M&T Bank Corporation (MTB) Q3 2008 Earnings Report, Transcript and Summary

Welcome to the People’s United Financial third quarter earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Philip Sherringham, President and Chief Executive Officer.

I am Philip Sherringham, President and Chief Executive Officer and with me today is Paul Burner, our Chief Financial Officer, who will be taking you through the financials in some detail in a few minutes. I would like to start, however, with a few comments about the past quarter. In the last three months since our last call we have all seen unprecedented changes of course in the banking and financial services sector. Over the past year or so I have been in the habit of saying capital and liquidity are king in the banking and financial services sector and we have substantial quantities of both. Today, those statements are more relevant than ever given the market turmoil we have seen and the global response we have seen from governments and central banks. We believe the U.S. government’s expanded rescue plan announced on Monday will help increase liquidity and help restore equilibrium to the economy and the market over time. Exactly how much time, of course, remains to be seen. I hope that you have all seen the recent Barron’s article featuring People’s United. If you haven’t there is a link to the article on the Peoples.com website. Barron’s reported that People’s United, “Stands out with the strength of its balance sheet, lack of sub-prime mortgage exposure and prospects for still strong returns. It is so well capitalized that it is hunting for acquisitions as others are watching their franchises shrink.” In other words, we continue to steadfastly pursue our strategy of being a premier regional bank. As a result of our historically conservative posture, reflected in both our balance sheet and our underwriting culture, we have the capital, the asset quality and we are continuing to look for acquisition opportunities. As one of the analysts who covers us recently noted, the quality of our portfolio is the highest among regional banks and our net charge offs are even better than those seen across the banking sector in the boom year of 2006. So before we begin I’ll ask you to please be sure to read the important disclosure statements on Slide 2 at your convenience. As you know by now we will be making forward-looking statements. Now, let’s move onto the highlights of the quarter on Slide 3. Net income in the quarter was $46 million or $0.14 per share. Return on tangible assets was 89 basis points compared to 91 basis points in the second quarter. The margin increased in the third quarter to 371, up 15 basis points or 4% from the second quarter of this year and this compares with a decrease of 11 basis points or 3% in the second and the first quarters of the year. A 10% annualized sequential decline in non-interest expense from the second quarter partially includes the continued benefits of cost reduction initiatives we announced earlier this year. As to asset quality, net loan charge offs for the quarter remain exceptionally low at 11 basis points for average loans on an annualized basis and 7 basis points for the second quarter. We continue to see a solid portfolio overall and though there can always be fluctuations given the current economic environment we believe our asset quality will remain strong. With that, I am pleased to hand it over to Paul Burner to provide you the details on the quarter.

On Slide 4 we will look in some detail at our average earning assets. While our total earning assets decreased $415 million to $17.4 billion from the second quarter of this year we continue to grow our average commercial loans by $73 million or 3% on an annualized basis. Adjusting for the shared national credit portfolio, which is in run off mode however, our commercial loan growth was 6% annualized in the quarter. Home equity loans have increased 16%. Our conservative underwriting continues. So our total earning assets increased $4.8 billion from the third quarter of 2007. The net resulted from the Chittenden Corporation acquisition. Slide 5 highlights the consistent increase of the commercial portfolio as a percentage of total earning assets in the third quarter of 2008 compared to both the last quarter and the year-ago quarter and it now represents 51% of average earning assets. Home equity lines and loans are now 12% of the whole while residential mortgages are down to 19% as the result of our intentional run off of these loans. What we classify as securities and short-term investments is also down slightly this quarter and significantly from last year. The year-over-year decline is due to the liquidation of some of the investments to fund the Chittenden purchase. As you probably know by now everything in this category is either Fed funds or extremely short duration senior agency debt. By focusing on the security of our investment portfolio we have been able to avoid the valuation declines that have so significantly affected other financial institutions. Slide 6 provides a detailed break out of our commercial portfolio and its commercial real estate component. As expected, our shared national credit portfolio balances continue to decline and represent 8% of the commercial portfolio for the third quarter. This reflects our decision to unwind this portfolio in an orderly fashion over the next two to three years. As we have said in the past I would emphasize that our shared national credits portfolio has performed and continues to perform exceptionally well. Also while we cannot specifically comment on any regulatory matters, we would note that even after the recently completed shared national credit exam we continue to have both zero NPA’s as well as zero delinquencies in the portfolio. The commercial real estate portfolio which comprises just over half of the commercial [inaudible] is well diversified as you can see. Residential development loans represent only 15% of the commercial real estate. Next we break out our construction portfolio. At $901 million it represents less than 7% of our total portfolio. Over half of the construction portfolio is for non-residential properties. Within the shared national credits portfolio the three straight states with the highest concentration are Washington, New York and Florida. Our Florida balances continue to decline and represent only 4% of this portfolio or about $36 million which is down from over $100 million last year. Turning the page you can see our asset quality trends in our commercial loan portfolio continue to be very stable. Net charge offs remain very low this quarter at 11 basis points and overall commercial NPA’s remained flat from June 30. As we stated before we see no systemic issues in our commercial portfolio. Slide 9 provides detail on our $5.4 billion consumer portfolio which as you can see remains very strong with weighted average loan to value’s of 50% for residential loans and 55% combined loan to value ratios for home equities. We also note uniformly high FICO scores for both portfolios. We feel this underwriting discipline contributed to the low net charge offs of $0.1 million or one basis point annualized and $0.2 million or 3 basis points annualized for residential and home equity loans respectively. Non-accruals likewise were quite low with 65 basis points and 15 basis points for the residential and home equity portfolios respectively. As you can see on Slide 10 this isn’t a one time event. We have had outstanding asset quality levels for quite some time now. I would note the graph on the right includes home equity and indirect auto which account for charge offs being higher than just the home equity stats on the prior slide. Turning the page we move to the liability side of the balance sheet with a look at the average funding mix. As we noted in previous quarters, our loans are fully funded by deposits and stockholders equity. This provides us with low cost funding as you can see here. In fact our total deposit cost of 1.63% this quarter represented a decline of 17 basis points from the second quarter of 2008. Our total cost of funds had even greater improvement dropping 16 basis points to 1.73%. Turning to the income statement on Slide 12, you can see the net interest income was $159.8 million for the third quarter, up 7% annualized from the second quarter reflecting disciplined loan and deposit pricing. Slide 13 breaks out the impact of our excess capital position on margin in the first three quarters of this year. In the third quarter the core bank margin was 3.99%, an increase of 19 basis points from the second quarter. As you can see, however, the totally asset sensitive asset capital yield which declined 8 basis points in order has a disproportionate impact on the blended margin which increased 15 basis points in the quarter to 3.71 despite the 19 basis point increase in the core bank margin. Next you can see the non-interest income in the third quarter increased $800,000 from the second quarter. Insurance revenues had a healthy increase in the second quarter primarily due to normal seasonality of renewals and service charges were up $700,000 or nearly 9% annualized. As you can see on Slide 15, our non-interest expense declined $4.2 million from the second quarter. The reduction is due in part to lower compensation and benefits expenses as the result of cost-savings initiatives announced earlier this year as well as a mixed bag of other lines aggregated in “other.” As we mentioned last quarter to reduce complexity and risk while at the same time lowering costs we are consolidating the charters of the six Northern New England banks that are currently subsidiaries of People’s United Bank. The consolidation will become effective January 1, 2009. At that point the banks will continue to operate as divisions of People’s United Bank. Also we don’t have an update to share with you yet on the core systems conversion but we are close to making a decision. Once we have we will have a better idea of the timing and the magnitude of the incremental cost savings from that major project. So the efficiency ratio decreased to 64.9% for the third quarter compared to 66.3% for the prior quarter. The improvement reflects continued focus on lowering expenses but it mitigated by the continued revenue headwinds given the rate environment. Now I will hand it back to Phil to wrap up.

As you can see from our presentation, People’s United delivered another solid quarter with respectable loan growth, no cracks in the foundation of our quality and margin expansion. We believe that our strong balance sheet and operating performance provide us with a superior foundation from which we can opportunistically pursue growth. Judicious management through our $1 billion asset capital continues to be a top priority for us. Our short-term positioning of this capital provides us exceptional liquidity and flexibility as we continue to explore opportunities for acquisitions. On that note, we anticipate the recent market turmoil will have a positive impact on our purchasing power and we remain opportunistic as we evaluate possible acquisitions. In short, we are constantly weighing our options to determine the most attractive use of capital to deliver long-term shareholder value and at the moment we still feel the best use of our capital is to have the patience to find and execute a well-priced acquisition that will best enhance the long-term profitability of the company. We do not feel under any pressure therefore to immediately deploy the excess capital in a poorly priced deal or in a [inaudible] stock buy back. However, we are committed to a strong dividend policy and feel that continues to be an appropriate avenue to enhance shareholder returns. That concludes our presentation. Now we would be happy to answer any questions you may have.

(Operator Instructions) The first question comes from Mark Fitzgibbon – Sandler O’Neill & Partners. Mark Fitzgibbon – Sandler O’Neill & Partners: I wonder if you could help us think through sort of the timing and magnitude of potential cost synergies from the Chittenden deal. Maybe give us a little update on how you think those will play out in the coming quarters.

As we stated initially when we announced the deal last year the cost savings will be I believe about $30 million. Those are the ones we announced and they will result primarily from back office consolidation which hasn’t occurred yet. At this point we haven’t really modified the basic envelope of the cost savings we will be getting from back office consolidation. When this occurs, it will occur when we are done converting, once again will occur some time towards the end of 2009. In addition to this, as Paul mentioned in his comments, we are in the process of consolidating the Charters and we suspect that could yield additional cost savings but again we are still working on qualifying those. Mark Fitzgibbon – Sandler O’Neill & Partners: Secondly, the spreads in the residential mortgage business have really started to widen out a bit. Is it conceivable you guys may slow down the pace of decline in that book and we could maybe expect it to stabilize or maybe even increase in the coming quarters?

That is a very good question actually. The book that we have, as you know, is aging at this point and it is composed primarily of loans that were made in the 2000-2006 time frame when basically the spreads in the mortgage business were overall low. So in that sense that particular book is probably going to continue to be allowed to run out. Having said that obviously as you point out spreads in the mortgage business have improved considerably and a lot of this we started recently a pilot program to originate jumbo mortgages throughout the franchise. At this point it is a $100 million pilot. We think the spreads in this business have improved to say the 120-150 basis point range at which point it is becoming palatable again for us to do that business. We are going to see what the response is to this and we will take it from there. But we are clearly sensitive to the issue. More broadly speaking, I would like to say that I think it is still too soon to determine how the overall market is going to shape up over the next few years. There is a lot of uncertainty right now and a lot of turmoil going on. It is not clear what part Freddie and Fannie will be playing going forward so we will have to see how the business is restructured and whether or not it becomes profitable enough for us to jump in fully if you will. Mark Fitzgibbon – Sandler O’Neill & Partners: How much of the non-performers, the $98 million you have of non-performers, came from the Chittenden side of things?

Probably a little bit over half of that. Mark Fitzgibbon – Sandler O’Neill & Partners: Obviously you guys have a lot of capital but I’m wondering given the government’s plan for infusing capital into institutions is such cheap capital might you consider taking down some of that to position yourself better for acquisitions?

Honestly, at this point our answer is no. We probably are one of those rare institutions that indeed, as you know, has so much capital…let’s look at the numbers a little bit. The most we could get from the government is $400 million dollars in our case. As you know risk weighted asset and 3% assets it is a little more than $400 million for us. Frankly we have $2.5 billion to $3 billion in assets and that $400 million wouldn’t do much for us. It comes with strings attached, as you know, including we have to grant warrants up to 15% of that amount and so on and so forth. All kinds of constraints. It is not very attractive to us. I think at this point we will pass on that.

The next question comes from Mr. Stephen – JP Morgan. Mr. Stephen – JP Morgan : I’m curious, as some of the capital injection plan may help some of your weaker competitors here, any change to your thoughts on the timing of capital deployment?

Obviously that has occurred to us. It is not clear yet who among the nine largest banks are going to receive the capital and so on. I will say this, and this is a general comment by the way, we truly believe that in times of uncertainty and upheaval and turmoil like those the fundamentals really matter. So we are very focused on maintaining our focus on keeping the fundamentals we have that are extremely solid. At the end of the day if you throw a lifeline, which is all it is going to be, to a weaker bank and allow them to survive a little bit longer it doesn’t make them a strong bank. It doesn’t enhance their overall quality or franchise or anything else. I don’t think strategically our position has changed materially in terms of being well positioned if you will. Having said this, the impact on timing remains to be seen. Some of the details of the capital deployment are not clear to us at this point. I don’t particularly believe that the government intends to inject capital to see as a quality problem to be taken care of. Frankly, I think they are hoping banks will get the capital and be able to deploy it in terms of new loans. So how that applies to some of those weaker competitors remains to be seen. Mr. Stephen – JP Morgan : Just one final question. How much margin pressure do you anticipate from the recent Fed cut that just occurred?

All things being equal we expect the margin to drop again to around second quarter levels from the 3.71 to around 3.56 give or take. 3.60 or 3.54 or somewhere in there.

The next question comes from Damon DelMonte – KBW.

I was wondering if you could comment on the home equity growth. Is that attributable to new loans you guys are adding to your books or higher utilization rates?

New loans.

Are you seeing that throughout the entire footprint or any particular area?

It is pretty much throughout the entire footprint.

With regard to the shared national credit portfolio can you just remind us what areas those loans are in? Types of loans?

They are basically three major components to the portfolio. There is commercial real estate loans, CNI loans and there are REITs It is roughly 1/3, 1/3 if you want to think about it. That is the picture and that is what we are talking about here.

Lastly, with all of the upheaval down in the Wall Street area I’m wondering if you are seeing any stress or spill over into the Fairco County market as far as stress in the residential book or even on the small business book.

At this point I’d have to say no. It is something we are watching carefully. We did screen our mortgage portfolio by listed employer at the time of application. Some of the companies that have been most affected by the recent turmoil and frankly the results were very encouraging. We came back with about $55 million at this time with loans with people who list Lehman Brothers, Bear Stearns and Merrill Lynch as their employer. $55 million our of a $3.8 billion portfolio. Frankly, all of those are performing excellently at this point.

The next question comes from Collyn Gilbert - Stifel Nicolaus.

Just a follow-up first to Damon’s question on the SNIC portfolio. What is it about that portfolio that has made it so strong? The fact you are showing such terrific credit metrics when it seems as if the rest of the syndicated portfolios are just falling apart.

Well, the short answer of course is the quality of our underwriting. I think as we have said many times the way we approach that business was maybe different from many other. We never simply signed on to a term sheet that say another lender agreed to. We re-underwrote the loan just as we were making it ourselves and again we focused on the types of businesses and the types of credit that we would make in franchise if we could find them. We didn’t stray. We didn’t go to for us exotic businesses such as Ag lending or telecom lending or high tech lending or stuff like that. I think it is a combination of the credit culture and the approach we brought to bear that is what you are seeing today.

Can you talk a little bit about the leasing portfolio and how that is holding up? Just some of the trends perhaps positively and negatively you are seeing in that business.

Again, I know quite a number of you might be concerned about this portfolio but frankly so far no we haven’t seen any negative trends at all. The portfolio is still growing. It is growing very nicely. The asset quality is holding up. The other thing I’d like to point out is that whenever we experience an issue in this portfolio we have been able so far to dispose of the asset we took back very quickly which is maybe a difference between us and others. Again, that is because of the types of businesses we have in the portfolio, the type of equipment we lend on we focus on equipment that has a well established resale value. More importantly of course, well established resale markets. It is generic stuff. Bread and butter. Remember those are all loans essentially. There is no leasing. There is no residual exposure in the portfolio. You are talking about pretty much stuff that can be turned around pretty quickly if it ever runs into any problems.

On the overall picture of the commercial growth, I guess I was a little surprised to have not seen that portfolio grow more during the quarter given what has gone on in the market and opportunities you may have seen. How should we look at the balance of the overall loan growth in terms of the run off on the res side and potential growth opportunities on the commercial side?

If you want to look at the big picture first, as we foretold if you will earlier this year, overall we didn’t expect much loan growth at all this year given the fact we had two major portfolios running out if you will. The first one being Shared National Credit and the second one being the mortgage portfolio. Now the mortgage portfolio is going up a lot faster than the Shared National Credit which we are happy about, candidly, for a bunch of reasons. That said, if you look at the growth in our commercial portfolio and if you excluded the Shared National Credit I believe the growth percent is like 6% which is down a little bit sequentially in the third compared to the second. This is down a little bit from the 12% we had in the prior quarter. Obviously as you know our economy overall is probably headed toward a recession. I think at some point we will see a slow down in loan demand and again since we are not compromising our underwriting standards that is probably the issue. I’d also like to point out that the different picture is depending on where you look in our franchise. If you focus on the Connecticut/New York/Southern New England portion of the franchise, commercial loan growth there is 15% and it is pretty much flat in the northern New England area. That is something else you would want to keep in mind.

On Slide 9 of the presentation, why did you guys exclude the impact of Chittenden in the resi mortgage and home equity credit statistics?

It is very simple. The data wasn’t available.

I thought you were going to say the data wasn’t as good.

No, we had every indication it is as good but we kept track of our loan to value information and for some reason Chittenden never did. We can’t go back.

The charge offs and the non-accruals are combined. It is just the loan to value and the FICO scores we don’t have available for Chittenden.

So that gives you the answer. The charge off numbers and the non-accruals include Chittenden. The LTV and FICO scores don’t. That is because they didn’t keep track of them.

Do you have a rough idea perhaps of what the LTV generally the originally the underwriting origination would be for them?

No. I mean, given their overall conservative posture we are very comfortable with that. We did some sampling. We can’t extrapolate it though.

The next question comes from James Abbott - FBR Capital Markets.

I have a question about deposits. We have seen the balance kind of running off the past couple of quarters and I was curious if you plan to continue maintaining pricing discipline. Would you like to see that balance stabilize moving forward?

Well first of all I want to remind you generally speaking we are awash in liquidity. We have over $3 billion invested short-term. So we haven’t been chasing deposits candidly. Yes we do plan to maintain disciplined price deposits. Now you are talking about the past couple of quarters. A portion of the drop in the second quarter as we pointed out at the time was due to our decision to move some trust deposits off balance sheet. It was about $220 million or so. So you should exclude that from the drop there. What has happened in the third quarter is as you know some of our competition, specifically Washington Mutual and Wachovia which had severe liquidity issues, were posting very high CD rates. We didn’t follow. We did lose some CD money to those competitors for awhile. Candidly, I think it is all coming back and information we have recently suggests that starting in September the amount of new CD money we are seeing is basically double what we saw on average on a monthly basis for the prior months of the year.

What I would add is typically the third quarter if we look back several years we normally shrink deposits. It is normal seasonality. If you look at the reduction that we had this year it is only about half the reduction we had in the third quarter versus second quarter of last year. In fact, if you just count the CD’s for a moment, which Phil had mentioned, our core deposits actually declined less in the third quarter than they have over the last four years. So I just really wanted to add the seasonality factor.

Along the same lines you can sort of see why and given our balance sheet the reason we are not anxious to get any government money is it is 5% money and on the margin that is what we would be investing. ½% is not particularly exciting.

The next question comes from Mack Kelly – [Stern AT]. Mack Kelly – [Stern AT]: The cost savings goal was $57 million pre-tax and $38 million after tax. Is that correct?

No. All numbers are pre-tax. Mack Kelly – [Stern AT]: The $38 million?

Yes. Mack Kelly – [Stern AT]: Has any of that been recognized so far or is it all waiting for those systems integrations and reductions? I thought it was $57 million pre.

Can you repeat your question? I’m sorry. Mack Kelly – [Stern AT]: What was the original cost savings goal?

$38 million. That was pre-tax. Mack Kelly – [Stern AT]: Has any of that been achieved so far?

Minimally. Again, as I pointed out most of it was tied to the consolidation of the back office and that hasn’t happened yet. The $57 million was different. It was across the franchise. It was a general plan to become more efficient. Mack Kelly – [Stern AT]: You used to provide a table presentation on margin expectations. I believe it was in the first quarter outlined basically at a 150 set funds the goal on the margin was 318. We are at 150 now. Obviously it has come in a lot better as you have taken down deposit costs. Beyond the fourth quarter if the Fed goes to 1% at the next meeting at the end of the month what would you anticipate the margin to look like next year?

I think the way to look at it is the fact we have $2.5 billion of excess capital. We said we want to keep that short and liquid so you can pretty much multiply $2.5 billion times the change in the Fed funds rate and compute the change in the margin.

Roughly speaking recently because of the disruption in the markets there have been some offsets due to the behavior of Libor. Libor, as you know, has been much higher than we expected. We have about $1.4 billion in loans tied directly to Libor. So that provides somewhat of an offset. Mack Kelly – [Stern AT]: So if Libor normalized that original table probably will be back in play. Is that correct?

Yes, but remember we don’t have the table handy unfortunately but the table was provided as the point in time and attempted to project the margin of the bank given several Fed fund rate levels, again at the time for the entire year. We haven’t updated the table.

That was a static analysis. We actually returned to disciplined pricing but we are enjoying higher spreads on the loans so we have been widening spreads a little bit on the deposits. Things should be better than what you might have seen in the past. Mack Kelly – [Stern AT]: We pretty well see now we are heading into a national/regional recession. What would you consider normalized charge offs for a recessionary environment?

We have said earlier, and we aren’t going to change our tune there, that 35 basis points on the commercial portfolio to be a normalized level of charge offs for commercial portfolio. As you know at 11 basis points we are very far from the 35 normalized. Going beyond normalized, normalized doesn’t account for a recession or degree of severity. It could be twice that I suppose but it is very speculative in terms of the answer.

The next question is a follow-up from Mark Fitzgibbon – Sandler O’Neill & Partners. Mark Fitzgibbon – Sandler O’Neill & Partners: I wonder if we can talk for a minute a little bit more about acquisitions. I think you had said before you are being disciplined in waiting. Should we take that to mean you think things are going to get a lot worse for the industry and you will have a chance to buy stuff a lot cheaper further along in the future?

That is one way of thinking about it. Yes, we are thinking that our purchasing power is on the rise as we wait at this point. The monkey wrench in the system is this potential capital injection from the government in some of those weaker banks. Again, it hasn’t played out yet so it is very difficult to say who is going to get what and what impact that will have on the posture. We don’t know yet. Mark Fitzgibbon – Sandler O’Neill & Partners: Wouldn’t logically that just give them more staying power to stay independent and try and ride out the cycle?

Yes. Clearly in some cases it probably will. That doesn’t really necessarily, as I pointed out earlier, enhance their overall long-term strategic position. If you are a weak bank you are going to remain a weak bank even as you are now, not 3% more capital. Frankly if things do get significantly worse and commercial credit starts to deteriorate which I think at some point we will that 3% will be eaten up very quickly in terms of some of those banks. Mark Fitzgibbon – Sandler O’Neill & Partners: With that as a backdrop is your view of maybe the size/type of company or geography of the institutions, has that changed at all?

Maybe a little bit. Our focus remains the Maine to D.C. corridor. Having said that, one needs to be very opportunistic in this type of environment so if we find a totally compelling scenario by a regulator assisted deal for instance or something else that wouldn’t fit the geography but fits other geographies in the country that is something we might look at. I want to emphasize this is not what I would consider a high probability scenario. But again it is something we will look at. In terms of size of the acquisition, yes depending again on what we are looking at we could be looking at something that is…it could be all over the place really.

At this time there are no further questions in the queue. I will turn the call back over to Philip Sherringham for closing remarks.

Thank you all for participating on the call. We will be back and focus on the fundamentals. I wish you all a happy fourth quarter. We will talk to you again in January. Thank you very much.