M&T Bank Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
January 19, 2023

There are 9 speakers on the call.

Operator

Welcome to the M&T Bank 4th Quarter and Full Year 2022 Earnings Conference Call. All lines have been placed on listen only mode and the floor will be open for your questions following the presentation. To allow for optimal sound quality. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Brian Clock, Head of Market and Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, Gretchen, and good morning. I'd like to thank everyone for participating in M&T's 4th quarter and full year 2022 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 by going to our website, at www.mtb.com. Once there, you can click on the Investor Relations link and then on the Events and Presentations link. Also before we start, I'd like to mention that today's presentation may contain forward looking information.

Speaker 1

Cautionary statements about this information as well as reconciliations of non GAAP financial measures

Speaker 2

are

Speaker 1

included in today's earnings release materials as well as our SEC filings and other investor materials. These materials are also available on our Investor Relations webpage, and we encourage participants to refer to them for a complete discussion of forward looking statements and risk factors. These statements speak only as of the date made and M and T undertakes no obligation to update them. Now I'd like to turn the call over to our Chief Financial Officer, Darren Kaye. Thank you, Brian, and good morning, everyone.

Speaker 2

As we reflect on 2022, We want to start by taking a moment to recognize the hard work and dedication of our more than 22,000 colleagues. Your tireless efforts to support our customers and communities during challenging times are the heartbeat of M and T. We also give a shout out to number 3 and the early responders who saved his life. You remind us all about the bigger game of life. A year ago, we outlined 3 key objectives for 2022: complete our long awaited merger with Peoples United deploy excess liquidity to reduce asset sensitivity while protecting shareholder value and to distribute capital that isn't required to support lending in our communities.

Speaker 2

Achieving those objectives, we believe, aligns with our goal to build a customer focused bank and resultant balance sheet that produces consistent predictable earnings over long periods of time. Against those objectives, here are a few key highlights of the work done in 2022. We closed the acquisition of People's United, the largest in our history. We also completed the systems conversion and continue the process of integrating this valuable franchise. The financial benefits of this combination are consistent to slightly better than our expectations at announcement.

Speaker 2

We repositioned the balance sheet to deploy excess liquidity, reducing our interest bearing deposits held at banks from $41,900,000,000 at the end of 2021 to under $25,000,000,000 at the end of 2022. In deploying that excess liquidity, we reduced costly wholesale funding. We organically, that is excluding the impact of Peoples, Grew loans by $4,100,000,000 and added $7,000,000,000 in net investment securities growth. These efforts, which also included the retention of most of the residential mortgage production as well as the acquired Peoples United $12,000,000,000 longer duration securities portfolio have led to a reduction in asset sensitivity, helping to protect our net interest margin from future rate shocks. In terms of capital, we resumed common share repurchases in last year's Q2, now having repurchased $1,800,000,000 in common stock, representing 6% of outstanding shares and our common dividend grew by 7% in 2022, representing the 6th year of consecutive increases.

Speaker 2

And despite the impact from the acquisition and the rapid rise in long bond yields, Our CET1 ratio remains strong at 10.4%, which continues to exceed our median peer bank. Our hard work translated into strong full year financial results. GAAP based diluted earnings per common share, which include merger related charges, were $11.53 compared to $13.80 in 2021, down 16%. Net income was $1,990,000,000 compared with $1,860,000,000 in the prior year, improved by 7%. These results produce returns on average assets and average common equity of 1.05% and 8.67% compared to 1.22% and 11.4% respectively in 2021.

Speaker 2

We note that these results were impacted by merger related expenses associated with the Peoples United transaction. Such expenses amounted to $580,000,000 in 2022 or $2.63 per share. Those same expenses were $44,000,000 or $0.25 per share in 2021. In accordance with the SEC's guidelines, this morning's press release Consistent with our long term practice, M and T provides supplemental reporting of its results on a net operating or tangible basis from which we have only ever excluded the after tax effect of amortization of intangible assets as well as any gains or expenses associated with mergers and acquisitions. We believe this information provides investors with a better picture of the long term earnings power of the combined institution.

Speaker 2

Operating income, which excludes the after tax impact from the amortization of intangible assets as well as merger related expenses, was $2,470,000,000 during 2022, up 30% compared to what with $1,900,000,000 in the prior year. Net operating income per diluted common share was $14.42 compared with $14.11 in 2021, up 2%. Net operating income for 2022 expressed as a rate of return on average tangible assets and average tangible common shareholders' equity was 1.35% 16.7%. This compares with 1.28% and 16.8% respectively in the prior year. On a net operating basis, we generated 4% positive operating leverage and 43% growth in pretax pre provision net revenue.

Speaker 2

This was due in large part to the $2,000,000,000 or 53% increase in taxable equivalent net interest income as the net interest margin increased some 63 basis points year over year. We are pleased with the results we achieved in 2022 in the face of many challenges, not the least of which was a rapid shift in monetary policy. But our work is not done. We will continue to recognize the value created by our merger, while building a more capital efficient, less asset sensitive balance sheet that will produce stable and predictable revenue and earnings over the long term. Let's take a look at the results for the Q4.

Speaker 2

Diluted GAAP earnings per common share were $4.29 in the Q4 of 2022, up 22% compared to 3 point $0.53 in the Q3 of 2022. Net income for the quarter was $765,000,000 18% higher than the $647,000,000 in the linked quarter. On a GAAP basis, M and T's 4th quarter results Produced an annualized rate of return on average assets of 1.53% and an annualized return on average common equity of 12.59%. This compares with rates of 1.28% and 10.43% respectively in the previous quarter. Included in GAAP results were after tax expenses from the amortization of intangible assets amounting to $14,000,000 in each of the 2 most recent quarters, representing $0.08 per common share in both quarters.

Speaker 2

Pre tax merger related expenses of $45,000,000 related to the Peoples United acquisition were included in the 4th quarter's GAAP results. These merger charges translate to $33,000,000 after tax or $0.20 per common share. M and T's net operating income for the 4th quarter, which excludes intangible amortization and the merger related expenses was $812,000,000 up 16% from the $700,000,000 in the linked quarter. Diluted net operating earnings per common share were $4.57 for the recent quarter compared to $3.83 in 20 22's Q3. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 1.7% and 21.3% in the recent quarter.

Speaker 2

The comparable returns were 1.44% 17.89% in the 3rd quarter of 2022. Both GAAP and net operating earnings for the Q4 of 2022 were impacted by certain noteworthy items. 4th quarter results included a $136,000,000 gain related to the sale of M and T Insurance Agency reported in other revenue from operations as well as $135,000,000 contribution to M and T's Charitable Foundation reported in other costs of operations. These items collectively net and did not materially impact net income. Let's take a deeper dive into the balance sheet and the net interest margin.

Speaker 2

Taxable equivalent Net interest income was $1,840,000,000 in the Q4 of 2022, an increase of $150,000,000 or 9% from the linked quarter. The increase was driven largely by the $143,000,000 impact from higher rates on interest earning assets, inclusive of the effect from interest rate hedges. Incremental $19,000,000 from volume and mix of earning assets, partially offset by a $12,000,000 reduction in interest received on non accrual loans. Net interest margin for the past quarter was 4.06%, up 38 basis points from the 3.68% in the linked quarter. The primary driver of the increase to the margin was higher interest rates, which we estimate boosted the margin by 32 basis points.

Speaker 2

In addition, the margin benefited from a reduced level of cash held on deposit at the Federal Reserve, which we estimate added 6 basis points. Total average loans and leases were $129,400,000,000 during the Q4 of 2022, up 1.5% compared to the linked quarter. Looking at the loans by category, on an average basis Paired with the Q3, commercial and industrial loans and leases increased by $1,700,000,000 or 4.5 percent to $40,000,000,000 With $1,200,000,000 or 4% growth being broad based across our core commercial banking clients and 5.42 $1,000,000 or 22 percent growth in average dealer floorplan balances. During the Q4, average commercial real estate loans decreased by $592,000,000 or 1 percent to $45,700,000,000 driven largely by declines in average construction loans. On an end of period basis, construction balances increased slightly from the linked quarter.

Speaker 2

Permanent average commercial mortgage balances or nearly flat quarter over quarter. Residential real estate loans increased $372,000,000 or about 2% to $23,300,000,000 due to the continued retention of new mortgage originations retained for investments, partially offset by normal amortization. Average consumer loans were up $384,000,000 or about 2% to $20,300,000,000 Recreational finance loan growth Continues to be the main driver. These average loans grew $325,000,000 or 4%. Average earning assets excluding interest bearing cash on deposit at the Federal Reserve increased by $3,200,000,000 or 2% due to the $1,900,000,000 growth in average loans and $1,400,000,000 increase in average investment securities.

Speaker 2

Average interest bearing cash balances decreased by $5,700,000,000 to $25,100,000,000 during the Q4 of this year, essentially in line with our projections. The sequential quarter decline was due to the drop in deposit balances and the cash deployed to fund loan growth and to purchase investment securities. Average deposits decreased $3,800,000,000 or 2% compared with the 3rd quarter. Our efforts to grow and retain deposits has helped reduce the rate of decline compared to recent quarters. However, due to the rapidly rising rate environment and increased competition for deposits, There has been a mix shift within the deposit base to higher cost deposits.

Speaker 2

Average demand deposits declined $2,600,000,000 Savings and interest bearing checking deposits declined by $2,300,000,000 partially offset by a $1,100,000,000 increase in time deposits. Average commercial deposits declined $4,800,000,000 as business owners shifted Bunny into both off and on balance sheet sweep accounts, paid down debt and main distributions. On balance sheet sweep average balances increased $2,500,000,000 during the Q4 of 2022. Turning to non interest income. Non interest income, Excluding the $136,000,000 gain from the sale of the M and T Insurance Agency, totaled $546,000,000 in the 4th compared with $563,000,000 in the linked quarter.

Speaker 2

Trust income was $195,000,000 in the recent quarter, up 4% from the $187,000,000 in the 3rd quarter. The increase was due largely to the impact of better market valuations on assets under management and administration. Service charges on deposit accounts were $106,000,000 compared with $115,000,000 in the 3rd quarter. The decline primarily reflects the waiver of service charges in October November on acquired customer deposit accounts. These service charges were also waived in September.

Speaker 2

Mortgage banking revenues were $82,000,000 in the recent quarter, down 2% from the linked quarter. Revenues from our residential mortgage business were $54,000,000 in the 4th quarter compared with $55,000,000 in the prior quarter. Both figures reflect our decision to retain the substantial majority of mortgage originations for investment on our balance sheet. Commercial mortgage banking revenues were $28,000,000 in both the 3rd 4th quarters. That figure was $49,000,000 in the year ago quarter.

Speaker 2

Other revenue from operations excluding the gain from the sale of the Amity Insurance Agency were 100 and $31,000,000 down $22,000,000 sequentially. The decrease was due to the impact of 2 fewer months of revenues related to the EMT Insurance Agency, which was sold in October lower commercial loan fees reflecting lower capital markets activities and a write down on the underlying assets in certain bank owned life insurance contracts. Turning to expenses. Operating expenses for the 4th quarter, which exclude the amortization of intangible assets and merger related expenses were $1,350,000,000 or $138,000,000 higher than the linked quarter. This increase was largely due to the $135,000,000 charitable donation in the 4th quarter.

Speaker 2

Excluding merger related expenses, salary and benefits expense decreased by $30,000,000 due to one less business day, the realization of acquisition synergies and the impact of the sale of the M and T Insurance Agency. The quarter included $21,000,000 in higher sequential advertising and outside data processing and software expenses. Both of these categories tend to show some degree of seasonality. The efficiency ratio, which excludes intangible amortization and merger related expenses from the New Charities gains or losses from the denominator was 53.3% in the recent quarter compared with 53.6% in 20 22's 3rd quarter and 59.7% in the Q4 of last year. Next, let's turn to credit.

Speaker 2

Despite the challenges of labor shortages and persistent inflation, credit remains stable. The allowance for credit losses amounted to $1,930,000,000 at the end of the 4th quarter, up $50,000,000 from the end of the linked quarter. In the Q4, we recorded a $90,000,000 provision for credit losses compared to the $115,000,000 provision in the 3rd quarter. Net charge offs were $40,000,000 in the 4th quarter compared to $63,000,000 in last year's Q3. The baseline macroeconomic forecast experienced nominal deterioration during the Q4 for those indicators that our reserve methodology is most sensitive to, including the unemployment rate, GDP growth and residential and commercial real estate values.

Speaker 2

At the end of the Q4, non accrual loans were $2,400,000,000 and represented 1.9% of loans, essentially unchanged from the end of the As noted, net charge offs for the recent quarter amounted to $40,000,000 Annualized net charge offs as a percentage of total loans were 12 basis points for the 4th quarter compared to 20 basis points in the 3rd quarter. Owns 90 days past due on which we continue to accrue interest were $491,000,000 at the end of the recent quarter compared to $477,000,000 sequentially. In total, 74% of these 90 days Past due loans were guaranteed by government related entities. Turning to capital. M and G's common equity Tier 1 ratio was an estimated 10.4% compared with 10.7% at the end of the 3rd quarter.

Speaker 2

The decrease was due in part to the impact of the repurchase of $600,000,000 in common shares, which represented 2% of our outstanding common stock as well as growth in risk weighted assets. Tangible common equity totaled $14,700,000,000 up slightly from the end of the period of the prior quarter. Tangible common equity per share amounted to $86.59 up 3% from the end of the 3rd quarter. Now turning to the outlook. As we look forward into 2023, we expect that inflation and higher interest rates will continue to impact the bank and our customers.

Speaker 2

We believe we are well positioned to sustain a strong net interest margin and pretax pre provision net revenue to risk weighted assets with our goal to generate top quartile return on average tangible common equity. As a reminder, the acquisition of Peoples United closed on April 1, 2022. Thus, The outlook for 2023 includes 4 quarters of operations and balances from the acquired company compared to only 3 quarters during 2022. This 2023 outlook also reflects the sale of M and T Insurance Agency that closed in October of 2022. During the 1st 9 months in 2022, this business recorded revenues of $31,000,000 and the results of its operations were not material to M and T's net income.

Speaker 2

Additionally, in December, our subsidiary Wilmington Trust, N. A. Announced the sale of its collective investment trust business. Trust income associated with this business totaled $165,000,000 in 2022 and after considering expenses, The results of operations from this business were not material to M and T's net income. Sale of this business is expected to close in the first half of First, let's talk about our net interest income outlook.

Speaker 2

We expect taxable equivalent net interest income to grow in the 20 3% to 26% range when compared to the $5,860,000,000 during 2022. This range reflects different rates of deposit balance growth, deposit pricing and loan growth. Consistent with the current forward curve, Our forecast incorporates 2 25 basis point Fed Funds hikes in the Q1 of 2023 and 1 25 basis point cut in the 4th quarter. Key driver of net interest income in 2023 We expect continued intense competition for deposits in the face of industry wide outflows. Full year average total deposit balances are expected to be down low single digits compared to the $158,500,000,000 during 2022.

Speaker 2

In order to offset deposit declines and to ensure a stable liquidity profile, we plan to issue senior debt during 2023. We continue to expect deposit mix to shift toward higher cost deposits with declines expected in demand deposits and growth in time deposits as well as on balance sheet sweeps. This is expected to translate into a through the cycle deposit beta in the high 30% to low 40% range. Next, let's discuss the drivers of earning asset growth. We currently plan to grow the securities portfolio by $4,000,000,000 compared to the $25,000,000,000 balance at the end of 2022, with the addition of longer duration mortgage backed securities throughout the year.

Speaker 2

Next, turning to the outlook for average loans. We expect average loan and lease balances during 2023 to grow in the 8% to 9% range when compared to the 2022 full year average of $119,300,000,000 This implies total average loan and lease balances in the Q4 of 2023 to be flat to slightly up from the $129,400,000,000 average during the Q4 of 2022. Mix of C and I, CRE and consumer loans, inclusive of consumer real estate loans, is almost 1 third each at the end of 2022. We expect this trend to shift slightly as C and I growth outpaces CRE. As we've seen during the second half of twenty twenty two, higher levels of interest rates are expected to slow down the growth in our consumer loan book in 2023.

Speaker 2

Turning to fees. Excluding the $136,000,000 gain on the sale of the M and T Insurance In the Q4 of 2022 as well as securities losses, non interest income was $2,230,000,000 in 2022. We expect 2023 non interest income growth to be in the 5% to 7% range compared to 2022. The outlook for 2023 reflects approximately 10 months of foregone income from M and T Insurance Agency as a result of the sale. Overall, mortgage banking revenues are expected to be up 5% to 7% compared to 2022.

Speaker 2

Commercial mortgage banking revenues are expected to rebound in 2023, and we will return to a gain on sale residential mortgage banking model in 2023. However, with the high level of interest rates, We expect muted origination volumes and thus anticipate total residential mortgage banking revenues to be relatively stable compared to 2022. We expect service charges on deposit accounts to be 3% to 6% higher than 2022 and anticipate trust income to be 8% to 10% higher in 2023. Turning to expenses. We anticipate expenses excluding merger related costs, the charitable contribution and intangible amortization to be up 10% to 12% when compared to the $4,520,000,000 we experienced during 2022.

Speaker 2

Approximately half of this increase reflects an extra quarter of Peoples United Expenses. This outlook also incorporates the impact from the sale of the M and T Insurance Agency. We do not anticipate Any material merger related costs in 2023 and intangible amortization is expected to be in the $60,000,000 to $65,000,000 range during 2023. As a reminder, 1st quarter expenses will be elevated as a result of our typical Seasonal increase in compensation expense. For the Q1 of 2023, we anticipate an uptick in the range of $90,000,000 to $95,000,000 That amount last year was approximately $74,000,000 Turning to credit.

Speaker 2

We expect credit losses to be higher than the strong results in 2022, but to remain below M and T's Legacy long term average of 33 basis points. Provision expense over the year will follow the CECL methodology and will be affected by changes in the macroeconomic outlook as well as changes in loan balances. For 2023, We expect taxable equivalent tax rate to be in the 25% range. Finally, turning to capital. We believe the current level of core capital exceeds that needed to safely run the company and to support lending in our communities.

Speaker 2

We plan to return excess capital to shareholders at a measured pace. M and T's common equity Tier 1 ratio of 10.4% at December 31, 2022 comfortably exceeds The required regulatory minimum threshold, which takes into account our stress capital buffer or SCB. With a solid starting CET1 ratio and the potential to generate additional amounts of capital over the next few years, We don't expect to change our capital distribution plans. We anticipate continuing to repurchase Common shares at a pace of $600,000,000 per quarter under our current capital plan. Before we go to Q and A, I wanted to take a moment and reflect back on some comments made

Speaker 1

at the beginning of the call,

Speaker 2

where we reference number 3 and how he is winning the game of life. Sometimes numbers can be symbols with deeper meaning than what meets the eye, like the divine proportion. I'd like to take a moment and share what I see with some of these numbers. The first game after number 3 went to the hospital. Our team returned to kickoff.

Speaker 2

The first time it has done so in 3 years 3 months. 1st playoff game was won by 3 points. Number 1417 are key leaders on our team. The difference between 1417 is 3. That number seems to come up quite often.

Speaker 2

If you look at those key leaders and you drop the 1 In front of 14 and the one in front of 7, you're left with 4, 7. 47 is an interesting number. I know you're all thinking about the periodic table of elements. 47 is the atomic number of silver. The Vince Lombardi trophy is made out of silver.

Speaker 2

Is that interesting? But it gets even weirder. The symbol for silver is AG. If you reverse those letters, you get GA, which is the abbreviation for Georgia, The potential site of the AFC Championship. And all of this is happening in 2023.

Speaker 2

There's that number again. Probably just a set of random coincidences or is it? With that, let's open it up to questions.

Operator

We ask that you please limit yourself to one and one follow-up. We'll take our first question from Matt O'Connor from Deutsche Bank.

Speaker 1

Go ahead, Matt.

Speaker 3

No, we've got you.

Speaker 4

Okay. Sorry about that. I guess sticking with the 3s, I think at one point you talked about a long term NIM of 3.6 to 3.9. So there's 3 involved there and they're divisible by 3 and, so why don't we kick it off with that?

Speaker 2

All right. I guess, our outlook for the net interest margin over the long term hasn't changed, Matt. The question is what's the long term? And when we look at the structure of An average bank balance sheet and the mix of funding that is deposits or wholesale funding, Those costs tend to be pretty competitive and it's the mix that ultimately drives the margin over the long run. And when you look at where we see our balance sheet going and that of the industry, We think it's we're in a unique time right now, where pricing Has not kept deposit pricing has not kept up to rates on loans and that's ultimately going to close.

Speaker 2

And so will we see that in 2023, those numbers? Unlikely. But As we go into 2024 and 2025, will we start to see the margin move back down into those normal historic ranges? We think so. And the most important thing about why we talk about that is we don't want to set up the bank And the expense structure, assuming that margins like that are going to hold, because recent history suggests that's just not likely.

Speaker 2

If it happens to, that's great, but We don't want to build the bank so that we're counting on those kinds of margins for the expense run rate that we have.

Speaker 4

Okay. So 3 years once again, 3 popping up to normalize on the NIM. But did I miss any comments on the NIM for 23 or most importantly what you're modeling for the Q4 of this year? Thank you.

Speaker 2

For the 1st or the 4th, Matt, sorry.

Speaker 4

Both on the full year and then most importantly, the Q4 of 'twenty three, what are you thinking on the NIM? And then I think that would assume both the forward curve and then I think commercial loans tend to reprice a little bit sooner than maybe Fed funds move. So If you have a 4Q 2023 estimate and then framing the puts and takes, which, it's helpful, including with the repricing earlier of the commercial loans.

Speaker 2

Yes, sure. If you look at the year, based on our current outlook, we think the average NIM for the year stays above 4%. You probably see a little move up in the Q1 just because of the impact of day count. And so you'll see a pop up, but actually it's quite likely that net interest income in dollars might actually be lower will likely be lower in Q1 of 2023 than it was in the Q4 of 2022. Taking into account that forward curve that's relatively flat, but starts to See some cuts at the end of the year.

Speaker 2

We think the margin will be higher in the first half of the year than in the second half of the year and probably heads down towards 4% as we get to the Q4 of 2023.

Speaker 4

Okay. Thank you very much.

Operator

Our next question comes from John Pancari from Evercore ISI.

Speaker 3

Good morning.

Speaker 2

Good morning, John.

Speaker 5

Also, I want to see if you

Speaker 3

could talk a little bit about any efforts here to protect The NIM at that level, particularly as we look at potential cuts in the Fed pivot, anything in terms of balance sheet positioning that we Should be considering in terms of, how much you're already doing to protect the NIM at these levels?

Speaker 2

Yes. There's a few things, John, that we've been working on all this year to start to protect the NIM. First, you've seen us increase the size of the securities portfolio, and we've talked a little bit about growing that a little bit further in 2023. Within there, we also anticipate shifting the duration a little bit. We've taken some duration So far, in on the balance sheet in the mortgage portfolio, we'll slow that down and we'll take that duration in the securities portfolio with some MBS.

Speaker 2

We'll also be doing we mentioned some term funding, which we'll lock that in, which will also help. And then the thing that ultimately is the biggest benefit to maintaining the margin and reducing asset sensitivity is deposit pricing, Right. And so it's a little bit painful when it's compressing on the way up, when it's catching up to the loan pricing. But ultimately the best way to combat declining rates is through repricing of deposits. And so those three things would be the biggest help.

Speaker 2

We will and continue to have a hedge portfolio that helps reduce Some of the asset sensitivity in the short term might help the NIM as some of the earlier hedges, that were put on that are a lower received fixed rate roll off. And so those are kind of the 3 major things that will have helped us reduce our asset sensitivity and will help us protect the NIM at these kind of higher levels as time goes on.

Speaker 3

Okay. So no major change in terms of the hedging, the swaps other than what is rolling off, correct? Yes.

Speaker 2

We'll see how much we grow from where we are at the end of the first quarter, because of the position of the balance sheet and what we'll do will likely not be to add to outstanding notional, but to add to forward starting Is likely what we would do.

Speaker 3

Right. Got it. Okay. Thanks. And then just one other follow-up on the commercial real estate front.

Speaker 3

Could Maybe give us an update on what you're seeing there in terms of credit trends, maybe trends in delinquencies and criticized That's in any signs of stress in the office portfolio that would help. Thanks.

Speaker 2

Yes, sure. Within the Commercial Real Estate Portfolio, the biggest trend that we've had going on for probably the last four quarters is just the reduction in the construction portfolio. And so a large number of construction projects were originated in late 2018 and during 2019. And as the pandemic went, they continued, but at a slower pace. And those have been coming to completion this year.

Speaker 2

And as those have come to completion, they've turned into permanent mortgage financing, oftentimes, not on our balance sheet. And so you've seen the decline in commercial real estate largely being construction related. When we look underneath at some of the major categories and we look at the criticized, We actually have seen hotel criticized balances peak probably about 2 or 3 quarters ago. It got as high as about 86% of our Hotel portfolio is now down below 50%. And if we're seeing remixing in the criticized, there's 2 categories.

Speaker 2

1 is Healthcare, which we've talked about a little bit before, and that's typically, assisted living and senior housing. And That's not from a lack of demand that we're seeing, some challenges in that portfolio. It's their ability to staff. And so we've seen occupancy rates in these portfolios come up, post pandemic, But they're not able to get all the way back to pre pandemic levels because there's not enough staff to adequately care for the folks that want to live there. And then the other place, obviously, we're looking at is office, and we're paying a lot of attention to office.

Speaker 2

The portfolio, I think, is As of the end of the year, right around 20% criticized. We're watching lease expirations And lease sign ups. The vast majority of our real estate portfolio has lease expirations out 2024 and later. So far, what we've seen is decent renewing. We are seeing some movement down in Price per square foot, but what we've been doing is going through all of the lease portfolios or sorry, the office portfolios and stressing both vacancy rates and lease rates to see where the debt service coverage ratio is and what making sure that we've got adequate coverage.

Speaker 2

If we talk about our expectations for charge offs in as we go into this year. That's the place where we'd have the most concern. When we talk about charge offs moving up from The levels we've seen in 2022, it will be some of those portfolios. This is the place where we've really got our eye.

Speaker 3

Got it. Thank you, Darren. It's very helpful. And frankly, I hope the number 3 is the number of touchdowns that the Eagles win the Super Bowl by this year. But

Speaker 2

Hey, we appreciate that. It's been a long tough year

Speaker 6

up here.

Speaker 2

A little good news would be nice.

Operator

Our next question comes from Frank Schiraldi from Piper Sandler.

Speaker 3

Just wanted to ask about just I guess a follow-up on the office book. If you could just remind us where The total office exposure is and then specifically the exposure in New York City.

Speaker 2

Yes. Not a problem. You should you'll see this when the K comes out. But the office exposure in total, It's right around $5,000,000,000 When you look at what's in New York City, it's about 15% that would be New York City. Okay.

Speaker 2

It's pretty widespread across predominantly the Northeast.

Speaker 3

Okay. And then just to follow-up on Cree in terms of, I think you mentioned that the permanent Cree book was Sort of flattish linked quarter with construction balances, rolling off. And it sounded like, want to make sure I understand for 2023, is the expectation that that permanent CRE book will Grow, just to a lesser extent than the C and I book or do you still are you still looking for outflows, in that or thinking about outflows in that CRE book. Thank you.

Speaker 2

Yes. Overall, Frank, we're thinking that the overall CRE book Does continue to drift down, but at a much slower rate than what we've seen in 2022. It will be a modest decline. Well, on average, it's actually Going to be up because of the People's United. But if you look versus the Q4, the permanent book on average is relatively flat compared to where the Q4 was and most of the decline would continue to be in the construction side of things.

Speaker 2

And I'll remind you that the construction portfolio is the one that is one of the ones that tends to carry higher loss rates in the stress test, which is part of the reason why we've been working to obviously support our customers so that they can finish the projects, but then to not add meaningfully to that once those reach their completion and find permanent financing.

Speaker 3

Got it. Okay. Thank you.

Operator

Our next question comes from Ken Usdin from Jefferies. Go ahead, Ken. Our next question comes from Ebrahim Poonawala from Bank of America.

Speaker 5

Hey, good morning.

Speaker 1

Good morning, Mike.

Speaker 5

Thank you. Just maybe on the balance sheet, so you mentioned about $4,000,000,000 in securities purchases from $25,000,000,000 at year end. If you don't mind reminding us like what that implies for the cash balance as we think about on a steady state, I think cash was about $25,000,000,000 for For the Q4, is $20,000,000,000 the right place for you or where the bank expects to be and how much of that might go away from like deposits So just thought process around that.

Speaker 2

Yes. There will be some movement, Ebrahim, between cash and securities over the course of the year. If you look at the as at the end of the year, probably down In the $9,000,000,000 range, if you look at the average for the year, probably thinking slightly below $20,000,000,000 between $20,000,000,000 $19,000,000,000 is probably the spot. That number is going to move around a little bit, obviously, depending on outflows in deposits as well as our funding needs to support loan growth, as well as to make sure we're managing the bank's liquidity profile. And so those will move around a little bit over the course of the year, but those are kind of round numbers where we're forecasting 2023.

Speaker 5

Got it. And I'm sorry if I missed it. Did you you talked about issuing some debt. Did you quantify how much in debt do you expect to issue through the course of the year?

Speaker 2

I didn't mention a number. Obviously, This is dynamic, right? And that the amount is going to be a function of what's happening with deposit funding and runoff and whatnot. But Right now, we think it's in the $3,000,000,000 to $4,000,000,000 range over the course of 2023.

Speaker 5

And what would be the cost of the debt today given just the shape of the yield curve? I'm just wondering, is it better to lock in term funding relative to short term right now based on the

Speaker 2

market? Well, It's a great question. There's obviously, the rate is depending on the tenor, right? And right now, there's a you like The opportunity to reprice the shorter dated notes, but they're trading higher than the longer term debt. And so we think low to mid-5s is the range of yields on that, depending on the term.

Speaker 2

And what we'll be trying to do since we've really brought down the level of wholesale funding at the bank will be to Not lock in all in one tenor, but to start to build a more balanced maturity profile as we think about the funding of the bank so that we don't have massive Amounts coming due all at the same time. And so I think as you think about it, think about it not being all One tenor and one type of but something that starts to build a little bit of a profile that is spread out over the next few years.

Speaker 5

Got it. And just on a separate note, the CRE book or the CRE office, do you have the debt service coverage ratios handy in terms of where they were at the end of the year?

Speaker 2

I don't know that I have that right off the top of my at the tip of my fingers here. Give me one second and let me see if I can find it. But It has in aggregate, that portfolio has been has still been above 1. And when we look at the LTVs in that portfolio, they still run below 60% on a weighted average basis. Obviously, there are some above that and some below.

Speaker 2

But as we look at it right now and we look at the client's ability to support the asset either with cash flow or with How much equity they have in the property, we feel pretty comfortable with where we sit, But we're watching it. As we've talked about, there's it's one of the places where we see the most risk and where we're focusing a lot of our attention from a credit perspective.

Speaker 5

Thank you.

Operator

Our next question comes from Manon Gosalia from Morgan Stanley.

Speaker 7

Hey, good morning. I was hoping you can break down your loan growth guidance for next year. In the past, you've spoken about the lending synergies from the Peoples acquisition and the footprint there. I think you've mentioned Small Business Card and Equipment Finance. So just, if you could break down how you see that contributing to loan growth in 2023 and how you see that evolving?

Speaker 2

I guess as we look at people's impact on 2023 from a loan perspective, It's certainly additive, but it's one of those things where the loan balances take a little bit of a time to build and to show up in a material way. So when we look at 2023, we continue our focus on C and I, and we expect to see Strong growth in the C and I portfolio, in over 2023. On an average basis, it prints a big number because it's Four quarters of Peoples and not just 3. And so 20 ish percent over the average in 2022. But outside of that, it comes down a little bit more like into the 3% to 5% range.

Speaker 2

There's a bunch of pieces in there. One of the ones that we talked about that impacted the Q4 was our dealer floor plan business. And what we've seen is some inventory builds as The supply chains open up and consumer purchases slow down a little bit with rising rates and so we saw some movement there. We did see some broad based movement in our core commercial customer. The leasing business or We prefer to call our equipment finance business, continues to show steady growth, which would show up in the C and I balances.

Speaker 2

And then the other thing where we'll be intensely focused is on building out our Small Business and Business Banking segment. That's one of the places where we see a great opportunity in the New England franchise and to deploy our methods of banking. When you look at the other portfolio CRE, we talked about relatively flash to slight somewhat down. The consumer real estate also flat to down and that's really that's the consumer mortgage business and that's Really just a reflection of normal amortization and because we will stop holding the originations, We'll go back to gain on sale. And then we think the consumer portfolio slows down a little bit, again, just because of the interest rates and the pace of Activity in terms of car buying as well as recreational vehicle purchases.

Speaker 2

The one offset there, which is also a people's related thing, But unfortunately, it doesn't grow the balances that much as we expect to launch our credit card into the People's United Markets, which will help grow credit card balances. But as I mentioned, they're still relatively small. And so hard to see in the balance growth, but nice from a margin perspective. One of the other things that is in the Peoples franchise, which we like is, we've talked about it before, the mortgage warehouse lending business, But it's a tough part of the cycle for the mortgage warehouse lending business that with refinance activity Almost nonexistent and purchased a little bit low that the balance is there, likely to still be a headwind. We don't think that they go down materially from here, but they won't go back to where they were in 2020 2021 without A decrease in the long term mortgage rates.

Speaker 7

That's really helpful. I think you've also I mentioned in the past that C and I is benefiting now because of less capital markets activity. Are you assuming some sort of reversal in your 2023 guide?

Speaker 2

We're cautious about the level of economic activity and seeing some slowdown in Inflation and GDP and what that translates into in terms of demand from our clients. It's really not much more than that. There isn't any Sign that we see that we're seeing a material slowdown or we're not seeing credit concerns. We're just seeing cautiousness, while people wait to see how the economy plays out in 2023. And so, we're cautious on it as well.

Speaker 7

Got it. And then just a follow-up on one of the prior questions. On the stress test, you've spoken about the adverse effects So the excess cash balances and of course the Fed has been stressing CRE more than the other asset classes. Just given that December 31st will be used as a starting point for the next stress test. Do you think you've done it now for how well do you think you're positioned going into that?

Speaker 7

Thanks.

Speaker 2

We've certainly made a meaningful shift in the balance sheet this year. Cash balances, we mentioned, are down The better part is $17,000,000,000 from where they were at the end of last year. The mix of C and I and CRE when we focus just on commercial balances It's almost fifty-fifty, where it was sixty-forty, before CRE. And when we look at the CR or the construction balances, they're down a couple of $1,000,000,000 And so and not to mention the margin is up, So the PPNR, start point is higher. Things that we've got our eye on and we're not we're uncertain a little bit is how the merger expenses will be treated in the stress test this year.

Speaker 2

But once we get through 2023, it should be clean, and so that will be helpful. And then the other question is what's the Fed scenario, Right. We haven't seen it yet. It's very likely that it will continue to focus in the real estate sector. Previously, it had focused on hotel and retail.

Speaker 2

Those seem to be doing a little bit better. So it wouldn't surprise us if the new focus is office and healthcare. And It just depends on where the emphasis is from that perspective as well. But We start from a really strong capital position. We've got the current SCB covered, which is pretty high, And we continue to move the balance sheet in a positive direction, which if it doesn't get us all the way where we want to be in 2023, It should carry us a long ways towards where we want to be in 2024.

Speaker 7

Very helpful. Thanks so much for taking my questions.

Operator

And our next question comes from Ken Usdin from Jefferies.

Speaker 6

Thanks. Sorry about before. Hey, Ken. How's it going guys? Darren, on the cost side, you mentioned obviously the conversion is being passed.

Speaker 6

Can you give us an update on what A portion of the initially expected $330,000,000 of saves from Peoples were in the 4th quarter run rate and if not fully there, when do you expect to get there?

Speaker 2

Yes. Ken, the vast majority of the saves are in there through the end of Q4. We're probably if you think about we were targeting 30% of the cost base. We're like 27% or something in that range is what we've achieved so far. When you look at it on a percentage basis, we're almost there.

Speaker 2

When we look at it on a dollar basis, the run rate is actually a little bit higher than we thought it would be because of inflation. When we talk about the percentage save, it's still the same. And so some of that will come out over the course of the year. We're running a carrying a little bit higher staffing in the branches, as we stabilize a little bit higher staffing in some of the call centers. And so those things will normalize themselves over the course of the year.

Speaker 2

But when we look at where we sit, From my perspective, we pretty much closed the book on the cost saves that we expected to achieve. Couple of other things that have worked out very positive is the one time expenses turned out to be a little bit less than we thought. We incurred a little bit less than severance expense. We also incurred a little bit less than some contract terminations than we thought at due diligence. And the nice thing is The Peoples was an asset sensitive franchise and with rates going up, the NII is coming in better than we thought.

Speaker 2

And so the PPNR It's

Speaker 3

a little

Speaker 2

bit higher than we expected. So overall, the numbers that we thought we would realize Post close and post conversion, are in line to slightly better than what we thought. And We're almost back to breakeven on tangible book value. So overall, we're very, very positive about where things sit early on. And as we mentioned before, excited to go to work in New England and bring M and T's brand of banking into that new market.

Speaker 6

Got it. Great. So then a follow-up to that is then if that's the case that you're pretty run rated, then we can all take a look at the kind of implied Underlying expense growth off of this Q4 and knowing that you have the seasonal step up in the first. So can you just kind of frame that for us? Just what do you think about that Organic side, what's driving it, in terms of the initiatives that you're focusing the most in terms of incremental expense growth From here?

Speaker 2

Yes. The biggest driver of that is compensation. And when you look at 2022, We made some meaningful adjustments to our associates' compensation. We raised the minimum wage. We've been dealing with competition For talent like everyone has and compensation expense is about 55% of our total expense base.

Speaker 2

And so when we look at the driver of that growth, it's Really that compensation cost that's driving it. Outside of that, the other line item you'll see where we'll be investing and have been is in Outside data processing and software, I think for us and for the industry, you see more and more reliance on purchase software. And with those purchase software contracts come licenses and maintenance fees, which tend to go up, every year. And then the other place, We probably see a little bit of growth is in advertising and promotion. As we continue to stabilize The franchise and introduce ourselves in New England, we'll see an uptick in that as we go forward and then kind of normalize into What I would describe as a normal percentage of our operating expense, over time.

Speaker 1

Thank you.

Operator

Our next question comes from Steven Alexopoulos from JPMorgan.

Speaker 2

Hey, Darren. Good morning, Steven. How are you doing? Good. I want to start, so looking at this quarter with the Q2 where you funded loan growth with excess liquidity, talking about issuing So debt, when do you think you'll start growing deposits again?

Speaker 2

Is this back half twenty twenty three? And where do you see the loan to deposit ratio trending There's always an ability to grow deposits. It's just at what cost, Right. And so we're always looking at number 1, our focus is on customers and customer relationships. And so for Situations where we would have single service time deposits or money market accounts, we may not choose to pay rate there because we can fund the bank more efficiently in the wholesale markets.

Speaker 2

But for customers who are operating account customers, which is our core funding base And part of our long term strategy, then we're more willing to pay rate. And so we're always making that trade off. And so to say that It's going to officially end in the second half of the year. I think would be a little foolhardy, but our idea is obviously there will be a spot you get to where customers maintain balances in their checking accounts if you're a consumer or your operating account if you're a business and you kind of hit that floor. And when will that floor hit?

Speaker 2

I think we start to see it as rates stabilize, and you'll see that as we go through 2023. But also we know that the deposit pricing lags, movements in Fed funds and moves lags movements in loans. And so our goal will be to stabilize it as we go through the year. But obviously making those trade offs that I mentioned as we work with clients. Okay.

Speaker 2

So where do you see the loan to deposit ratio moving forward? Sorry. I think over time and again, time, Maybe let's call it 3 years, uh-huh, just to pick on our number 3, is over the long term Loan to deposit ratios for us and for the industry will trend back to their long term average. And when we think about those loan to deposit ratios And those long term averages, that's also part of the reason why we talk about that net interest margin over the long run normalizing back to where it's been historically. And so we're kind of we think maybe around 80 ish, a little bit above as we get to the end of 2024 sorry, 2023.

Speaker 2

But it's obviously a function of how we choose to pay and fund the bank. Okay, great. Thanks for taking my questions.

Operator

And our last question comes from Gerard Cassidy from RBC for the Capital

Speaker 3

Markets. Darren?

Speaker 2

Good morning,

Speaker 8

Gerard. I was going to say another 3 was In the middle of the call, your stock was up 3%, but now it's up over that, so I can't use that.

Speaker 2

Well, we appreciate that and the three reference. So there's something that happens in every call and it kind of seems to run its course. So 3 is this one.

Speaker 8

There you go. Question for you regarding your comments about the commercial real estate portfolio. When you look at it, particularly for office, there's a concern, of course, with the work from home possibly being more permanent And there'll be less space needed, possibly vacancy rates go up in the office space. What do you think is the greater risk? The occupancy rates going higher because of that trend or the refinancing risk where your customers Having to refinance because their mortgages are terming out.

Speaker 8

They have to refinance it and the rates are just so much higher today than when People took down these mortgages maybe 5 years ago.

Speaker 2

Right. So I think it's hard, Gerard, to pinpoint it on 1 or the other because they work Together, right? I mean, if occupancy and price per square foot was okay or holding up, then you probably got the coverage to refinance when your loan is due. Remind you, when we underwrite, whether it's multifamily, office or hotel, We underwrite to long term interest rates and long term occupancy rates. And so we've got some Some protection built in with our clients when we underwrite, so there's a little bit of room there.

Speaker 2

But as we look at it, I think in the short term, It's the refinance risk is a little bit bigger. Over the long run, we debate this a lot internally. We go back and forth with our Chief Credit Officer that this trend of more remote work, It's hard to handicap where that's going to end up, right? You can see some changes in the economy, you see some movements with some of the tech firms with employment. That may or may not drive people back into the office, we don't know.

Speaker 2

But when you see younger people early in their professional career, You can see the benefits to being co located with their coworkers. And so that trend, I think, ultimately starts to come back. Is it 5 days a week? Probably not, but it's not going to be 0, at least this is Darren's opinion. So take it for what it's worth.

Speaker 2

To me, the bigger issue is when you look long term at the population, There's a big chunk of the population called the baby boomers that are approaching retirement age. There are not enough of them to sit coming in the next wave to use all the space That they needed to sit in to be employed. And that's a longer term cyclical trend, which will affect these things. And so there There's going to be some pain in the short term, no doubt. Over time, rates will move up and down and refinancings will happen.

Speaker 2

There will be some movement in and out. But to me, the longer term trend is what's happening The population and the working population and what's the capacity that exists today versus what the likely future looks like, absent any other changes In politics and I will leave it at that before we get into a discussion I don't want to get into.

Speaker 8

Sure. As a follow-up question, Based upon your experience and your conversations with your colleagues at M and T, what do you think is driving what we're seeing today where The CECL reserve build, you and your peers obviously have to take a look at the economic forecast. Many people use Moody's, which is weaker this quarter than last quarter, which drove up reserves. But at the same time, I think you mentioned your net charge off Numbers are expected this year to be below your through the cycle levels, spreads in many areas, High yield securities or even one of your peers said the corporate loan spreads haven't widened out yet. What's going on where we're not seeing, I don't think Some metrics telling us we're going to have a tough downturn, whereas the reserve build is pointing to a weaker economy.

Speaker 2

Yes. I think, Gerard, to me, when I think about the way we all, set aside reserves, we've got It's weighted heavily on your economic forecast and your R and S period, Irreasonable is affordable period, which for a lot of the industry is the 1st couple of years and then there's a reversion to the long term average. And so what you're seeing today is the current view where the charge offs are well below the long term average. And so the allowance is always going to take that The long term into account and then you're forecasting and bringing forward those losses based on the assumptions that go into the R and S period. And the expectation for unemployment to go up and for GDP to come down It's there.

Speaker 2

It's in the baseline. For Moody's, it's moved a little bit. Most people like us will not just look at the baseline, but look at a more Severe, economic scenario as well as a better one. And you kind of wait those and It doesn't necessarily need to be what you see today in the pricing and the spreads versus what's in these forecasts. They should be connected, but they're not always, right?

Speaker 2

And there's always going to be points in time where these disconnects exist. And so we look at and we think about the provision is keeping the bank safe. It's capital by another form. But as we underwrite business, we're always looking at each individual relationship and its ability to pay back. And the spreads are going to be a reflection of the expectation of that credit risk through the cycle.

Speaker 2

And so for us, We've had so many long term relationships where we've seen the behavior of these clients through the cycle and their willingness to step up And many times bring outside resources to help maintain their payments and stay Accruing and so each organization is different, but that to me is a little bit of why you might see a disconnect between What's actually pricing today versus what's in the CECL outlook.

Speaker 8

And just quickly on the CECL outlook, what was the weighted unemployment rate that you guys came up with in your analysis? You mentioned you used the base case, but you also took into account the more severe case as well?

Speaker 2

Yes. We're kind of in the 4 For one range on unemployment in the base. And that's during the R and S period, Right. And so once you get past that, then you're reverting to the long term.

Speaker 8

Okay. Appreciate it. Thank you, Darren.

Operator

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

Speaker 1

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

Speaker 3

Thank

Operator

Thank you. Have a good day. Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect and have a wonderful

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Earnings Conference Call
M&T Bank Q4 2022
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