M&T Bank (MTB) Q4 2015 Results - Earnings Call Transcript

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M&T Bank Corporation

Q4 2015 Earnings Conference Call

January 19, 2016 11:00 AM ET

Executives

Donald MacLeod - Director of Investor Relations

René Jones - Vice Chairman, Chief Financial Officer

Analysts

Ken Usdin - Jefferies & Co.

Frank Schiraldi - Sandler O'Neill & Partners, L.P.

Marty Mosby - Vining Sparks

John Pancari - Evercore Partners

David Eads - UBS

Bob Ramsey - Friedman Billings Ramsey

Geoffrey Elliott - Autonomous Research LLP

Brian Klock - Keefe, Bruyette & Woods, Inc.

Gerard Cassidy - RBC Capital Markets

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the M&T Bank Fourth Quarter 2015 Earnings Conference Call. It is now my pleasure to turn the floor over to Don MacLeod, Director of Investor Relations. Please go ahead, sir.

Donald MacLeod

Thank you, Jackie, and good morning. I’d like to thank everyone for participating in M&T’s fourth quarter 2015 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 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 8-K, 10-K and 10-Q for a complete discussion of forward-looking statements.

Now, I’d like to introduce our Chief Financial Officer, René Jones.

René Jones

Thank you, Don, and good morning, everyone. Thank you for joining us on the call this morning. As noted in this morning’s press release, we were pleased with our progress in what proved to be a very busy quarter. The overall financial performance was strong and we completed the merger with Hudson City Bancorp, which was immediately accretive to M&T’s net operating earnings, risk-based capital ratios and tangible book value per share in-sync with our earlier projection.

I’ll review a few highlights of the quarter and the year, including some perspective on how the merger impacted our results for the quarter. And then we’ll share our thoughts on the outlook, after which Don and I will be happy to take your questions.

Turning to the results, diluted GAAP earnings per common share were $1.65 for the fourth quarter of 2015 compared with $1.93 in the third quarter and $1.92 a year earlier. The decline came as a result of merger-related charges in connection with the Hudson City transaction.

Net income for the quarter was $271 million compared with $280 million in the linked quarter and $278 million in the year-ago quarter. In order to assist investors in understanding the impact of merger activity on its financial results, M&T provides supplemental reporting of its results on a net operating or tangible basis from which we exclude the after-tax effect of the amortization of intangible assets, as well as expenses and gains associated with mergers and acquisitions.

After-tax expense from the amortization of intangible assets was $6 million or $0.04 per share, per common share, in the recent quarter, compared with $3 million and $0.02 per common share in the prior quarter, and $4 million and $0.03 per common share in the fourth quarter of 2014. The increase in the recent quarter reflects amortization associated with the $132 million of additional core deposit intangible created through the Hudson City Merger.

Included in the fourth quarter results were significant merger-related charges, including $76 million of noninterest expenses and a $21 million provision for credit losses for the acquired Hudson City loan portfolio. I’ll discuss the accounting for the acquired loans in a few moments.

Combined, these items amounted to $61 million after-tax or $0.40 per common share. There were no such charges in the previous quarter or the year earlier quarter. M&T’s net operating income for the fourth quarter, which excludes merger-related items and the intangible amortizations that I just mentioned was $338 million, increased from $283 million in the linked quarter and $282 million in last year’s fourth quarter.

Diluted net operating earnings per share were $2.09 for the recent quarter, an increase of 7% from $1.95 in both the previous quarter and the year-ago quarter. Net operating income yielded annualized rates of return on average tangible assets and average tangible shareholders’ equity - common shareholders’ equity of 1.21% and 13.26% for the recent quarter, comparable returns were 1.18% and 12.98% in the third quarter of 2015.

In accordance with the SEC guidelines, this morning’s press release contains a tabular reconciliation of GAAP and non-GAAP results including tangible assets and equity.

Looking to the balance sheet and the income statement, Hudson City added about $24 billion of total assets after our restructuring, which included $19 billion of loans and $18 billion of deposits. Over the four days immediately after the closing, we retired $10.6 billion of Hudson City’s borrowing, which was funded by the sale of $5.8 billion of investment securities and the remainder by Hudson City’s cash on hand.

Taxable-equivalent net interest income was $813 million for the fourth quarter of 2015, up from $699 million in the linked quarter and $688 million in the fourth quarter of 2014. The increase includes approximately $110 million of net interest income attributable to Hudson City.

The net interest margin was 3.12% during the quarter, down 2 basis points from 3.14% in the third quarter. Our explanation of the decline is relatively simple this quarter. We estimate that the inclusion of Hudson City diminished the margin by about 3 basis points.

On the core side - on the core M&T side, we estimate there was 1 basis point expansion, as pressure on the core margin was more than offset by rising short-term interest rates, which included an increase in short-term LIBOR rates in advance of the Fed’s December action.

Average total loans increased by $13.3 billion from the linked quarter, primarily reflecting the partial quarter impact from Hudson City. Substantially, all of the Hudson City loans are residential mortgage loans. Thus, the acquisition had limited impact on growth in the other loan categories.

Growth in each of those other loan categories was solid on an average basis compared to linked quarter. C&I, commercial and industrial loans increased an annualized 6%, aided by the seasonal rebound in auto floor plan. Commercial real estate loans increased by about 9% annualized. Consumer loans grew an annualized 10%, reflecting continued growth Indirect Auto.

While lending conditions on the commercial side remains very competitive with pressures from both bank- and non-bank-lenders, loan demand remains healthy, bolstered by repeat business with existing customers, who value our relationship approach to lending. We continue to see strong results in the commercial bank in our metropolitan region, which includes New York City as well as Pennsylvania and Baltimore - as well as Pennsylvania and Baltimore.

Growth was somewhat softer in upstate in Western New York. Average core customer deposits, which excludes deposits received at M&T’s Cayman Islands office, CDs over $250,000 and brokered deposits increased 16% un-annualized from the third quarter, primarily reflecting the impact from the acquisition.

Noninterest income - now turning to fees, noninterest income or fee income totaled $448 million in the fourth quarter, up from $440 million in the linked quarter, contributing to fees from - the contribution to fees from Hudson City was not significant. Mortgage banking revenues were $88 million in the fourth quarter compared with $84 million in the third quarter. Residential mortgage banking revenues declined by $6 million, the majority of which is attributable to a 23% reduction in residential mortgage loans originated for sale.

Commercial mortgage banking revenues were up $10 million from the prior quarter reflecting a solid quarter of multifamily FHA origination.

Service charges on deposit accounts were $106 million, little changed from $107 million in the third quarter. And trust income was $115 million in the recent quarter, slightly improved from $114 million in the previous quarter.

All other revenues from operation were $144 million, up from $138 million in the third quarter. Both the third and fourth quarters of 2015 were characterized by particularly strong commercial lending-related fees. The recent quarter’s results included higher levels of syndication fees, while the previous quarters’ results included a sizable gain on previously leased equipment which did not recur.

Turning to expenses, operating expenses for the fourth quarter, which exclude the expense from the amortization of intangibles and merger-related expenses, was $701 million compared to $650 million in the third quarter. Those operating expenses included approximately $40 million attributable to Hudson City. The efficiency ratio which excludes intangible amortization and the merger-related expenses improved to 55.5%, reflecting the two-month impact from Hudson City.

It is notable that on a full year-over-year basis, adjusting for the merger and the sizable contribution to the M&T Charitable Foundation made in this year’s second - last year’s second quarter, total operating expenses were down slightly from 2014.

Next let’s turn to credit. Overall, credit quality remains strong. Nonaccrual loans at the end of 2015 were $799 million, up slightly from $787 million at September 30. The ratio of nonaccrual loans to total loans was 91 basis points at year-end. The significant decline in that ratio from September 30 reflects the addition of Hudson City’s loan portfolio.

Net charge-offs for the fourth quarter were $36 million improved from $40 million in the third quarter. Annualized net charge-offs as a percentage of total loans were 18 basis points for the period with the ratio also benefiting from the addition of the Hudson City portfolio to total loans.

The provision for credit losses was $58 million for the recent quarter, which includes the $21 million merger-related provision I mentioned earlier. The allowance for credit losses was $956 million at the end of 2015 and reflects our assessment of the loss content in the loan portfolio. The ratio of allowance to total loans was 1.09% which also reflects the addition of the Hudson City loan portfolio.

The loan loss allowance as of December 31 was 17 times 2015 - I’m sorry, was 7 times 2015’s net charge-offs. Loans 90 days past due, on which we continue to accrue interest, including loans acquired at a discount were $273 million at the end of 2015. Of these loans, $232 million or 85% are guaranteed by government related entities.

Before I leave credit, I’d like to provide you with some background on the accounting for the loans that we acquired with Hudson City. As you know, GAAP requires acquired loans to be recorded at fair value at the date of acquisition with no carryover of the acquired entities allowance for loan loss.

That fair value reflects the use of interest rate and credit loss assumptions. In connection with the Hudson City merger, we recorded $19 billion of Hudson City loans held for investment at their estimated fair value. Approximately $1 billion of those loans are classified as purchased impaired loans we recorded at a discount to par and are being accounted for under SOP 03-3.

The fair value of the remaining $18 billion of acquired loans exceeded the outstanding loan balance resulting in a net premium which will be amortized over the remaining lives of the loans as a reduction of interest income. GAAP does not allow the credit loss component of that premium to be bifurcated and accounted for as a non-accreting difference, as was the case in previous acquisitions when all loans were deemed acquired at discount.

GAAP also provides that an allowance for credit losses on loans acquired at a premium be recognized for incurred losses in that portfolio, even though in a homogeneous portfolio of residential mortgage loans - the specific loans to which those losses relate cannot be easily identified.

M&T believes that this accounting requirement results in an additional provision for loan losses that was already factored into the fair value of the loans at the acquisition date. As a result, the $21 million incremental provision has been characterized as a merger-related expense. Hopefully that’s helpful.

Turning to capital, our Common Equity Tier 1 ratio, under the transitional Basel III capital rules currently in effect, was an estimated 11.06% at the end of the recent quarter up from 10.08% at the end of September. Completion of the Hudson City merger added an estimated 80 basis points to that ratio.

Tangible book value per share was $64.28 at the end of 2015, up 5% from $61.22 at the end of September and up 13% from $57.6 at the end of 2014.

As a point of comparison, over the past five years M&T has grown tangible book value per share at a compounded annual growth rate of over 14% through a combination of organic growth and prudently priced expansion.

Next, I would like to take a moment to cover the key highlights of 2015 results.

GAAP based diluted earnings per common share were $7.18 compared with $7.42 in 2014. Net income was $1.08 billion up slightly from $1.07 billion in the prior year, net operating income, which excludes intangible amortization and the merger-related expenses, was $1.2 billion, improved from $1.1 billion in the prior year.

Diluted net operating earnings per common share was $7.74, up from $7.57 in 2014. Net operating income for 2015 expressed as a rate of return on average tangible assets, average tangible common shareholders’ equity was 1.18% and 13% respectively.

Before I turn to the outlook, as many of you have seen on January 6 the U.S. Attorney in Delaware took action against Wilmington Trust Corporation related to alleged conduct prior to M&T’s acquisition of Wilmington Trust Corporation in 2011. As the U.S. Attorney noted in his press release, this alleged activity relates solely to Wilmington Trust’s commercial banking operations during that time period.

While we are limited in our ability to discuss this matter, it is important to note that we strongly believe that this unprecedented action is unjustified and Wilmington Trust intends to vigorously defend itself.

Now, turning to the outlook, as Don and I were saying yesterday, the daunting task we undertake every January to offer you a projection of what we think will unfold over the coming year. But in retrospect, the thoughts we offered you on this call last year weren’t too far off from what actually occurred. So here we go again.

I should first note that the end-of-period balance sheet is more representative of our run rate balance sheet than the averages for the fourth quarter, given the November 1 effective date of the merger. During the fourth quarter, we saw a steady to positive momentum in the lending environment. And as a result, including the newly acquired loans from Hudson City, we would expect low to mid single digit growth in total loans in 2016, with a slightly higher pace of growth in commercial and consumer loans, partially offset by contraction in the residential mortgage loans, as we expect that the Hudson City portfolio will continue to pay down.

The pace of payoff will obviously depend on interest rate. Our outlook for the net interest margin is dependent on further actions by the Federal Reserve. Given what the implied forward rate curve is telling us, we’d expect the net interest margin for the full year of 2016 to be stable or slightly better than what we reported in the fourth quarter.

The full run rate impact from the addition of Hudson City’s balance sheet will be a modest source of pressure early in the year. As we’ve seen over the past several years the impact of cash balances brought in through Wilmington Trust could have an impact on the reported margin but would be additive to revenue.

Excluding the impact from the sale of the trade processing business in 2015’s second quarter, both the $45 million gain in the single quarter of revenue we earned prior to the divestiture, we would expect flat to modest growth in noninterest expense and fees. We expect pressure on mortgage banking revenues in a higher rate environment and continued industry-wide pressure on consumer service charges to be offset by growth in other fees, assisted of course by higher short-term rates.

Regarding expenses, in light of the limited revenue opportunities, we’re looking to keep core expenses relatively contained, continued investment spending, including technology investment, offset with savings elsewhere as other projects reach completion.

Our goal is to strive for positive operating leverage over the course of 2016. As to Hudson City, we’d estimate that an additional $40 million to $50 million of expense reductions will result from further actions we expect to take over the first-half of 2016, particularly the branch and systems conversion.

These should ultimately result in realizing the majority of our expected expense savings by June or let’s say the first-half of the year. Separately, we’d estimate that there are about $40 million of merger-related expenses remaining to be incurred, the majority coming over the first-half of 2016.

Aside from the national news on energy lending which shouldn’t have a material impact on us, we see no indication of a change in the credit cycle. Net charge-offs amounted to just 19 basis points for the second year in a row, which is roughly half the long-term average. But as we said on this call last year, our conservatism won’t let us count on beating that figure in 2016.

Income tax expense in the fourth quarter included a $4.6 million benefit from technology research credits related to prior years through 2014, which were approved by the IRS in December. We know that the provision in the tax code providing for such credits was extended by Congress in December. Any additional benefits in the future will depend on the size and type of technology investments that we make.

As you know, the capital plan we submitted in connection with the 2015 CCAR process, which received no objection from the Fed included $200 million of share repurchases in the first-half of 2016. We expect to begin implementing that program shortly.

Lastly, we will review our capital position with our board on both a nominal basis and under stress as we prepare our CCAR 2016 capital plan and stress test for submission to the regulators in early April.

We’ve got another year of earnings retention under our belts, as well as the capital accretion from the merger. Looking forward, our expectation is that the Hudson City loan portfolio will continue to pay down, moderating our overall loan growth. And thus, our pace of internal capital generation will remain high.

Those are our thoughts, hope you’ll find them helpful as the year unfolds. Let’s now see what happens.

Of course as you are aware, our projections are subject to a number of uncertainties in various assumptions regarding national and regional economic growth, changes in interest rates and credit spreads, political events, and other macroeconomic factors which may differ materially from what actually unfolds in the future.

Now, let’s open up the call, before which the instructor will briefly review the instructions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Ken Usdin with Jefferies.

René Jones

Good morning, Ken.

Ken Usdin

Hey, good morning, René. Hey, just two clarifying points on just how the two companies pulled together up, just based on the fee side I just wanted to make sure I understood. When you’re talking about hoping to keep fees pretty flat this year, should we be thinking about the kind of the $440 million, $450 million run rate for the last three quarters, that ex that $45 million gain you had in the second quarter? I just want to make sure I wasn’t missing what you were saying about the pre-business-sale quarter.

René Jones

Well, I was just - I think what we were doing is looking at the full year 2015 and sort of taking out that unusual gain in that obviously the first quarter business that we had, gain was $45 million. And then, we were just looking year-over-year. As you know, kind of as I look at the - going forward, we’ve got decent loan growth. We will be flat to some margin expansion. So that gives you some single-digit revenue growth.

Ken Usdin

Yes.

René Jones

And if we can get year-over-year, a spread on that, revenue versus expense growth, then I think we get a little leverage there to the bottom line. So that’s how I’m thinking of it year over year.

Ken Usdin

Yes, perfect. And then, my second question is just on the expense side. So you talked about keeping the kind of core M&T flat. You just have the natural growth coming with the addition of Hudson City minus the cost saves. So again, just trying to understand, you pointed to - for the rest of the income statement starting kind of off of the fourth quarter. But I don’t think that’s quite at what you’re saying here. So how do we just think about the trajectory of where expenses start from, if there’s a way you can help us get tighter there?

René Jones

Where expenses start? So again, I think I start on the M&T side with full year and think about year over year. There’s nothing much unusual there, except for maybe the $40 million tradable contribution that we had in 2015. And that’s the basis from which I’m operating.

If you look at the fourth quarter results, we gave you the number. We said that that roughly $40 million of the operating expense came from Hudson City, and that was two months. And from there - there were some expense saves in those numbers. But from there, we estimate - from that run rate, we estimate that we have actions to take that would add up to between $40 million and $50 million in annualized expense savings. And that is net of the hires, any additional hires that we would have to do related to Hudson City and New Jersey.

Ken Usdin

Okay. So the $40 million is two months, that’s about $60 million that includes a little bit. That’s 240 million full year. And then, think about the $40 million or $50 million off of that. But that’s a net number.

René Jones

Yes.

Ken Usdin

Great. Thank you, René.

Operator

Our next question comes from the line of Frank Schiraldi with Sandler O’Neill.

René Jones

Good morning.

Frank Schiraldi

Good morning. Just a follow-up on the expense side, just trying to think about efficiency ratio here, and obviously you’re at that high-end at least for the quarter of 50% to 55% efficiency ratio. As you extract those cost saves from Hudson City next year, does that just alone result in further improvements for the efficiency ratio or are we more likely to see that benefit sort of show up in investment elsewhere, all else equal?

René Jones

Yes, I mean, our goal is without Hudson City we try to maintain some level of operating leverage. In that, we’ve got a number of things that we’re doing to sort of optimize our operations. And we’re hoping to put that money back into IT spending. At the end of the day, we’ll put the money back into IT spending, regardless of how much progress we make in other areas, because we think it’s really important. So we’ve talked about that for some time.

When you think of the efficiency ratio, when you think first of Hudson City, I even done the math, but you got one more month of Hudson City, right? So there’s probably some additional impact on the efficiency ratio when you full three months in the quarter. And then, we have work to do to reduce - get the cost saves that we talked about.

One thing I would point out is that, it’s not as if we’re getting those cost saves on January 1, right, so you get the full year impact of $40 million to $50 million. That’s the run rate impact that you’re going to get on an annualized basis after you’ve taken the action. So that also should have an impact on the efficiency ratio.

When I look at our performance this past year, I think we did a pretty good job of managing expenses, but I also think quite frankly, the improvements we saw in the efficiency ratio comes from the fact that we did have growth in revenues in a pretty tough environment in that spread-wide. And when you think about it, if you adjust for the charitable contribution and the gain from the divestiture, we were 57% something in the second quarter. We were 57.1% in the third quarter.

And I think it’s about 2 percentage points that Hudson City benefited our efficiency ratio. So we’re running pretty well. We had a pretty good year on both sides of the equation.

Frank Schiraldi

Sure, and then just one follow-up on the - actually on deposit pricing. Just when I look at New Jersey as a whole, seems like there is a number of institutions, particularly in that state that are deposit hungry, so to speak. And so just wondering is there a significant opportunity to improve margins with re-pricing of higher cost deposits at Hudson City or do you think you may have to defend share more by holding that pricing over the next, call it 12 months?

René Jones

Yes, so I think of it - I’ll break it into two pieces. I think about it a little differently. So we’ve got this very, very large base of deposit customers who are primarily all the CDs. So they’re single-service households for us. And in that group we don’t have a big interest in necessarily rationalizing pricing so to speak, because we really would like to get to know those customers.

I’ve got a couple of letters myself already, couple of people introducing them to me. And they clearly fit the profile of people we would love to have a more full-service banking relationship with.

So I think that will take a little time and I don’t think we’ll be hasty to do that at the outset of this year. But then, separately, we do think there is a very large opportunity for full-service checking account relationships that we would typically hold. And most of those relationships aren’t just a checking account. They tend to have multiple products and services as we roll out our relationship banking approach.

So it’s sort of two and quite frankly really what we’re trying to do is, is we get a nice shot of an introduction to those customers and we will be trying to convince them that we should be their primary bank for all of their deposit service. So that means you can’t move too quickly to just treat it as a financial asset, they’re customers.

Frank Schiraldi

Right, understood. Okay. Thank you.

Operator

Our next question comes from the line of Marty Mosby with Vining Sparks.

René Jones

Hi, Marty.

Marty Mosby

Hey, I want to ask you little bit about the way in which the premium on those loans that you brought over, how that dynamic kind of work. So that’s a little different than what we’ve seen so far with that accounting with the discounts that were in prior accounting.

As you bringing over the premium like you said you already had the negative accounting for. But now, you also had to put on allowance. So will you have net charge-offs from those loans and go against the allowance that you created or - just was wondering how that will work logistically going forward.

René Jones

Yes, Marty that - yes. So think of it this way. Those loans that you acquire at a premium you are just not allowed to use the SOP discount accounting that you are used to in a lot of deals or that you saw in Wilmington. We deemed Wilmington’s, pretty much the whole portfolio to be purchased at a discount. So what ends up happening is they get treated - and the loans at a premium are treated out of FAS 91 just like originated loans. You have charge-offs as well.

Marty Mosby

So it will act more like a regular portfolio going forward which will make your statistics and metrics kind of look more normal versus being skewed.

René Jones

Yes, maybe our lives easier too.

Marty Mosby

Right, right. And then the other thing you mentioned and it was the second bank which they kind of keep my ear open. But today we had - now that you’re the second bank to talk about LIBOR going up earlier in December and the benefits - like kind of think about or explain little bit more about that, because the prime rate tied to the Fed funds rate is where you typically would get some of that re-pricing on the commercial business. But a lot of that shifted over to LIBOR. So did you get a full month’s worth of benefits in the fourth quarter as the LIBOR moved up ahead of the prime rate?

René Jones

I have to check. I don’t think - I think it was not quite. It was obviously more than half, but it moved up steadily and it might have been slightly below the full impact of the Fed increase. But it started, if I recall, I think it started in late November.

Marty Mosby

It did started way early and if you look at the percent first in LIBOR versus prime, what’s your percentage at this point of your whole loan portfolio, floating loan portfolio?

René Jones

That’s a great question. The fixed portion is about of our - you want just the loans or the total assets?

Marty Mosby

Just the floating rate loans, just the floating rate.

René Jones

It’s about 51%. So it would be - fixed rate loans would be about $35 billion out of the $88 billion. And then you got to think of - you often think, while we just brought on a lot of fixed rate mortgages we keep in mind that I think almost half of those are actually a variable rate or floating rate resets, right. So you don’t - it’s not quite intuitive, but they’re not all fixed.

Marty Mosby

Got you. Okay.

René Jones

I think the other part of your question, Marty, is if you look at that in the variable rate space, so the remainder will be about $52 billion, $53 billion; $35 billion, $36 billion are LIBOR based. So those are the ones that began getting the benefits late November. But you wouldn’t have seen anything in many of our prime rate portfolio, so home equity portfolios, because they look to December 31 and then go to the next re-price date, which is different for each customer before they look back, so would start to occur 30 days, over the 30 days into January.

Marty Mosby

Good. That was the mechanics I was looking for.

Operator

Our next question comes from the line of John Pancari with Evercore ISI.

René Jones

Good morning, John.

John Pancari

Good morning. Want to see if you can give us a little bit more color René on the loan growth front. Just in general it appeared a little bit lighter when you exclude the impact of Hudson City, a little lighter than what I was forecasting, and if you’re seeing anything there for the quarter that impacted the level of growth, and then separately on your outlook. I know you indicated that commercial and consumer growth should strengthen through the year and just want to see what type of strengthening you expect within those portfolios. Thanks.

René Jones

Yes. No, I didn’t see, we didn’t notice anything unusual in the loan growth. I mean, I characterize it as strong, because I think the numbers were pretty decent growth. But I also know that if I look to our loan committees, I think we had the second highest loan production in the fourth quarter on the commercial side that we’ve seen in several years before fourth quarter.

So things look relatively healthy. And as a way of reference, and of course I’m going to get this wrong, but I think year over year we’ve been running at 4%, 4.5% loan growth or something like that. So I think there is really no sign that it’s flowing. In terms of the market it’s kind of interesting. So we characterize it to still be intensely competitive, as other banks are really offering better pricing and then sometimes structure than we’re able to.

But on the whole, pricing in lowest market like it’s still coming down slightly, it’s not stable but still coming down. Smaller banks are routinely below 200 basis points in terms of margin, maybe 150 to 160 basis points. We’re seeing places where there is no recourse, limited covenants, and in some cases people waiving due diligence.

And so for us, when we look at the growth, a lot of times what we’re seeing is that we’re able to do fairly well, but that’s coming primarily from existing client. And they really focus on the fact that we’re relatively proactive. We spend a lot of time with them. We know their businesses. And we’re fairly consistent regardless of what’s happening in the environment. So that’s where most of our loans are coming from.

And each market is a little different. And we’re trying to sort of make sure that we avoid any pitfalls from that like we’re not chasing people in a particular market without the knowledge to take on that customer. I think I talked a little bit about it. I don’t know if I have, I have the number somewhere. But we saw growth primarily in Philadelphia, Tarrytown, New York region. We had growth that was about 4% annualized. In a year-over-year basis that was about 6%.

We also saw Pennsylvania was about 4% and Baltimore Washington was about 2%. And remember that, Baltimore had been relatively slow for us. So we’re pleased that that has actually continue to do pretty well. The opportunity is different in every market. In upstate New York, which has been relatively slow, there is a huge construction boom and that’s where most of the job on energy is coming from. There is knock-on effects in the other businesses, but that’s what’s driving it. But if you get down to Washington DC, it’s a different set of factor, so it varies by region.

John Pancari

Okay, that’s helpful, René, thank you. And then separately, just want to see how much you can comment on this. Just wondering if you can give us an update on the status of your efforts to meet remaining parts of the regulatory agreement around the BSA/AML deficiencies, just want to see where you stand there. At least give us an idea of the timing maybe in terms of how long it could take to address the remaining parts of that. Thanks.

René Jones

Yes. Thanks for the question, John. I’ll start by saying, I’m not sure. I think that we’ve got our BSA program well in hand and off and running. We substantially completed everything that we think we need to do there and really what ends up to happen is you got to go through - you go through your normal annual exam cycle and make sure that you’re really buttoned down. So, we’re very heavily focused on that and remediating any additional customers that we have to which at this point of time would be all the low-risk category, because of course through the course of last year we got through - we got through the high risk in moderate customers. And obviously we have to do a really good job of making sure that as we put Hudson City on to our systems that all those capabilities at the conversion extend over too. So we’re focused heavily on that.

The other piece I would put into perspective, which is not directly related to the written agreement per se, is that we continue to just focus on all of the rest of our risk management. We think it’s really important whether it’d be in the compliance areas or whether it’d be in sort of modernizing or continuing to elevate our CCAR process. So that’s where our focus is on and I think the written agreement over time will just take care of itself. But we don’t really control the timing and it’s hard for us to be able to estimate something like that.

John Pancari

Got it. All right. Thank you, René.

René Jones

Yes.

Operator

Our next question comes from the line of David Eads with UBS.

René Jones

Hi, David.

David Eads

Hi, good morning. Maybe following up with some of the loan commentary you just had. I’m curious, we got the regulators come out on - you’re talking about conditions in CREmarket. I guess I’m more curious, whether you think - you see any impact of that and whether you think that’s going to have any real impact on the competitive environment for CRE lending from some of these smaller banks.

René Jones

I don’t know. I mean, it’s interesting. We had an annual update that we do on our real estate in our board meeting in November, before all that stuff came out. And it’s sort of mirrored everything we said and talked about, sort of mirrored what the Fed is saying. So those trends are definitely out there. I think one of the things that’s clearly happening at this point in time is that there is still not - in the overall market, some markets may be different, but there is not yet an oversupply. And to us it’s a bit of a warning that you got to keep - you got to watch out for your underwriting.

As you know, I mean, it’s a great question to ask us, because we definitely have a concentration there, particularly in the New York City area. But we tend to not change our underwriting standard. So, for example, if you look at our entire real estate book today, total CRE whether it’s an owner occupied or IRE, our loan to value is 59.5% and in investment real estate it’s 58.3%, all right.

So our intention is to remain really conservative. We stress cap rates as we began to - as we underwrite, just to look at what might happen in that space. But having said that, I think if you were less sophisticated, if you were smaller it does - and given some of the things that we’re seeing, I think everybody is right to be concerned, you’ve got to be very prudent.

Having said that, there are lot of great customers out there who are doing great projects which can be underwritten at the right amount of risk and for the right price and those tend to be customers that we’ve known for fairly long time.

David Eads

Okay. Thanks for that. And then more broadly on loans, just to kind of confirm, when you talk about the guidance for low to mid single digit loan growth next year, that’s off of the 2015 ending balances, correct?

René Jones

Yes. That’s the way to think about it.

David Eads

Right. And should we think about - it sounds like the - just similar to what kind of like the net loan growth is fairly encouraging to me. And it sounds like it’s much more driven by a stronger outlook for kind of the non-mortgage categories rather than expectations for less runoff in the mortgage book, is that a fair read?

René Jones

I think it’s a fair read. I think the one thing I might re-characterize is on the existing book of business. What I would say for me personally is that we for long time have watched loan growth and had sort of a tepid view towards it, will it keep staying that way. It’s really clear now that the loan growth trends have been really consistent and very solid.

So my sense is, we don’t see any signs of them abating. And quite frankly, as I said, our production in the fourth quarter was relatively high, so slightly positive in my mind in terms of confidence.

David Eads

Okay. That’s very helpful. Maybe just one last one, I know there is lot of kind of moment in the allowance this quarter when bringing Hudson City loans, but now you’re at about 1.1% allowance coverage. Is that a reasonable - I mean, are you guys comfortable with that level that kind of the way we should think about the allowance in the near term?

René Jones

Well, this is our job to make sure we do a good estimate of what we think the inherent loss is in the portfolio. And it just so happens, that when you look at the Hudson portfolio that we’re bringing on, not only is it mortgages, right, which are naturally going to - have a lower loss content in the overall book, but the portfolio at Hudson City, the majority of the portfolio has very good credit statistics.

I think it’s something like over the last 16 quarters their loss rates have been about 20 basis points and then if you look at the current LTVs of the $19 billion, they would be at 59.7%, if you look at the original LTVs they would be at 67.9%, so - and good FICO.

So I think there is some subset, mainly the billion dollars that we talked about that have higher delinquencies than the typical M&T portfolio, but the majority is not all of those loans went to the impaired loan, the SOP 03-3 category that we talked about. And we concentrated those in there. We looked for those in the portfolio to segregate them out. Okay. And…

David Eads

Great.

René Jones

Yes.

David Eads

Got it.

René Jones

No, that’s good. So I think the other thing I would say and point to you is, remember, that portfolio is generally going to be running off. So there will be a natural migration back towards our typical allowance ratio.

David Eads

Right, that makes lot of sense. Thanks.

René Jones

Yes.

Operator

Our next question comes from the line of Bob Ramsey with FBR.

Bob Ramsey

Hey, good morning, René, Don. First question for you, when you talked about the net interest margin outlook, could you share with us what the interest rate assumption is that underlies that outlook and then let us know what the rate sensitivity looks like today with Hudson City on the balance sheet?

René Jones

Yes. I think we had two hikes in that, in the forward rate we were using - forward rate we were using. And, yes, in terms of the interest rate sensitivity, I think, we’ve given that number before. Bear with me one second.

Bob Ramsey

Sure.

René Jones

Yes. So we would see about 3.2% increase in the margin for a 100 basis point move in rate up.

Bob Ramsey

Got it. Then sort of circling back to loan growth, it looks like, if I add in the $19 billion of fair valued Hudson City loans in the fourth quarter, balances are about flat for the fourth quarter with obviously some runoff in Hudson City being offset by the growth at M&T. Is that fair, because I’m just rounding the $19 billion, I don’t know the exact dollars, but…?

René Jones

I think you got to remember that the number we gave you which I think was $13.3 billion, because you’re using averages. We only had two months, and I think - yes, so you only would take out in that average $13.3 billion.

Bob Ramsey

Okay. I was looking at end-of-period to end-of-period. So taking end of period M&T, adding $19 billion and then get into the end of period consolidated.

René Jones

All right. Give me minute. I got some end of period balances. We had growth, I mean, our annualized growth in end of period in C&I was 3.7% CREwas 6.6%, total commercial was 5%, consumer was 7.8%.

Bob Ramsey

I guess, what I’m asking is, was that offset by the Hudson City runoff, because if your total end of period in the third quarter was $68.5 billion and you had $19 billion, that gets you $87.5 billion, which is where you ended the year?

René Jones

I mean, I think the number - I got to get the - yes, that’s right. So maybe we’re looking - oh well, so first of all, I’m going to get it in concept and then I have to go back. Yes. There is runoff every month in that - in the - the end of period - by the end of the period that portfolio from Hudson was $18.4 billion.

Bob Ramsey

Okay. And it came on at $19 billion, so you add $600 million of runoff then, right?

René Jones

The $18.8 billion, $18.6 billion you’re saying in the opening balance sheet. So we had $200 million of runoff.

Bob Ramsey

Okay.

René Jones

Those are my estimates quickly to do that, but…

Bob Ramsey

Got it. Okay. That helps. That’s what I needed then. And then, in terms of credit quality, obviously, credit looks great. Are there any signs anywhere in your book of softness or areas of potential concern? I know you’re not really big in energy; but outside of anything energy-related is there anything else out there that shows softness?

René Jones

How do I say that? So the answer is no, not in any particular category. Our nonperforming loans were exactly the same as they were a year ago, which is kind of interesting in the sense that it means that there are some things coming in and some things going out, which we’ve seen economies where that, where it’s better than that.

But if you think about it like even in the quarter the types of things we saw going into nonperforming; there was a beverage wholesale distributor, which I always think should never go into; there was an educational company; there was a provider of fiber optics; auto dealer. So no themes at all really, maybe just I would call them almost idiosyncratic issues.

Bob Ramsey

Okay. Good to hear. Last question and I’ll hop out. But could you remind me how much of these seasonal increases in the first quarter, I guess, especially now on a combined basis, in that salary and benefits line?

René Jones

Yes, Don, what is that number?

Donald MacLeod

It would be in the range of $40 million to $45 million. Some of the stuff would be affected by the Hudson City employee base, for example the FICO reset. But the major component of that is the cash bonuses and the equity grants, which they will not be impacted with. So Hudson will not have as huge an impact as the sort of legacy M&T employee base.

Bob Ramsey

Okay. But altogether $40 million to $45 million lift in the first quarter?

Donald MacLeod

Yes.

Bob Ramsey

Okay. Thank you.

Operator

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

Geoffrey Elliott

Hello there. Another question on credit, when you’re looking for early indicators that the credit cycle might be turning, what are the sorts of metrics which have started to flag red earlier in the past, and how are they performing now?

René Jones

When we say that things look stable on the credit front, we’re looking at all measures. We’re obviously looking at our own statistics in terms of delinquencies and early stage delinquencies which have all been pretty quiet on the front. One of the things that we’ve - that sort of piqued our interest is that obviously, you see in the market the spreads for - the high yield spreads going up.

And so, when you take those out ex-energy, one of the things we noted is that, sort of in that lower level - lower tranches of the CMBS market, since June of last year, they’re up 200 basis points. And so, actually if you take high-yield bonds ex-energy, they are up 200 basis points in that period. If you take CMBS they’re up 200 basis points, bank spreads are up a little over that same period too.

So we particularly look at that and then take a look at the underlying credit metrics. The only place and it’s not in M&T’s book, on a national level where you see both higher spreads and higher delinquencies, is in the indirect auto space. When we look at our book, maybe because it’s so concentrated in the 700 FICO space plus, we’ve actually seen no deterioration there. So those are some of the things we’ve been looking at lately.

Geoffrey Elliott

And then just as a follow-up, those sort of your market indicators that you follow, do you think there are reasons why the relationship might not work the same way as in the past or do you think the historical relationship should hold?

René Jones

It’s a great risk management question. I don’t know. I think - look, I think that you - our MO has typically been to be more cautious which has resulted in slower growth when times are great and everybody is available to lend. And when you look at the market today, the one thing that I would say that we’re seeing is not only are all banks healthy, large and small, but you’ve got the debt funds in the market, you’ve got the insurance companies back in the market and you saw some of the trends that we’re talking about.

So in our minds, when we look at our reserves, for example, we tend to look at the idea that these loans are being underwritten, right, at historically - there is more pressure on people to do deals in lower structure and those types of things. So that means the loss is inherent and all books are probably are growing a little bit and when you get to these phases.

I guess the other thing that I would say is what sometimes gives us pause, and then, this year we saw a couple of these things. When we look and we see that we’ve lost a customer and someone has taken our loan out that was actually a classified loan for us, right, that tends to worry us.

If I take myself all the way back to the ‘80s, I remember lots of banks that were reporting low delinquencies and no foreclosures. But when you look at the underlying reason, it was because somebody was willing to refinance that buyer out, and so all the losses were hidden.

I don’t think that changes, I don’t think you can always see it in your statistics. So you have to be very careful when times are good, because that’s when the difficult loans are made.

Geoffrey Elliott

Thank you.

Operator

And our next question comes from the line of Brian Klock with Keefe, Bruyette & Woods.

René Jones

Hi, Brian.

Brian Klock

Hi, Rene. Hi, Don. Just a couple of quick follow-up questions. Rene, in the other revenue from operations, so it was $118 million, it was up $15 million from last year’s fourth quarter. The third quarter had, what, $14 million in gains - lease-related gains. So I guess the sequential increase still seems like there is maybe $18 million or $19 million quarter over quarter increase. Is there anything in there that’s nonrecurring or seasonal?

René Jones

Well, you know what, we had a very strong quarter in terms of commercial loan fees, either fees on origination or large syndication fees, both - some in size but also in volume. And what I would say is those tend to be relatively lumpy.

The gain that you saw from the - in the third quarter was also related to one of our commercial businesses or commercial leasing business. So I wouldn’t expect every quarter to look like this one by any means. But having said that, I kind of step back and say, well, on the year-over-year basis, right, the business seems to be doing pretty well. And there’s fair amount of activity.

Brian Klock

Okay. Fair enough. And two last questions Hudson City related, I guess, thinking about the tax rate from Hudson City was higher than M&T’s core. I guess, after the adjustments for the tax credit what should we be thinking about for a consolidated tax rate for 2016?

René Jones

I can give you the theory. But I don’t think I can give you the tax rate. So obviously, so we had the tax credits there, so you got to adjust for that and you can see where M&T has been running as you do that. And then, we often talk about the marginal tax rate for the next dollar of income. That will be up slightly from where our marginal rate was before.

You will have to take a look and get a reset as we get into the first quarter, but up slightly after you normalize for the $4.6 million. And when I say slightly, I’m very cautious to say that, because I don’t know how much you’ll notice it.

Brian Klock

Okay. Okay, and then, last question just with Hudson City in the books, still feeling good about the mid single digit accretion for 2016?

René Jones

Yes. Yes, I think we saw some accretion today. I mean, I think, I would say, an estimate for me is maybe $0.05 accretion in there from Hudson City in this first two months for the quarter. So that would be - that would kind of put us right on track if you think about achieving the rest of the cost saves.

Brian Klock

All right, sounds good. Thank you for your time.

René Jones

Sure.

Operator

Our final question comes from the line of Gerard Cassidy with RBC.

René Jones

Hey, Gerard.

Gerard Cassidy

Hey, René. How are you? A question…

René Jones

Good. They always put you way in the back of the queue.

Gerard Cassidy

What’s that?

René Jones

They always put you way in the back of the queue.

Gerard Cassidy

I know. I guess, save the worst for last, I guess. Couple of questions for you. One, can you give us an update? Obviously your transitional tier 1 common ratio came in at about 11 - just over a shy of above 11%. We all know everybody has to carry extra capital to make it through CCAR. Can you remind us what you’re comfortable with in terms of keeping a buffer above what you think you need to get through CCAR in terms of this tier 1 common ratio, because 11% seems awfully high to me?

René Jones

Yes, 11% is very high. I mean, think of it this way. We were just over 9% when we entered our first CCAR. And we obviously got no objection, but we also - the point I’m making here would be we fared well on a quantitative basis. And then, when we entered the second time, we were below 10%, we were maybe, I don’t know, 9.80% or 9.70% or somewhere in that range, and we also fared well.

So that kind of began to give us some sense of where we needed to put our target governance - in those areas is where our target governance that’s where if we started to get lower than that that we would be thinking about our governance process and maybe not having buy-backs and those types of things. But as you can see, we’re well above that.

Gerard Cassidy

Right.

René Jones

We’re above that because of couple of things, obviously the transaction. But now we’re generating capital at a very, very, very high rate.

Gerard Cassidy

Correct.

René Jones

And so our thought process is that our optimal capital structure is definitely lower than where it is at today. But we’ll have to work our way through the CCAR and go through that process. Having said that, when you look at this, to us it’s one of the more important things, I mean, it’s why we would go to pretty heavy length to continue to invest and make the CCAR process like perfectly linked with the rest of our processes in the bank, because it’s so important to be able to do well and to be able to show your risk profile, so you can return that capital. So that would be our view and our intent.

Gerard Cassidy

Last year, if I recall, I think you lost through the CCAR process your capital reduced by just under 300 basis points. So if we say the bogie for everybody is 5% tier 1 common after CCAR, which in your case, what, if you add 300 that would get you up to 8%. And obviously, you never want to run at 8%.

Could you actually lower your tier 1 common to 9% if you wanted to or would that be some sort of violation of governance that you’d be hesitant to do that?

René Jones

Oh, no, I think you got to go through - you got to go through your process. The idea that you would dramatically start lowering your capital ratios, I don’t think it makes much sense. We tend to think about moving it in the right direction. But having said that, I mean, as I just framed, I mean, that’s probably where optimal capital structure is in that range, right around what you’re talking about and framed by last couple of CCARs. So there is a lot of excess over that, not quite 200 basis points, but near that. And you’re on the right topic.

I think, the way I think about it, Gerard, is I was looking at the fact that we - as we talked about, we grew, I think we said 13% of tangible book value per share. So we’ve done that. We’re probably over our target capital ratios in generating that growth in tangible book value per share. And so the good news is we haven’t destroyed it or wasted it.

Gerard Cassidy

Right.

René Jones

And at the end of the day - at the end of the day, we got to protect it until we have the opportunity to return it to you or invested in something that’s above the returns that we get today.

Gerard Cassidy

Sure, which leads me to the next question, I believe last year your combined return of capital, dividend and buy-backs, as a percentage of earnings was under a 50%. I’m guessing you’re probably going to ask for more once you get all the scenarios that they’re going to give you guys for CCAR. But are guys comfortable being in that 80% to 90% of earnings like some of your regional peers are at already in returning that capital to shareholders?

René Jones

Well, I think for us, what I would say is that, you’re right. I mean, we’ve been - we’ve maintained a much more conservative posture in terms of payout ratios. And there is nothing on the surface that you could see that would suggest that we shouldn’t be returning capital at the same rate as others. And if I break that down for you, I think now what you’re going to see in terms of our peer group that that we share with you in our investor decks, we would now have the highest tier 1 common ratio, but for one.

But the most important thing also is we’re generating capital probably at a faster rate as well. So there’s nothing that would suggest once you get through your stress test you look at your risk, one of the risks we’ll be looking at is our new concentration risk with mortgages in New Jersey. But as I should point out to you, when we ran the last two CCAR tests we had New Jersey in it and we had those presumed to be acquired loans in our stress test. So we’ll focus on that.

But to your point, there is nothing that would suggest that we shouldn’t be able to return capital at a rate consistent - at least consistent with others.

Gerard Cassidy

Great and then just some quick questions, the Federal Reserve - Congress has reduced the amount of dividends the Federal Reserve will distribute to their members. I believe Bank of America said today, it’s going to cost them $50 million a quarter. Have you guys come out with anything that might affect you, assuming it affects you?

René Jones

Yes, so it’s about $9 million, the change.

Gerard Cassidy

Okay. And then, finally, on your tax spending, you mentioned that you are spending additional monies or continue to spend on tech. Can you give us an idea as a percentage of total expenses, is it 5%, 10%; any kind of color there?

René Jones

How do I do that? No, I mean, I think - I’m going to get it wrong if I do, because I don’t have it at the top of my head. But I think we’re talking tens of millions of dollars when we talk about increasing the rate. And if we can accelerate the rate of that technology spend a bit we’ll be in good shape.

So would you notice it? You might notice it, when I step back over six months and the full year to - then we would be able to talk to you about how much that is. And I guess the reason for that is that, when we think about technology, we kind of shortcut it a bit. We’ve talked about just IT. But it’s not just sort of buying a system and putting it in. We’re doing a lot of process change.

So, for example, in the wealth and institutional services division in Wilmington, we’re looking a lot at the different capture systems when a customer gets on-boarded. And going from that end and streamlining and changing the process, which involves automation.

So it’s not like you just sort of turn the spigot on very fast. It’ll be a gradual rise and we’ve been focusing on that a couple of quarters. So I don’t know, I don’t think huge jump, tens of millions maybe, but not a huge jump. And we’ll probably talk about it more as we get through 2016.

Gerard Cassidy

Great. Thank you so much for your time.

René Jones

Thanks, Gerard [ph].

Operator

Thank you. That was our final question. Now, I’d like to turn the floor back over to Don MacLeod for any additional or closing remarks.

Donald MacLeod

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

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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