Q1 2022 M&T Bank Corp Earnings Call
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Welcome to the M and T Bank first quarter 2022 earnings conference call. At this time all participants are in a listen only mode. Following management's prepared remarks, the call will be open for questions. If you would like to ask a question at that time.
Please press star one on your telephone keypad.
Please be advised that today's conference is being recorded I would now like to hand, the conference over to Brian Clark head of markets and Investor Relations. Please go ahead.
Thank you Gretchen and good morning, I'd like to thank everyone for participating in <unk> first quarter 2022 earnings conference call.
Both by telephone and through the webcast.
If you have not read the earnings release, we issued this morning, you may access it along with the financial tables and schedules from our website www Dot MTBE dot com and.
By clicking on the Investor Relations link.
And then on the events and presentations link.
Also before we start I'd like to mention that today's presentation may contain forward looking information.
Cautionary statements about this information as well as reconciliations of non-GAAP financial measures are included in today's earnings release materials as well as our SEC filings and other investor materials.
These materials are all available on our Investor Relations webpage and we encourage.
All participants to refer to them.
For a complete discussion of forward looking statements and risk factors.
These statements speak only as of the date made.
<unk> undertakes no obligation to update them.
Now I'd like to turn the call over to our Chief Financial Officer, Darren King.
Thank you, Brian and good morning, everyone.
As we reflect on the past quarter it wasn't eventful one.
First off we were pleased to have closed the acquisition of peoples United Financial on April one.
And to welcome our new colleagues customers and shareholders to the <unk> family.
We're excited to turn our complete focus to successfully integrating people's United of course, not losing sight of the tenants the define empty.
Delivering superior customer service offering rewarding careers for our colleagues engaging in the communities, we call home and providing top quartile long term returns to shareholders.
We plan on completing the systems conversion in the third quarter of this year.
Subsequent to our January earnings call the outlook for interest rates has changed materially.
Low levels of unemployment and continued supply chain disruptions exacerbated by the situation in Ukraine have pushed inflation to levels not seen since the early 19 eighties.
Interest rates began to rise even before the federal reserve raised its fed funds target in late March and the forward curve anticipates additional hikes coming more quickly than we anticipated in January .
The changing rate environment created an opportunity for us to deploy excess cash into investment securities at a faster pace than we previously outlined and to restart our interest rate hedging program.
While we are beginning to see the tailwind from rising interest rates positively impacting our net interest income.
Those same higher rates have prompted headwinds to our mortgage banking business, both for origination volumes and for gain on sale margins we.
We expect these headwinds to persist.
Despite these macro challenges credit quality remains strong and expense growth has been well managed.
We are well positioned for the future and excited about the opportunity to integrate the people's United franchise, as well as to deploy our excess cash and excess capital.
Now, let's review our results for the first quarter.
Diluted GAAP earnings per common share were $2 62 for the first quarter of 2022.
Third to $3 37 in the fourth quarter of 2021.
Net income for the quarter was $362 million.
Compared with $458 million in the linked quarter.
On a GAAP basis Mmc's first quarter results produced an annualized rate of return on assets, just shy of 1% at 97% and an annualized return on average common equity of eight 5%.
This compares with rates of 1.15% and 10, 91% respectively in the previous quarter.
Included in GAAP results in the recent quarter were after tax expenses from the amortization of intangible assets amounting to $1 million or one cent per common share down slightly from the prior quarter.
Also included in this quarter's results were merger related expenses of $17 million related to the People's United acquisition the.
This amounted to $13 million after tax or <unk> 10 cents per common share.
Consistent with our long term practice <unk> provides supplemental reporting of its results on a net operating or tangible basis.
From which we have only ever excluded the after tax effect of amortization of intangible assets as well as any gains or expenses associated with mergers and acquisitions.
<unk> net operating income for the first quarter, which excludes intangible amortization and the merger related expenses was $376 million.
Compared with $475 million in the linked quarters.
Diluted net operating earnings per common share for $2 73 for the recent quarter compared with $3 50 in 2021 fourth quarter.
Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 1.0% to 4% and $12 four 4% for the recent quarter.
The comparable returns were 123% and $15 nine 8% in the fourth quarter of 2021.
In accordance with the SEC guidelines. This morning's press release contains a reconciliation of GAAP and non-GAAP results, including tangible assets and equity.
Included in the recent quarters GAAP and operating results was a $30 million distribution from Bayview lending group.
This amounted to $23 million after tax effect and <unk> 17 per common share.
We received a light distribution in the fourth quarter of 2020 as well as the fourth quarter of 2021.
Next we will look a little deeper into the underlying trends that generated these results.
Taxable equivalent net interest income was $907 million in the first quarter of 2022.
A decrease of $30 million or 3% from the linked quarter.
The primary drivers of the decline were $20 million and lower interest income and fees from PPP loans as well as the $16 million reduction of interest accrued on earning assets, reflecting the two day shorter calendar quarter.
Those factors were partially offset by higher rates on interest, earning assets and cash interest received on non accrual loans.
The net interest margin for the past quarter was $2 six 5% up seven basis points from 258% in the linked quarter.
The primary driver of the increase to the margin was a reduced level of cash held on deposit with the federal reserve, which we estimate boosted the margin by 10 basis points.
That was partially offset.
By a four basis point decline, resulting from the lower income from PPP loans.
Rising interest rates had a modest one basis point benefit to the margin as the fed action on the fed funds target came relatively late in the quarter.
All other factors, including day count and interest received on non accrual loans had a negligible impact on the margin.
Yeah.
Compared with the fourth quarter of 2021.
Average interest, earning assets decreased by some 4% or $5 8 billion.
Reflecting a $5 6 billion decline in money market placements, including cash on deposit at the fed.
Partially offset by a $920 million increase in investment securities.
Average loans outstanding decreased by about 1% compared with the previous quarter.
Looking at the loans by category on an average basis compared with the linked quarter.
Commercial and industrial loans increased by $976 million or about 4%.
That figure includes a decrease of approximately $780 million in PPP loans.
That decrease was more than offset by $361 million growth in dealer floorplan balances and a $1 $4 billion increase and all other C&I loans.
Commercial real estate loans declined by 5% compared with the fourth quarter.
Three factors contributed to that decline.
Elevated payoff activity was the primary driver, including several criticized and nonaccrual loans assumed by other lenders.
The quarter also saw construction loans converted into permanent.
Off balance sheet financing often facilitated by our <unk> Realty Capital Corporation subsidiary.
And finally, new origination activity remained subdued compared to prior years.
Real estate loans declined by residential real estate loans excuse me declined by 3% consistent with our expectations.
The change reflects new loans originated and retained for investment which were more than offset by normal runoff combined with the sale of Ginnie Mae buyouts as they became eligible for retooling into new or MBS.
Consumer loans were up nearly 1%.
Activity was consistent with recent quarters, where growth in indirect auto and recreational finance loans has been outpacing declines in home equity lines and loans.
On an end of period basis, PPP loans amounted to just $592 million.
Average core customer deposits, which exclude Cds over $250000 decreased about 5% or some $6 billion compared with the fourth quarter.
That figure was roughly evenly divided between noninterest bearing and interest checking.
Trust demand deposits drove the decline in demand deposits following lower levels of capital markets activity compared with the fourth quarter.
The decline in interest checking reflects our ongoing program to manage deposit pricing downward while our liquidity profile remains strong.
Some higher cost escrow deposits were moved off our balance sheet to other institutions willing to pay higher rates.
Turning to noninterest income.
Noninterest income totaled $541 million in the first quarter compared with $579 million in the linked quarter.
As noted <unk> received a $30 million distribution from Bayview lending group and each of the past two quarters.
Mortgage banking revenues were $109 million in the recent quarter compared with $139 million in the linked quarter.
Revenues from our residential mortgage banking business were $76 million in the first quarter compared with $91 million in the prior quarter.
Residential mortgage loans originated for sale were $161 million in the recent quarter compared with $191 million in the fourth quarter.
Both figures reflect our decision to retain a substantial majority of mortgage originations for investment on our balance sheet.
The primary driver of the linked quarter revenue decline as the higher interest rate environment is pressured gain on sale margins for loans previously purchased from Ginnie Mae servicing pools, and which have become eligible for resale or re pooling.
Although these loans typically have higher rates, the new originations that difference has been narrowing.
Residential gain on sale totaled $14 million in the recent quarter compared with $26 million in the prior quarter.
Commercial banking revenues were $33 million in the first quarter, reflecting a decline from $49 million in the linked quarter.
That figure was $32 million in the year ago quarter.
As a reminder, the commercial mortgage banking business tends to show seasonal swings.
<unk> totaled $66 million in the first half of 2021 compared with $99 million in the second half.
<unk> also included an elevated level of prepayment fees.
Trust income was $169 million in the recent quarter little change from the previous quarter, but up 8% from the year ago quarter.
Service charges on deposit accounts were $102 million compared with $105 million in the fourth quarter.
That decline primarily reflects seasonal factors.
The previously announced repricing of our consumer checking products did not have a significant impact on the first quarter, but we expect foregone revenues from the program to reach a run rate of $15 million per quarter by the second half of the year.
Turning to expenses.
Operating expenses for the first quarter, which exclude the amortization of intangible assets and merger related expenses were $941 million.
The comparable figures were $904 million in the linked quarter and $907 million in the year ago quarter.
As is typical for <unk> first quarter results operating expenses for the recent quarter, which include included approximately $74 million of seasonally higher compensation costs relating to the accelerated recognition recognition of equity compensation expense for certain retirement eligible employees.
Macleod.
Also it reflects the HSA contribution the impact of annual incentive compensation payouts on the 401, K match and FICA payments as well as the annual reset in FICA payments and unemployment insurance.
Those same items amounted to an increase in salaries and benefits of approximately $69 million.
In last year's first quarter.
As usual, we expect those seasonal factors to decline significantly as we enter the second quarter.
Aside from these seasonal factors that flow through salaries and benefits operating expenses declined by $38 million compared.
Compared with the fourth quarter.
Lower professional services costs as well as lower pension related costs drove that decline.
The efficiency ratio, which excludes intangible amortization and merger related expenses from the numerator and securities gains or losses from the denominator was 64, 9% in the recent quarter compared with 59, 7% in 2020 one's fourth quarter and 63% in the.
First quarter of 2021.
Those ratios in the first quarters of 2021 and 2022, each reflect the seasonally elevated compensation expenses.
Next let's turn to credit.
Despite the challenges of the pandemic and experience supply chain disruptions lowers labor shortages and persistent inflation.
Credit as stable to improving.
The allowance for credit losses amounted to $1 5 billion at.
At the end of the first quarter little change from the end of 2021, we.
We recorded a provision for credit losses of $10 million in the first quarter, which was partially offset by just $7 million of net charge offs.
Yeah.
As the COVID-19, pandemic eases forecasted economic indicators continue to show improvement from the prior period.
And inflation remains persistently high with upward pressure from energy prices and constrained supply chains, which have been impacted by Russia's invasion of Ukraine.
The first quarter's baseline macroeconomic forecast considered these developments, although there was little difference in the forecast from the prior quarter for those indicators that have a significant impact on our seasonal modeling results, including the unemployment rate.
GDP growth in residential and consumer real estate values.
The result of these considerations is an allowance for credit losses that is consistent with our prior estimate.
Non accrual loans increased very slightly amounted to $2 1 billion.
That equaled two 3% of loans at the end of March up slightly from two 2% at the end of last year.
When we file our first quarter 10-Q, and a few weeks, we expect to report a modest decline in criticized loans.
As noted net charge offs for the recent quarter amounted to $7 million.
Annualized net charge offs as a percentage of total loans were just three basis points for the first quarter, which we believe is an all time low.
That figure was 13 basis points in the fourth quarter.
Loans 90 days past due on which we continue to accrue interest were $777 million at the end of the recent quarter.
In total 89% of these 90 days past due loans were guaranteed by government related entities.
Turning to capital.
<unk> common equity tier one ratio was an estimated 11, 6% compared with 11, 4% at the end of the fourth quarter.
This ratio reflects earnings net of dividends combined with a slight reduction in risk weighted assets.
Tangible common equity totaled 11 5 billion.
Down just three tenths of a percent from the end of the prior quarter.
Tangible common equity per share amounted to $89 33.
Down 47.
Or one half of a percentage point.
From the end of the fourth quarter.
This is very moderate decline reflects our patience in deploying excess liquidity into long duration investments until the interest rate outlook became clear.
As previously announced we expect to resume the repurchase of common shares shortly starting with the $800 million buyback program recently re authorized by our board.
Now turning to the outlook.
On April one we closed the People's United acquisition.
That development combined with the rapid change in interest rate expectations have had a material impact on our outlook for full year 2022.
The information that follows reflects the combined balance sheet, a more recent forward curve and.
That includes three quarters of operations from People's United.
First let's talk about our outlook for the balance sheet.
Excluding the impact of acquisition accounting adjustments at closing, we acquired $63 billion in total assets, including.
Investment securities totaling $12 billion.
Cash placed at the federal reserve totaling $9 billion.
Loans of $36 billion.
And other assets of $6 billion.
Yeah.
Deposits totaled $53 billion.
Borrowings and other liabilities totaled about $1 billion each in equity totaled $7 5 billion.
The purchase consideration was approximately $8 4 billion.
Yeah.
With the increase in rates. The deal is now expected to be slightly dilutive to tangible book value per share.
However, this also means that future earnings will benefit from additional acquisition accounting accretion.
Let's go into a little more detail on our outlook for growth in the combined balance sheet.
First the interest, earning cash position at the beginning of the second quarter totaled just over 45 billion.
We expect these balances to decline to slightly under 30 billion.
By the end of 2022.
Due to a combination of growth in the securities portfolio.
Loan growth as well as a reduction in wholesale funding.
Investment Securities for the combined company totaled $21 billion at the beginning of the second quarter and.
And we expect.
To grow the portfolio by $2 billion per quarter.
This cadence could accelerate or slow depending on market conditions.
We start this quarter with $40 billion in C&I loans, including just over $800 million in PPP loans.
CRE residential mortgage and consumer loan portfolios are 46 billion.
$22 billion and $20 billion respectively.
In order to provide more details on our outlook for loan growth, let's first look at our expectations for spot our end of period loan growth from the beginning of the second quarter through the end of 2022.
Total combined loans are expected to grow in the 3% to 5% range from the beginning of the second quarter.
Excluding PPP and Ginnie Mae buyout loan balances total combined loans are expected to grow in the 4% to 6% range.
The outlook for C&I loan growth, excluding PPP loans is in that same 4% to 6% range with solid growth excuse me and dealer Floorplan balances.
Yeah.
PPP loans are expected to continue to pay down over the course of the year and not have a material impact on loan growth.
Our CRE loans, we expect the heightened level of payoffs to have largely run their course and thus the outlook for total combined CRE loans as essentially flat for the rest of this year.
The tailwind from our mortgage retention strategy are expected to help drive 7% to 8% loan growth and residential mortgage balances over the course of this year.
And excluding the impact of the retooling of Ginnie Mae buyouts growth is expected to be in the 12% to 14% range.
Of course mortgage rates and home supply will ultimately affect that pace of growth.
Finally, we're pleased with the momentum in our consumer loan portfolio and expect this growth to continue to be strong over the remainder of the year.
Anticipating growth in the 7% to 9% range in this portfolio.
To help you understand the outlook for end of period growth outlook.
Outlook for end of period loan growth ties into growth in average the average balance sheet when compared to Standalone MNT 2021 average balances.
We expect.
Average loans for the combined franchise to grow in the 24% to 26% range when compared to Standalone <unk> full year 2021 average balances of 97 billion.
On a combined and full year average basis, we expect average C&I growth in the 43% to 45% range.
We expect average CRE growth in the 15% to 16% range.
And average residential mortgage growth in the 26% to 28% range.
And finally, we expect average consumer loan growth in the 16% to 18% range.
As we look at the outlook for the combined income statement compared to Standalone empty operations from 2021, we believe we are well positioned to benefit from higher rates and have managed through the macro challenges. We noted earlier on this call.
This outlook includes the impact from preliminary estimates of acquisition accounting marks that are expected to be finalized later in the quarter.
Our outlook for net interest income for the combined franchise as for 50% full year growth compared to the $3 8 billion in.
In 2021.
We expect that 50% growth to be plus or minus 2%, depending on the speed of interest rate hikes by the fed and the pace of the deployment of excess liquidity as well as loan growth.
This outlook reflects the forward yield curve from the beginning of this month.
Turning to the fee businesses, while higher rates are expected to pressure mortgage originations and gain on sale margins.
Growth in trust revenue should benefit from the recapture of money market fee waivers sooner than previously anticipated.
We expect noninterest income to grow in the 11% to 13% range for the full year compared to $2 2 billion in 2021.
Next our outlook for full year 2022, operating noninterest expenses is impacted by the timing of the People's United system conversion and subsequent realization of expense synergies.
We anticipate 23% to 26% growth in combined operating noninterest expenses when compared to $3 6 billion in 2021.
As a reminder, these operating noninterest expenses do not include pre tax merger related charges charges.
At the time of the merger announcement, one time pre tax merger charges for estimated at $740 million, including $93 million of capitalized expenditures.
These merger charges are not expected to be materially different than these initial estimates.
We expect the majority of these merger charges to be incurred in the second and third quarters of this year.
Turning to credit.
We continue to expect credit losses to remain well below <unk> legacy long term average of 33 basis points.
For 2022, we conservatively estimate that net charge offs for the combined company will be in the 20 basis point range.
As a reminder, the provision for credit losses in this year's second quarter will include provision related to the non purchased credit deteriorated loans from People's United.
We are still finalizing the acquisition accounting marks but given the improvement in economic conditions over the past year. This provision will likely be lower than the $352 million pre tax provision estimated at the time of the announcement the so called double count.
Finally, turning to capital.
Due to the delay.
And growth in capital at both firms.
Preliminary combined CET, one ratio at closing should be over 11%.
We believe this level of core capital is higher than what is needed to safely run the combined company and to support lending and our communities. We plan to return excess capital to shareholders at a measured pace.
We will be participating in the DFAST this year and again in 2023.
Normally next year would have been an off year for a category four bank like MNT. However, the federal reserve has reasonably requested that we participate again next year, so that our stress test and stress capital buffer can be assessed including the balance sheet and operations of peoples United.
With a solid starting capital position and the potential to generate significant amounts of capital over the next few years, we don't anticipate the test results, causing a material change to our capital distribution plans.
Our objective as always is to bring our CET one ratio down gradually to a level that is near the high end.
The lower quartile of our peer group.
Based on that objective, we anticipate ending 2022 with a CET one ratio in the 10, 5% range.
As noted earlier, we anticipate restarting the currently authorized $800 million common.
Common share repurchase program now that the acquisition is closed.
Now, let's open up the call to questions before which Gretchen will briefly review the instructions.
Yes.
At this time, if you'd like to ask a question. Please press the star and one on your Touchtone phone you may remove yourself from the queue at any time by pressing the pound key once again that is star one to ask a question, we'll take our first question from Betsy <unk> from Morgan Stanley .
Hi, good morning, good morning Betsy.
I just wanted to drill down a little bit on your comment around the returning excess capital to shareholders at a measured pace.
If you could give us a sense as to how youre thinking about that because obviously with <unk>.
With loan growth coming in there will be a little bit about the competition, but not that much. So.
I guess really the underlying question is how measured as measured in your mind.
Yes.
As we think about Betsy.
Going to go through the next couple of quarters and the impact of some of the onetime expenses associated with the deal will have an impact on capital. In addition to the buybacks and so as we think about it it might be a little bit lumpy and a couple of these quarters, but if you think about it over the course of the next three years is moving down and maybe the.
The 20% to 30 basis point per quarter range, that's probably a good starting point.
The bit of the wildcard obviously is also the pace of increase in the fed funds rates.
Does.
The combined banks asset sensitivity.
That will have a meaningful impact on our net income and capital generation. So.
It will need to be monitoring that in addition to the pace of buybacks.
To hit that kind of 20 to 30 basis point target so it might bounce around a bit but thats kind of when we think about it how we tend to think about it.
Okay and then just.
A follow up.
The expense savings could.
Could you just remind us the pace of the realization of those that youre anticipating.
Yes, so if we go back to the.
The due diligence we were.
That and continue to target about a 30% decrease in the People's United expense base.
And when you look at when that really starts to come in it really is in the fourth quarter of this year and will probably leak a little bit into the first quarter of next year, just given the timing.
Most of the.
A reduction in expenses is tied to the system conversion event and so typically after that you'll have some folks who will stay on.
At that time, plus 30, plus 60, plus 90 days just as we stabilize the operations.
And then those expenses will start to go away so.
It will really be as we get to maybe the December timeframe of this year that will hit that run rate and really into the first quarter of 2023.
Thank you.
Okay.
Our next question comes from Ebrahim <unk> from Bank of America.
Good morning.
I was wondering if you could just go back to your NII Guide.
Thank you mentioned, 50%.
Yeah at Alere.
Well all in with the B zone, just talk to us at all and talk to us add on piece of cash deployment, what youre buying and.
And where do you expect to keep excess cash may be SDN can be pretty big.
Sure.
I guess, a couple of things on what's going on there.
And that.
Just looking at the cash and the cash deployment some of it will be into.
Securities, we talked about a pace of an incremental $2 billion a quarter and growth in the securities portfolio net of runoff.
When you look at the securities portfolio, and where we've been focused of late it's been in the shorter end of the curve.
Typically in the two to three year space I think if you look at how that curve.
Look you see that it kind of flattens out once you get.
Five years, and so we don't see a benefit to that extra duration, but part of the way we're getting some of that duration is through the retention of the mortgages were originating.
Through our retail channels and so part of the cash then is deployed into the residential mortgage balances that will sit on our balance sheet.
And then obviously the other loan growth that we talked about.
And those are the things that we think help bring the cash levels from the pace of the place we are combined.
In April of around $45 billion down to 30.
The other part that I that I Didnt mentioned was there is some some.
Some wholesale funding that is coming through the merger and as we as we look at our cash position.
We can bring those wholesale balances down.
And fundamentally as with the liquidity position that we have.
Understood and just tied to that on the funding side. We saw some deposits run off you've talked about this last quarter remind us in terms of when we think about deposit balances, where you expect them to Kendall.
Kind of more rate sensitive index, David deposits that you expect to do.
The balance sheet over the coming quarters.
Yeah, I guess, we're not anticipating.
Additional runoff in the deposit portfolio right now.
We will go through I think the first 100 basis points I think for us and generally for the industry given the loan to deposit ratios in the industry.
The deposits are likely to be sticky and.
And we won't see much movement due to rates.
As we go through the.
Through the cycle.
A cadence that happens with these the deposits that tend to be the most rate sensitive.
Our usually those in the wealth business.
As well as in the municipal government space and Youll tend to see betas move through there a little bit faster.
And consumer land it takes a little bit longer for a firm rates to start to drive behavior and over time, you'll see some movement in and out of out of checking accounts into money market savings and time accounts.
But that will all be based on the pace at which the industry starts to move up rates.
Just on time deposits there is a slightly higher time deposit portfolio at People's than there has been an empty.
And you might see a little bit of runoff in the time deposits early on but as rates.
Move.
Assuming they move as anticipated at some point Youll see those lines cross and.
That portfolio will stop shrinking.
Excuse me and then on a combined basis it will start to grow but that's probably not.
<unk> is the growth part is probably not until late this year early next year would be my guess just based on our past experience and where the where the forward curves are.
Got it thanks for taking my questions.
Yeah.
The next question comes from Matt O'connor from Deutsche Bank.
Hi, I was hoping you could flesh out the kind of a half percent.
Target end.
Yes, that's the block like why so high I think that's above where most of our peers are targeting and I appreciate you're converting a deal and you got some thoughts that you want to say it but.
Is that kind of.
Intermediate.
Target and over time, we'll bring it down over the course of a benign not in a habit with you from your peers or how did you arrive at a time of house and how long term with that.
Yes.
Happy to answer the question Matt.
The 10, 5%.
As a stepping stone along the way.
We haven't changed our thought process about how we manage capital.
We're always looking to deploy it into the franchise first and always looking to support customers and loan growth within our within our markets.
And to the extent that that's not there at a at a reasonable return then we'd love to get it back to shareholders.
We always think about the dividend.
As an important element of that and we try to make sure we target as we've talked about before right around a third of earnings as a dividend.
Payout target and we think that gives us a good flexibility too.
Make sure that we can maintain that payment through through the economic cycles, and then we tend to favor using buybacks is.
The rest of it.
<unk>.
The $10 five when you look at where we're starting and you look at.
What we believe is going to be the capital generation of the combined organization.
And against the backdrop of an asset sensitive franchise in a rising rate environment. The capital generation, we think becomes pretty compelling.
And so the pace of deployment against the pace of capital generation makes it tough to bring that ratio down very quickly.
And as you pointed out it's an intermediate step that next year will be the first year, we go through the <unk>.
The stress test with our combined balance sheet and what the history has taught US is when you go through that first time.
There can be surprises in how the portfolios are treated or react under the fed stress test models.
And sometimes in those situations there can be data gaps that you need to remediate and so we understand those issues and challenges, but we are you know what.
We think that going into that test at that level.
As just a safer place to be and then we will have more information when we come out the other side and expect to continue on our path down to the target that we've always talked about we'll obviously have to look at that target.
As we take into account the new balance sheet in the combined bank that we have because we are getting some new portfolios.
I want to run them through our own stress test models.
To understand how they how they perform under stress but.
Consider the 10 five is a stop along the along the journey towards our more typical target target.
Okay. That's helpful and then on the liquidity.
I'm, probably missing some sort of liquidity rule on this but why can't you and other banks that have time to cash.
Dump it in short term treasuries, we've seen very unusual move in the treasury market. So you could basically accelerate all that rate leverage.
And not really take any risk right like my press release. It was about 130 12 month of Cooper side doesn't impact.
If you want I don't think.
So just remind us like what what liquidity rules out there that's preventing you from doing that and it's not a rule.
Why wouldn't you consider that quite yet.
Yes.
There is not a rule mattering when when youre going through for banks that are subject to the liquidity the liquidity coverage ratio.
There is an expectation about what percentage of their liquidity is held in high quality liquid assets I think the treasuries Calvert cash is one of the preferreds and so.
Shorter duration cash oriented instruments would affect banks that are LCR banks, which are category three banks.
For a bank like MSC.
We're not subject to that but when we look at the benefit of locking in now a two year treasury versus where we see this as a forward curve going we think we're going to get a lot of that just with the rate moves without having to lock it in but yet.
Maintain the flexibility of that cash and we keep the the marks off the off the balance sheet and so you can see we are starting to buy in.
And we will continue to build a portfolio that does take advantage of some of that.
While trying to protect the flexibility that we have and we'll still expect to benefit from the from the increase in rates and we're trying to dollar cost average in a little bit into that position and really the focus for us I can't speak for others, but the focus for US is over the course of the next couple of years.
<unk> building.
The mix of the balance sheet between less than cash what's in securities within the securities portfolio, what's the duration of it how are we thinking about that with what is the duration of the whole portfolio and as we talked about with what's in mortgages and then the other thing that's really important is how much.
Cash and what's your deposit runoff assumption right, because if you get too far into the securities portfolio and all of a sudden you see some migration in deposits and.
And you've got to go out and fund those.
Or you got to react to outflows with rate.
If you go too far too fast you can get yourself upside down and so obviously at two years. There is a lot less risk of that but those are the kinds of things that we're always thinking about and debating internally when we think about the pace at which we want to deploy that cash into into something that might you know over the course of the next couple of quarters provide.
At a higher yield, but based on as I mentioned, where it looks like the fed is moving.
Might catch up pretty quickly there in the cash.
Thank you for squeezing what would be the longer term target of call at securities to assets or maybe its securities plus residential mortgages.
It's the way you think about it but you said rebuild and kind of remix next couple of years and what we're really unscathed.
Think about it.
Yes, I guess.
Way to think about it Matt is to look at the combination of our securities portfolio plus our on balance sheet mortgages and look at that as a percentage of assets and then look at where the peers set and if you think about the.
The peers, who has the lower percentage of those.
So the bottom quartile of the peers, when you add up securities and mortgages as a percentage of assets.
Think that kind of range for us.
As we've talked about before our goal was always to deploy our liquidity into lending.
While making sure that we're we're not taking on crazy asset sensitivity and so we will look to bring that close that asset sensitivity down.
And those would be the some of the primary cat.
Categories in which we would we would look to do that.
Okay. Thanks for taking all my questions.
Our next question comes from John <unk> from Evercore.
Okay.
John Your line is open.
Yeah.
You might be on mute.
After two years of the pandemic, we've still got mute.
And we'll take our next question from Ken Houston from Jefferies.
Hey, Thanks, a lot good morning, guys, Hey, Darren just wondering if you could just drill down into a couple more pieces of NII first of all can you help us understand that you mentioned that the accretion can you help us understand how much accretion youre expecting either in dollar terms ideally or.
Because I understand the percentage that adds to growth.
Yes, sure when you look at the NII like I mentioned, we're still finalizing what the marks are but when you look at the forecast for the year and the coming years.
The impact of the accretion will be positive compared to where we thought it would be when we when we announced obviously because of the change in the interest rate environment, but when you look at the percentage.
It could move what we what we guided it's maybe a couple of percentage points.
In either direction more likely to be accretive the not really the bigger driver of the growth in NII is just the composition of obviously of our balance sheet and our asset sensitivity and the new rate curve.
Which is the biggest part of that driver.
Okay. So there is accretion in there, but you are saying it could be more than what you have in there, but youre not going to you until you finalize the marks.
Youre not going to update us on just what the amount of the accretion is in there.
We will give you all of the information once we finalize it but I guess, what I'm, saying is it's not going to change the outcome.
In a meaningful way.
Okay got it and then just second question just on you.
You talked about some of the moving parts within the betas, but can you just talk us about what you're expecting for deposit betas and how that might have changed given the.
Aster pace of expected hikes that we're now seeing from the fed thanks, yes.
Yes, no problem.
We talked a little bit about deposit betas earlier on and.
It's really.
When we when we disclose the sensitivity in the.
In the Q.
Yes.
What we will see there is the first 100 and the first 100, we really don't think Theres a lot of reactivity and really when we look at the 100, we look at each 25 and then we'll look at the subsequent.
25, but really.
We think the first 100 has relatively low deposit betas, probably in the 10% to 15% range probably towards the bottom end of that.
Hughes by portfolio.
When you look as I mentioned before at some of the.
Government and municipal deposits they tend to be a lot more rate sensitive as do the wealth balances and so those would drive up the deposit beta and for our smaller business customers and our consumer customers.
The betas are a little bit lower.
Clearly as you get higher.
And the absolute level of fed funds, you start to get a little bit more attention.
One of the things that I think is different this cycle from others not just for us but for the industry for all of us to keep in mind is.
There is now an ability to pay interest on commercial checking accounts, which there hadn't been before.
And.
You you would look at.
The impact on commercial balances historically would be on earnings credit and then the offset on fees and from an interest perspective. It was typically in sweep accounts and is either on or off balance sheet well.
Now much of that will happen in those commercial checking accounts, where clients will have to decide between earnings credit against fees or between earning an actual interest income based on the rate on those.
Those products and so.
It's something we haven't seen how reactive those specific products will be because we haven't really been through a tightening cycle. That's looking like the one that's in front of us.
But again big Big picture. If you just go back to where loan to deposit ratio set and all the liquidity that sets not just on our balance sheet, but on others.
Unless there is a meaningful change in that position or meaningful loan growth you probably have deposit betas that are at.
At the lower end of the.
Of what we saw in the last tightening cycle.
Yes got it thanks, a lot Darren makes sense.
Our next question comes from Steven Alexopoulos from Jpmorgan.
Hey, Darrin has everything doing great. Good morning, good morning.
Good on asset sensitivity could you give color you said you restarted the hedging program in the quarter could you give color on what Youre doing there and now that peoples as close whats the new level of asset sensitivity versus what you guys last disclosed.
So I'll go in reverse order.
The new level of asset sensitivity is slightly less than what it is empty standalone. If you look at the two balance sheets, both were asset sensitive.
And on a combined basis.
<unk> sensitivity drops maybe.
Maybe a percentage point and a half a point.
In that range.
We saw in the peoples portfolio over the course of the last year similar phenomenon that we did in that there has been some loan declines certainly PPP loans that paid off and turned into cash and so they were.
Looking and then managing their portfolio.
In a very similar fashion to how we were and so there really wasn't a big change in the combined asset sensitivity and then when you look at those the hedging program.
What we've been trying to do is since we see the curve.
That is forecast.
We can use some forward starting swaps much like we had done in the prior cycle to lock in those those increases before they happen.
So in effect if you see.
Where are we today nine increases in fed funds.
You can lock that in with a forward starting position and then you'd have to see 10 or 11.
Before you thought that was a bad decision.
And given the fact that you are still asset sensitive you'd be pretty happy if that was the case.
But being able to lock in some of these today.
Can you can protect in case, the pace isn't at that level and so it's really with the with some of those cash flow hedges.
Very similar to how we built the portfolio last time, we try to.
Leg into it a little bit and.
<unk> build.
Build it out each each month.
As we go forward.
Got you okay.
That's helpful. And then for my follow up question I want to go back to your response to Betsy's question on the cost save phase and are you still assuming 85% in 2022 and is the number still $330 million.
So I'm trying to think about 85% that's not a number that's oh I know what youre thinking about it I've got a first year I'm with you now.
Just given the timing of when we.
When the deals happen.
It will start to see that run rate achieved.
Towards the end of the year is at 85% this year, we're not going to see 85%.
In actuality in calendar year 2022, just because we're not doing the conversion until the third quarter.
And so in reality, we will start to get to the.
The run rate as we as we come out of the year and so really the way to think about it is it's.
It will really kick in full year in 2023.
And then it's.
We're still in the range of thinking that we're around 30% cost saves, but keep in mind that the peoples expense basis changed.
So the dollars will be slightly different they're there they've seen the same thing we have with the expense growth and wage inflation and so the the good news is in dollar terms the savings are probably a little bit higher because the cost went up but the reality is as the.
Percentage save has really not changed much.
Okay. So the dollar is up a bit and basically.
By the end of the fourth quarter, you'll be at the run rate.
Yes, the fourth quarter not the.
Fourth quarter, Yes, yes, really like I mentioned there is a.
A lot of it is going to come out in the third quarter, but theres always some.
Some residual some folks that are.
60, or 90 days fast conversion and if we're doing the conversion.
And around the early part of September a little bit of that leaks into.
In the fourth quarter and so by the time, we get out of the out of this year, we should be pretty close to the run rate as we as we jump off into 2023% to 100% run rate.
Right, Okay. Okay got it thanks a lot.
Our next question comes from Gerald Cassidy from RBC.
Yeah.
Hey, Darren how are you.
Gerard how are you doing good thank you.
The question I have has to do with I think you said that you were able to see some of your criticized loans take.
<unk> taken off your balance sheet from competitors I was wondering if you can elaborate it I'm not going to ask the names of who did this but could you elaborate.
The underwriting standards that you were holding these customers to that made it more enticing for them to go to another competitor assuming they get better.
Other terms and conditions and do you see that continuing in the second and the third quarter of this year.
Yes.
We've seen a fairly as we mentioned fairly substantial amount of payoff activity this quarter.
A bunch of it was in and around New York City real estate and in many cases.
The leisure and hospitality industry AK hotel.
And it's a variety of.
Players Gerard that that our covenants, sometimes its private equity and sometimes it's the funds.
We have seen a couple of refinanced by other banks and it might not necessarily be.
The credit per.
Per se.
And what I mean by that is.
When when you've got a company on your on your books and you have been watching their performance over time and you downgrade them you want to see a few quarters of re performance before you upgrade them somewhat and they get classified as a troubled debt restructuring potentially depending on what happens.
And someone who comes in new it's not a troubled debt, it's not a PDR for them, it's a new loan they can structure. It the way they want in some cases, we saw us get refinanced out and then.
Additional dollars were added.
And so it's a new loan and someone else the size and so the treatment from an accounting and a capital perspective is a little bit different.
And they're not waiting for a little bit longer history of performance before they re graded and change it right they might look more prospectively.
Then we might typically look where you're wanting to see a few months, maybe even a couple of quarters of sustained performance before you change the grade and so for.
For those reasons, that's why you tend to see this stuff.
I think in.
I would.
Humbly say that a lot of times people look at our underwriting and know our history of it and so are willing to take us out because they know these these credits are strong in.
A lot of times that that proves out doing when you look at the charge offs this quarter.
At three basis points. The reason that was that was so strong was as much because of recoveries.
Does the things that we had previously charged off where it turned out that the collateral values, where we thought they would be and we were able to recover what we had previously charged off and so.
Theres, a number of things that happen.
Others take us out.
It's.
That's something that we necessarily left but it's part of the cycle.
Very good and in view of the time I'll just leave it at one question. Thank you okay.
Our next question comes from John Payne Pan Kearney from Evercore.
Good morning, Thanks for taking my.
My question.
Just one from me on the on the credit.
On the commercial real estate front I know you had indicated that the book should be relatively flat here going forward can you just maybe talk about what gives you confidence in that front I know you mentioned paydowns were impacting the balances for the first quarter I don't know if you have the amount of those pay downs and what gives you confidence that they could abate and then lastly.
Do you expect the potential securitization that you mentioned of the peoples permanent financing portfolio to come into play here. Thanks.
Yes, so I think theres a theres a couple of things that are behind that John .
And over time, when when we look at our portfolio we tend to see.
Growth in our portfolio when there's activity in the market.
And there hasnt been as much activity until recently with property is starting to change hands and so part of what we were just talking about about some of the Paydowns as property is starting to change hands and so that typically is as a benefit for us.
The other thing is when we look at some.
Some of the payoffs and we mentioned that many were in our.
Non accrual our criticized space and in the hotel part of our portfolio. We've seen a number of upgrades and we continue to expect more upgrades to come because we are seeing.
A definite improvement in that portfolio and so for those reasons, we expect to see a little bit less payoff and paydown activity there.
Mentioned, a little bit about the construction.
Loans and those paying paying off.
And a lot of cases, what you were seeing as some folks trying to lock in where they could.
Fixed rate rather than the construction line as a variable rate and so people are trying to lock in some of the financing in the face of a.
Of rising rates, which of course can still can still happen, but loans have to be at a certain place along the way, meaning the construction loans have to be far enough along that you can convert some of it into into permanent.
And then I guess the other is the other part of it is just the utilization rate of those lines and where they stand that as the projects near completion they'll continue to grow towards 100% and when we look at where that utilization is today.
It's higher than it's been since.
Well in our history that I'm looking at but certainly from the low point in December of 2019, and so when you open up a bunch of construction lines and the projects start to move forward.
You see those lines slowly build and grow and from a low of maybe 50% in 2019.
We're now in the call it 68% to 70% range and so at that point. The construction has got to go to completion.
For the developer to get paid out and so those lines will continue to grow which will be a bit of an offset and so for a bunch of those reasons. That's why when we look forward.
We think that there'll be enough growth to offset some of the paydowns that are that are natural and expected.
And the other thing, which we shouldn't discount from from just loan growth in general is now that there's certainty around the deal and the merger.
There's that anxiety goes away for our employees and for our customers who are waiting and I think that's.
Didn't discount that that does have an impact on the psyche and that as folks feel that certainty and understand the credit window that will start to see the activity ramp up and so thats also part of part of that forecast.
Okay, Let me take on the potential securitization of the permanent financing bulk of peoples.
We have.
It's too early John to go through that I mean, we still we've talked about it youre, 100% rate, we talked about it at the merger announcement and is something that we think is an opportunity.
Still see that as a great way to be able to provide capital for our clients.
And it's something that we'll look at in.
More to come as we go through through the second quarter and third quarter.
Just give us give us a second too to integrate these two banks and I promise, we will come back.
Got it thanks Darren.
Our next question comes from Frank.
Sure Aldi.
Line is open from Piper Sandler.
Hi, Darren.
Good morning, just a quick follow up on asset sensitivity I recognize that deposit betas are going to start lower and trend higher at some point, but just to simplify things I wondered if you had any updated thoughts.
With peoples in tow what a given 25 bps hike should do for the NIM at least at the beginning of this cycle.
Yes early on.
Just to give an update on where we had been before we talked about standalone.
I think it was maybe nine to 12 basis points before.
Combined.
With the change in the portfolio a little bit higher.
We would estimate kind of 10% to 14, obviously as you mentioned deposit betas are the driver of the range from 10 to 14.
And on a combined basis 25 basis points.
On a full year annualized basis that 10% to 14, we think equates to about $165 million to $225 million and incremental NII.
Great. Okay I'll leave it there thank you.
No problem.
And our next question comes from Bill Clark Your line from Wolfe Research. Your line is open.
Thank you good afternoon, Darren Thanks for taking my question.
So how are you thinking about growing the securities portfolio versus putting on swaps from here and separately. How are you thinking about what level of liquidity you should use excess right now against the backdrop of a more aggressive.
Balance sheet runoff to cycle.
Yeah.
Yeah.
It's a great question, it's something that we spend a lot of time.
Talking about as a management team and our treasurer and Treasury team spends.
Obviously, all day everyday thinking about it.
We have a long ways to go clearly were before where liquidity constrained.
We've mentioned when we start the combined bank with $45 billion in cash.
And so.
But as we think about the mix between how much we put in the securities portfolio and how we think about the hedges.
What we like about the hedges is it's a nice offset obviously to the to the loan book, but its capital friendly.
And so if you think about what we've seen in the last quarter with if you try to cover asset sensitivity and reduce it solely through the securities portfolio in <unk>.
Fixed rate product to.
To the extent that it's held in available for sale and then you have equity risk as rates continue to rise, whereas when we do it through the hedging.
It's more equity efficient.
What we recognize though is that.
Just given some of the changes that are happening between LIBOR and so far in the rate of the loans are coming on the books.
And the changes that to move the position down we won't be able to do is solely with hedging and so that's when we start to look at some of the other instruments and we look at and make a trade off decision between mortgage backed securities versus just the mortgages that we can hold on our balance sheet.
When we look at the flow that we think is coming today out of our retail production. We think that provides us a nice opportunity to manage down some of that asset sensitivity and deploy that liquidity.
And then when we think about <unk>.
Securities for the rest and will.
I think it will continue for now to focus at the shorter end of the curve. There just because we've got some of the longer part covered and the mortgage book.
And the thing that we always just kind of keep an eye on is what's happening in that deposit book and really thats. The trick right. As you as you look at what's happening with those deposit balances they look pretty sticky.
Based on what we see right now.
Yeah.
But we will want to hold a certain amount of liquidity and cash.
For part of our liquidity coverage.
And liquidity management.
And the under stress, but but go at a pace, where if you've got the excess you can always deploy it but if you find yourself short that's a.
Little bit of a problem, so we'd rather kind of work our way down slowly.
To take that away and then ultimately as we mentioned before get to a position where that securities plus mortgage balances as a percentage of the total balance sheet.
Kind of in the range of the top end of the the bottom quartile of the peers.
Understood very helpful. Thank you.
Yeah.
And our next question comes from Brian Erinn. So from Portales partners. Your line is open.
Thanks.
Pretty clear, but it looks like now.
Net interest income is going to go up by hundreds of millions of dollars in subsequent quarters am I missing something.
That's how we see it.
But the caveat of course is the fed curve actually has to come true.
So far we've got 25 basis points.
Whats the final share count because I need to make sure I understand this great great.
Uh huh.
Post.
Deal.
It's in the 176 months 77 range.
I used $1 7 billion million Vermilion shares congratulations you guys well done. Thank you. Thank you.
And our last question comes from Christopher <unk> from Wells Fargo. Your line is open.
Thanks for squeezing me in I'm, just wondering what you think the organic growth rate for the portfolio, but more specifically the loan book will be in 2023.
Yes.
Yes, we're still going through and doing the work.
There.
I don't have any reason to believe that it will go.
Much below the kind of 2% to 3% rate that we've been seeing.
Our expect this year I mean, this year is a little bit high because we had we had some runoff and this pause that we talked about well, while there was uncertainty but in general.
It's hard to outgrow GDP.
And Owen GDP might be a little bit high, but we're expecting that that will start to come down when.
When I think about the puts and takes CRE is probably going to stay a little bit.
Lower as we talk about and complete the portfolio repositioning that we've we've talked about for a while.
And we think we've seen some really strong growth already this year.
And expect that to continue.
There is clearly a question about the pace of recovery in the.
In the in the floor plan business.
When you look at a lot of the growth.
It was early in the quarter late in the year.
At the end of the quarter, you started to see a little bit of a slowdown in production again and supply chains and so.
If that gets resolved you could see a higher growth rate in C&I without it it might not be quite as robust.
And obviously that spills over into the indirect consumer.
Consumer Rec Fi and then mortgages I think mortgage activity will be a function obviously of how high the 30 year goes and then what's happening with the with people changing homes, which has been and when we look around many of our geographies. The biggest issue seems to be just availability of homes to buy.
Versus desire to actually.
Purchase at least right now, we'll see whether that that shifts as I mentioned when rates go up but I would be thinking as a starting point in that in that 2% to 3% range for the whole portfolio.
Thank you.
And it appears we have no more questions at this time I will now turn the program back over to Brian Clark.
Great. Thank you all for participating today and as always if clarification of any of the items in the call or news release is necessary.
Please contact our Investor Relations Department at area Code seven one <unk> eight four to 5138. Thank you.
This does conclude today's program. Thank you for your participation you may disconnect at this time have a great day.
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