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M&T Bank Corporation (NYSE:MTB)

Q2 2009 Earnings Call

July 20, 2009 10:00 am ET

Executives

Donald J. MacLeod – Vice President of Investor Relations

Rene F. Jones – Chief Financial Officer & Executive Vice President

Analysts

Steve Alexopoulos – JP Morgan

Matthew O’Connor – Deutsche Bank

Craig Siegenthaler – Credit Suisse

Bob Ramsey – FBR Capital Markets

Matthew Clark – Keefe, Bruyette & Woods, Inc.

Ken Zerbe – Morgan Stanley

[Anod Christion – Four Research & Management]

Christopher Nolan – Maxim Group

Jennifer Demba – SunTrust Robinson Humphrey

Collyn Gilbert – Stifel Nicolaus

Ken Usdin – Bank of America Securities

Todd Hagerman – Collins Stewart

Amanda Larsen – Raymond James & Associates

Operator

My name is Juliann and I will be your conference operator today. At this time I would like to welcome everyone to the M&T Bank second quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) I would now like to turn the conference over to Ms. Don MacLeod, Vice President of Investor Relations.

Donald J. MacLeod

This is Don MacLeod. I’d like to thank everyone for participating in M&T’s second quarter 2009 earnings conference call both by telephone and through the webcast. If you have not read the earnings release we issued earlier 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.

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 8K, 10K and 10Q for a complete discussion of forward-looking statements. Now, I’d like to introduce our Chief Financial Officer Rene Jones.

Rene F. Jones

Because we closed on the Provident Bank shares merger during this past quarter, there are some merger related expenses as well as the impact from purchase accounting which affect our reported results. Hopefully, I’ll be able to provide you with some clarity on just how they impacted us.

Diluted earnings per share were $0.36 in the second quarter of 2009 compared with $0.49 earned in the first quarter of 2009. Net income for the recent quarter was $51 million compared with $64 million in the linked quarter. The amortization of core deposits and other intangible assets amounted to $0.08 in the second quarter of 2009 compared with $0.09 in the linked quarter. There were after tax merger related costs of $40 million or $0.35 per share in the recent quarter. Merger related costs were $1 million or $0.01 per share in the linked quarter.

Diluted net operating earnings per share which exclude the amortization of core deposit and other intangible assets as well as merger related charges were $0.79 for the recent quarter, up 34% from $0.59 in the linked quarter. M&T’s net operating income for the quarter was $101 million compared to $75 million in the linked quarter. On this same operating basis, that is excluding intangible amortization and merger related expenses, we estimate that the Provident merger was in just its first five weeks, accretive by $0.01 per share in the second quarter.

In addition to the merger related expenses that I just mentioned, the recent quarter’s results include three additional items that I’d like to break out for you. First, the quarter’s results included the impacts from the special FDIC assessment which amounted to $33 million on a pre-tax basis and $20 million or $0.17 per share on an after tax basis. This only relates to the special so called one-time assessments and does not include the higher run rate for the normal FDIC insurance expense.

Second, we recorded pretax other than temporary impairment charges of $25 million for certain private mortgage backed securities carried in our available for sale securities portfolio as well as the TruPS CDOs we acquired in the partner’s trust merger. This came to $15 million or $0.13 per share on an after tax basis. Finally, we recorded a $13 million partial reversal of the allowance for capital mortgage servicing right. This equates to an after tax benefit of $8 million or $0.06 per share. In the aggregate these three items reduced the second quarter’s net operating income by a net $27 million after tax or $0.24 per diluted share.

Next, I’d like to cover a few highlights from the balance sheet and income statement. Tangible equivalent net interest income was $507 million for the second quarter compared with $453 million in the linked quarter and $492 million in the second quarter of 2008. The net interest margin was 3.43% compared with 3.19% that we recorded in the first quarter of 2009. There was no material impact on the net interest margin from the Provident merger.

As we indicated on the January and April conference calls, the deposit base and a portion of our wholesale funding book was repriced in relation to the very sharp reduction in short term rates last December. We continue to see a slightly positive bias in the net interest margin based on the current forward rate interest curve. As for the balance sheet, average loans for the second quarter were $50.6 billion compared to $48.8 billion in the linked quarter. The entire increase came as a result of the Provident merger.

On a core basis M&T’s loan portfolio was flat compared to the first quarter as customer demand for loans particularly on the commercial side remained sluggish. Comparing the major sections of the core M&T portfolio to this year’s first quarter, commercial and industrial loans declined by 2% or 7% annualized. This was driven by a 10%, 41% annualized decline in auto floor plan lending as dealer inventories were reduced in response to the historically low levels of auto sales. Commercial real estate loans increased an annualized 4% and residential real estate loans increased an annualized 9%. This was largely due to the fact that a large portion of the applications taken and locked in the first quarter were actually funded in the second quarter. The origination warehouse peaked in May as applications and funding slowed when mortgage rates rose in the second quarter. Consumer loans declined by an annualized 2% with lower indirect auto loans offsetting modest growth in home equity lines of credit.

If we view our lending activity from the perspective of our community bank regions again, on a core basis excluding the impact from Provident, we experienced growth in average loans for each region. For example, average loans in upstate New York grew an annualized 6% as compared to the link quarter. Our metro region which includes New York City grew an annualized 5%; Pennsylvania grew an annualized 3% and the mid Atlantic grew 4%. The declines came in our non-community portfolios which in aggregate were down an annualized 10%. This includes the indirect consumer portfolio and the auto dealer portfolio I mentioned earlier.

We continue to see strong growth in core deposits. Average core customer deposits excluding the impact from Provident and which excludes foreign deposits and CDs over $100,000 increased by an annualized 24% from the first quarter. The quality of that growth is high. For example, relative to last year’s second quarter, excluding the impact from acquisitions, demand deposits are up $2.5 billion or 33%.

Turning to non-interest income, excluding securities gains and losses non-interest income was $296 million for the recent quarter. This compares with $264 in the link quarter and $277 million in the second quarter of ’08. The former Provident franchise contributed $8 million of non-interest income for the quarter. Mortgage banking fees were $53 million for the quarter compared with $56 million in the linked quarter and $38 million in the second quarter of 2008. As I mentioned refinancing activities slowed significantly later in the quarter after mortgage rates rose.

Service charges on deposit accounts were $112 million during the recent quarter, improved from $101 million in the linked quarter. In addition to the expected rebound from the seasonally low first quarter, Provident contributed $6 million to this line item. The other revenue was $77 million compared with $59 million in the first quarter and $77 million in the second quarter of ’08. The improvement from the linked quarter was primarily due to higher commercial loan and letter of credit fees, advisory fees and [inaudible] revenue.

Turning to expenses, operating expenses which excludes merger related charges and the amortization of intangible assets were $482 million compared with $421 million in the first quarter of ’08 and $403 million in the second quarter of 2008. Provident contributed $21 million of the quarter’s operating expenses. The quarter’s results included the $33 million special FDIC assessment as well as an additional $17 million for the regular FDIC insurance premium. FDIC expense was just $6 million in this year’s first quarter. As I mentioned, the second quarter’s results also included a $13 million partial reversal of the evaluation allowance for capitalized residential servicing rights compared with a $5 million reversal in the first quarter of ’09 and a $9 million reversal in the second quarter of 2008.

Let’s turn to credit; as we noted in the press release the Provident loan portfolio is being accounted for in accordance with the Statement of Financial Accounting Standards 141R and Statement of Position 03-3. What this means is that the Provident loan portfolio has been marked to fair value as of the acquisition date by analyzing the net present value of cash flows from these loans. The result is that the fair valuation process eliminates the need to carry over Provident’s loan loss allowance as was done in past acquisitions.

Non-accrual loans increased to $1.1 billion or 2.11% of loans at the end of the recent quarter compared with $1 billion or 2.05% at the end of the previous quarter. Through the second quarter we continued our efforts to assist residential mortgage borrowers. As of June 30, 2009 modified loans totaled $259 million of which $107 million were classified as non-accrual. Modifications continue to be primarily attributable to our portfolio of all day mortgages.

Other non-performing assets consisting of assets taken in foreclosure of defaulted loans were $90 million as of June 30th compared with $100 million as of March 31st. Net charge offs for the second quarter were $138 million compared with $100 million in the first quarter of 2009. Annualized net charge offs as a percentage of loans was 1.09% compared with 83 basis points in the linked quarter.

The provision for credit losses was $147 million for the second quarter compared with $158 million in the linked quarter. The provision exceeded net charge offs by $9 million. Charge offs included $33 million related to the partial sale of a loan taken to non-performing in this year’s first quarter. So, in essence, our reserve build for future losses was larger than the $9 million figure would indicate.

The allowance for credit losses at the end of the recent quarter was $855 million which amounted 1.62% of total loans. That ratio was reduced by the addition of the Provident loan portfolio for which no allowance was carried over in accordance with the new accounting for acquisitions. For the foreseeable future, we will also report an allowance for M&T legacy loans. That ratio was 1.76% for the quarter up three basis points from 1.73% as of March 31, 2009.

The loan loss allowance as of June 30, 2009 covered the year-to-date annualized net charge offs by 1.8 times. Loans past due 90 days but still accruing were $155 million at the end of the recent quarter compared with $143 million at the end of the sequential quarter. This included $144 million and $127 million respectively of loans that are guaranteed by government agencies. M&T’s tangible common equity ratio was 4.49% at the end of the second quarter compared with 4.86% at the end of the first quarter. The decline is attributable to the impact from the Provident merger.

Net operating earnings for the quarter of $0.79 per share which does not adjust for the impact of the OTTI charges and the FDIC special assessment again exceeded our $0.70 per share quarterly dividend.

Turning to our outlook; as I mentioned earlier our outlook for the net interest margin hasn’t changed. We continue to expect credit costs to remain elevated throughout the year and we probably still haven’t seen the peak. We also still expect a certain level of variability in charge offs in any single quarter. Overall, net charge offs continue to be in line with our internal expectations.

With the difficult credit environment, M&T remains very focused on expenses. There are concerns in some corners that the special FDIC assessment announced this quarter won’t be a onetime thing; let’s see. Over the long term, the effective 56% tangible efficiency ratio for the quarter seems a bit high to me and suggests we have some work to do.

Finally, the Provident transaction is progressing well. As is our preferred practice we converted the Provident franchise over to our systems simultaneously with the closing and the former Provident branches reopened with M&T signage. The task before us is to continue to realize the merger synergies that we outlined at the time of the acquisition while retaining and growing the customer base.

Through the first half of 2009 we have recognized $69 million of Provident merger related expenses through the income statement. An additional $22 million was recognized either through purchase accounting or by Provident prior to closing. Based on our original $99 million estimate from last December, this leaves $8 million. I would not expect additional merger related charges to materially exceed this level.

If you adjusted for the net charge offs that Provident recognized on its loan portfolio and the OTTI charges taken against its securities portfolio prior to the closing of the transaction, the purchase account marks came in largely in line with our projections. All of these projections are of course subject to a number of uncertainties, various assumptions regarding national and regional economic growth, changes in interest rates, global events and other macroeconomic factors which may differ materially from what actually unfolds in the future.

We’ll now open up the call to questions before which Juliann will briefly review the instructions.

Question-and-Answer Sessions

Operator

(Operator Instructions) Your first questions from Steve Alexopoulos – JP Morgan.

Steve Alexopoulos – JP Morgan

Could you talk about what you saw on inflows and the credit size and classify for commercial real estate loans during the second quarter?

Rene F. Jones

Let me start Steve by talking about our focus on non-performing and then I will get my way to your question. If you look at the quarter, non-performings went from 2.05 to 2.11 but it was a very active quarter so we had a number of credits that were actually paid out [inaudible] a number of auto dealers. We also saw a number of residential development properties which we resolved because we sold down the notes.

Remember, in a couple of cases what you have is through the normal workout process M&T is not going to become a builder of homes so at some point on particularly the raw land type of things, our exit would be to sort of sell the notes. What was encouraging about that is there actually appears to be a lot more appetite not only from financers but also from builders coming back in to the space, particularly in the Mid Atlantic looking to sort of step in to projects. So, through those types of things we had a number of items that went out.

If you look at the items that went back in to non-performing and we had for example, a provider of healthcare services which while still paying is having difficulty in the retirement space where they are very dependent on people to sell their existing homes before they can actually buy in to the new retirement communities. We had a continued migration of a number of builder related type projects which is sort of the normal progression from what we’ve been talking about quarter in quarter out on the residential development side.

We had also had a various number of other things. The company focused on utilities and natural resources that went in to non-performing. So, a lot of ins and outs and I think on the whole what that tells you is that the migration still continues. But, having said that, that the market for assets [inaudible] has improved and we’re actually seeing some improvements as we’ve worked through the portfolios that we’ve spent time on over the past 18 months.

I would say particularly in the commercial real estate space, most of the activity has still been around the residential development portfolio. We do see migration in the investor real estate portfolios but as you can see not a lot has gotten its way through the process to sort of go in to the sort of non-performing classification. That will likely happen down the road but we just haven’t seen it today getting in to those late stages. I think you’ve read a lot about commercial real estate and so I would expect to see at least a migration there in to non-performing but that will be later in the year, early in 2010 is what we’re thinking today.

Steve Alexopoulos – JP Morgan

Maybe just one other question, Rene give where tangible common is now post Provident, how should we think about the acquisition appetite? If a deal comes along would you be willing to issue common to do it or are you going to wait first to rebuild it organically?

Rene F. Jones

We don’t, especially now that we’ve sort of gotten through the integration process of the Provident deal, we’re open to things that would improve our franchise value and things that probably stay particularly close to our existing market. You know, you’d have to deal with the financing when you saw the transaction in front of you but there’s nothing that suggests to us that for the right transaction that we wouldn’t be willing to do it and that the capital markets wouldn’t be open to it.

Operator

Your next question comes from Matthew O’Connor – Deutsche Bank.

Matthew O’Connor – Deutsche Bank

Just a follow up on the income producing commercial real estate, I think a lot of people are concerned about it, our CMBS research team is actually very negative on it in generally, especially in New York City. I think you guys have been a lot more conservative then some but if you could just remind us how your commercial real estate is different than maybe what we’re seeing in the CMBS markets?

Rene F. Jones

I’ll take it in a couple of parts, remember the first distinction is the CMBS market versus traditional balance sheet lenders who are underwriting to put the stuff on the balance sheet and knew they would have to contend with the credit risk going down the road. Clearly, you’ve seen - the first thing is sort of the underwriting standards, when you look at the difference in cap rates and then two other assumptions, the difference in the turnover rate of particularly apartments in New York City as well as the assumptions that were used in terms of an increase in the rent rolls, there’s a drastic difference between what we’ve seen in our portfolio with in fact, what we’ve seen from other portfolio type lenders versus what you saw in the CMBS market.

That’s not to say that when you see a decline in the real estate market because financing has dried up, that that won’t affect portfolio lenders. What I would guess though is that what it comes back to is your original loan-to-value that the loans were made at is one. Then two, how you structured those loans so in a number of cases for example, as we migrate through the process, it wouldn’t surprise me down the road to see certain properties have to move through the credit process and maybe go in to non-performing.

But, as I think about a number of those loans and the way in which they’re structured with a fair amount of equity up front with also supported secondarily by Mezzanine tranche of equity, the loss content on those loans is not what you would expect, they’re much lower so it gets back to leverage. Remember, you can see the leverage on our balance sheet, for the same two commercial real estate properties that were underwritten, one goes in to a security and one goes on to our balance sheet. The leverage is much, much higher on that CMBS security so by definition your back fill to the same sort of thing which is the amount of leverage which you’ve got on the properties and the amount of leverage that you got in to the structure, really dictates the types of losses you’re going to take.

So, I think that’s the fundamentals of it. We don’t think that to the extent this is a downturn in commercial real estate that we will escape a downturn, we just think that like every single one of our other portfolios so far through the cycle, that we would fare much better.

Matthew O’Connor – Deutsche Bank

If you had to guess, let’s just say CMBS losses on a cumulative basis would be x percent, everybody has their own estimate, if you had to guess relative to those losses do you think yours would be maybe two thirds of that, one third of that?

Rene F. Jones

I’ll be very honest with you, I don’t know. I wouldn’t have any sense of that. I mean, what we’re focused on right now Matt is sort of getting in front of all the credits and making sure we’re very aware of the portfolio so that to the extent that we see problems that come up on the horizon, we’ll have already worked through the solution with those borrowers. We’re down looking at credit-by-credit and not really thinking too much about a 10,000 foot estimate like that.

Matthew O’Connor – Deutsche Bank

Then just separately, you mentioned that the core efficiency ratio is too high for where you would like it to be. How much of that do you think is on the revenue side? I guess how much is on the expense side? I’ve always thought that you guys have done a very good job managing the expenses so I guess I’m a little surprised that there would be a lot of cost cuts available out there.

Rene F. Jones

In the cycle we’re spending a lot of time on our loan portfolios, we’ve got a lot of credit costs and quite frankly, the revenue is just slow. I can’t point to any particular place but it’s not unusual for us to feel confident that we can run the bank in the low 50s over the long term. I’m not talking about next quarter but, over the long term it’s not a stretch for us to say that we’d have an efficiency ratio in the low 50s, we’ll have to get to the details.

Matthew O’Connor – Deutsche Bank

So it sounds like more on the revenue side than the expense side, just to be clear?

Rene F. Jones

Probably both.

Operator

Your next question comes from Craig Siegenthaler – Credit Suisse.

Craig Siegenthaler – Credit Suisse

First, on credit quality, I’m just wondering if you can provide us with an update on the modifications? It looks like the cumulative level was up pretty significantly this quarter but I am also wondering how the bucket that went in to non-accruals, that growth looks like it was a little bit slower.

Rene F. Jones

Just on residential mortgage modification?

Craig Siegenthaler – Credit Suisse

On the all day? It’s mostly all day I believe.

Rene F. Jones

I think there’s been no change in the pace of what we’ve been doing on the modifications, it’s been steady. But, I’m just looking for the actual dollar increase.

Craig Siegenthaler – Credit Suisse

You have the increase on the non-accrual levels though?

Rene F. Jones

It’s 1.4 on the non-accrual level but on the total the increase was 43.5 in total.

Craig Siegenthaler – Credit Suisse

Then I’m just wondering, can you remind us how M&T and the regulators decide if a loan actually goes in to TTDR or is modified and back on accrual?

Rene F. Jones

Well, for our residential mortgage portfolio, when something goes delinquent and if we modify that loan it would be recorded as a TDR and it would be recorded as a non-performing loan and we would expect it to have at least six months of positive performance before it moved out of non-accrual.

Craig Siegenthaler – Credit Suisse

They all go in to non-accrual first?

Rene F. Jones

Well, no. If we modified a loan that was current, it has never missed a payment then it would not be classified in to non-accrual.

Craig Siegenthaler – Credit Suisse

As long as the assumptions are at the market or the interest rate?

Rene F. Jones

But it’s still a modified loan and it is still reported as a modified loan.

Craig Siegenthaler – Credit Suisse

Then you’ve previously disclosed the redefault rate and it’s been very low at M&T, like 25% I believe, much lower than the industry and I’m just wondering how that trended in the second quarter?

Rene F. Jones

It was up but it’s still below the 40%. So, we saw it actually uptick a bit.

Craig Siegenthaler – Credit Suisse

Do you guys have that number?

Rene F. Jones

Our six month redefault rate is 26%, last quarter was 25% so you’re probably in the 30s for the quarter.

Operator

Your next question comes from Bob Ramsey – FBR Capital Markets.

Bob Ramsey – FBR Capital Markets

A quick question on net charge offs, I know you all mentioned in the press release some of the growth year-over-year was largely attributable to the partial charge off of one commercial credit, how much was that? And, can you just remind me what that credit was?

Rene F. Jones

The amount was $33 million that we charged off and it was the credit that we described on our first quarter conference call in which it was our largest unsecured credit. I think we disclosed it was about $95 million. We took the charge because we sold down half of our exposure. If you then look at the rest of the book, if you were to adjust for that, the commercial side including middle market, CRE, residential development loans, those were all down several million. If you look at our consumer book, on a link quarter basis consumer charge offs were down $5 million, 15% and if you look to the residential portfolio the core and all day portfolios in that residential number were relatively flat.

What we did have was about – our single one close construction, our residential construction portfolio went from about $1 million in charge offs to $12 million in the quarter. Much of that was as a result of sort of getting in front of a number of properties disposing of either the properties or the notes, taking possession of the homes and so forth. So, with that increase in charge offs we’ve now sort of taken that portfolio down to a balance of $156 million. There’s a lot of reduction in exposure that’s sort of going on.

Bob Ramsey – FBR Capital Markets

Then, you mentioned repossessing some of those properties, it looks like your REO was actually down in the quarter as well. Could you maybe – you also mentioned I guess appetite for a lot of credits out there, what is sort of the ultimate severity you’re seeing on REO that you are disposing of?

Rene F. Jones

Oh, it hasn’t changed, [inaudible] it’s not really pretty. I don’t know Don, is it what 30%?

Donald J. MacLeod

No, on some of the raw land in the Mid Atlantic it’s over 50.

Rene F. Jones

Oh yeah, we’re realizing 30%, taking a loss of 70%. But, that’s probably the high end.

Donald J. MacLeod

From what Bob tells me the severity on properties where there’s more of a vertical component where there’s actual structures, our loss content has been 30% to 40%.

Rene F. Jones

But just to sort of break down the ORE, we ended last quarter with $100 million and if you don’t include Provident we dropped to $78, most of that is residential properties that are in there. The drop comes from reevaluating a couple of development projects. Then, you add another $12 million that came over from Provident and you get back to the $90.

Bob Ramsey – FBR Capital Markets

Then I guess the last question for you, Bayview obviously the losses there were much lower this quarter. Can you just give a little update on what’s going on in that business?

Rene F. Jones

Yes, nothing has changed from what we said, we said that they would probably run with small operating losses for the foreseeable future. The numbers were a little bit better because they had some gains on marking loans and on Canadian exchange. So, my sense is that not much has changed there. I would expect that to run at a small slightly loss in our operating statement as we go forward, not unlike the first quarter. The rest of the business, as we’ve mentioned before is sort of tracking in a relatively positive fashion with our Bayview asset management businesses and with the residuals that they have on the balance sheets.

Operator

Your next question comes from Matthew Clark – Keefe, Bruyette & Woods, Inc..

Matthew Clark – Keefe, Bruyette & Woods, Inc.

Can you clarify the modified loans you had at the end of the quarter of $259? I know $107 of that is on non-accrual, just reconcile that with the renegotiated loans of $171. I guess is that $171 embedded in the non-accrual number or is that separate and distinct from the $259?

Rene F. Jones

The renegotiated loans are $170 and the $142 is in that number. I mean, it’s all there, I’m just not quite sure what you’re getting confused with?

Matthew Clark – Keefe, Bruyette & Woods, Inc.

The modified loans of $259, $107 of that is in non-accrual but I’m just curious as to whether or not those are also considered renegotiated loans at all or not? Or, if you’re using renegotiated as TDR and modified is not I guess?

Rene F. Jones

It’s not a double count.

Matthew Clark – Keefe, Bruyette & Woods, Inc.

In terms of the losses that you took on the construction side, I think on the builders side I think you mentioned that they increased to about $12 million this quarter, can you give us a sense where those losses came from, whether or not that was solely Mid Atlantic and whether or not you’re seeing anything else?

Rene F. Jones

Matt that was actually a different portfolio, that’s a one close residential construction loan where an individual is building a home. That portfolio is about $156 million in size so they came from all over. Some from the footprint but a number of things that are left over from the work we had done when we had taken over those Regions offices, they were in Florida, they were in different places.

On the residential builder development for the quarter, those losses were down. I think we had $22 million of losses in the first quarter, or actually let me do it on the total, $22 million on the first quarter and $15.5 this quarter. We’ve said before, I think we said in January that we had about $100 million in charge offs in ’08 and I can’t see any reason why it would be any different, I would say the same is true there, we’re sort of just working through that portfolio. It’s not getting worse, it’s just sort of the work we have in front of us and I would guess we’ll see a pretty consistent number there as we move forward.

Matthew Clark – Keefe, Bruyette & Woods, Inc.

Then just back on the criticized classified list, can you give us a sense, I don’t know if you’d want to size it up at all but at least the magnitude of the change you saw I guess first quarter to second quarter?

Rene F. Jones

I don’t think we saw any change, I mean it’s a very steady migration. I think that if you look at the non-performing you kind of see it there, you see the trend. If we began to see that the classified loan book in those great 10, 11, 12 actually started slowing, we’d probably tell you. We haven’t seen that happen. We spent some time talking to a large sample of our customers in upstate New York, Pennsylvania and then down in Baltimore and Washington and most of those clients are somewhat pessimistic about where the economy is. They’re all working on lowering expenses in their businesses and sort of trying to offset the lower demand.

There are some bright spots, the bright spots would be discount retailer would be also in there, the packaged goods space, they seem to feel a bit more optimistic than the others. I think the economy is still in somewhat of a malaise and I would expect the migration to continue as it has. If there’s any good news, what we sort of understand is as the economy turns around a bit and begins to stabilize is a lot of those companies are going to be much, much stronger than they were before they went in to the cycle. So, if there’s a positive story, that’s the positive story.

Matthew Clark – Keefe, Bruyette & Woods, Inc.

Then lastly, just a small one, the tax rate looked a little light. Can you just tell us what that related to and I guess your expectation to the balance of the year?

Rene F. Jones

Matt, the simplest way is we had a lot of onetime expenses, whether that be merger related expenses, the FDIC charge, the OTTI charge and I think you’ll see some reflection of that and that the tax rate is lower. The tax rate will probably be low as long as you continue to have those onetime level charges. I tend to look at our earnings and have a much more normalized rate of somewhere in the low 30s on an ongoing basis.

Operator

Your next question comes from Ken Zerbe – Morgan Stanley.

Ken Zerbe – Morgan Stanley

Now generally I understand what you did to put the Provident loans on your balance sheet by fair valuing them but is there a point in the future, and how soon might this materialize where you might need to take some charges or build reserves on that portfolio?

Rene F. Jones

That’s a great question Ken. So, how it works it we’ve marked the things to fair value and to give you a number, we have a fair value mark but underneath that fair value market which is interest and credit we have about $320 million of credit related marks on that $4 billion of loans. What you’re required to do is as you take those losses against that mark as you go forward, to the extent that you are not going to realize the full amount, you would then accrete the excess of that credit mark in to your earnings over the life of the loan.

If you assume that on average these loans, they vary, but they have five years, as you get to two years out you probably have a pretty good sense of how well you did on the mark. To the extent that you came to a conclusion that the $320 million wasn’t enough, you would then be required on a specific loan, for example, to add to your provision. If you think about, and I haven’t done this work normalized but, if you look at where Provident losses were running all the way through say this first six months, that’s a pretty hefty number $320 million. So, if we would know something Ken, I think it would be at least a year and a half out before we would have any sort of sense of whether we were too much on that portfolio or whether it’s a different number.

Ken Zerbe – Morgan Stanley

The other question I had, given the large increase in NIM this quarter, what’s your outlook going forward? And, do you think you can continue to reduce your deposit costs?

Rene F. Jones

I don’t think it as actually – think about the fact that we probably have – you can see the average yield on our time deposit portfolio, maybe it’s 2.30, 2.60, somewhere in that range, 2.39 and that will continue to roll off in to the more normalized rates that we have so that’s the positive side of the margin that gives us a slight upward bias. The rest, deposit rates are already relatively low.

Ken Zerbe – Morgan Stanley

So relative flat going forward.

Rene F. Jones

Things have been very stable with the interest rate environment so as long as that holds I think we’ve got some positive momentum on the way up.

Donald J. MacLeod

The other thing to keep in mind is as the loan portfolio turns itself over and new stuff comes on at today’s higher market spread.

Rene F. Jones

That’s a steady positive.

Ken Zerbe – Morgan Stanley

So just to clarify, loans coming on at a higher spread which is pretty consistent across the industry plus flat deposit costs, how much an increase in NIM should we be expecting?

Rene F. Jones

Just a positive number.

Operator

Your next question comes from [Anod Christion – Four Research & Management]

[Anod Christion – Four Research & Management]

A couple of questions, first on the mortgage banking can you talk a little bit about the pipeline and how we should think about the second half of the year should either trend to more normalized levels or [inaudible]?

Rene F. Jones

Let me give you a couple of numbers first, in terms of I think the most important thing is because you recognize the revenue sort of upfront as the loans are loss I’ll give you the application, in the first quarter our applications were $3.9 billion, in the second quarter they were $2.8 billion so down a fair bit as rates when up. I haven’t yet checked where we are, rates have actually come back down some so I would expect the volume to pick up a bit. If you look at the pipeline, mortgages that sort of fit in our pipeline, last quarter that was $2.3 billion, this quarter it was $1.5 billion. So, clearly slower, the question will be what happens with interest rates.

[Anod Christion – Four Research & Management]

Then a question on your reserves and Provident, one of the metrics that I was looking at was the reserves to non-accruals and that come down from like 85% or so to 77%. I’m not sure you go by one single metric but this is certainly a metric that analysts do look at and so given some of your commentary about credit outlook in the near term will continue to be elevated, how should we think about the current level of reserves? A related question, what’s the average carrying value of your non-accruals?

Rene F. Jones

Let me try to answer, first of all I spend a lot of time thinking about this because we get asked that question quite a bit and the first thing you notice is that we’re kind of in line with the industry so, that ratio is lower than it has been in past cycles. But, when I look at our own book, about one quarter of our non-performing loans are residential real estate so $260 million or something like that. If you look at the portion for example that we mentioned the $107 I think we said that was modified loans, when we modified those loans, the net present value of the payment give up is recorded as a FAS 114 reserve.

That number at the beginning of the cycle, we were booking a reduction in value of say 23%. Now, it’s much, much less so maybe on average that’s at $0.15 on the $1. So by definition because it’s the start of a commercial real estate cycle, your overall ratio is very, very weighted down because you’ve taken a lot of specific reserves on residential real estate. I think that’s probably the biggest factor that you’re seeing in the numbers and as you kind of work your way through [inaudible] through the portfolio and get to commercial real estate, I think you’d see sort of a completely different view.

That’s the best I can explain for you because our process if very focused and right now we seem to have a lot of specific reserves on credits and a lot of them tend to be residential real estate that drag that ratio down. We tend to look at our coverage ratio so how many times is our current charge offs, sort of looking back last 12 months, how many times does that cover the reserve. We also internally look forward in our forward forecasting and so today, as we said in the press release we were at 1.8 times, I think last quarter the industry average was 1.1 or somewhere around that level so I think we feel that we’re fairly adequately reserved.

[Anod Christion – Four Research & Management]

Then do you have a sense of what’s the average carrying value?

Rene F. Jones

I don’t know how to answer that because there are so many different types.

[Anod Christion – Four Research & Management]

Because some of your competitors make the argument that we charge off the non-accruals aggressively so the ratio, you are in line with the industry averages is what you say but if others are charging off aggressively then we are comparing apples and oranges.

Rene F. Jones

I guess if we were not charging off aggressively then our non-performing loan ratio would be much higher than everyone else because they would just sit around. The other place I would look is for the types of issues we’ve been talking about, think about residential construction or builder construction, the fact that ORE portfolio before Provident is $78 million and most of that is residential kind of tells you a lot about how fast we get at things.

If you go back to the auto industry, three years ago we told you there was a problem in auto floor plan and today we don’t have much of a problem because we worked on it and got through that cycle fast. I would say that what gives us comfort is the fact that we tend to get at things quickly so we’re not left with multiple issues at the same time. Think about commercial real estate, people are talking about it as a 2010 issue, we have no interest in not getting through any problems we have quickly.

Operator

Your next question comes from Christopher Nolan – Maxim Group.

Christopher Nolan – Maxim Group

Given where the dividend is right now, for the full year 2009 do you anticipate that you’ll be able to have funding cover the overall dividend?

Rene F. Jones

Well Chris, we don’t forecast earnings so I’ll leave that to you. I mean look, I think we said six months ago, our head of corporate finance said that we would complete this transaction, six months would go by and we would be at a 4.4 intangible and we’re at 4.49. So, we’re pretty pleased with how our forecasting process goes both in terms of earnings, the deal, credit. We feel that we have a fairly decent handle on that. When we think about capital and dividend policy we’re going to continue to focus on building that tangible ratio over time. I think quite frankly, when you look at our actions it’s pretty clear.

Christopher Nolan – Maxim Group

The second question I had, a follow up to an earlier question from Matt on commercial real estate and your reply in terms of increased equity in terms of your commercial real estate borrowers, are you facing an issue in terms of many of your commercial real estate borrowers having to find additional equity as they seek to refinance the maturing loans?

Rene F. Jones

I don’t know that that is the case. I think the case is simply that there is no place for them to get refinancing as it comes up on the credit side. The deals are structured that they are, it’s kind of hard to change that but really the issues is as we move out, there are some credits for example, if they don’t find refinancing solutions six to nine months out then they could have a problem. Then, you’re left with in the worst case scenario, how is that deal structured.

Donald J. MacLeod

I guess the only thing I would add is people who were financed elsewhere are finding it difficult to come to us to get refinance because they don’t have enough equity in their deals.

Christopher Nolan – Maxim Group

Just a last question, what sort of LTVs are you looking at in terms of new commercial deals these days?

Rene F. Jones

Put it this way, if you look at many of our portfolios, New York City, they’re at 60% loan-to-value, so we’re not changing our tone and we’re obviously considering the current market in those evaluations.

Operator

Your next question comes from Jennifer Demba – SunTrust Robinson Humphrey.

Jennifer Demba – SunTrust Robinson Humphrey

My question is about your TruPS portfolio and what are you carrying that at now when you include the Provident deals?

Rene F. Jones

Let me just go back in pieces, I think the partners we have maybe $5 or $6 million left on our books of book value there. Then, on the Provident portfolio, in due diligence we said that we would mark them I think at $0.195 on the $1 and we actually marked them to $0.15. I think that all of the things combined that the bank piece of that is probably around $65 million and then all of the bank, the REIT and the insurance is probably just at or just under $100 on our books because remember the par value was almost $600 million.

Jennifer Demba – SunTrust Robinson Humphrey

Going back to an earlier topic, the onetime close portfolio you said was about $156 million today, what would that have been a quarter ago and say a year ago?

Rene F. Jones

A quarter ago I’m going to guess $196 or high $190s and a year ago maybe as high as $400 million.

Operator

Your next question comes from Collyn Gilbert – Stifel Nicolaus.

Collyn Gilbert – Stifel Nicolaus

Three quick questions, one did you see a big differential in the individual loan sizes of your inflow and outflows in the NPL bucket?

Rene F. Jones

Not really, not really. There were a lot of credits but I guess they were generally smaller with the exception of one or two so I don’t think there’s a big change there.

Collyn Gilbert – Stifel Nicolaus

Second thing, can you give a little bit of color as to what you think the run rate on expenses are going to be over the next few quarters?

Rene F. Jones

I think they’ve been pretty well controlled, I don’t see any reason why they wouldn’t stay well controlled. That’s the core and then of course we’re only five weeks in to our owning the Provident franchise so there’s work to be done there so I think that’s a positive. We can probably lower expenses from that.

Collyn Gilbert – Stifel Nicolaus

You didn’t want to sort of quantify that with a number?

Rene F. Jones

Well, I mean it’s no different than what we said. I guess we said 45% expense saves on that transaction and you know that probably work is done on 29% or something like that. But, you haven’t seen that yet so you’ll get a better sense in the third quarter of what that looks like.

Collyn Gilbert – Stifel Nicolaus

Then just finally on the M&A side, can you just give a little bit of color as to what specifically you would be interested in? I know in the past you had spoke to the success of the partners trust transaction, kind of the mid market deal over capitalized risks, low risk on the asset side of the balance sheet, good funding side, has that changed at all or given the environment have your M&A criteria changed? What are you thinking from a geographical perspective or business perspective?

Rene F. Jones

Our criteria hasn’t changed and it’s almost identical to what we’re doing in our core organic growth. Wherever we can focus on taking share in our existing communities, that’s what we’re going to do. It really works on the acquisition front because you have a much lower risk transaction so to the extent that there are things in particularly and around our foot print we would have a bias towards those types of things because it is a pretty risky environment out there and we would only do things that make a lot of sense and that have a fair amount of synergies. It’s not any different from what we’re doing on the organic basis with for example our loan portfolio as you saw in those results.

Collyn Gilbert – Stifel Nicolaus

How about a size preferential, is there a type of transaction that would be just too small that wouldn’t be worth it to you all?

Rene F. Jones

I don’t know, Provident was a wonderful transaction, it was only $6 million in assets but it was our third largest deal ever. So, that’s who we are.

Operator

Your next question comes from Ken Usdin – Bank of America Securities.

Ken Usdin – Bank of America Securities

Just one question on credit quality and provision so if we’re to understand that NPAs are flat and the outlook is suppose to be pretty reasonable but you’re expecting that some of the CRE stuff might not turn up until the end of this year in to next year, the amount of over provisioning was rather tight, you only over provided by just a little bit this quarter. How do we think about where provision expense goes from here? And, if you’re as confident as you are about the quality of the book from here, have we seen the peak in provisioning expense already?

Rene F. Jones

It’s good to know that I sound confident. I think that there’s nothing super optimistic about the state of the economy it’s just getting a lot worse so I’d give you that as a backdrop. Technically, we sold down a large credit that we had provided for so you would think that if everything was neutral that you would have actually under provided. So really, there’s a fair amount of all of that that was released was reabsorbed by new credits and then we added $9 million on top of that. So, I kind of look at that as we sort of steadily added it’s just that we’ve resolved a number of credits as we have sort of taken new issues on.

I don’t think it’s going to change much. I think from time-to-time when we’ve had large credits we’ve had to provide in excess like last quarter, like the fourth quarter of ’07 and we’ll continue to do what we need to do. But, I think what actually helps us is our consumer portfolio has fared very well. I think that has helped us a lot and we have not had some of the outside losses in our consumer portfolio that you’re seeing in the industry so that’s what helps us.

Ken Usdin – Bank of America Securities

Then what are the types of things, when you mentioned the things that might potentially turn either later in the year or in to next, what are the most important factors for us to be watching from you as far as those migration patterns on the CRE side?

Rene F. Jones

Non-performing loans and what we say on the call, we hate surprising people so as we learn things we’ll share them with you. I can’t point to anything specific but just the standard traditional credit metrics that are out there and we’ll try to give you color as we see them, as things change.

Ken Usdin – Bank of America Securities

Actually, one more quick one if I can Rene, a couple of the fee income line items were really strong this quarter, kind of follow ons of [interstate] environment like the mortgage banking line and I’ll assume that’s what drove the really strong tradings revenue line. Should we expect those areas to moderate as we get to a little bit more of a normal environment?

Rene F. Jones

I think that might be true on the mortgage side. I think the trading income is essentially – it’s also tied to our deferred comp plans many of which we inherited so as the market goes up, the Dow, the S&P, you get higher valuations there. Having said that, if you look at where the overall stock market is, our asset sensitive, market sensitive kind of fee is like trust and brokerage and those types of things, they really have remained very, very weak so I haven’t seen an uptick there. I guess the rest of the stuff, the commercial banking fees have done very well and I would expect while it may be lumpy from quarter-to-quarter that there’s still going to be a fair amount of business out there for us.

Operator

Your next question comes from Todd Hagerman – Collins Stewart.

Todd Hagerman – Collins Stewart

Rene, I just had kind of a similar question to Ken’s, just asked a little bit differently, just in terms of credit M&T has done a number of targeted reviews over the past year and then some on some of the more troubled portfolios. As I listen to your credit outlook, was there anything specific that may have been completed this quarter in addition to Provident or anything kind of pending as I think about for example the Mid Atlantic home builder portfolio, the New York City portfolio and so forth?

Rene F. Jones

I believe this quarter we focused on a review of commercial real estate. We said in the past that that’s where we’re heavily focused. We’ve been focusing on our review of commercial real estate but we did do a pretty deep dive in to the auto floor plan business. We did that because we were very focused on what our exposure was to GM and Chevy and those types of things. That actually came out fairing pretty well and we had relatively low exposure to a lot of the impact of sort of reducing the size of those institutions and actually the outcome has been a little bit better. We spent a lot of time focusing on that area and then we obviously have just finished the annual shared national credit exam but nothing to speak of really.

Todd Hagerman – Collins Stewart

On the shared national credit that was in the numbers I’m assuming, the second quarter? Any preliminary results there?

Rene F. Jones

Anything that we know, anything that we know would be in the numbers to the extent that we’re the lead.

Todd Hagerman – Collins Stewart

Could you just remind us, as you took a look at that auto related exposure, where is does all in net exposure stand at this time?

Rene F. Jones

I’ll try and get a total exposure number for you in a minute but I would say if you look at just the floor plan piece, that a year ago was probably at $1.6 to $1.7 billion just in the floor plan piece and it’s actually dropped dramatically. The last I looked maybe it was $1.2 or something in that range because the remaining dealers that are left have very, very low inventory so the whole thing a year ago was $2 billion, the total floor plan outstanding balances were $1.1 billion. So the exposure there is way down.

A lot of that has to do with just sort of the fact that inventories are low because car sales are down but then also the work we’ve done over time we’ve really reduced our exposure to domestic dealers. I would guess we started at $2 billion of total exposure including real estate and those things and maybe its $1.5 now.

Todd Hagerman – Collins Stewart

Then maybe if I could, just an update in terms of New York City real estate portfolio, you’ve talked about your comfort level there, very little past due, could you just update us where the past due numbers trended this quarter on New York City.

Rene F. Jones

I don’t think we have any, there’s nothing significant.

Todd Hagerman – Collins Stewart

Nothing significant?

Rene F. Jones

I don’t believe we have anything in non-performing?

Donald J. MacLeod

There had been the one for $5 million.

Rene F. Jones

A $5 million credit but that’s been there for a long time. Again, I’ll just say that we are not saying that we are immune to losses in those portfolios we’re saying two things, timing and as it comes we’ll be affected like everybody else but we do think we will hold our own as we go through those types of things just as we have in other areas.

Operator

Your next question comes from Amanda Larsen – Raymond James & Associates.

Amanda Larsen – Raymond James & Associates

I just wanted to know what were your early stage delinquencies? And, if there were any notable increases or decreases in any particular loan bucket?

Rene F. Jones

As I looked at total delinquencies as a whole, it’s an estimate now as we have to sort of audit some of those numbers but, the total 30 to 89 day ratio went from 1.03 last quarter to the 97 this quarter. We’ll have to check that and it will come out in our [FRY9C].

Amanda Larsen – Raymond James & Associates

Then also, what do you think you’d be more likely to do first, an accretive acquisition or pay back the TARP?

Rene F. Jones

Two different things, I don’t know that they really relate to each other.

Operator

Your next question comes from Bob Ramsey – FBR Capital Markets.

Bob Ramsey – FBR Capital Markets

I couldn’t find in the release the amount of preferred dividend expense or the end of period balance with Provident in there, can you just give me those numbers?

Rene F. Jones

The total TARP would be $751.5 billion and the dividend, you can actually get at the dividend because we have a line on page 13 of the release that shows net income and net income available to common shareholders, so the difference there is the dividend. It looks to be about $10.5 to $11 million.

Bob Ramsey – FBR Capital Markets

Was there any non-TARP preferred with Provident, or no?

Rene F. Jones

They have $26 million of mandatory convertible that they issued in April of ’08 that’s left. They issued $50 and we had a piece of it that got cancelled out.

Operator

There are no further questions at this time. I’ll now turn the conference back over to Mr. MacLeod for any closing remarks.

Donald J. MacLeod

Again, I’d like to thank you all for participating today. As always, if a clarification of any items on the call or the news release is necessary, please contact our investor relations department at 716-842-5138.

Operator

Thank you all for participating in today’s M&T Bank second quarter 2009 earnings conference call. You may now disconnect.

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Source: M&T Bank Corporation Q2 2009 Earnings Call Transcript
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