quarter compared with $96 million in the linked quarter. Residential mortgage loans originated for sale were $625 million in the quarter, down about 10% from $696 million in the fourth quarter. Total residential mortgage banking revenues, including origination and servicing activities, were $62 million, essentially flat compared with the prior quarter.

Commercial mortgage banking revenues were $26 million in the first quarter compared with $34 million in the linked quarter, reflecting seasonally lower originations activity. That comparable figure in the first quarter of 2017 was also $26 million.

Trust income was $131 million in the recent quarter, up from $130 million in the previous quarter and 9% above the $120 million earned in last year's first quarter. New business generation continues to be strong, and results were aided by the appreciation in the equity markets. Service charges on deposit accounts were $105 million, down seasonally from $108 million in the fourth quarter.

Turning to expenses. Operating expenses for the first quarter, which exclude the amortization of intangible assets, were $927 million. The first quarter's operating expenses included the $135 million addition to the reserve for litigation matters, while last year's fourth quarter results included a $44 million contribution to The M&T Charitable Foundation.

Operating expenses for the recent quarter also included $56 million of seasonally high compensation costs related to the accelerated recognition of equity compensation expense for certain retirement-eligible employees, the HSA contribution, the impact of annual incentive compensation on the 401(k) match and FICA payments, as well as the annual reset in FICA payments and unemployment insurance. Those same items amounted to an approximate $53 million increase in salaries and benefits in last year's first quarter. As usual, these seasonal factors will not recur as we enter the second quarter.

Next, let's turn to credit. Overall credit quality continues to be in line with our expectations, matching the benign trends seen over the past 4 years. Annualized net charge-offs as a percentage of total loans were 19 basis points for the first quarter compared with 12 basis points in the fourth quarter, which included a higher level of recoveries on previously charged-off loans. Charge-offs in last year's first quarter also equaled 19 basis points.

The provision for credit losses was $43 million in the recent quarter, exceeding net charge-offs by $2 million. The allowance for credit losses was $1 billion at the end of March. The ratio of the allowance to total loans was unchanged at 1.16%.

Nonaccrual loans decreased by $18 million at March 31 compared with the end of 2017. The ratio of nonaccrual loans to total loans declined by 1 basis point, ending the quarter at 0.99%. Loans 90 days past due, on which we continue to accrue interest excluding acquired loans that had been marked to a fair value discount at acquisition, were $235 million at the end of the recent quarter. Of these loans, $224 million or 95% were guaranteed by government-related entities.

Looking at capital. M&T's common equity Tier 1 ratio was an estimated 10.59% compared with 10.99% at the end of the fourth quarter and which reflects earnings retention during the first quarter, share repurchases and the impact from the net decline in end-of-period risk-weighted assets. During the first quarter, M&T repurchased 3.8 million shares of common stock at an aggregate cost of $721 million.

Turning to the outlook. Based on first quarter results, our outlook for 2018 remains consistent with what we shared with you on the January conference call. To reiterate those thoughts, we expect 2018 overall to look much like 2017 with growth in total loans ranging from flat to a low single-digit pace. The net interest margin has widened following the December and March actions by the Fed, and the market is expecting additional actions over the remainder of 2018.

Based on the current level of interest rates and reflecting the impact of the interest rate hedges we entered into last year, we continue to estimate that a hypothetical future 25 basis point increase in short-term rates should result in a 5 to 8 basis point benefit to the net interest margin. This also embeds a series of assumptions on resultant deposit pricing reactivity for various deposit categories. So far, deposit pricing reactivity continues to be less than we have modeled. Based on those balance and margin assumptions, we expect modest year-over-year growth in net interest income.

The higher interest rate environment has impacted residential mortgage loan originations, both volumes and gain-on-sale margins. Residential mortgage banking revenues could be pressured, absent our ability to acquire additional servicing or subservicing business. We do anticipate seasonal improvement in commercial mortgage banking revenues as the year progresses.

The outlook for the remaining fee businesses remains stable with growth in low to mid-single digits. Notwithstanding the addition to reserve for litigation matters, we expect low nominal growth in total operating expenses in 2018 compared to last year. As noted, we expect the seasonal surge in salaries and benefits we saw in the first quarter to normalize in the second quarter.

Our outlook for credit remains little changed. There are no apparent significant pressures on particular industries or geographies. However, one factor in most of the stress credits we're seeing at present is leverage.

As to capital, we continue to execute on the 2017 capital plan with $475 million of repurchase capacity remaining through the end of the second quarter. We have submitted our capital plan for the 2018 CCAR cycle to the Federal Reserve and await the stress-testing results, which should be published late in the quarter.

Of course, as you're 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, Lori will briefly review the instructions.

(Operator Instructions) Our first question comes from the line of Ken Zerbe of Morgan Stanley.

I guess, just starting from loan growth. You mentioned that sentiment is picking up and paydowns are slowing. But the guidance for loan growth still seems pretty -- I'm going to say tepid for the flat single-digit pace given the runoff of the resi mortgages, of course. When you look at first quarter numbers, I mean, were you expecting first quarter to be fairly weak and with a stronger half pickup? I'm just trying to get a sense of if this trend is in line with your expectations for loan growth because the industry loan growth, as you probably can imagine, is pretty weak overall.

Sure, Ken. When -- what's happened in the first quarter is pretty consistent with how we expected the year would unfold. When we were looking at 2018, it was our view that the trends that we had seen in the back half of 2017 would start to moderate a little bit, meaning that paydowns would likely slow down a little bit but not enough for the originations to materially outrun them. And we'd see kind of slower growth in the first half of the year, and it would pick up in the back half of the year as the impact of the -- most importantly, the tax changes goes through and businesses have a better sense of where GDP is heading and how they choose to invest. It seems like there has been more optimism within our customer base since the tax reform. I guess the only thing that's dampened that a little bit of late has been some of the trade and tariff conversation that's going on. I think there's a little bit of uncertainty now based on those comments that are -- those actions that are ongoing. But overall, the mood is definitely more positive than what we saw in the second half of last year. And where the first quarter ended up is very consistent with our expectations that we had coming into 2018.

Got it. Okay. Great. And then just second question. Can you just give me a little more detail in terms of what those equity securities were that you're holding on balance sheet that drove some of the volatility. And I guess, also the question is like why are you still holding them? Or what's the rationale for holding them, given that they will introduce additional earnings volatility going forward?

So those equity securities are almost entirely GSE preferred, so Fannie and Freddie. Those are securities that we've had since, I think, about 2007. And we wrote them down pretty dramatically in '09 or '10. I have to get the exact date for you, but they're pretty much fully written down. When we were going through the fourth quarter of last year and looking at the changes to the tax law, we sold down a substantial portion of those, but we kept a little bit because of where the pricing had moved and where we thought the real value was. So there's a little bit left over, and it's down to, I don't know, book value maybe $18 million or less than that, $9 million. The current value, I think it's around $18 million. So it's -- there's not a lot of downside in the valuation. And if we get some GSE reform, maybe the investment will pay off down the road.

Your next question comes John Pancari of Evercore.

On the deposit side, just wondered if you could give us a little more color on the decline in the noninterest-bearing. How much of that was a seasonal factor? And how much of it was just the trend through the quarter? And how much of that was expected in terms of that type of move?

So John, on deposit balances and movements in the quarter, there are 3 factors, 1 of them trust related and 2 of them related to commercial. So trust demand balances, as you guys know, move around quite a bit depending on the activity in the capital markets. And it was a little bit slower in the first quarter than what we had seen in the fourth quarter, which that moves a reasonable amount from 1 quarter to the next, depending on what's going on. Within the commercial book, we do see a seasonal decline in commercial deposit balances usually every first quarter. What tends to happen is commercial companies will build up their deposit balances going into the fourth quarter as they prepare for their distributions to their principals and to employees. And as that gets paid out, you see those balances go down. We are starting to see a little bit more interest in sweep balances. As rates have moved up, corporate treasurers have shown a little more interest in managing the return that they're getting on their balances. You're seeing that in some movement into sweep and discussions about that, some movements in rates. And it's the combination of those 2 things, commercial and trust-related deposits, that moved the noninterest-bearing down in the first quarter. As we look forward, we also see in some of our interest-bearing checking accounts likely some movement there in the future quarters related to escrow balances where we're expecting some of those escrow balances to move from M&T to other organizations, which those balances, we pay pretty much Fed funds on them. And so we'll replace them with a like deposit instrument at a similar cost. So we're not anticipating any change materially to our cost of funds, but there will be some geography movement in terms of where the balances sit on the balance sheet in future quarters.

Okay. All right. And then secondly, on the expense side. I know in terms of your outlook, you mentioned nominal growth there. I think you have previously indicated approximately 2%-or-so, give or take, in terms of year-over-year expense growth for the year of '18. Is that still intact? Is that the best way to think about nominal?

Yes, that's the best way to think about it, John. And when we talked about this on the fourth quarter -- so we'll hold the litigation reserve to the side, what we had talked about was kind of what we would describe as normal quarterly expenses, which tend to appear most in the second and third quarter. And if you annualize those and kind of grew those around 2% and then add on the seasonal compensation cost that we just discussed and happened in the first quarter, which they always do, that was the math behind the expense number and the target.

Got it. So the positive operating leverage, the expectation is still intact.

The positive operating leverage expectation is certainly intact.

Your next question comes from Ken Usdin of Jefferies.

If I could just follow on, on the balance sheet. Darren, would you -- given that there is still some remixing to your point about the deposits, do you think that -- does this quarter kind of mark the bottom for the average earning asset base given that flush-out that you'd had and some -- your points about some of the ins and outs that might go forward? [Next to that], earning assets grow from here? Or is there still a net down that could still happen?

So Ken, when you think about the earning assets, it can be a little tricky quarter-to-quarter just because of the dollars that sit at the Fed that are trust related, right. And we've seen some large moves quarter-to-quarter on those that they can move by $1 billion, $2 billion. At the end of 2016, they actually moved by $2 billion or $3 billion a quarter. So if we hold those to the side because they're a little bit less predictable, and we just look at the lending and loan balances, we're close to the bottom. I don't know that we're quite there yet, but we're close. And the reason I'm not quite calling the bottom right now is depending on the rate of pickup in commercial loan growth. So we saw some nice uptick in commercial real estate balances this quarter, and we saw C&I balances kind of flatten out, which is a good thing. But in aggregate, we've got the runoff of that residential real estate portfolio. And just the normal amortization in paydown, which looks like we've been seeing over the last few quarters around 13% to 14% annualized. Until that portfolio gets a little bit smaller, the dollars that we need to add in other categories, meaning in C&I and CRE or in other consumer loans, needs to be kind of $600 million a quarter-ish for us to see absolute growth in total loan balances. And it's the combination of those factors. I think we're close. And if we get a little bit more uptick in investing activity in our commercial customers and commercial real estate, then I think we'll see that turn sooner. And if not, then we'll probably be flattish through the year, which is why we gave the overall guidance for the year of flat to kind of low single digits.

Okay. And as a follow-up to that, you mentioned expectation for modest [in aggre], but even with the FTE adjustment delta, you're up 6-and-change already just based on this December hike pulling through. So if we continue to get the Fed funds curve move forward and the type of pull-through on that 5 to 8 basis points, it would seem that you could do decently better than "modest." I don't know if you could help us kind of talk through a zone of expectations on that front or to any extent would be helpful.

Sure. So as we look forward at the net interest income and future Fed moves, what's left in the forward curves today, I think, is an increase in late summer -- mid- to late summer and one right at the end of the year. So the one at the end of the year will have not a material impact on our net interest income for the year. So there's one more rate increase. I think when we originally came into 2018, we were expecting 2, 1 of which we thought would happen in January, and it happened in December. So the rate of increase in Fed funds rates is a little bit faster than we thought. And as long as we can maintain loan balances in line with the guidance that we gave and what we've seen so far, there's probably a little bit more upside in net interest income, but I wouldn't think a ton, meaning we don't anticipate seeing as much of a gain in dollars in net interest income in 2018 as we saw in 2017.

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

I was wondering if you could talk a bit about your technology spend and just kind of thoughts on whether you have to further ramp it up looking out the next couple years. I mean, obviously your cost guidance this year was pretty clear about the relatively flat, x the (inaudible) charge. But just conceptually, how are you thinking about investment spend if you look out next couple of years?

Sure. So technology spend has been increasing at the bank pretty consistently for the last 3 to 5 years. Certainly, over the last 4, when we look back at where we have spent and our trajectory into 2018, in total, our IT spend has been growing 10% to 13% a year. That's both on new technology as well as on maintaining plant and equipment. When you think about the categories that we're investing in, it's very broad. I tend to think about it in terms of customer-facing tools that we're investing in. We've talked about our mobile app and upgrades we've made to the mobile app and the website. This year, we'll see Zelle go live late second quarter, early third quarter. We're making some improvements to the tools that our commercial customers use for their cash management, so things to help make it easier for customers to work with the bank. We're investing in employee-enabling tools. We're making a major investment in our commercial loan origination systems, which are intended to help the RMs spend less time in front of their computers doing loan spreads and putting packages together and give them more time to be with customers, helping advise them on their business needs. In the consumer space, we're improving our account-opening tools and procedures so that the amount of time it takes to open a checking account or credit card account can be dramatically reduced so that our team members can spend more time giving advice to customers during that interaction rather than taking information and preparing the application. And then there's investments that we're making in infrastructure that we need to make just because we're a bank. We've been investing a lot in data quality and in our data warehouse. We, of course, invest in privacy and cybersecurity to make sure that we're buttoned down. And when you add up investments along those dimensions, that's where we've been investing our technology dollars and will continue to. What has been happening, though, which is it's wash -- it's a wash in the expense numbers is that as we make those improvements -- or we make those investments, there other parts of the bank where we're becoming more efficient where changes to process and business model are helping us reduce our costs. And therefore, you don't see as clearly in the numbers a big spike in technology investment. And I think the other thing that we've talked about before is you don't tend to see that big spike because, for us, we're very measured in the pace at which we deploy new technology. And we find that that's an important way to minimize risk, and it minimizes risk in 2 fashions: the less change you introduce to the system or at least more measured you are, if something goes wrong, it's easier to correct and fix and identify because there's only a couple things that have changed in any given one time. And the other important aspect of risk management is the change that you introduce to your employees and to your customers. Too much change all at once can cause service disruptions or can cause short-term pain while employees adapt to the new way of doing business. And for that reason, we try to be very measured and consistent in terms of the pace in which we're investing in and deploying new technology.

Okay. That's helpful. And then just separately, if we look at your CET1, obviously, very strong at 10.6. And just what are your thoughts in terms of where you need to be longer term kind of in this new regulatory environment that we're in that seems like there's been some softening for banks in general and, in particular, for you or banks your size and risk profile?

Sure. So where we sit with our CET1 ratio today is, I would say, middle-ish of the peer group based on where we saw everyone's CET1 ratios through the end of last year. And as we've talked about for the last few years, our objective is to operate towards the bottom end of that peer range. That's a bit of a moving target. But when we look at, as you pointed out, our business model and the strength and lack of volatility in our earnings, we think that that's a good target and place for us to be. As the rules get sorted out and the changes come through as we see the changes that were proposed by the Fed last week as well as the bill that's in the House right now, as more clarity comes from those bills and the direction, we'll obviously continue to assess where we're operating and what we think makes sense for M&T.

Your next question comes from Steven Alexopoulos of JPMorgan.

I wanted to first follow up on C&I. When you talk your C&I customers, what are they saying that they're likely to do in the short run from the benefit of the lower tax rate? And are they at least signaling that an increase in CapEx and investment is coming at some point?

Sure. So based on our conversations with our C&I customers, in particular, over the last 90-or-so days, we mentioned that there's been a definite movement up in terms of their optimism. And there has been more discussion with our relationship managers about investment in property, plant and equipment. So those discussions are starting, which I take is a positive sign because that hadn't been the case during 2017 and before. So I think there's a little bit more optimism that GDP growth rates will stick where they are, at least for a long-enough time horizon to get customers comfortable making those investments and adding that fixed expense, so to speak, to their income statements. So definitely, a little more positivity. And we're optimistic that, that will translate into some more loan demand as we go through the year.

And do you see an increase, maybe not drawing on lines, but an increase in commitments wanting to get the lines in place at this point?

During the quarter, we saw some uptick in commitments, probably saw a little more increase in the rate of utilization than in the rate of commitment during the first quarter. But that's not atypical.

Okay. And then separately, on the deposit side, you saw a very modest increase in deposit costs again in the quarter. We saw a few other banks indicating they're starting to see deposit competition stepping up a bit here. Are you seeing a shift in the environment and what you'll need to pay on deposits?

Sure. Deposit competition, I would say, is starting to show signs of moving. It depends again on which category we're looking at. If we look at our wealth business and affluent customers, pricing has mattered to them and their advisers for a long period of time. And nothing's really new there other than the absolute rate as the -- as Fed funds move. In the commercial space, we're definitely seeing business treasures thinking a lot more about how they're getting paid for their excess balances. And there's more conversation about what kind of earnings credit rates are appropriate given the balances that they have. And the discussions of moving more balances into sweep is -- those conversations are happening more frequently than they were 2 quarters ago. So you can see that coming. On the consumer side, when we look at what's going on there, there continues to be less action in interest checking and savings and decidedly less in the money market space with the exception of the online banks. But that, from our experience, is pretty typical for this point in the cycle that, when rates start to move up, the action tends to be in certificates of deposit. And that's where we've kind of seen most of the competition. We've talked a little bit about that over the last couple of quarters that it -- so far, the price competition has tended to be at the shorter end of the curve where there's some steepness. It's tended to be 12 months or less. Starting to see a little bit of creep towards 18-month CD prices, but otherwise, not much at the longer end of the curve given the relative flatness of it. So those are kind of the places, I think, we're starting to see it. And when we run our sensitivity models, we think in 25 basis point increments. So we're about where we thought we'd be, maybe slightly slower with the last 25 basis points. But you can definitely feel things are starting to get a little closer to when we'll see a turn.

Darren, if that's the case, your NIM response has been at the upper end typically of the 5 to 8 basis points in response to a Fed move. Do you think we start moving towards the lower end of that range?

I think each one is appearing to be unique onto itself. But we would -- we continue to believe that somewhere in that range is the right place for the next 25 and likely the 25 after that. If something changes, we'll let you know. But I think that's a good expectation.

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

My first question is a follow-up on the excess capital question. As you think about where the stock is trading today on book, how should we think about how M&T's thinking on buybacks are evolving as valuation changes. And maybe a better way to ask it is could you help us get a sense of what your IRR is or earn-back period is on your stock buybacks at current levels?

Sure. I guess, as we look at our capital position and we think about where we sit, well, we start from a macro perspective, which is we want to deploy that capital obviously in the business. And the best way to deploy it is through customer growth and loan growth, which we know where that's been for the last few quarters, although we did see some uptick. But we're always thinking about how much capital we'll need, not just for what we have on the balance sheet today but future growth. And then after that, we have excess. And the question then is how best to deploy it between dividends and share repurchases or special dividends. When you look at our dividend right now, it's set to increase by $0.05 a share this quarter. That was approved in last year's capital plan. But after the tax rate changes, our dividend payout ratio is going to be below probably 20% -- around 25%, maybe slightly below 25%. And we've historically been higher than that in kind of 27% to 33% range, so we should expect some movement there. And then we've got what's left over. And we've never been an organization that has held onto excess capital just in case. And if there's no loan growth, then the only other place to deploy it is on M&A. And given the prices of other organizations and the risk involved that we think it's a better risk-return tradeoff right now for us to buy back our own stock than it is to either sit on it or go chasing ill-advised deals. And so that's how we think through our buyback from the top of the house and where we get to on our decision to deploy and to buy.

That was very clear. And just a follow-up to all the margin questions that you've gotten. Could you remind us on the asset side, your wholesale variable-rate exposure. Is the benchmark rate more 1-month or 3-month LIBOR? And while it's small for you, also wondering, on the long-term borrowing side, if some of that exposure has been swapped out to floating rate. And if so, if it tends to 1-month or 3-month LIBOR.

Sure. So on the debt side, that's easy. It's all been swapped to floating, and it's based on 3 months. And when you look at the asset side of the balance sheet, generally, our book is priced off of 1-month LIBOR. There are some consumer loans. Obviously, they're priced off of prime, which is really Fed funds. But 1-month LIBOR tends to be the pricing basis for other loans.

Your next question comes from the line of Geoffrey Elliott of Autonomous Research.

When you were talking about credit, you touched on leverage as being a driver of the issues that you have seen even though, at this point, they're pretty infrequent. Can you just elaborate a little bit on that leverage comment? What specifically have you been seeing?

Sure. So if you happen to read René's letter to shareholders, we talked a lot -- he talked a lot in the letter about changes that are happening in the structure of the market and covenant reductions and leverage. And when we've gone through our credit, which we do at the end of every month and look at the various situations that are challenged, leverage has tended to be a place where -- we haven't charged anything off, but that's where we're -- things are criticized and where we've got an eye on it. And it tends to be where the credit to EBITDA and the debt service coverage ratios are moving into a range where they're certainly above what you would think or where we've seen traditionally our book and on both of those measures. And that's really where the comment came from that that's -- for the things that we're seeing, that's the common theme. And it's not inconsistent with some of our observations about the macro market in general. Just thankfully, we have less of it in our book than the average.

And then maybe following up on that, do you guys have a sense of where you think we are in the macro cycle? I know it's clearly something that matters a lot to you. There are indicators that you watch internally that you think are helpful in giving a steer on that, that you can talk about.

I guess, there's not a specific internal measure that we look at and say we're early, mid- or late in the cycle. But I'll give you some thoughts because it's a source of internal debate about where we are. And I think some of the macro signals are giving us different messages about where we are in the cycle. So when we're -- the #1 thing that has always kept us out of trouble and kept our charge-offs where they are is our focus on returns. And because we think about returns when we're looking at and evaluating credit decisions, we need to get comfortable with the risk/reward for the decisions that we're making. And we'd seen some challenges in that over the last 6 months, seemed like the things got a little bit better after tax reform. But when we were looking at pricing and covenants and collateral levels, there was some signal saying, uh oh, things are getting a little bit challenged. When you compare that to where GDP is and how much of a rebound there has been in just total economic activity since the last recession, this recovery is still not all the way back and to what you would see typically postrecession. But when you look at the time since the recession, it would suggest that we're way far along and that we're towards the end. So we got some signal saying we still got room to go when, obviously, we got the backdrop of the stimulus that's happened from Washington on the positive side, meaning there's still some room to run. And then when you look at where spreads are moving and where covenants are moving, these things tend to happen later in the cycle when people start grasping for growth. So that's the thought process and the observations that we have behind where we are in the cycle. Our own view is probably we're at least mid- and moving towards late, but I don't think we're all the way to the late yet. It probably got extended a little bit given the changes that recently have gone through in Washington.

Your next question comes from the line of Brian Klock of Keefe, Bruyette, Woods.

So Darren, sorry to ask another question on the guidance around NII. But since I think when you guys gave guidance for the full year on the fourth quarter call, you said about 3% was the sort of year-over-year modest NII growth. Is that the same level we should be thinking about when you say modest year-over-year growth?

I think when we gave that, we were anticipating a slightly slower rate of increase in Fed funds and, therefore, what we might see on margin expansion. When we look over the course of the year, I guess, we're probably thinking 3% to 4%, probably more like 4% now given where rates have gone, offset a little bit by the flattish balance sheet, which Fed expectation hasn't changed that much from where we were at the end of the year and a little more positive on net interest margin, given where the Fed funds it has gone and is projected to go.

Got it. That makes sense. And then, I guess, a follow-up to that, average earning assets, obviously, you talked about some of the movement in with some of the trust deposits, et cetera, but the expectation was, today, you said average loan growth to be flat to slightly up. Do we still think average earning assets could be flat year-over-year?

It's a tough one to handicap, Brian, just because of the movement in that one category of assets that are sitting at the Fed. And those relate to trust demand, which is really a function of market activity that we have within our -- with the businesses in our global capital markets business. And that's really what adds a lot of volatility to the total asset picture. I guess, the good news is when those assets drop, the margin goes up. But obviously, the reverse is true. When you look at their impact on NII, it's really not that great. And really where we spend most of our time watching is the core loans and the loan categories and where we anticipate that coming out over the course of the year. And that's really where we expect that flat-to-modest increase back-end weighted like we've been talking about today and in January.

Your next question comes from Peter Winter of Wedbush Securities.

End-of-period loans were still slightly below the first quarter average, and I'm just wondering if you could talk about what loan growth did in the month of March.

So our loan growth in the quarter was pretty consistent with what was in the H.8 data from the Fed in that it was a little bit back-end loaded, a little bit better in March than we saw in January and February. You can get some movement in end-of-period balances, depending on some business that sits within our real estate realty capital corp, where assets are waiting to go off to Fannie and Freddie, and that can cause some end-of-period fluctuation. But overall, during the quarter, we saw progressively better loan growth, particularly in C&I, as the quarter went on.

All right. And just very quickly, will the tax rate go back to that range of 25% to 26% going forward?

Yes. Over the course of the year, we think that's a good range. Obviously, we gave that range because the effects and specifics of the tax changes were unknown. And this quarter was impacted by that accounting change that actually went into effect last year. But otherwise, we think that's still a appropriate range to be thinking about.

Your next question comes from Marty Mosby of Vining Sparks.

Quick statement and then a question. I think we've changed our tail around a lot on this bench margin and balance sheet when, in reality, you just have transient deposits that go in and out. My margin was off by 10 basis points, but my earning assets were too high. And so once you make that adjustment, our NII number was exactly what it was -- what you came out with this quarter. So it really is just these kind of pop in and out that then create incremental, very low-yielding, low-spread kind of assets that mess with the margin but not net interest income. Then my question is, you've got about 40% of your funding that comes from free funds, which is one of the highest amongst our coverage. And if you look at that on the bottom of your rate page, we have contribution of interest-free funds. It was 19 basis points last year, and it's up to 24 basis points this year. Is that 5 basis points, which I think has been a positive and will continue to be a positive lift to your margin, included in this kind of 25 basis point Fed gives you 5 to 8 basis points? Or is that kind of a lagging effect that you get after the fact as your asset yields roll higher?

Marty, thanks for the statement. You nailed it with that comment about the relationship between the margin and the earning assets. As it relates to the contribution of interest-free funds, that's something that we think about when we're going through our asset liability models and sensitivity and is factored into the 5 to 8. The impact you see down here is the effect after all the changes that happened in the other categories and calculated into the net interest margin. That effect will obviously change quarter-to-quarter, depending on what percentage of the funding those balances make up. And as you pointed out, we've got a very strong percentage of the balance sheet that's sitting in noninterest-bearing deposits, a function of our strong commercial balances as well as some of those trust demand balances that will go in there and move around from quarter-to-quarter. When we look at that on a go-forward basis and we think about it in our asset liability modeling and in our sensitivity, we probably spend more time there thinking about will those balances shift into other categories like sweep or interest-bearing as opposed to, obviously, paying a price there, paying rate specifically for them. And that's how it gets factored into the -- into that 5 to 8.

No, it just can take longer for that to be realized, and that 5 to 8, it kind of feels like a instantaneous next quarter kind of projection. So it could be that we're getting just a little bit more towards the upper end of that range because some of this is still spilling over from prior hikes that we're getting down the road. But thanks, and I appreciate the feedback.

I think there's a little bit of that, Marty, and I think -- don't forget the other thing that happened this quarter, in particular, was how 1-month LIBOR moved so far in advance of Fed funds that, that also helped, in a good way, push us above that target range or that range that we had given as a rule of thumb. I think without that, we probably would have been more like the 8 as of -- certainly, not all the way down to the 5 for some of the reasons that you cited, but that had a positive impact on the margin this quarter.

Your next question comes from Saul Martinez of UBS.

Just building on the commentary on leverage. And I guess, it's a bit of a broader question. But to what extent is elevated leverage amongst commercial borrowers already negatively impacting credit demand and limiting the extent to which loan growth rebounds? Or can it limit the extent loan growth rebounds even if we do see paydowns normalize, even if we do see the economy and GDP growth perk up and CapEx pick up? Does it -- are we at a level where -- or are we at a point where maybe commercial loan growth is more subdued than nominal GDP growth because leverage has built up in the economy over a number of years?

It's a great macroeconomic question. I think when you look at the banks versus the nonbanks, the rules on leverage and what's considered an HLC by the Fed would have pushed a lot of the leverage that might have existed in the banking system into the nonbanking system. Since the rules changed, how much that's impacting loan growth perhaps at the higher end of the C&I spectrum where they would have tended to access the public markets and the capital markets to issue bonds and use leverage, I think as you move down the spectrum, you would tend to see a little bit less of that impacting demand. But obviously, the big balances come from those larger customers. So you're probably on the right track with your thesis of overall loan growth being impacted by that because of the impact of the bigger customers and bigger balances. It probably makes sense that when you look at where loan growth is, large banks versus small banks in the H.8 that's I'm sure part of the reason why you see that difference in growth rate in those 2 categories.

Yes. Interesting. I guess, a little bit more of a mundane question. Any update on the runoff of the Hudson -- the higher-cost Hudson City deposits, where we are in that process? And how much of, I guess, of a tailwind from a funding cost standpoint there is still left?

Sure. We are getting largely through that portfolio. We're down to about 25% of our Hudson City-related time deposits that have yet to reprice. So we're 3/4 of the way through that. And what's interesting is when you look at the movement in Fed funds and the slow increase in the price we're paying or the rate we're paying on what we would call legacy or non-Hudson City time deposits, they're creeping up. And the Hudson City ones have been creeping down, and we're almost at a point where they're in sync. And so there's probably a little bit more tailwind on Hudson City deposits and their impact on our total cost of funds, but we're getting to the point where those 2 are going to converge. And likely at some point this year, we'll see time deposits bottom out and start to go the other way just because of where we are in the rate cycle.

Your next question comes from Gerard Cassidy of RBC.

If we take a look at your history, you've done a great job in making acquisitions. And I know they're opportunistic and episodic, but can you give us some color on what you're seeing out there for potential acquisitions? I know you guys don't go into bidding or auction wars or so on and so forth. But what's your guys' feel on what you're seeing from an opportunity to maybe to be able to get back into mergers and acquisitions in the next 12 to 18 months?

Sure, Gerard. We're certainly hopeful that the market starts to come back. From what we see and hear, there's some discussions but nothing that really seems serious at this point. I think there remains to be or remains a bit of a discrepancy between seller expectations versus buyer expectations with regard to price. And that's probably not unreasonable given where we are in the credit cycle, in the rate cycle, right. That credit is as good as it's going to be, but everyone thinks that will continue on forever and rates are going up and margins continue to expand. So people feeling pretty good about their prospects for the future, which is impacting the price they might be willing to accept to partner with M&T or any other buyer, for that matter. So we're certainly hoping to be back in the game. But as Bob always said, and those words ring clear, banks are sold not bought and you need a willing seller to -- for something to happen. And based on where things are, right now, it seems like there'll be continuing discussions. But I suspect not a lot of action in the short term.

Your next question comes from Christopher Spahr of Wells Fargo.

This is regarding your technology strategy and your measured approach. Can you compare that to your approach with the AML issue? Are you using a lot of in-house or third-party people to kind of execute that? And a follow-up question. Can you give some metrics so that we can see the progress, such as the number of users that are active online or mobile users?

Sure. So when you think about how we execute technology projects, we have a combination of in-house resources and outside contractors. And the mix is probably around 60-40, 60% inside, 40% outside. But that can vary dramatically on the nature of the project that's being worked on. There are some instances where it might be newer technology where we need to augment our team with more outside expertise, and then part of the mission of the project is to have knowledge transferred from the outside party to inside. And then there's other ones where it's primarily inside. If it's an existing system where we have folks that have been -- care and feeding of that system over the years, then those upgrades or changes and enhancements will be done primarily with inside folks. As you look out at everything that's going on in the world and the pace of change, I think it was also a comment in René's shareholder letter that we're thinking a little bit more about outside partnerships and reevaluating those as a way to move a little bit more quickly. And so there, you would see a slightly different mix than we might have in the past between inside and outside resources. But in general, 60-40 is probably a good way to think about it. And when I think about mobile adoption -- I'm looking around for -- I'll have to have Don get back to you on what the exact number is. But our mobile adoption rates continue to grow each quarter. I want to say we're in the mid-30s percent of active checking account users that are active on mobile. And active would mean they'd sign on more than once in a month. But we can go back and we'll get some more exact figures on that.

Your next question comes from the line of Frank Schiraldi of Sandler O'Neill.

Just a couple quick ones. I just wondered if you had any -- or give any color on geographic trends you're seeing in loan growth in the quarter. Any surprises there in terms of where you're seeing the loan growth, either positive or negative?

We had some -- when we look at loan growth by geography, both C&I and CRE, we didn't really see a ton of difference by geography for C&I. For CRE, we saw a little bit more growth in New Jersey, in Upstate New York, and in metro or New York City. I guess, when we looked more by industry or type rather than by geography, that's where we saw some interesting trends. We see continued demand for warehouse space for multifamily and also growth in assisted living and skilled nursing. And I guess, when we stood back after we went through those and thought about some of the macro trends that are going on, it actually made a lot of sense that as retail gets impacted and business shifts to the internet that warehouse capacity is more in demand because that's how customer needs are being fulfilled. As the population ages, obviously, you need a little bit more assisted living and skilled nursing. And then one of the other macro trends that continues is people are coming back into urban centers, particularly the millennials and empty-nesters. And that's driving demand for multifamily. So it really kind of made a lot of sense to us when we looked back at where the -- where some of the action was.

Okay. Great. And then just finally, wondered if you could give any color on what I'd call sort of the noncore items in the quarter. The increase in litigation reserve was fairly sizable, I thought especially given a recent disclosure in the 10-K in terms of potential liability from ongoing litigation. And then secondly, just the Bayview distribution, if we should just look at that really as just a one-off here.

Sure. So on the litigation expense, I really don't have any other comment on that other than what we said earlier in the call and in the earnings release as it relates to ongoing matters. So we'll comment on that. When you look at the Bayview distribution, that was a distribution that we hope will happen on an annual basis, but it's going to be based on the performance of that organization. We have an ownership stake. And as they make distributions to the other partners, we get a proportional distribution as well. We're hopeful that it will -- that they will continue, but the timing and the magnitude are hard to predict.

Does that -- did that distribution come back? Or the positive outcome, I guess, you saw in the distribution this year, is that reflective of the securitization market coming back and their core business coming back for Bayview?

No, not really. When you look at Bayview over the course of the last decade, I guess, since the change in the financial crisis, they've kind of reinvented themselves in how they run their business. They took a lot of the expertise that they had in mortgage lending and changed it into other related activities. And that's part of what we're seeing in the turnaround in their results and, therefore, in us receiving a distribution.

Thank you. I will now return the call to Don MacLeod for any other short closing remarks.

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

Thank you. That does conclude the M&T Bank First Quarter 2018 Earnings Conference Call. You may now disconnect.