Q3 2019 Earnings Call
Ladies and gentlemen, this is the operator today's conference is scheduled to begin momentarily until then your lundell again be placed on music cold. Thank you for your patience.
At this time I would like to welcome everyone to the M.T. think Q3 2019 earnings call.
All lines have been placed on mute to prevent any background noise.
After the speaker's remarks, there will be a question and answer session. If he would like to ask a question. During this time simply press Star then the number one on your telephone keypad. If he would like to withdraw your question press the pound Keith. Thank you I would now like to turn the call over to Don Macleod Director of Investor Relations. Please go ahead.
Thank you submit a thing good morning.
I'd like to thank everyone for participating in EM and TS third quarter 2019 earnings conference call, both by telephone and through the webcast.
If you're not ready earnings release, we issued this morning, you may access it along with financial tables and schedules from our website www dot MTB dot com and by clicking on the Investor Relations like and then on the events and presentations link.
So before we start I'd like to mention that comments made during this call might contain forward looking statements relating to the banking industry into empty bancorporation imitate encourages participants to refer to RCC filings, including those found on forms 8-K, 10-K, and 10- Q4 complete discussion of forward looking statements.
Now I'd like to introduce our Chief Financial Officer, Darren King.
Thank you Don and good morning, everyone.
As noted in this morning's earnings press release Amitiza results for the third quarter includes several items that we think are worth highlighting.
Total revenues grew from the prior quarter and a year ago quarter, notwithstanding the lower interest rate environment and associated pressures on net interest income.
Although we recognized an additional valuation allowance on our mortgage servicing rights, which reflects higher expected prepayments arising from lower interest rates. We also recorded an impressive increase in mortgage banking revenues.
This demonstrates how mortgage loan originations connect as somewhat of a partial hedge for the mortgage servicing business.
Loan growth continues to be study and inline with our expectations for low single digit aggregate growth in 2019.
Credit quality is consistent with our recent experience with net charge offs stable at rates well below our long term average.
Further decline in criticized loans was accompanied by an increase in nonaccrual loans, primarily the result of one large long previously reported as criticized.
[noise], let's take a look at the specifics.
Diluted GAAP earnings per common share were $3.47 for the third quarter of 2019 compared with $3.34 in the second quarter of 2019 and $3.53 in the third quarter of 2018.
Net income for the quarter was $480 million compared with $473 million in the linked quarter and $526 million in a year ago corridor.
On a GAAP basis.
<unk> third quarter results produced an annualized rate of return on average assets of 1.58%.
Annualized return on average common equity of 12.73%.
This compares with rates of 1.6% and 12.68% respectively in the previous quarter.
Included in the GAAP results in the recent quarter, where after tax expenses from the amortization of intangible assets amounting to $4 million or three cents per share our per common share little changed from the prior quarter.
Consistent with our long term practice empty provide supplemental reporting of its results on a net operating or tangible basis from which we have only ever excluded the after tax effect of amortization of intangible assets as well as any gains or expenses associated with mergers and acquisitions when they occur.
[noise] EM and Ts net operating income for the third quarter, which excludes intangible amortization.
Was $484 million.
Compared to $477 million in the linked quarter and $531 million in last year's third quarter.
Diluted net operating earnings per common share were $3.50 for the recent quarter compared with $3.37 in 2019 second quarter and.
And $3.56 in the third quarter of 2018.
Net operating income yielded annualized rates of return on average tangible assets, an average tangible common shareholders' equity of 1.66% and 18.85%.
For the recent quarter.
The comparable returns were 1.68% an 18.83% in the second quarter of 2019.
In accordance with the Fccs guidelines. This mornings press release contains the tabulate reconciliation of GAAP and non-GAAP results, including tangible assets an equity.
[laughter].
Recall that both GAAP and net operating earnings for the second quarter 2019 were impacted by $48 million write down of empties investment in an asset manager.
Which have been accounted for using the equity method of accounting.
The write down amounted to $36 million after tax effect or.
27 cents per common share.
In July 2019, 70 agreed to sell its investment in the asset manager, which had been obtained in the 2011 acquisition of Wilmington Trust Corporation.
The sale was consummated in late September .
There were no such noteworthy items in 2018 third quarter.
Turning to the balance sheet and the income statement.
Taxable equivalent net interest income was $1.04 billion in the third quarter of 2019.
Down by $12 million or 1% from linked quarter.
This reflects a narrower net interest margin, partially offset by growth in both loans and total earning assets.
The margin for the quarter was 3.78% down 13 basis points from 3.91% in the linked quarter.
Contributing to that decline were several offsetting items.
On the positive side I'm more favorable mix of earning assets interest, earning assets, specifically a higher proportion of loans added about two basis points to the margin.
A higher level of cash on deposit at the fed accounted for an estimated two basis points of the decline in the margin.
We estimate that lower short term market rates, primarily LIBOR accounted for some eight basis points of the decline.
This is consistent with our expectations of a 49 basis point decline in the margin over the ensuing 12 month period. Following a hypothetical 12 25 basis point cut in the fed funds target and by application LIBOR.
[noise] higher cost of interest bearing deposits, primarily mortgage escrow deposits accounted for approximately five basis points of the decline.
We continue to see inflows of these escrow deposits.
Result of higher prepayment.
Of mortgage loans, we service or sub service on behalf of mortgage backed security investors.
Absent the higher level of escrow deposits. The total cost of interest bearing deposits would've been approximately flat as we manage deposit rates lower.
As expected the migration of deposits into higher yielding categories, notably commercial deposits into interest checking in on balance sheet suite.
Has slowed in rates offered on new certificates of deposit have declined.
Average loans grew by 1% compared with the previous quarter.
Originations remain solid well payoffs and paydowns remain consistent with levels, we've experienced in the first half of 2019.
Looking at the loans by category on an average basis compared with the linked quarter.
Commercial and industrial loans were roughly flat compared with the linked quarter as the usual seasonal softness in loans to auto dealers to finance inventories was offsetting growth in other categories.
Commercial real estate loans grew 1% compared with the second quarter.
[noise] residential real estate loans declined by less than one half percent compared with the linked quarter.
As was the case last quarter. The continued comparatively steady pace of pay downs of mortgage loans acquired in the Hudson City transaction was partially offset by higher levels of loans originated for sale.
Nations for sale aside we expect the portfolio of acquired mortgage loans to continue its low double digit rate of principal amortization in future quarters.
Consumer loans were up 4%.
As growth in Recreation finance loans continues to outpace declines in home equity lines in loans.
There were no particular standouts positively or negatively in our community by community banking regions from a loan growth perspective.
From the line of business view recreational vehicle financing as well as residential and commercial commercial mortgage banking were particularly strong.
Average core customer deposits, which exclude deposits received at empties Cayman Island office and Cds over $250000 grew an estimated 3% compared to the second quarter.
This primarily reflects the escrow deposits we referenced earlier.
Turning to non interest income.
Noninterest income totaled $528 million in the third quarter compared with $512 million in the prior quarter.
Mortgage banking revenues were $137 million in the recent quarter compared with $107 million in the linked quarter.
Residential mortgage loans originated for sale were $835 million in the quarter up from $723 million in the second quarter, reflecting a new wave of refinancing activity in the face of lower longer term in the face of the lower longer term interest rate environment as well as seasonal strength.
Total mortgage banking revenues, including origination and servicing activities were $88 million in the third quarter improved from $72 million in the prior quarter.
Finance residential mortgage banking revenue. Thank you Don.
In addition to higher gain on sale revenues the increase reflects reaching the run rate of the residential loan servicing and Subservicing that we acquired in the first and second quarters.
Commercial banking revenues were $49 million in the third quarter compared with $35 million in the linked quarter.
Reflecting notably stronger origination activity.
The $30 million or 20% increase in total mortgage banking revenues.
Brings with it higher expenses, notably $5 million of compensation costs as well as the 14 million dollar valuation allowance recorded during the quarter on our mortgage servicing rights.
[noise] Trust income was $144 million in the recent quarter unchanged from the previous quarter.
Recall that the second quarter results include $4 million of seasonal fees earned assisting clients with their tax filings, which did not recur in the third quarter.
Trust income continues to grow in the upper single digit range over the prior year.
Service charges on deposit accounts were $111 million up from $108 million in the second quarter.
The recent quarter included $4 million of securities gains representing valuation gains on equity securities. While the second quarter of 2019 included $9 million of similar valuation gains.
Turning to expenses.
Operating expenses for the third quarter, which exclude the amortization of intangible assets were $873 million compared with $868 million in the prior quarter.
As previously noted the prior quarter's results included a $48 million write down of our investment in an asset manager acquired.
In the Wilmington Trust merger.
The two most recent quarters results reflect an addition to evaluation allowance on our mortgage servicing rights as a result of lower long term interest rates.
Those additions amounted to $14 million and $9 million in the third second quarters, respectively.
As noted earlier those same lower rates.
Have prompted a notable uptick in residential mortgage loan originations and associated gain on sale revenues.
Salaries and benefits were $477 million up $21 million from 456 million in the prior quarter.
Contributing to the increase was one extra compensation day in the third quarter amounting to $5 million as well as $5 million of compensation costs arising from the uptick in residential and commercial mortgage loan originations that I just referenced.
In addition, the third quarter results include another $10 million of costs that we would not expect to recur in the fourth quarter.
The efficiency ratio, which excludes intangible amortization from the numerator and securities gains or losses from the denominator was 55.9% in the recent quarter relatively unchanged from 2019 second quarter.
The ratios for both quarters include the additions to emmis to the MSR valuation allowance, while the second quarter figure includes the write down of the investment in the asset manager.
Next let's turn to credit.
Overall credit quality remains consistent with our recent experience given the continued strength of the economy.
Annualized net charge offs as a percentage of total loans for 16 basis points for the third quarter little changed from the 15 basis points in the first half of 2019.
Non accrual loans increased by $140 million at September Thirtyth compared with the end of June reflecting one large commercial loan to a wholesale distributor that was previously included in criticized loans.
The ratio nonaccrual loans to total loans rose to 1.12% at the end of the quarter.
Notwithstanding the increase in nonaccrual loans total criticized loans decreased further from a level seen at the end of June .
The provision for credit losses was $45 million and the recent quarter exceeding net charge offs by $9 million.
The excess provision primarily relates to the non accrual loans to the wholesale distributor net of the decline in other criticized loans.
The allowance for credit losses increased to $1.04 billion at the end at the end of September .
Compared with $1.03 billion at the end of the previous quarter.
The ratio of the allowance to total loans increased by one basis point to 1.16%.
Loans 90 days past due on which we continue to accrue interest excluding acquired loans that had been marked to fair value discount at acquisition were $461 million at the end of the recent quarter.
Of those loans or hundred $34 million or 94% where guaranteed by government related entities.
Turning to capital.
Inventories common equity tier one ratio was an estimated 9.81% at September thirtyth compared with 9.84% at the end of the second quarter.
The modest three basis point decline reflects the net impact of higher loans earnings retention and capital distributions.
During the quarter empty repurchased 1.9 million shares of common stock at an aggregate cost of $300 million.
Now turning to the outlook.
As we entered the final quarter of 2019, our guidance for the year remains little change from our prior comments.
We continue to expect growth in total loans in 2019.
To be at the low single digit pace with continued run off in residential mortgages more than offset by aggregate growth in the other loan categories.
The reductions in short term rates implied by the forward curve will continue to pressure both net interest income and the net interest margin.
However.
We still expect modest year over year growth in net interest income for 2019.
[noise], all else being equal and holding aside volatility in escrow deposit balances and associated cash balances placed at the fed.
Each hypothetical reduction of 25 basis points in the fed funds target should result in four to nine basis points of margin pressure over the ensuing 12 months.
The servicing and subsurface servicing acquisitions, we completed combined with the strong third quarter origination activity in both our residential and commercial mortgage banking operations has resulted in mortgage banking revenues growing better than expected.
While trust income has been inline with our expectations.
Growing at a little better than a mid single digit pace.
We would not expect mortgage banking results for the fourth quarter, either residential or commercial to match those seen in the third quarter.
The remaining fee businesses continue to perform in line with our expectations growing in the low single digit range.
<unk>.
Expenses for the year have grown a little more rapidly than we previously indicated driven by two primary factors.
Growth in the mortgage business and investments in the bank, notably his staff.
Higher expenses associated with the servicing and sub servicing acquisitions as well as from the compensation expense associated with strong mortgage originations activity drove expenses above our initial expectations.
We also continue to expect to see some offsets to the year to date additions to our T. staff through lower contractor and consulting expenses starting in the fourth quarter.
We expect fourth quarter expenses to be lower than the recent quarter.
Our outlook for credit remains little changed.
While sentiment about a potential recession is building, we're not seeing or hearing signs of a slowdown.
Our customers largest concern is their ability to find enough workers with the right skills to add to capacity.
As noted criticized loans will be down this quarter from the ended June .
That said the specific reserve taken on the wholesale distributor we mentioned could result in a notable charge off in the coming quarters.
Regarding the new loan loss accounting standard known as Cecil.
We've completed our second parallel run and expect to disclose preliminary results in the third quarter 10-Q.
To preview those results and based on the current economic forecasts.
We'd expect the allowance for losses on loans and leases to increase by approximately 5% to 15% upon adoption of the accounting standard.
That in turn should result in an impact to our capital ratios of less than 10 basis points.
Regarding capital.
We expect to continue to execute the capital plan that we previously outlined.
Of course as you are aware our projections are subject to a number of uncertainties and various assumptions regarding national and regional economic growth changes in interest rates political events and other macroeconomic factors, which may differ materially from what actually unfolds in the future.
Now, let's open up the call to questions before which Samantha will briefly review the instructions.
Ladies and gentlemen, as a reminder, if you would like to ask an audio question. Please press Star then the number one on your telephone keypad again that is star wanted to ask your question.
Your first question comes from the line of John Pancari from Evercore.
Morning.
Good morning, John .
On the.
On the expense outlook.
I just wanted to get an idea I know you'd indicated that the.
Fourth quarter expenses should not.
It should be down from the third quarter level, just trying to understand how we should think about the magnitude of that decline.
No your previous expectation had been that the second half expenses would be similar to first half. So that would imply that still holds that would imply a pretty sharp drop off in fourth quarter. So just wanted to get an idea what type of decline we can expect thanks.
Sure. So as we look at the fourth quarter and a in and thinking about some of the things that happened in the third quarter.
I'll start with that the mortgage business, obviously had a great quarter and there was about $20 million of expenses associated with that.
Which.
We didnt account for to be honest, because we weren't sure where rates were going to be when we gave the guide and so that $20 million is I would just kind of added to the guide, but let's not forget that there was $30 million of of revenue that came along with that.
And then there was about $10 million of expenses.
That we recognized in the third quarter that I don't foresee re occurring in the fourth and so where we're at that point, we're a little bit above what the guide was that we wouldn't expect things to be.
Necessarily equal in terms of.
Each quarter in this in the second half being exactly the same so we think that theres some room for the expenses to come down.
And get down to the to the level that would have been implied.
On an average basis in the in the Guy that we gave before.
Okay, and then on that same topic on the you mentioned that obviously the higher mortgage related costs were factor, but also a higher cost than you expected in your technology investments.
You give us a little more color there what surprised you there and.
Good how should we think about that when we look at.
2020.
If it could be a factor again as you.
We're kind of six cents is going out. Thanks sure you know I guess in the ITC space, there's that there's a few things, some which which I would describe is timing related in the quarter.
When you see in the other software our other or processing and software line or were there. Some annual licensing expenses that came in in the quarter, we wouldn't expect those to repeat.
When you look in the other cost us where a lot of the professional services expenses and in there you know we've talked about before the pace at which the contractors.
Roll off as the as the new staff comes on and there were some projects that extended maybe 30 days or 45 days, a little bit longer than we thought to bring them to completion.
We've seen those roll off as we get to the ended the quarter and that's why we feel feel confident that will actually start to see that of the impact of the.
Adds to staff and the and the reduction in contractors as we go into the fourth quarter and start to recognize that into 2020.
Okay. Thank you.
Your next question comes from the line of Ken Zerbe from Morgan Stanley .
Great. Thanks, Good morning, good morning.
Actually just had a quick question in terms of the mortgage banking business, obviously with the servicing that you've taken on.
Obviously this quarter. It was a really good result, but if we think it by the ongoing run rate from this I know you said fourth quarter is probably not going to be as highs threeq, but.
What is kind of the right level, if thats effect, if you can kind of what sort of pick a number I'm trying to get a sense or we had some meaningfully sustainably higher level given the servicing assets. Thanks.
Sure. So we're definitely at a at a higher level than where we would have been if you compared to the the third quarter of last year. So the third quarter of this year would reflect pretty much a full quarter's run rate of both the servicing rights that we acquired as well as.
The sub servicing a and that should be fairly stable of course servicing is a declining asset and so the fees come down a little bit each quarter based on the unpaid balances and then really the volatility that we wouldn't expect to repeat but is also a bit of a function of rates is just the origination activity.
And right now I'm talking specifically on the residential side.
Now one of the things that does tend to happen when you buy servicing rights is as you take the impairment or or set up the allowance for prepayments when those things prepay oftentimes that shows up or down the road in gain on sale and that was part of part of the uptick in this.
Last quarter.
In the commercial space.
We had just a fantastic third quarter I think it was the highest origination quarter in our history in ER in commercial mortgage driven off the originations.
Thank you saw a lot of activity in the marketplace, where rates have come down and where there was some concern about the the amount of business that Fannie and Freddie might do towards the end of the quarter they reaffirmed their.
Their appetite for the coming five quarters, probably take a little bit for the pipeline to rebuild but should be a solid quarter, but what I would consider a more normal.
Great.
Have a gain on sale in the commercial mortgage space versus what we saw in the third quarter and those are really what was part of our comments about some of the things that were a little bit outsized in the mortgage business in the third quarter of this year was really about originations as opposed to servicing and servicing should be pretty consistent as we go from here.
Okay, Great and can you just remind us like what is the dollar amount roughly that the.
Our servicing the sub servicing rights contributed to this quarter's earnings.
When we when we talked about it.
In March.
We talked about an additional $60 million of servicing revenue for the year with that kind of building and peaking in this quarter.
So no we're probably in the range of 17.
And to $20 million somewhere in there.
Maybe maybe a little maybe closer to 17 than a than to 20.
In terms of what the run rate is on.
On that that had acquired servicing no I guess I'll, just I'll reiterate that.
You were in a fee based on the unpaid principal balance in each month those decline as people make their payments so as those decline.
That fee income will will move down at a similar face.
Alright, perfect. Thank you.
Your next question comes from the line of Matt O'connor from Deutsche Bank.
Hi, guys.
A follow up on expenses, a little bit it's been a pretty busy day just.
As I kind of.
Turning to add in the comments that you may about expense in the fourth quarter backing out the 30 million and kind of come into that maybe average and what youre thinking before what does that imply before Q dollar expenses, if you do that math.
I guess, if you do the math.
Look at what we would have implied in the guide it would have been right around 830 $835 million a quarter and you're probably in that range for the fourth quarter.
Okay.
That's helpful and then a follow up.
It was asked earlier, but as you think about the underlying expense growth at the company.
Lastly, mortgage was unusually high and you talk to some lumpiness and the investment.
But as you think about kind of whether its full year 2020 or a medium term.
Underlying expense growth.
Here is that and we're getting to the next question.
As I think there is some concern that bancshares size may not have.
The scale that you need and that's why we're seeing some expense pressure.
Okay guys.
So much and obviously with a rate headwinds out there.
Pressuring revenues on that side, it's more back to five potentially so if you guys just address those to those topics. Thank you.
Yeah, I guess I'm trying to remember them all you settle out there Matt the.
I guess when overall when you look at the expenses at the bank. This this year was a year of expense growth that was very atypical for empty.
Obviously, a bunch of it was related to the mortgage business and the servicing that we acquired that was 40 million. We so far added about $22 million to the allowance the valuation allowance, which we might not have anticipated.
When we first agreed to acquire those loans back almost almost a year ago and so so those have driven the expenses up and then the other thing that's been happening obviously is the investments we're making to change the way we deliver it the bank and I think is probably one of the big things that has talked about in terms of scale and what vote.
We're doing is I think we're positioning ourselves to actually better compete with the with what our competitors both regional and large national players by by the investments that we're making and so by shifting more of the resources or more of the team the team on staff.
I think we can increase capacity in terms of what we're able to deliver for the same expense base.
And that's part of why we're baking that that move and also the move to [laughter] excuse me more agile approaches.
I would should bring.
New capabilities to market, a little more quickly than than what we may have done in the past and so part of the shift is to make sure that were competitive and you know, but in the time that you're building that capability.
You've got other projects going on and we've talked a little bit before about the the the kind of double expense that you incur while you're making that transition a it'll happen a little bit a each quarter as we go through that but we'll start to see some of the the pay off of that in the coming quarters, and we think we'll start to see it in the fourth quarter with the professionals.
Services cost going down and so when you think about where expenses are and have been for Mt. Overtime. It will give you a our thoughts on 2020, when we get to January but really when you look at Mt. Through time, we've been a low nominal expense growth player.
You know generally kind of 2% a year or less and.
We certainly think that we're in a an industry, where that's warranted and we think about that all the time and given the growth this year.
And investments that we've made a we'll look to see if we can't be in or below that range.
As we go into 2020, but like I said, we'll we'll give you more more details on that in the January call, but.
I I don't think we need to run at this kind of expense rate on an ongoing basis and we absolutely have some.
Ways to improve productivity based on the investments that we've made which will help us stay competitive and obviously, we will react to the to the changing rate environment, which we've done successfully in the past.
Okay. That's helpful. Thank you.
Your next question comes from the line effect, Frank Shirazi with Sandler O'neill.
Good morning.
Just wondering on the.
If you could Darren if you give a little more color on the the credit that moved into non accrual in the quarter.
In terms of industry geography, collateral and any color you could give would be interesting. Thanks.
Yeah sure.
Obviously, we're not going to talk about.
Specific customers per se, but when we look at this one.
When.
Customer there a wholesaler.
And so some of the financing is tied to inventory and receivables and they've had some some challenges.
Internally.
With their management and that's put them in a bit of a cash fine and and that's why we've kind of moved it from criticized and non accrual and the question will be the value ultimate value the receivables and collectability of those as well as the inventory.
We obviously don't they could zero, but we do expect that there will be likely some some some loss on that as a as it was the work our way through.
Obviously, given the the magnitude of this relationship.
The industry was then we went through all of our relationships over.
$100 million.
Which fortunately I can count them on both hands.
And look through them and they're not in similar industries and are in fact quite healthy.
And we looked through for other wholesaler and distributor type relationships.
And we didn't find any others that that had to similar situation. So you know when I look through the loans that went into criticized through the first and second quarter. A this was one of them. We when we talked about it at the time.
We looked for any common themes in a in those criticized loans either in terms of industry geography.
Or the like and we couldn't find anything.
Other than they tended to be situational specific and oftentimes related to.
To management and I would describe this as a in that same milk.
Okay.
And then as a follow up you you.
Clearly mentioned, you're not seeing broader weakness in credit just wondering if there's any areas.
That youre seeing is becoming more frothy a areas you guys are shying away from in your various geographies.
Nothing in particular.
We've obviously, we've paid a lot of attention all the way along to some of the office space.
Alan things going on a recent recently in the industry, but we don't we don't have much there.
When when we look around Theres nothing in particular that so I would point to that is what I would describe is very frothy.
There continues to be lots of competition for lending pricing seems to be fairly reasonable when I look at our spreads they've been fairly consistent for the last three quarters. They did drop.
After tax reform you kind of saw a resetting of the industry.
After a.
After you saw resetting of margin after tax reform, but that stabilized since then.
And overall things seem seem really good.
Structures haven't really changed much from what we've been dealing with over the last.
Few quarters.
And and as we look obviously, New York City is the place we pay a lot of attention too and we don't see anything there that causes us concern so.
There is it.
Nothing is really standing out right now, which always makes you wonder what's going to pop. So we're working to continuously looking through the portfolio to see where there might be signs of weakness, but at this point theres no one geography industry or loan type b it seems.
Hi, permanent mortgages, construction, where where where we have any concerns.
Okay, all right thanks for the color.
Your next question comes from the line of Ken Usten from Jefferies.
Thanks, Good morning paid Darren can we talk a little bit more about net interest income I heard your comments about the year over year growth expected still for 19, but to the points about the cuts that have already happened and your guidance about what it does the four to nine on a full year basis can you help us understand the pushes and pulls.
With just the remaining burden from the cuts and then the excess liquidity in terms of how you expect the NIM to trajectory from here in terms of magnitude of compression as you look to the fourth.
Right.
Its a.
It's bit of a moving target. These days isn't that came with the pace of LIBOR in them and where the fed might go a and that's really why we try to help or give you guys. The guide by by talking about the four to nine basis points that way you guys can figure out what you think though the rate curve might look like.
But I guess a couple of things that I think are important when we talk about the margin and the net interest income.
When you look over the last two quarters at the at the margin compression.
The print it doesn't sound doesn't seem great obviously, but when you look at net interest income it was down $9 million last quarter and down $12 million this quarter and when you look at some of the things going on underneath that might take your beyond the four to nine.
You look at increases in cash balances and the cash balances carry a positive spread, albeit small so they don't.
Harm net interest income, but they certainly harm the margin.
And you would see the same thing with the escrow balances that have grown last quarter in this quarter as well that there you know basically a.
Slightly positive.
In some cases slightly negative carry and so they don't have much of an impact on and I and net interest income, but they do on the margin and so as we look forward. The the 49 for 25.
Seems fairly reasonable to us that'll, though the actual margin will move around a little bit depending on what happens with escrow balances, which can be as much a function of the rate environment and prepayments as well as other cash balances.
Fed.
So so there's a there's a bunch of pieces.
That are moving there.
But but at its core its four to nine the one thing that I think is encouraging is we've started to see deposit cost bend over.
If not for the escrow balance growth this quarter.
We would have seen the increase in interest bearing deposit costs basically zero, a and we start to see some traction on repricing activities as we go into the coming quarters, which will help.
Moderate the impact of any further decreases in LIBOR.
But it still keeps you within that four to nine range as we go forward.
And then.
Yep.
Yes, so just that does that I guess my follow up would just be then to your point about the modest downward trajectory of Eni dollars.
Is that the trajectory that you'd still expect given I know and I hear you on all the moving parts of it but you.
Do we still.
Just gap to expect that modest slide in Eni is a go forward from here or is there something that can change with regards that trajectory.
The trajectory.
It might move around a little bit in any given quarter, depending on on the pace of deposit repricing, but those are over the over a 12 month.
Average is kind of the four to nine and then obviously the big drivers just LIBOR and how fast LIBOR moves down and how many rate cuts we get.
The.
Most of the of the two we had this quarter are in there, there's probably a little bit of residual from the last cut.
Just because of when it happened in the quarter, but.
So we'll see some of that in the fourth quarter or and then we'll see what happens with a LIBOR in the fed over the coming meetings.
Okay last quick one just you'd mentioned that how much higher are the.
Escrow deposits price versus you know I guess, the average interest bearing deposits at 85 to your point that the 85 would have been closer to flat without the escrow. So can just give us understanding of the difference between where the escrow deposits are coming on versus where you are kind of averages underneath.
Yeah sure so.
Round numbers when you look at the escrow balances, they're priced off and index either off of fed funds are off alive or so they're kind of around one a a these days and when you look through the rest of the portfolio. It's primarily commercial interest checking that is driving a the interest expense on that line.
Nine and within there there's a range of rates those are individually negotiated with each customer based on the on the relationship and the and the magnitude of it and you know my my recollection.
Is that the average there is around 70.
75 basis points, so you probably double in terms of what.
The escrow balances are earning versus what the the other ones are the nice thing about the escrow balances is because they are linked to the index as the index moves so too does the cost of those.
Understood. Thank you Don.
Your next question comes from the line of Steven Alexa pulls from JP Morgan.
Okay.
Stephen Your line is open.
Right.
Stephen you might have yourself on mute.
Yes.
Your next question comes from the line of Marty Mosby with finding Sparks.
Well thank you.
Wanted to touch base with you in just the summarize these moving pieces because when you think about your expenses.
You really have one the mortgage valuation if I'm getting you're right in other expenses.
Typically that kind of gets netted out in the revenues.
You wouldn't see that grossed up expense. So that's that's driving your expenses higher this particular year.
You've got this transition going from external.
Technology support to internal technology support so right in the middle of that doubling up of expenses.
You are seeing the benefit of those two things rolling off as you know kind of guided towards a 40 to 50 million dollar reduction in expenses as you go from the third to fourth quarter.
As you go into next year.
If you kind of take that dynamic forward. It seems like your expenses could actually drop as you go into 2020 once you get the benefits of not having the external.
Spend and you don't have the let's say the.
Long term rights are flat. So you don't have this valuation situation.
Okay.
So I guess if you if you look forward Marty I think.
The way you're thinking about it is exactly the way, we're seeing it and thinking about it and really the only thing that would be a timing difference on when we might see the expenses actually drop versus the growth rate dropped very dramatically. The latter we're definitely expecting.
To see actual decrease.
We still got that the transition going on with that a tech team that's going to continue through 2021, and so we're we're looking to bring on a a large number of folks and they've come on in chunks of probably 100, 250 and that kind of happened consistently over.
Or maybe.
A quarter to every four months and when you're in that time period, you're you're bearing the double cough and so we've we've started down that path. You know we did our first wave this year, probably took us a little bit longer to get up to speed a little bit longer to get some of the contractors out than than we might have anticipated going on.
We are going into it but we're getting smarter in how we do that and better able to match the timing. So we shouldn't carry quite as long as we did this year, but we will continue to see that the cost of that transition happened through 2020, and really start to see the benefit in 2021.
On the mortgage side like you pointed out that that stuff should wash itself out and as we go through.
2020, compared to 2019 in the mortgage portfolio holding the valuation reserve to the side.
That should start to normalize itself and the expenses will will obviously move in relation to how the unpaid balances are performing and then when we watch some of the other other costs and some of the other professional services. There were some other activities that we had going on this year. The we wouldn't expect to repeat.
And so those should help expenses the offset there is just a compensation costs.
For folks that have been added to the team and no interest give people raises that that raises your.
Your your run rate and you've got offset that so theres a couple of things going on back and forth, but when you. When you think high level over the next couple of years, though the way you're thinking about it Marty is exactly the way we're thinking about.
And then on the credit side because really.
The the variances on this particular quarter or a mom on are expensive and then up in the credit side, you know the $9 million you put into the allowance and you put some into it last quarter as well is that you know covered what you expect to see in the charge off from this large relationship.
Mike You know get charged off and then you know next couple of quarters. So have you kind of prefunded that and so when we see the event, you'll actually just been drawing down reserves to pay off.
Expected loss.
So.
What would happen there Marty was that loan was obviously criticized before we started to.
Reserve for it at that point there were some other criticized loans that that either paid off or became performing and so what we had put aside for them well help cover.
The increase in the one that went non accrual and then we added to it and so based on what we know today. It's in the it's in the provision and we feel good about it but this this one is a little bit more of a fluid relationship and it just because the nature of the call.
Lateral and so depending on how things move with that organization.
The the collateral values could move around a little bit honest and that's why we Ah why we moved into non accrual and why we set up are added to the provision or add to the reserve.
And let you guys know that we'll probably have something.
In the future, but the exact magnitude and timing is still a little bit unclear.
But outside of that I, just point out criticized coming back down.
And the rest of the.
Portfolios and we look at the delinquencies and what the what has been happening with a with a charge offs.
You know knock on wood everything has been fairly stable and predictable and all else equal one would expect that as rates come down that would help debt service coverage coverage ratios and customer's ability to pay a which would lead you to believed that the charge offs might tick up you know the counter argument obviously.
As if GDP slows and growth slows that well the interest costs might come down you got to keep an eye on revenues and that the ability to service the debt from that side of the equation.
Thanks.
Your next question comes from the line of Chris Spar with Wells Fargo.
Thank you I have a balance sheet question a tech follow up question. So for the balance sheet. The long term debt has been trending down for the past three to four years.
Is that going to stabilize or do you think that can continue to run off base your liquidity needs kind of get kind of smoothed out.
Unless you have another deal.
Okay. So if you look at the at the long term debt.
It's it's been coming down, but there's been a bit of an uptick in short term and and then obviously an uptick in some of the deposit balances in the last little while I'm, particularly driven by escrow and so the mix of long term in short term, we will now start to.
Reevaluate given that LCR has the ruling has been finalized so we were kind of using more short term borrowing.
To manage the liquidity coverage ratio and our investments and HQ L.A., while we're waiting for the rules to be finalized and so now that there is little bit more certainty there we'll look at how much securities.
Balances, we want on the balance sheet and look at the funding mix of those but we've also got some long term debt that is going to.
Rollover next year, and obviously, we'll look to replace that but subject to where we see the balance sheet going but we think we've got some opportunity there to to manage the securities portfolio now that the rules have been finalized and ER and given how we feel about the strength of the organization.
And regarding tech so I believe when they talk to you in the past its around 10% or so your revenues or spin on technology around maybe little bit less than 700 million with about 60 40 run dipping change the bank and.
As you bring more stuff in house do you see either one of those changing.
No I guess.
Well I don't think disclosed.
Or talked about what the tech budget is in specifics I think the 10% to 12% that you might be referencing is we talked about the compound annual growth rate of that part of the budget and then the mix between you know kind of run the bank versus.
Improve the bank build the bank whatever you want to describe you know 60 40 is probably a a reasonable estimate that can move around from year to year, depending on what's going on well, we're making investments in a new regulations like FDIC threeseventy or c.. So I don't know, whether we would call that build the anchor run the bank.
We're probably splitting hairs there, but at the end of the day. The total tech budget in in the short term is running a little bit higher.
Because of the transition that we're making our belief is that we.
We will all else equal be flat with more on staff unless contractors as we go forward and then the growth rate from there wouldn't need to be at the 10% to 12% rate.
But would probably continue to run at a rate slightly above the bank average and that the investments, we're making in technology would be offset by cost reduction somewhere else as we gain productivity improvements from the tech spend.
In the new staff that you're bringing on a deep focused on besides the FDIC and Cecil.
Digital delivery AI a mill.
Comp is a cloud.
Transitioning apps to the cloud, where where are you putting it just didnt feel to work.
Well, we've got a whole host of things that we're working on a bunch of them you named obviously some of the regulatory changes have been a I'm a big consumer of our of our tech team a this year as we get ready for FDIC 370, and Cecil but at the same time, we've been making a consistent investments.
In a lot of the systems that are used either by our customers are by our employees, who interact with our customers a we've been doing that in the commercial loan origination space, we've been doing it in the Treasury management and merchant space or in the commercial part of the bank we've been doing it in some of the M&A supply.
Note that we do in our institutional client services business.
We've been doing it in customer facing things both in our wealth management business as well as in the consumer business.
We continue to make investments in cyber security or in data.
And so it runs a whole host.
We are starting to migrate some applications to the cloud or some of the newer ones are often run on on the cloud and we're doing some of that so we've got a host of whole range of of places where we're investing.
But it always kind of starts with the customer work works backward and looks at where we and the competition and where we need to make sure. We're positioning the bank and then also looking for ways that we can.
Obviously improved productivity or efficiency.
Thank you.
Your next question comes from the line of Brian Foran with autonomous.
If it gets a little it's easy to get lost because it hits. So many line items and everything like has a lag and timing issues and.
I guess, if you step back like was this a good acquisition like accretion or return on invested capital. However, you want to measure it.
If you just set aside the quarter to quarter stuff and where rates are these escrow deposits like.
This all work.
Yeah.
And again, Brian first part of it we missed.
Just a mortgage servicing like it's it's hard to really parse apart everything like if you just think about it on a net basis.
Has the acquisition and the resulting business it builds.
Did work is it accretive is that going to be good for 2020 or is there. Some underlying slippage. It's just hard to you know there's so many moving parts and hit so many line items.
Sure.
I think the short answer is we are still happy with the the acquisition of the mortgage servicing rights its probably not quite the return that we thought when we first did it a and that's affected by the timing of some of the charges that were taking a but overall weeks we.
Well, it's accretive and above our long term cost of capital, which is how we kind of evaluate everything. So we had some wiggle room built in which you always do given the volatility of this business and when when we look at it to your point stepping back we still feel good about it and are happy we did it.
Great. Thank you.
Your next question comes from the line of Gerard Cassidy with RBC.
Darren.
Good morning Gerard.
Quick question, there seems to obviously to be concerns about.
Your IP spending and maybe not keeping up with some of the bigger banks.
One measure would you recommend investors look at to show that you are as competitive as the big banks, obviously, the big banks can be splashy with the dollar signs that they're spending in years will be a lot less because your smaller bank, but is deposits. The preferred area look we sure deposit growth year over year was better.
The money that big banks, but can you share with us what we should be looking at.
Sure. It's a great question Gerard.
I guess I think the best place to look at his his customer based measures. So I would look at customer growth rates.
Customer attrition rates.
Satisfaction rates, so it could be JD power could be Greenwich in the in the commercial and small business world to be some of this is really research in the wealth space, but I mean at the end of the day then the number one thing you're investing in technology for is the is to help.
Provide a great experience for your customers and make sure that you're on par with everyone else on things that are just kind of what we would call hydrogenics are expected.
And look for places, where you can differentiate what you're doing and.
One of the things to keep in mind when you compare the regional banks to the large ones is the large banks have.
Broader based businesses than we do you know we don't have trading operations for instance, which would which would consume a lot of dollars and.
I can't speak for everyone else, but what I can speak for inventory is through all the acquisitions that we've done we've never maintained duplicate systems and so there's not a were not carrying that expense and we don't need to incur the cost of of running them or consolidating them.
And so you know a lot is made of how much you spend I think most important is are you, giving your customers the tools and capabilities and services that they're looking for a and they let you know all the time you know you can kind of look at deposits as you pointed out your are the only thing is just got to watch or in my opinion on deposits is.
You can move the deposit balance number with rates a lot faster than you can't with technology and the one that's really hard to fake is transaction accounts are operating accounts, whether their consumers small business our commercial.
Entities and and when we think about our tech investments are always thinking about the those those parts of the customer experience and how we can make it better.
Great. Thank you.
Your next question comes from the line of Saul Martinez from yes.
Hi, good afternoon, Thanks for taking my question.
So.
I guess, one a parse through a lot of the moving parts around the NIM guidance, I'm, dairy and and and try to figure try to put dollars side around it and I know, there's a lot of uncertainty about rates and whatnot, but.
49 basis points of Nims pressure for every 25 basis point reduction in the short end.
Looks like you know the fourth quarter, one month LIBOR the average should be additive.
Sharpen my pencil here, but you know, maybe 40 50 basis points lower and what it was on average in the third quarter I'm, especially if we see in October cod.
You know it it's important nine basis points I mean, it seems like is it fair to say that it's going to be hard not to see some degradation and reduction in net interest income in the fourth quarter on a nominal dollar basis versus what you would you posted in the third quarter.
I think thats right.
So the the actual margin you you've got the math right and looking at where a fed funds in LIBOR might be over the quarter. You know the NIM the print of the NIM might move around a little bit from that depending on where cash balances ended up and how much more estriol comes on but but you're in the right ballpark and then when you.
Look at the the dollar impact.
You know it it's going to come down when you look at the guide that we've given I think you should be able to figure out where where we think it's roughly going to be in the fourth quarter and it did the the other wildcard is deposit repricing, but.
But like we mentioned we feel we feel good about the progress that we made this quarter.
In spending over deposit pricing, a and we should start to see that that come down.
This quarter and then the other thing and so that's a little bit tricky to gauge or it's just the pace the loan growth at in the quarter in particular, because the fourth quarter always seems to have some some uptick and then the question. There is when did that occur right you should start to see little earlier in the quarter in the floor plan auto floor.
Land balances.
But oftentimes, we see a big December and you kind of wonder what drives seasonality. It's a it's year end and people looking to close deals for the for the tax year, and we always seem to see a a spike in some of the loan or loans that book in December and obviously that will.
Depending on the timing impact the dollars of net interest income.
Got it I guess, if I could just get one more in a little bit more of a broader question.
But to the downside of having.
Sort of best in class profitability efficiency.
Deposit franchise is that it does leave you more vulnerable when the environment starts to turn.
A little bit worse, I guess the questions just how do you think about.
Sustaining profitability and creating value.
In that environment, how do you think about you know opportunities, where you can grow and I guess the gist of the question is can you do that.
On a on a standalone basis can you really.
Or you need to do something more strategic to really able to sustain sort of the best in class type of profitability and operating metrics you have.
No I appreciate the question because it's a really good one and the the the strength of the franchise as you point out as both a blessing in occurs and when when you look at.
How we run the bank and how we think about the bank. We've always started with returns and so to talk about the returns a I'm. Most pleased to hear you say that because that's that's our focus and that that thought process is what has kept a set of trouble and what has help us make a lot of the investment decisions that we've done through time and.
And you know, sometimes it was a acquiring servicing or sub servicing.
Business.
Because the returns made sense based on what was going on in the industry. It's helped us decide when to make loans and how to structure them because of the returns don't make sense to us we've tended to step away and it's helped us priced acquisitions and make sure that were being thoughtful with a with capital and how we deployed to grow.
With mergers and acquisitions and so when when you look overall one of the key things for US is making sure that we maintain those returns and if that means we need to be patient in time and have a little bit less growth. We're okay with that because we would rather make sure we protect the profitability and the ability to generate cash.
A little.
So that we can make some of the investments that we're making and if you look at really the last 12 months to 18 months.
We had some outsized increases in the net interest margin because of the positioning of the balance sheet and the run off of the Hudson City portfolio, which allowed us to grow the loans deploy capital and increase the the margin and we took advantage of that and we up the investment that we were able to make a in the franchise.
The the reverse is true and that as a as we see rates come down and our our net interest margin relative to the peers kind of resumes its more normal position of up slightly above the median.
We should be able to.
Bring anticipate bringing the a the expenses down commensurate with that so you kind of you look across the different alternatives that you have of making loans or investing in other businesses buying other banks or deploying excess capital to shareholders and think about the returns.
Obviously, the first place we want to invest as in the business and in our customers and this year, we've been able to do that a little bit more with the loan growth that you've seen.
And we think we can continue to do that but iden <unk>, we don't feel pressure.
To have to get to a certain size or to buy some growth or either in the form of poor pricing.
Or in poorly or ill conceived acquisitions.
And we'll continue to focus on on returns and being patient and making sure that we're running a good bank and that will leave us we believe with opportunities when when they present themselves.
Okay. Thanks, so much really appreciate it.
[noise] there no further questions I would now like to hand, the conference back over to Don Macleod for any additional or closing remarks.
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This does conclude today's conference call you may now disconnect your lines.