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M&T Bank Corporation (NYSE:MTB)

Q2 2008 Earnings Call

July 14, 2008 10:00 am ET

Executives

Don Macleod – Director of Investor Relations

René F. Jones – Chief Financial Officer, Executive Vice President

Analysts

Steve Alexopoulos - J.P. Morgan

Matthew O'Connor - UBS

Ken Zerbe - Morgan Stanley

Bob Hughes - Keefe, Bruyette & Woods, Inc.

Jason Goldberg - Lehman Brothers

John Fox - Fenimore Asset Management

Ken Usdin - Banc of America Securities

Collyn Gilbert - Stifel Nicolaus & Company, Inc.

Jeff Davis - Ftn Midwest Securities Corp.

Al Savastano - Fox-Pitt, Kelton Cochran Caronia Waller

Todd Hagerman - Credit Suisse

[Tamesha Anderson] - Dreyfus

Operator

Welcome to the M&T Bank second quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Don Macleod, Director of Investor Relations.

Don Macleod

I'd like to thank everyone for participating in M&T's second quarter 2008 earnings conference call, both by telephone and through the webcast. If you've 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 may 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, 10K, and 10-Q for a complete discussion of forward-looking statements.

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

René F. Jones

As usual, let me begin by highlighting a few items from this morning's press release before I respond to questions.

Diluted earnings per share, which include the amortization of core deposits and other intangible assets, were $1.44 in the second quarter of 2008 compared with $1.95 in the second quarter of 2007 and $1.82 earned in the linked quarter.

Net income for the recent quarter was $160 million compared with $214 million in the second quarter of 2007 and $202 million in the linked quarter. Recall that the results for the first quarter of 2008 included an after-tax $29 million or $0.26 per share benefit related to the Visa IPO.

Amortization of core deposits and other intangible assets amounted to $0.09 per share in the second quarters of both 2008 and 2007 and $0.10 per share in the linked quarter. There were no merger-related costs recorded in the second quarter of either 2008 or 2007, while such costs totaled $2 million or $0.02 per share in this year's first quarter.

Diluted net operating earnings per share, which exclude the amortization of core deposits and other intangible assets as well as any merger-related costs, were $1.53 compared with $2.04 in the second quarter of 2007 and $1.94 in the linked quarter.

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. Net operating income for the quarter was $170 million compared with $224 million in the second quarter of '07 and $216 million in the linked quarter.

Obviously, credit was a key factor in this quarter's results, so let's start there. Nonperforming loans increased by $92 million to $587 million at the end of the recent quarter compared with $495 million at the end of the previous quarter. That increase includes $67 million of residential developer and homebuilder credits. Non-performing loans in the other commercial portfolios increased by $22 million. Taken together, nonperforming consumer loans and residential mortgages were essentially flat relative to this year's first quarter. Nonperforming loans were $296 million at June 30, 2007.

The nonperforming loan ratio was 120 basis points as of the end of the second quarter compared with 100 basis points at the end of the linked quarter and 68 basis points at the end of the second quarter of '07.

Foreclosed property, predominantly consisting of other real estate owned, was $53 million, flat compared with the linked quarter. This compares with $18 million at the end of the second quarter of 2007.

Net charge-offs for the quarter were $99 million, up from $46 million at the end of the first quarter for an annualized charge-off rate of 81 basis points of total loans compared with 38 basis points in the linked quarter. Out of the $53 million total increase in net charge-offs from the linked quarter, $36 million came from the residential development and homebuilder portfolio relating to three credits in our Mid-Atlantic region. A provider of work force solutions and a publishing company accounted for another $11 million of the increase.

As has been our practice over the past year, we continue to closely monitor and conduct frequent reviews of our residential builder portfolio. The results of our most recent review indicate continued pressure in certain counties largely within our Mid-Atlantic footprint. We have seen that the performance and valuation of each project within those counties varies widely and, as a result, additions to nonperforming and charge-offs have been a bit chunky.

We would expect further migration of a portion of these credits through our classified and nonperforming loan book, however, outside of the Mid-Atlantic region, we are fortunate to have little exposure to some of the high risk or problem markets around the country, as much of our lending was contained within our core footprint.

Taken together, charge-offs on consumer loans and residential mortgage loans remain relatively stable from this year's first quarter. The provision for credit losses in the second quarter of 2008 was $100 million, slightly exceeding net charge-offs. This compares with $60 million in the linked quarter and $30 million in the year ago quarter. The allowance for credit losses was $774 million, an increase to 1.58% of total loans as of June 30, 2008, up from 1.57% at the end of the linked quarter and 1.53% at the end of last year's second quarter.

Loans past due 90 days but still accruing were $94 million at the end of the recent quarter compared with $81 million at the end of the sequential quarter, and this includes $89 million and $77 million, respectively, of loans that are guaranteed by government-related entities.

Now turning to other parts of the income statement, taxable equivalent net interest income rose to $492 million for the second quarter, up from $485 million in the linked quarter, giving an annualized increase of 7%. The net interest margin increased by 1 basis point in the second quarter of '08 to 3.39% compared with 3.38% in the linked quarter. There were no significant items impacting the comparison of the margin with the first quarter.

Average loans for the second quarter were $49.5 billion, an increase of $947 million or an annualized 8% growth from the linked quarter.

By category, annualized loan growth compared to the linked quarter was as follows. Average commercial and industrial loans grew at an annualized rate of 15%. Average commercial real estate loans grew at a rate of 11%. Average residential real estate loans grew at an annualized rate of 3%.

Late in the quarter we securitized $545 million of seasoned, held-for-investment residential mortgages into Fannie Mae pass-through securities. We executed a similar transaction for some $330 million early in July. Average consumer loans declined an annualized 3%, with a slight increase in home equity lines of credit offset by a slight decrease in auto loans.

Endofperiod loans as of June 30, 2008 were $49.1 billion, down an annualized 1% from the linked quarter due to the mortgage securitization I just mentioned. Excluding that securitization, end-of-period loans grew by an annualized 3%.

As we discussed three months ago, our determination to focus on lending to core banking relationships within our footprint, while avoiding out-of-footprint or transactional-type businesses - or business - has moderated our loan growth from the rate we experienced in the first quarter.

Deposits were another highlight of the quarter. Average non-wholesale deposits grew at an annualized rate of 10% as compared with the linked quarter, with money market, savings, and demand accounts all showing good growth, partially offset by runoff in time accounts. Through the past two quarters, we've lowered deposit rates more slowly than the overall decline in the marketplace as one component of our overall effort to grow deposit households.

Turning to non-interest income, non-interest income for the second quarter of '08 was $271 million compared with $283 million in the second quarter of 2007, and was $280 million in the first quarter of '08 exclusive of the $33 million of securities gains that arose in the first quarter from the Visa IPO.

Service charges on deposit accounts increased to $110 million in the recent quarter compared with $105 million in the second quarter of '07 and $103 million in the first quarter of '08. The majority of the linked quarter increase came from a return to normalized levels of consumer service charges from seasonally low levels in the first quarter. In addition, service charges for commercial customers were higher compared with the linked quarter, reflecting the reduced earnings credits being offered in today's lower interest rate environment.

Mortgage banking fees remain quite resilient at $38 million for the quarter compared with $36 million in the second quarter of 2007 and $40 million in the linked quarter.

The quarter's results also included a $13 million pre-tax loss from our investment in Bayview Lending Group. This figure includes M&T's pro rata portion of severance and similar expenses related to downsizing BLG's infrastructure in the current environment. We expect additional such expenses next quarter. Bayview is riding out the storm, so to speak, by contracting its level of loan originations and employing its contingency liquidity plans, as suggested at the time of our last conference call and which we further described in our first quarter 10Q.

Considering these actions and for the reasons we described in detail in our first quarter 10Q, we have again concluded that it is not appropriate to consider the investment in Bayview to be other than temporarily impaired at this time.

Included in securities losses for the quarter was a $6 million other-than-temporary impairment charge on one of our availableforsale investment securities. These impairment charges related to our very small holdings of mortgage-backed securities that have option ARMs as collateral.

Unrealized losses on the available-for-sale security portfolio recognized through other comprehensive income were $403 million as of June 30, 2008 compared with $277 million at March 31. Despite the increase, our tangible common equity ratio rose to 5.03% at the end of the second quarter compared with 4.94% at the end of this year's first quarter.

Operating expenses, which exclude amortization of intangible assets were $403 million compared with $376 million in the second quarter of '07 and $404 million in the first quarter of 2008. The results for the first quarter of 2008 include a pre-tax $15 million benefit related to the Visa IPO.

The recent quarter's results include $236 million of salary and benefits expense, a $16 million decline from the seasonally high expenses recorded in the first quarter. This is consistent with our past experience.

The second quarter's results also include a $9 million partial reversal of the valuation allowance for capitalized residential mortgage servicing rights compared with a $5 million reversal in the second quarter of 2007 and a $5 million addition to the allowance in the first quarter of '08.

The efficiency ratio calculated on a tangible basis, that is, excluding intangible amortization, was 52.4%, improved slightly from the linked quarter.

This brings us to our outlook. The thing that gives us the most comfort in the current environment is the fact that the nationwide housing crisis hasn't really impacted our ability to generate income. The areas that we've exited, such as the mortgage offices we took over from another regional bank in 2005 or the origination of Alt-A mortgages, which we discontinued in 2007, were never important contributors to our top line. Our pre-tax, pre-provision profitability remains strong and should enable us to navigate through the current credit crunch.

The fundamentals of our business remain solid, and we don't expect significant changes from the recent patterns we have experienced. We expect full-year loan growth to remain in the mid to upper single digit range, with slower growth in the second half compared to the first half.

The net interest margin should be relatively stable, but could fluctuate by a few basis points in any given quarter. And we may see a moderation in mortgage banking revenues as the increase in long-term interest rates has slowed refinancing activity. Overall, however, this should have a modest impact on our non-interest income.

Expenses will continue to be closely scrutinized. The primary risk we see is that the housing slowdown and the rising energy prices continue to represent a drag on the broader economy, causing credit to continue to deteriorate in areas beyond the housing industry.

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, political events, and other macroeconomic factors which may differ materially from what actually unfolds in the future.

So now I'll open up the call to questions, before which Elsa will briefly review the instructions.

Questions-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steve Alexopoulos - J.P. Morgan.

Steve Alexopoulos - J.P. Morgan

René, can you talk quick about your exposure to Fannie/Freddie securities? What was it at the end of the second quarter?

René F. Jones

Yes, at June 30 we have about $190 million of unsecured debt with Fannie and Freddie, and $162 million of preferred stock. All of those things are marked-to-market, so I think our exposure on that front is somewhat limited.

We have, of course, out of $9 billion investment book, we have $3.5 billion of mortgage-backed securities that in some way, shape or form, have to carry government - or carry GSE guarantees. But I think on that front, everybody there is pretty much in the same boat.

Steve Alexopoulos - J.P. Morgan

Could you just talk quick about the credit performance of your consumer auto loans in the quarter?

René F. Jones

Yes. I think, on the whole, relatively speaking, that was a pretty good story. If we look at our delinquencies, they're only up slightly from a year earlier on that indirect auto book. Recall that we have about a $3.6 billion portfolio of auto loans there.

The charge-offs continue to rise, but albeit at a reasonable pace. And I think relative to everything else, we think it's going pretty well.

Clearly there's been stories out there about the lower values of the autos, and I would expect, as you go through the option process that the severity on losses gets a little bit greater. But, quite frankly, I think we've done a pretty decent job of managing that, so it's not our top concern overall.

Steve Alexopoulos - J.P. Morgan

Could we talk about what you see as your capital needs over the next couple of quarters?

René F. Jones

We're marching along as planned. I think we're doing a pretty good job of generating growth, improvements in our tangible capital. And I think that one of the things that bodes well for us, as I mentioned, is that we're still able to absorb losses and produce pretty strong growth.

I think our tangible equity, common equity, tangible [RE] was 22%, which probably puts us somewhere around 13% in capital generation rate, and we'll count on that. As long as our asset growth actually remains relatively low, we'll be able to build back into our range of 5.2 to 5.6.

Operator

Your next question comes from Matthew O'Connor - UBS.

Matthew O'Connor - UBS

Can you just talk a little bit more about how you decide whether or not to write down BLG? It seems like there's been a loss in three, I think, of the last four quarters. You mentioned the business has been basically downsized and, we're just not seeing too many deals getting done, so just walk through how you evaluate whether it's permanently impaired or still temporary.

René F. Jones

Matt, I think the place to start is with our comments from the last call. Bayview seems to be doing all of the right things and is on track with slowing down the business in a way that really protects the franchise value. In April I think I said that if the market didn't come back in a year from now, Bayview would need an alternative business approach that is not solely dependent upon the securitization market.

And really, when you think about it, there are two major factors which you'd consider in the process. One is that, first and foremost there has to be a demand out there for small, balanced commercial lending, and we believe that definitely still exists. And then Bayview has to have access to cash flow to be able to continue those operations and to fund that growth, and to the extent that they get that, either from the securitization market or some other fashion, then clearly, the business is not impaired.

We can't rule out anything in the future, but at 6/30 we don't believe the investment was other than temporarily impaired.

Matthew O'Connor - UBS

And then, during my visit about a month ago, you had implied that even if you did have to write down the investment that alone would not be enough to have to raise capital.

René F. Jones

You can do the math. You've seen our performance over the last couple of quarters. We generate a fair amount of tangible capital generation so; I don't see capital raising as an issue at this time.

Matthew O'Connor - UBS

On the deposit side, it seems like you let some of the higher-cost CDs roll off while you had some good growth in the savings side. Could you just give us a little more color on what's the strategy in the deposit side and [inaudible] side overall is?

René F. Jones

We've talked about this for some time. I think the way I would like to focus on it is that if we look back over several quarters, several historical quarters, one of the things that we saw that we didn't like was that we weren't getting enough deposit growth in terms of core accounts, particularly in the Mid-Atlantic.

And so over the past year we've begun to focus on a number of things that, we think will better position us over time. One of the most obvious things that you see is that, starting in the fourth quarter of last year we didn't lower rates as much as everybody as the market rate started to come down, so that obviously helped.

But on the commercial side, we're doing a lot in the way of, rounding out our suite of cash management products and making sure that we're up to date there. We've done a number of things on the consumer side in terms of renovating branches and we plan to add de novo branches this year. I believe we've completed three of those through June 30 and probably are headed to do another three in the second half. So we're doing a number of things, including advertising and other things that are all pointed towards getting continued growth in our deposit households.

So we're pretty pleased. With a relatively stable margin this quarter and 10% deposit growth; we think the process is working.

Operator

Your next question comes from Ken Zerbe - Morgan Stanley.

Ken Zerbe - Morgan Stanley

My question really is on reserve build. With provisions increasing both sequentially year-over-year, charge-offs rising, the environment not getting any better for anybody, can you just walk me through your logic? Why are you holding your reserve build constant when, for the most part, every other bank is sharply increasing their reserves in the face of a challenging environment?

René F. Jones

Ken you've got to go back to our process. And so, as we migrate loans through the book, through our different stages of our 15-grade system, we're adding an allowance as the credits migrate through the system.

So, case in point, you saw an uptick in nonperformings primarily related to four credits that were in the builder space, and you also saw an uptick in the charge-offs. But much of that book, as we've been saying for some time, we've been doing, three to four reviews annually on those portfolios, which began back even more than a year ago. So a lot of that loss content is already inherent in the book, in the allowance that we have today.

If you think about the builder space, we've talked about for some time that we have this about $2 billion portfolio of outstandings for residential homebuilders. I would think today that in our criticized loan book, about 25% of that book is already in our criticized loan book. Half of that is in our Mid-Atlantic portfolio.

So with the work that we keep reporting on and the deep dives that we've taken into the book, we're trying to get at the loss content early. If you look back over time, what you would see is that we never really dropped our reserves in 2005 because we saw a lot of issues on the front. Remember that we were slowing our loan growth because we didn't like the structures on deals in New York City, we didn't like the pricing; quite frankly, we just didn't like what we saw. So much of what we were doing all of that time was building up our reserves over time on the credits, and many of the credits that you see today.

Ken Zerbe - Morgan Stanley

I may have to follow up with this a little bit later because, I'm just looking at reserve ratio and it's up just 6 basis points year-over-year, give or take - 5 basis points year-over-year - so, we really have seen a lot in the last year.

René F. Jones

You're going to see big increases in the industry in reserves. We have a secured book. We do not have a credit card portfolio. So, look at things like coverage ratios. The loss content that you're trying to get at, we can't, sock away reserves just for the sake of socking away reserves. It's all about identifying specific loss content that you have and reserving appropriately for it.

Ken Zerbe - Morgan Stanley

On your Alt-A portfolio, can you just comment about the trends there, I think some $13 million or so of losses? I think that was mostly related to Alt-A. How is that trending?

René F. Jones

If you take the way the press release was written, take the $13 million that we mentioned and the $5 million in seconds. All of that comes from our Alt-A portfolio, so the number was $18 million. That was flat with the first quarter.

We've actually seen a relatively leveling off of, the loss content in that portfolio. And we've begun to see in the last two or three months a slight downtick in the delinquencies in that portfolio.

So I think the best thing that we can say is that we really feel that we've got our hands around that process. We've been at it for some time now, over a year, and I think we think we've got our hands around it. We've done our work there.

I would expect to see a continuation of those trends, loss estimates up or down a bit, but pretty much I would expect the loss trends to continue there for a number of quarters.

Operator

Your next question comes from Bob Hughes - Keefe, Bruyette & Woods, Inc.

Bob Hughes - Keefe, Bruyette & Woods, Inc.

René, could you give us an update on the balances of Alt-A firsts and seconds that you have at quarter end?

René F. Jones

I can try. I think we're down to $1.1 billion now.

Bob Hughes - Keefe, Bruyette & Woods, Inc.

That's inclusive of both?

René F. Jones

Yes, that's inclusive of both. Don, do you happen to have the seconds?

Bob, I just don't want to give you a wrong number. I want to give you one consistent with I think last we presented at the first quarter, we had about $67 million, in the $60 million number on the seconds, and now that's down to about $50 million, and the remainder is firsts.

Bob Hughes - Keefe, Bruyette & Woods, Inc.

René, on auto, I know it's a space you have been watching closely for some time now. Have you seen anything concerning in the floorplanning segment, and can you give us an update on how big that portfolio is? And then secondly, could you talk a little bit about SUV and pickup exposure and how you might stand relative to the industry from a concentration perspective?

René F. Jones

Just to follow up on that last one, the numbers on the seconds is $47 million, Bob.

First, with the floorplan portfolio, it's really interesting. Time flies. We've been talking about that portfolio for almost three years now. I didn't realize it was that long. And because of that, through the first six months, we're in a net recovery position. The nonperforming loan book and, related to the floorplan is also down.

Despite the fact that that industry continues to weaken, I just think we've done our work there. I can't rule out that as, oil prices continue to go up and the economy remains a bit slow that we won't see things get a little worse there, but I think we've really done our work in cleaning out that portfolio.

I've already talked a little bit about; actually, if you look at our losses on auto floorplans, actually our nonperforming loans, we were at about $25 million in the first quarter. That's down to $16.5 million on that book.

I think I've already talked about what - Bob, can you repeat the second half of your question?

Bob Hughes - Keefe, Bruyette & Woods, Inc.

The second half was just really around SUV and pickup exposure for the indirect book. From a concentration perspective, where do you stand? Is it above or below the industry level in general?

René F. Jones

Yes, I've got those numbers. I'll give them to you in a second. But they clearly, from the work that we've been doing, that position has migrated downward. Because if you think about it, we saw those two years ago, that people were getting stuck with a lot of inventory on these cars they couldn't get sold because of the gas prices moving up. If I look at where we were in May, we had about 31% of our loan book in the SUV space and 19% in the truck space. And a year ago, that was about flat - 30% and 20%. So it's remained relatively flat from that perspective.

In terms of the used versus new, more of our portfolio is actually on the used side. I think two-thirds of our portfolio is used auto.

Operator

Your next question comes from Jason Goldberg - Lehman Brothers.

Jason Goldberg - Lehman Brothers

René, you gave us, I think, a good job in terms of your expectations for loan growth, margin, expenses, the income, etc. Just any thoughts in terms of what happens with respect to charge-offs as the back half of the year plays out?

René F. Jones

We're pleased on the consumer side. The charge-off content, including the residentials, were relatively flat, and I would think that, there would be, a slight migration upward in consumer just because of the state of the economy. And then, of course, remember, as we get to the - roughly the, late third and fourth quarter, you do see a seasonal uptick in consumer charge-offs. But I think it's easy for you to get at that by just looking at year-over-year trend on the consumer side.

One of the things that was unique or I'd say different about this quarter, if you remember on the call I said that charge-offs had to go up simply because we had no commercial charge-offs in the first quarter, very little. And so you saw what I would consider to be a more normal, view of a quarter, with a significant amount of commercial charge-offs.

I think it's going to be hard. We've done a lot of work on the builder space, and so we have a fair amount of loans that are in our classified loan book, but those projects are performing, very different on a projectbyproject basis. So what I would guess is that we'll see some chunkiness from time to time. It's very difficult for me to predict, exactly what's going to happen with charge-offs, but I think that, on an overall basis, I wouldn't expect charge-offs or nonperforming levels to abate significantly.

Jason Goldberg - Lehman Brothers

And then just do you have what your Tier 1 capital ratio was for 2Q?

René F. Jones

I can give you an estimate. I think I've estimated Tier 1 at 776, so up, I don't know, we were probably at 760 or something like that at the end of the first quarter.

Operator

Your next question comes from John Fox - Fenimore Asset Management.

John Fox - Fenimore Asset Management

René, could you just repeat, when you were talking about NPLs, I think you gave the increase for the residential builders and the other, and then a total for residential mortgages, so could you just repeat that information, please?

René F. Jones

Yes.

John Fox - Fenimore Asset Management

Are you talking about residential, building and developers up $67 million?

René F. Jones

What we said is that, yes, $67 million of the $92 million increase was in the residential, developer and homebuilder credits. And then the other commercial portfolios increased by $22 million, and then there was virtually no change in the consumer and residential mortgages combined.

John Fox - Fenimore Asset Management

And you gave a number of $296 million. That's the total amount of NPLs.

René F. Jones

A year ago, so at 6/30 it was $587 million, up from $495 million at March 30.

John Fox - Fenimore Asset Management

And what were nonperforming assets?

René F. Jones

Total nonperforming assets were $640 million, up from $547 million at the end of the first quarter.

John Fox - Fenimore Asset Management

In terms of Bayview, on the income statement, is this the run rate? Is there something unusual? You mentioned there was some severance. What is their run rate at this point for Bayview?

René F. Jones

As they work their way to getting down to a steady state level that they can continue to operate at, we should probably see, next quarter should look a lot like this quarter that we've seen. But all of that includes loss content that has worked to get them to a lower loss rate. And so I think by the time you get to the fourth quarter, you'll see a more normalized run rate for the company.

John Fox - Fenimore Asset Management

That would be a loss rate, but at a lesser amount?

René F. Jones

That's a good guess.

Operator

Your next question comes from Ken Usdin - Banc of America Securities.

Ken Usdin - Banc of America Securities

René, I was wondering if you could just go a little bit deeper into, the outlook for credit, not so much on a provision or charge-off basis but just, how are you thinking about the broader economy in terms of the non-builder exposure? What are you seeing by way of small businesses, middle market companies, and non-residential real estate? How deep are we getting here and to the extent those problems are really just going to start to occur that haven't to date?

René F. Jones

Setting builder aside, let's set the residential aside, because we've talked a lot about that. I think we've seen in the business banking space or in the smaller C&I credits, a steady migration up in those portfolios. Not different from what anybody else has been talking about in the industry, albeit, though, I think we're starting from slightly lower levels.

My guess is that, particularly with the price of oil and inflation out there, I think that you're going to continue to see that migrate up. I think you probably will see something, more migration in the C&I loan book, although we haven't seen a big move in that as of late. So that's probably out there on the horizon. If we were sitting here six months from now and talking about a move in our classified loan book or in our nonperformers, we would then be looking at loss content in '09. We haven't seen it yet, but I wouldn't be surprised to see that happen.

The commercial real estate space has been outside of builder has been very solid to date, and we again are pretty pleased with the underwriting that we did over the years there.

Ken Usdin - Banc of America Securities

On your nonresidential, so you're not really seeing any leakage into even housing-related type of areas, like retail or office?

René F. Jones

Not at this time.

Ken Usdin - Banc of America Securities

On the builder book, you mentioned you've gone through $2 billion book quite a few times but, how far along do you think, in terms of really recognizing the NPLs just what do you think is through the book as - what proportion of the book do you feel is really through the book versus pending NPLs? Where is that book as far as its migration status, as far as you think from a, getting from Point A to Point Z?

René F. Jones

You saw the three charge-offs that we had. Two of those were on credits that we had talked about in the past. And really what the issue was on those two credits was that the amount of spring sales was even slower in the last, couple of months than our base case was. And so across the board we're seeing slower sales, and that means that there have to be price adjustments down in order to hit a price point where they're going to be able to move the properties.

If you look at the third , I'm giving you color on the types of things that are in the book - the third large charge-off was really a land acquisition and pre-development loan. So you've got unimproved and - raw and unimproved land there. And really what you're looking at on those particular cases is if the builder, doesn't have the wherewithal to support the project, then land values are pretty low these days, maybe 40% to 50%.

So we've taken all of that into account. We've just completed in May our most recent review. And to put that into perspective, we reviewed primarily the Mid-Atlantic portfolio, which at 6/30 was $586 million of outstandings. Half of that book is criticized. And we reviewed - primarily focused on our East portfolio, which is $195 million of outstandings, and that actual portfolio has held up much better.

So I think what you're going to see is that, clearly you will learn more of, you'll see more charge-offs, you'll see more nonperformers, but from our perspective in going through that review in May, from our internal perspective, we didn't see a lot of new credits. It's just that a lot of things got a bit weaker.

I would guess that we're going to have to see a couple of quarters like the one we've seen, and it'll take some time to get ourselves through that book. But keep in perspective; I said 25% of that book has already been classified. That number represents just 1% of our loan book.

We're going to see this. It'll take some time. I don't know, two, three quarters. We'll slug through it just like we slugged through the auto. But on the whole, relative to the size of M&T, we don't think it'll be  it's anything to be overly concerned about.

Ken Usdin - Banc of America Securities

And just to clarify the numbers there again, 25% of the whole builder book is classified? I just want to make sure I have that number right. You said half of Mid-Atlantic is criticized, but then you said 25 -

René F. Jones

Yes, let me be real specific on that. So if you look at our about $2.1 billion of total outstandings there, 25% of that book is in our criticized loan book. Almost all of that is in, the subset, the $1 billion that we call, that's managed out of our mortgage division. And 50% of that classified loan book is in the middle - 57% - sorry, 47% of that book I'm talking about, the criticized loan book - is in the Mid-Atlantic. So it's very concentrated.

Ken Usdin - Banc of America Securities

With the buildup in the unrealized losses this quarter - and you mentioned you only had one security that was temporarily impaired - can you give us just the outlook of, what it really takes as far as spread movements to, cause these temporary impairments to go more of a permanent status?

René F. Jones

We've got a $9 billion securities book. We take, on every security, we look at all of the underlying collateral, and we take a look at the delinquencies 30, 60, 90 days, and apply some expectation of what will happen to that underlying collateral.

We've gotten pretty good at that because it's one of the side benefits of having that residential mortgage book. We've gotten pretty good at being able to predict what's going to happen when a loan, goes into its 30 days delinquent.

So we take those estimates, and we run out what we believe to be, a lifetime loss on the securities book, on the collateral. And then we compare that against the enhancements. So in our internal rules, any security that has less than 2.5 times coverage, so its enhancement is less than 2.5 times the expected loss rate - we put that on our watch list. At June 30, that watch list was just about $77 million out of a whole book of $9 billion, and this $6 million came from that, right?

And if you look at it, what's interesting about it is if you look at the loss content on that - so this particular bond was $6.5 million. It was trading at $0.10 to $0.15 on the dollar. And the collateral, it was collateralized with a pool of option ARMs. Interestingly enough, they were high FICO. They were low LTV. However, the delinquency rate on that pool was really increasing dramatically, particularly over the last few months. And so our coverage on that particular bond was probably as low as - I think it might be 0.7%, so below 1% overall coverage.

What is helpful to us is that out of that entire book, we only have about $19 million of mortgage-backed securities that have option ARMs as collateral, so $19 million out of a $9 billion book. So we feel pretty good about it.

But as the coverage ratio drops on those projections, even though there's no loss content today, we would consider taking the investment other than temporary impaired.

Yes. And again, in this particular case there hasn't been any lapse in payment.

Operator

Your next question comes from Collyn Gilbert - Stifel Nicolaus & Company, Inc.

Collyn Gilbert - Stifel Nicolaus & Company, Inc.

René. I think you had said at one point you were combining through the loan portfolio and trying to assess the balance of borrowers that are somehow tied to real estate, whether it would be, plumbing or whatever the industry that would be tied to real estate. Have you finished that process and, if so  or can you give any color as to what that exposure might be?

René F. Jones

We're still in the process of doing that. We actually want to go through and look at our residential exposure, by zip code. But really, I think today a good estimate of that would be $2 to $2.5 billion in terms of residential.

Operator

Your next question comes from Jeff Davis - Ftn Midwest Securities Corp.

Jeff Davis - Ftn Midwest Securities Corp.

Has the institution been contacted by the FDIC or other regulators regarding M&T being approved to acquisition failed institutions? If so, do you all have any interest in doing so? Are you expecting much within your footprint that might become available?

René F. Jones

It sounds funny but it's almost the standard [Willie Loman], some of those questions nobody's calling. So the answer there is no.

But, we're always ready. We would be cautious. We think today, in today's environment, you'd have to do your work and your due diligence, but the idea of a potential opportunity, if it were to come our way, we would be interested.

Jeff Davis - Ftn Midwest Securities Corp.

I was thinking more of just a straight deposit assumption-type deal as opposed to having to take the credit risk on the left-hand side of the balance sheet.

René F. Jones

Yes, yes. No calls today.

Operator

Your next question comes from Al Savastano - Fox-Pitt, Kelton Cochran Caronia Waller.

Al Savastano - Fox-Pitt, Kelton Cochran Caronia Waller

Can you give us some color on what the severity on the homebuilder portfolio has been, and do you expect that trend to continue? And then secondly, on the Bayview investment in securities you have, can you give us an idea of what the collateral is and what the market is on that as well?

René F. Jones

It really varies on a case-by-case basis. One of the things we also did this quarter is we did a hard review of all of our appraisals. And in some cases, the case where, you've got a troubled project and its raw and unimproved land, you could be looking at [$0.40] to $0.50 on the dollar for those.

Having said that, the appraisals that we've seen have been all over the board. If you look at projects that are in basically the same country or same proximity, you're getting valuations that vary widely based on in part on the performance of the project, but it's also, in some cases I think we've got some pretty conservative appraisals that are out there.

But, the most severe march would be on unimproved land that is out there.

I think with respect to Bayview, we probably have somewhere in the neighborhood of $400 million in outstanding bonds. The largest of those is something that we purchased in the last fall which was a security backed mostly by residential mortgages, some subprime, some Alt-A, some normal prime credits, and that was for about $300 million at that point in time. Those loans have paid down considerably. I think we probably on that one particular case are down to somewhere around $230 million in just that first six or seven months. So they seem to be performing very well, they have a very high level of coverage.

The other small portions that we have were prior to our relationship with, our equity relationship with Bayview Lending Group. We had purchased a number of their small balance commercial securities. I'm going to say that that's in the neighborhood of $100 million or less that we have there, and all of those are performing well. And that collateral is very similar to the types of collateral that BLG is issuing today, that's the securities that they're issuing today.

Al Savastano - Fox-Pitt, Kelton Cochran Caronia Waller

Just to clarify, in Bayview there's no straight debt. It's all secured by some real estate?

René F. Jones

I believe that that is true. Yes, I think that's true. Yes, absolutely, that is absolutely the case. So most of your risk is just the simple underlying collateral there.

Al Savastano - Fox-Pitt, Kelton Cochran Caronia Waller

Just going back to the severities, can you give us some color on the residential construction side and the severity you've seen this quarter? You gave us the land and you said the land severities can be anywhere from $0.40 to $0.50 on the dollar in terms of value. How about on the residential construction side?

René F. Jones

It just depends. It’s all over the board. There is no consistency whatsoever. Particularly, the way we've in my comments I talked about that we were seeing some difficulty in a number of counties. As you move from one county which might be completely oversold to another that is not, the valuations, could be standing up very, very well. So it really is on a case-by-case basis, and you have to get right down to the county level to be able to distinguish anything there.

Al, back to your other question, outside of Bayview Lending Group, we do have an unsecured - I'm sorry, we have a secured loan to Bayview Financial, which is the 80% owner of BLG, and that's also secured by residential real estate and/or residuals.

Operator

Your next question comes from [Tamesha Anderson] - Dreyfus.

Tamesha Anderson - Dreyfus

Could you just give a comparison of the homebuilder book in terms of exposure, nonperformers, and charge-offs from the linked quarter and from the year ago quarter?

René F. Jones

If you were to look at charge-offs, we had $38.3 million in charge-offs this quarter. Last quarter that would be $3 million, and in the fourth quarter that would have been about $4 million, nothing before that.

On the nonperformers, we are currently at about $163 million in nonperforming loans. Last quarter that was about $95 million, and a year ago that would have been about $37 million.

Operator

There appear to be no further questions at this time.

Don Macleod

I'd like to thank you all for participating today, and, as always, if clarification of any of the items in the call or the news release is necessary, please call our Investor Relations Department at 7168425138. Thank you.

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Source: M&T Bank Corporation Q2 2008 Earnings Call Transcript

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