M&T Bank Corporation (MTB) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the M&T Bank Third Quarter 2013 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Don MacLeod, Director of Investor Relations. Please go ahead.

Thank you, Maria, and good morning. This is Don MacLeod. I’d like to thank everyone for participating in M&T's Third Quarter 2013 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.mtb.com and by clicking on the Investor Relations link. Also, before we start, I'd like to mention that comments made during this call might contain forward-looking statements relating to the banking industry and to M&T Bank Corporation. M&T encourages participants to refer to our SEC filings, including those found on Forms 8-K, 10-K and 10-Q for a complete discussion of forward-looking statements. Now I'd like to introduce our Chief Financial Officer, René Jones. René F. Jones: Thank you, Don, and good morning, everyone. Thank you for joining us on the call today. As I noted in the press release, M&T's profit softened during the recent quarter as compared with the previous quarter. This reflects the impact from -- the impact to M&T from the industry-wide slowdown in mortgage banking activity, as well as higher operating expense, arising from our investments in risk management, capital planning and stress testing, regulatory compliance and technology and operating infrastructure. I'll cover more details on these investments in a moment. The recent quarter was also marked by continued strengthening of our Tier 1 common capital ratio, which increased by 52 basis points to 9.07%. Let me first review a few of the highlights from the quarter's results, after which Don and I will be happy to take your questions. Turning to specific numbers. Diluted GAAP earnings per common share were $2.11 in the third quarter of 2013 compared with $2.55 in this year's second quarter and $2.17 in last year's third quarter. Net income for the recent quarter was $294 million compared with $348 million in the prior quarter. Net income was $293 million in the third quarter of 2012. During the period, we completed the remainder of our actions initiated to strengthen our capital and liquidity position in an efficient -- in the most efficient manner. We converted some $1 billion of FHA loans on our balance sheet into Ginnie Mae securities, which we retained in our investment portfolio. In addition, we securitized and sold $1.4 billion of capital intensive lower returns indirect auto loans. These transactions generated $56 million of pretax securitization gains, which contributed $34 million to net income for the quarter or $0.26 per common share. You will recall that M&T's results for the second quarter included net pretax gains on the sale of investment securities amounting to $56 million. Also, during the second quarter, we reversed an accrual amounting to $26 million pretax for a contingent compensation obligation assumed in the Wilmington Trust merger, and which had expired. Taken together, those items contributed $50 million after tax to net income for the second quarter or $0.38 per common share. Since 1998, M&T has consistently provided supplemental reporting of its results on a net operating or tangible basis from which we exclude the after-tax effect of amortization of intangible assets, as well as expenses and gains associated with mergers and acquisitions when they occur. After-tax expense from the amortization of intangible assets was $6 million or $0.05 per common share during the third quarter compared with $8 million or $0.06 per share in the prior quarter. There were no merger-related expenses incurred in the third quarter of 2013. In the second quarter, merger-related expenses amounted to $5 million after-tax effect or $0.04 per common share. M&T's net operating income for the quarter, which excludes amortization -- intangible amortization and merger-related expenses was $301 million compared with $361 million in the linked quarter. Diluted net operating earnings per share -- per common share were $2.15 for the recent quarter compared with $2.65 in the linked quarter. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholder's equity of 1.48% and 17.64% for the recent quarter. The comparable returns were 1.81% and 22.72% in the second quarter 2013. In accordance with the SEC guidelines, this morning's press release contains a tabular reconciliation of GAAP, non-GAAP results, including tangible assets and equity. Turning to the balance sheet and the income statement. Taxable equivalent net interest income was $679 million for the third quarter of 2013, down by $5 million from the linked quarter. The net interest margin was 3.61% during the third quarter compared with 3.71% in the second quarter. The narrowing of the net interest margin was largely the result of a $13 million decline in prepayment fees and interest on non-accrual loans. This accounted for 7 basis points of the decline in margin. The remaining 3 basis points of the decline reflects the core margin pressure that we've been projecting for some time and that we continue to expect to unfold over the course of the year -- over the course of the next year. The higher level of earnings assets would have been sufficient to grow net interest income despite core margin pressure, were it not for the return to normal levels of prepayment fees and cash basis interest. As for the balance sheet, average earnings assets grew by an annualized 4% or about $700 million from the second quarter. This included a $1.7 billion increase in average investment securities and a $1.1 billion decline in average loans, both of which reflect the securitization activity, primarily the FHA securitization that I mentioned earlier. In addition to these securities -- to the securities retained through the securitization of FHA loan, we purchased an additional $1.6 billion of Ginnie Mae securities in the open market over the course of the third quarter, essentially reinvesting the proceeds from our second quarter sale of private label securities and the late third quarter securitization and sale of indirect auto loans. On an end of period basis, investment securities were $8.3 billion as of September 30. After annualizing for the securitizations, growth in average loans for the quarter was an annualized 1%. Average commercial & industrial loans grew by 2% annualized. That growth was muted by the typical seasonal slowdown in floor plan loans, which declined by almost $100 million. Excluding floor plan, C&I loan growth was 5% annualized, slightly lower than what we've been seeing over the past several quarters. Average commercial real estate loans grew an annualized 1%. Adjusted for the securitizations, average residential real estate loans declined an annualized 5%. The $1.4 billion auto loan securitization did not have a significant impact on average consumer loans, as it was completed in late September. However, adjusting for that securitization, consumer loans grew an annualized 2%. Despite pricing pressures, M&T's commercial loan origination has been consistent quarter-over-quarter. However, refinancing activity has driven the apparent slower rate of loan growth. From a regional perspective, upstate in Western New York continues to be our strongest reason for loan growth. The average total loans in that region grew by an annualized 5% compared with the linked quarter, while the average C&I loans grew by an annualized 8%. Our Metro region, which includes New York City and Albany area and Philadelphia was just behind that with annualized growth in total loans of about 4% and annualized C&I growth of about 12%. The mid-Atlantic, including Baltimore, Washington and Delaware, continues to experience the softest loan growth, with high single-digit annualized declines in C&I and CRE, as well as total loans. This region is where we're seeing the most competition, particularly with respect to pricing and structure. Average core customer deposits, which excludes deposits received at M&T's Cayman Islands office and CDs over $250,000, grew an annualized 3% from the second quarter. From an end of period basis, core deposits grew an annualized 6%. We continue to maintain a high level of excess funds at the fed, amounting to $1.8 billion at the end of the quarter. The average balance for the quarter continue to reflect the high level of deposits by institutional trust customers early in the quarter and included the portion of the proceeds from the auto securitization that occurred later in the quarter. Turning to noninterest income. Noninterest income totaled $477 million in the third quarter compared with $509 million in the prior quarter. The quarter -- this quarter's figures includes the $56 million in securitization gains I referred to earlier, while the second quarter figure includes $56 million of net gains on the sale of investment securities. Mortgage banking revenues declined to $65 million in the recent quarter compared with $91 million in the prior quarter. This includes 3 components. Residential gain on sale revenues were $17 million for the third quarter, a decline of $23 million from the second quarter. The residential origination volumes declined by 41% from the second quarter to $1.1 billion, while residential gain on sale margins declined by 48 basis points. On the commercial side of mortgage banking, gain on sale revenues declined by $11 million, returning to more normalized levels after a record second quarter. Residential mortgage servicing revenues grew by $7 million to $30 million in the third quarter. The increase reflects about 1 month of revenue from the subservicing contract that we entered into during the quarter. We expect to see in the neighborhood of $15 million of additional servicing fees in the fourth quarter as the revenue from that contract reaches its full running rate. Fee income from deposit services provided were $114 million during the third quarter compared with $112 million in the linked quarter. Trust and investment revenues were $124 million, a little change from $125 million in the prior quarter. The second quarter results benefited from the normal seasonal uptick in tax preparation fees. Turning to expenses. While we've noted the expected ramp up in expenses for some time now, the full impact of those investments in risk management, capital planning and stress testing, regulatory compliance and technology and operating infrastructure became particularly apparent in this quarter's results. Operating expenses, which excludes merger-related expenses and the amortization of intangible expense, were $648 million for the third quarter compared with $578 million in the second quarter. The linked quarter variance includes the $26 million accrual reversal in the second quarter that I mentioned previously, as well as an increase of $44 million in operating expenses. Contributing to that increase was a $16 million rise in salaries and benefits. That was largely attributable to, first, the $7 million related to approximately 500 FTEs brought on board for the subservicing contract at the outset of the third quarter. Next, $4 million attributed to an extra compensation day in the quarter, and then $2 million reflecting the ramp-up in staffing related to our BSA/AML and capital planning and stress testing initiatives, including some 200 FTEs. Also contributing to the linked quarter increase was an $18 million increase in professional services, largely attributable to $7 million spent for specialized consulting services related to BSA/AML, $6 million of additional spending on certain technology-related investments, as well as our risk infrastructure and $1 million related to the subservicing contract. Looking -- if you were to look at expenses on a year-over-year basis, the $46 million increase, as compared to last year's third quarter, is characterized as follows. About 37% of the increase in expense is a result of our regulatory compliance initiatives, BSA/AML capital planning and stress testing, including some 250 additional FTEs. Approximately 24% of the year-over-year rise is accounted for by the subservicing contract. And finally, you will recall that the staff -- you will recall that the staffing hired for our New Jersey initiative during the first 4 months of this year drove about 20% of the increase, including some additional 175 FTEs. We hope you find this detail helpful. The efficiency ratio, which excludes securities gains and losses, as well as intangible amortization and the merger revenue expenses was 56.0% for the third quarter compared with 50.9% in the prior quarter. Excluding the reversal of the Wilmington Trust accrual, the efficiency ratio would've been about 53.2% in the second quarter. Next, let's turn to credit. Our credit quality remained strong and in line with our expectations. Nonaccrual loans declined $49 million from the end of the second quarter, and the ratio of nonaccrual loans to total loans declined by 2 basis points to 1.44% as of the end of the third quarter. Net charge-offs for the third quarter were $48 million compared with $57 million in the second quarter. Annualized net charge-offs, as a percent of total loans, were 29 basis points for the third quarter and the year-to-date. The comparable figure was 35 basis points for the second quarter. The revision for credit losses was $48 million for the third quarter, which equaled the net charge-offs. Reflected in the aforementioned gain, resulting from the securitization and sale of the $1.4 billion of auto loans, was an associated reserve release of $11 million. The net effect was a decline in the allowance for credit losses to $916 million as of the end of the third quarter. The ratio of allowance to credit losses for total loans increased to 1.44% at the end of September 30 from 1.41% at the end of the prior quarter. The loan-loss allowance, as of September 30, 2013, was 4.8x annualized net charge-offs for both the recent quarter and the year-to-date. Loans 90 days past due, excluding acquired loans that had been marked to fair value at acquisition, was $340 million at the end of the recent quarter. Of these, $321 million or 94% are guaranteed by government-related entities. Loans 90 days past due were also $340 million at the end of the second quarter, of which 93% were guaranteed by government-related entities. M&T's Tier 1 common capital ratio was an estimated 9.07% at the end of September, up 52 basis points from 8.55% at the end of the second quarter. Our estimated Tier 1 common ratio under the recently adopted Basel III capital rules is approximately 8.75%. The Tier 1 common ratio has increased by some 161 basis points since the third quarter of 2012, while our tangible common equity has grown by $1.1 billion or a 20% increase. Turning to the outlook. We continue to see the potential for an estimated 3 basis points of quarterly core margin pressure. The reported net interest margin will continue to be impacted by the levels of excess cash held at the Fed. Despite the slower loan growth during the quarter, our outlook for loan growth remains relatively unchanged. In addition, we may continue to purchase investment securities to round out our liquidity asset buffer. At this point in time, assuming that interest rates stay where they are, some continued modest softness in mortgage origination seems likely. As noted, as revenues from the subservicing contract reach their full run rate in the fourth quarter, we effectively have a cushion against further declines in total mortgage banking income. And with respect to credit, our year-over-year charge-offs of just 29 basis points are below our long-term average of 37 basis points, and we would expect to report a slight increase in criticized assets in our upcoming 10-Q. Stated simply, credit quality remains strong. Turning to expenses. We estimate that our current outside level of spending will likely remain elevated for the next several quarters. As a management team, we've concluded that to the extent that we can make the necessary investments and strengthen our infrastructure now, it will position us well to sustain our long-term record of relative outperformance. With respect to capital, we've exceeded the 9% threshold for our Tier 1 common capital ratio under the Basel I rules, and as we said, our current estimate is 8.75% under Basel III and we plan to continue to build capital over the near term. As you know, I am not at liberty to discuss the details of our regulatory matters, but by way of an update on the BSA/AML matter, we believe the progress to date has been considerable. And while we have a lot of work left to do, we continue to work diligently to create a high-quality BSA compliance program that fully addresses the concerns raised in the written agreement with the Federal Reserve. Of course, as you're aware, our projections are subject to a number of uncertainties and various assumptions regarding national, regional economic growth, changes in interest rates, political events and other macroeconomic factors, which may differ materially from what actually unfolds in the future. With that, let's open up the call to questions, before which Maria will briefly review the instructions.

[Operator Instructions] Our first question comes from Matt O'Connor of Deutsche Bank.

Just to clarify on the NIM outlook of down around 3 basis points per quarter, is that off of the 3.61% that we saw this quarter? René F. Jones: That's an interesting question. I guess, the way I look at it, Matt, is I look at it a couple of ways. So if you think about -- if you were to go back to the first quarter, I think we were 3.71% in the first quarter. So we're also down 10 over the 6 months, and there's probably 2 basis points of day [ph] effect -- there's actually some effect of cash. So if you look at the underlying trend, we're coming down about 3 basis points. So it's hard to answer your question because it depends on the level of cash, where your starting point is. The other way I look at it is assuming cash, and obviously days over time are the same. If you look at it on a year-over-year basis, we were down 16 basis points, and 11 of that was the -- about a $2.4 billion increase in cash. So we only had about 5 basis points of compression. I think that really reflects the 3 basis points we've been talking about, offset by the fact that our acquired loan portfolios had been performing better. So you're going to have to pick your number, but I don't think of it as off any particular number because it gets reset with the cash balances. Is that helpful?

It is. And I guess what I was getting at is the prepayments fees coming down. Would you consider this quarter kind of a bit more typical in how those fees are or were [indiscernible]? René F. Jones: Yes, very typical, very typical. I mean, as I kind of look back over the last -- I don't know, I just glanced at the last 6, 7 quarters. The numbers are between $7 million and $9 million. So this quarter was $9 million. The aberration was just last quarter was up 13 from that.

Okay. And then just separately, obviously, the mortgage banking business for the industry is going through a pretty sizable correction both on volumes and on the profitability, as we think about the gain on sale. Has your thought process in terms of the mortgage banking business medium and longer term, changed at all in terms of -- obviously, your pending deal, you're going to build out the agency mortgage business there. Anything that you're seeing for the environment overall changing how you think about sizing that and the strategic importance of all that? René F. Jones: Yes. I mean, the one thing that we see that's on our minds, and we've kind of made some stake in the ground, I guess, on it. But if you go way back before the crisis and before the new structure and the higher requirements, including -- and then including the put back fees and those types of things. People were happy getting gain on sales between 80 and 100 basis points, and the big issue for us is that the business cannot support those lower levels of gain on sale. So you kind of have to hit a floor and pick that target. The big question will be is whether the rest of the industry actually adheres to that. But as you know, we tend to focus on profitability. And at least for the last 30 years or so, we've been able to avoid chasing all that stuff. So I think that's the big question that's out there for me is are people are going to behave rationally. We've had gain on sale margins come down somewhere around to about 200 basis points now. And I'm not sure that they can go all that much lower and have it make a lot of sense to be in that -- to do a lot of volume in that business, but that's the big change that we're grappling with, and so far, it seems to be holding up fine around those levels.

Our next question comes from Matt Burnell of Wells Fargo Securities.

Just, I guess, a little question on the competition within the loan market. You mentioned that the mid-Atlantic is the most competitive among your 3 regions. I guess, I'm curious as to within the competition among the other 2 areas, has that competition gotten tougher and are there deals, more deals now that you're potentially walking away from due to either pricing or structure than there might have been 3 to 6 months ago? René F. Jones: Everywhere or outside of the mid-Atlantic?

I was actually speaking specifically outside the mid-Atlantic. René F. Jones: Outside the mid-Atlantic. Yes, I mean, there's levels of pricing pressures across the board, and I -- outside the mid-Atlantic because, there, it's just -- it's significantly different. And you can kind of see that in my comments around the volume, which are declining, because in the mid-Atlantic, just as a background, I mean, there's a point at which we're not really hitting our risk return levels, and we just can't use the balance sheet for that purpose. So for some time, it was the life companies. I think I've talked about that for a while, but now, you've seen the banks join in -- several banks join in on that. But if you look at the other areas, each of them is a little bit different. And if I think of like, I work my way up, I work my way north on the map, you got -- in Pennsylvania, in the sort of central Pennsylvania, maybe Harrisburg area, we talked to our customers. Their expectations for the loan growth is relatively soft. They're not -- they're really hesitant to do anything on the CapEx front. They also have a lot of -- how should I say it, low confidence in sort of the economic recovery. So they're not doing a lot of hiring, and so what that results in is there's just not a lot of activity, but there's a lot of folks actually going after the transactions. So what we're seeing in that particular market is a willingness to -- for people to take on -- what's probably more important than the pricing pressure there is the willingness to take on the whole credit or larger chunks of credit by smaller institutions, and so that affects loan growth. So as you know, I mean, if you have a granular portfolio, you're going to be less lumpy. If it goes the other way, you're going to have more risks. If you look at smack in central Pennsylvania, there's been actually a little bit of a rebound from the Marcellus shale. But again, not enough to drive what we're seeing around pricing and structure in that case. But then as you flip your way up to most of upstate New York, and our definition of upstate New York, we have 5 communities, all 5 communities have loan growth. I would say by historical measures, pricing has got a slight downward trend, but volumes have held up fairly well, and I can't tell you exactly what that is. There's a manufacturing base up here, and people seem to be a little bit more willing to make investments. And I think your competition is different. Because of the number of banks, you actually choose not to bank up here. So that's the landscape. I mean, I would say that over the last 3 quarters, the pricing issue in any one quarter wasn't all that noticeably more, but now it feels like it's gotten pretty heavy. So hopefully that helps.

Yes. Just a couple of questions on expenses. You mentioned that those are likely to be elevated for a number of quarters into the future. And I guess, specifically on the FTEs that were added for the servicing portfolio, is it your expectation that those will remain relatively static to the number of FTEs you on-boarded? Or do those come down over time, therefore, reducing the potential expense related to that revenue? René F. Jones: Well, on servicing, those are -- I mean, those are tightly managed around the level of the servicing portfolio. And so we have about an $81 billion servicing portfolio until we're properly staffed for it. If that were to run down over time, you wouldn't need as many staffing, but it depends on sort of what comes on the opportunity side there. That's pretty steady.

Okay. Yes, fair enough. And then on the BSA/AML compliance cost, it looks from your comments that you're running at an annualized rate. Round number's about $60 million a year for those. Any sense as to how long that might continue? And once you get this investment done, presumably you're largely over with that, is that a 1 or 2-year timeframe or is that longer? René F. Jones: Well, Matt, I can only comment about -- I comment about all of the stuff because I think what we've decided is that -- and we decided this some time ago, that it doesn't make sense to take a long time to make all these investments. The regulatory environment is changing. The operating environment is changing as well. So we figured we would accelerate those changes and try to get a bulk of work done. We saw this before -- we've seen this before. We sought after each of our areas of expansion in the early '90s, and then, again, after the all first period. And now we're seeing it again after we've gone through several acquisitions in about a 5-year period of growth. What's different this time is we're just deciding to look at the whole thing together. So I think that makes the expense naturally higher. With respect to BSA, at some point, there is a natural level of staffing that's going to make us -- how do I say this, have a state-of-the-art program and -- but that will level out, but it will take some time for each of those things to happen. That's why I said, over the next several quarters, we think it's going to be relatively elevated so -- and then from there, each piece is different. So CCAR is different. BSA is different. Overall risk management structure, a different animal as well. So as the expenses come down, that will -- it won't all happen at once.

Our next question comes from Keith Murray of ISI.

Just a follow-up on the BSA/AML. You're talking in the next several quarters. I mean, how -- what inning would you describe [indiscernible] or sort of what percentage of the way you think you're there on that? René F. Jones: That's a great question. I don't know. So you end up with an issue, a weakness in your program, but then the reality is that it's not likely just go fix your weakness. You actually have to -- you have to think about it in a way of building the state-of-the-art, best-in-the-industry practices, in part because the -- of all trillions of dollars of illicit activity that ends up going through the banking system, those folks are ramping up their efforts to try to figure out new ways to get around you. So at the end of the day, we're revamping our whole process and that takes a fair amount of time. The real question becomes when do you get enough of it done so that you actually have confidence in your own process so that your board has confidence in it as well as the regulators having confidence in it, and there's no answer to that question. You just work hard and you figure out how to keep on course for making sure you have a high-quality product as opposed to trying to get it done too quickly.

Fair enough. And then let's assume, for argument's sake, that the deal with Hudson City closes in January. How long do you think it will take to get that franchise sort of set up the way that you guys want it to be? Is that 1-year or 2-year build? René F. Jones: First, I'd say -- first thing I'll say is we haven't spent any time thinking about Hudson City lately. We've been really focused on the things that I've just talked about. But I mean, if you look at any transaction, we've got a pretty strong track record of how long it takes to do something like that. Wilmington Trust took a lot longer because it was a different animal. And if you're putting together a thrip sort of regardless of size, you would be -- it would be very short order. And what you'd have to do is kind of go back and talk to a few folks about what's pretty well-documented about what we've done in the past, but today, we're not -- this is not what we're focused on. We've got -- our eyes are all focused on the regulatory matters at hand.

Our next question comes from Brian Klock of Keefe, Bruyette, & Woods.

So I mean I hate to kind of beat on the expense side again, but I guess when I [indiscernible]. René F. Jones: You like [indiscernible].

What was that? René F. Jones: You like expenses, I know you.

I know, I'm sorry about this. So the cash expenses in the quarter, right, $648 million, and you mentioned with the previous questions that, obviously, a lot of the expenditure is BSA/AML, the CCAR and regulatory-related stuff that's going to stick around for a while. I guess is that -- is there anything in there though that we could start seeing some small savings coming out? Or do you think that around this kind of cash basis, somewhere around $650 million is where that's going to be on the next couple of quarters? René F. Jones: Okay, that's a great question. So I think it's 2 things, 2 things. First of all, because of the earlier question and the fact that we're trying to do -- we're trying to get a lot done relatively quickly, we're using a lot of outside services. So I mean, that and you can pick your time horizon for how long you're off and running on your own. So quite frankly, a lot of the requirements under CCAR and those things are that you actually -- you're not really in a solid position unless you are doing all that stuff on your own. To us, that's a shorter time frame. I don't think we're going to see much of a reduction in the next couple of quarters, but you can see where you'd see some benefits and not necessarily having all that outside services helping you as you stabilize your processes. But the flip side is, as you think about it, and we think about the total expense base, if you look back to times when we had decline in mortgage volume, we tend to focus very heavily on rightsizing and rationalizing the mortgage business. But in the way M&T works, you actually tend to look at the entire bank. And what is logical that will need to happen over some time, we're still scoping it all out, is that while we're spending a lot more on regulatory compliance and the control structure is that we're going to have to begin to rationalize the expenses in other areas, right? So in terms of is $648 million our forever run rate? No, not at all, nor is 56% or 58% efficiency ratio. That doesn't make sense much to us. But we've been at this in attacking it so directly, that we haven't spent much time rationalizing. We've just been spending time building, right? So there will come a time -- not that far away, where we will be able to begin to think about where we can manage the expenses a little bit better. $648 million is not a run rate.

Right, I didn't think so, but thanks for the extra color on that. And maybe just to go back to another question on the NIM as a follow-up here. You talked about prepayment penalties. Can you tell us what happened, I guess, on the accretable yield because the prepayment income you're talking about is obviously prepayment on loans and not -- you're not talking about the accretable yield on that? René F. Jones: Yes, again, accretable -- let me just tell you, the total interest income on the $4.7 billion of acquired loans that we have was $71 million, I think. The last quarter, it was $77 million. Looked at another way, we had 15 basis points of lift in our yield last quarter from the acquired portfolio. We have 14 basis points this quarter, right? So you can kind of see that, that's embedded into the 3 basis points of margin for us that we've been talking about, and that 14 basis points of lift that we have will go away as those loans pay down.

Got it. And I guess if I can take one other shot at it, then I'll get back in the queue. I guess you talked about not being really focused on Hudson City today because, obviously, getting through BSA and CCAR are primarily the biggest things you're focused on, but really -- I mean, should I take that to mean that you really can't think about Hudson City until you get the BSA and AML issues behind you? René F. Jones: Well, yes, that's what we're doing. That's exactly what we're doing, right? I mean, we're focused on the pool bank first, and we're going to get that done, and we're going to do it right. And then from there, we'll see what we do with the expansion plans, right? I think that's the most effective way to approach it.

Our next question comes from Erika Najarian of Bank of America.

I just wanted to ask a question on your expense outlook in context of the broader efficiency ratio. The efficiency ratio has clearly creeped up year-over-year. And as we think about the next few quarters, if expenses stay elevated, is there enough revenue lift somewhere to take the efficiency ratio down from the 56% that you posted this quarter or until we see some rightsizing of the regulatory-related expense, it's going to stay at the 56% level? René F. Jones: I mean, I think same answer. For several quarters, our expenses and therefore, our efficiency ratio is going to be elevated. The thing I would say, Erika, is it's not necessarily and probably not likely a rightsizing of regulatory expenses. It's the rightsizing of everything else because the regulatory environment is not like a couple of weeks. It's a total change in the industry, and you've got to have a different infrastructure. So most of our savings are going to come from other areas, and we'll probably have increased spending on -- even from where we are on compliance and infrastructure around risk.

Got it. And my second question has to do with potential growth of your balance sheet. Do you expect to plow -- just plow the excess deposits into your bond portfolio if loan growth continues to be sort of where your outlook is or rather deposit growth continues to outpace loan growth? Or do you expect to lever the balance sheet some to increase your securities as a percentage of your earning assets? René F. Jones: The way I would say it is, as always, we're profitable enough to be patient. So we are not done with our liquid asset buffer. We did a lot -- as you saw, we did a lot of work when rates popped up, and we were able to get the government-backed securities at the rates of about 3.25%. Those yields have backed off, but our plan is to keep doing that, and particularly, if there's any increase in rates, we'd probably dive in and do more of that. But once we're at a steady state in terms of, for example, our liquidity coverage ratio, then I think the answer really is, is we're only going to do loans if they make profitable sense because we don't really want to weaken our balance sheet, and our history around securities is the same thing. So it will be quite interesting because, really, what you're seeing on the cash balances is that consumers and businesses are just uncomfortable spending. So it's all the same issue. But what tends to happen at M&T is we end up with fairly slow revenue growth, but a decent return and a healthy balance sheet. That is becoming more and more of a concern to me when I look what's the stories I'm getting out of the field and the different regions around pricing and structure.

Your next question comes from the line of Ken Usdin of Jefferies.

Just the first question, just -- with regarding net interest income, hearing your point about a little bit of coordinating pressure, it seemed like the period end -- there's a lot of moving parts this quarter, so with the loans and securities, securitizations, whatnot. So I just want to understand, I think period end balances for earning assets look a decent amount higher than earning assets. So are we at the point where we can expect NII to resume growth from here? René F. Jones: Yes. I think that's kind of what I was trying to say in my comments. If you take away the swing in the prepayment fees, we would have had profit growth of $7 million, $8 million, linked quarter, and that's because of all the additional investment securities mostly. So I think that's right. That's what you'll see. You got some momentum going into the quarter. And then from a margin perspective, those are costing us a bit, right? In terms of a net interest margin percentage, they're coming down, it's coming down a bit, other than the fact that we're using cash. So it depends what happens to those cash balances again. But the way we look at it is that actually puts some slight margin pressure on you, but I still think, as I look at it, we probably have growth [indiscernible].

Okay, got it, right, driven by earning asset growth. René F. Jones: Yes.

On the mortgage banking side, I just wanted to clarify something. You talked about the $15 million incremental fees from the servicing deal and you talked about expected weakness on what I think was the resi side. Are you saying that you expect those to pretty much offset each other? René F. Jones: I would love to say on the residential side that things have stabilized. But because I've only seen 2 months of it, I'm a little nervous, but I wouldn't -- I would expect a decline in resi mortgage probably to be smaller than the lift from -- but it's been early. It was such a quick ramp down, but I'm thinking that the servicing increase probably should readily offset the other side, but hard to say, right?

Yes. And then on the cost side of just mortgage again. Related to the servicing deal, were those costs already run-rated in the third quarter so we'll see the fee benefit in the fourth, but do we get an incremental cost side increase related to the servicing acquisition? René F. Jones: No, not material -- so yes, you're right, those expenses were there at the outset of the quarter. They were there around July 1.

Okay. And then the last, last thing for me just regarding -- you did a lot of these securitizations and capital kind of benefit type of transactions this quarter. Do you anticipate doing much more of that? Or did you kind of take care of a lot of the shifting those several transactions in the third? How are you thinking about balance sheet efficiency and mix going forward? René F. Jones: We -- what I would categorize it as, Ken, is we did most of what the repositioning of things that were on our balance sheet. What we have left to do is maybe some issuance of unsecured debt and maybe some more purchases of liquid securities to invest that in. Maybe in the near term, we're on a program to do that.

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

Sort of following along that line of thinking, should we think about the securitizations this quarter as sort of steps being taken right now to reposition the balance sheet or will auto securitization be an ongoing piece of your revenue stream? René F. Jones: That's exactly what we're talking about right now. I mean, one of the things that we found when we kicked this off was that the appetite for yield was so high that it made the transaction work. But having said that, at least, in my history, it's an indirect auto loan, you can't get a return on your book. It's hard to get a return by selling it to somebody else. So we're thinking about that. And we'll probably be in much more of a flow-oriented program, because a lot of times, the appetite for that product is a little bit different than our own appetite just because we have different cost of capital or different return requirements. So more, but we haven't got there yet, but we're thinking about that.

Okay. And then as you think about that, would the thought process be to securitize every quarter or a couple of times a year? Or how do you think about sort of the ebb and flow of originate and sale? René F. Jones: I mean, we're just building an infrastructure. So I don't know we would do enough volume to be doing it anyway near it. I mean, once in a great while, at this point, I think, is probably the answer. The other thing is, if you're going to do that, Bob, you would see it right away because we would have to originate those for sale, right? So unless you see it's actually reclassifying those loans as we book them on, we're not there yet to be able to do something like that.

Got it. And then one last question on expenses. I know you've talked a lot about sort of how they're going to be elevated. Is the build out done, though? I mean, do they remain elevated at these levels? Or are there further increases related to hiring or other from where we are today? René F. Jones: It depends on the topic. We've made a lot of progress on, I believe, our capital planning. I don't know enough to suggest that we're done, but we've made a lot of progress there. We have more hiring to do on the BSA/AML, and as we talked to the folks, the plan is to continue to hire there. But I think we also are beginning our efforts on the other areas, you know what I mean? So my sense is that -- I don't have it in front of me. If I could give you -- Bob will probably put it in his annual report. But if I could give you a regulatory number, that number is probably going to go up, but I don't think our overall expenses will be going up.

Our next question comes from Gerard Cassidy of RBC Capital Markets.

Can we come back to the expenses that you're talking about that you've incurred in handling the regulatory issues? And they are going to remain elevated, of course, for a number of quarters. Can you give us an estimate of what you think down the road, what's kind of onetime, the outside consultants that you're using? And I know you've hired a bunch of people, and that's embedded, and that's going to remain around for quite some time. Is it 30% of the total numbers kind of the outside people and the rest is ongoing? René F. Jones: It's a tough question. Let me tell you why. Once I say it, it will sound obvious. But day one, when you decide to make your investment, it's heavily loaded with outside people. So and then at times, at the end, when you're at your steady state, there's none. So I mean, if you're at -- say, probably, we got a high percentage of people and you're seeing us replace, as those outside people go away, you're seeing us replace with core infrastructure. The CCAR we're probably be further along. So that's a tough one. And then actually, most of this management stuff is actually -- we hired Don Truslow. He's hiring permanent staff, so that's all permanent. If you want to look at it, if you want to look at what could be more variable, look at the professional service line, look at the ramp up of professional services. Don't just look over the last year. Look at it over 8 or 9 quarters, and you'll see in that professional services line what -- where you have expenses that could move.

Okay, good. And then second, you've been able, as you've pointed out in this quarter, to do a little restructuring in the balance sheet, strengthens your capital ratios and with a very nice gain to boot. Last quarter, you had some securities gains. Do you still have those types of opportunities in the next 2 or 3 quarters to help defray some of those elevated costs that you're running into with the regulatory issues here? René F. Jones: Well, no. I think the way I look at those -- each of those transactions, maybe with the exception of the Visa, were net cost to me. So the indirect auto loans were lower returns, but they were above our cost of capital. And so that was just the least cost way to get the liquidity profile, but they're all net cost. So to the extent that I don't have to do any more of those, I'd be very, very happy. So -- and I think as we kind of look at our projection where we will be, as I said, the only thing we really have left on the balance sheet is maybe more liquid. And fortunately, we have a fair amount of cash to be able to do that today. So yes, I wouldn't expect to see a lot of those types of gains and sale-type activities.

Speaking of those auto loans, aside from the lower yields that you just mentioned, did credit come into your thinking as well in securitizing them about the potential for increased delinquencies or anything? René F. Jones: Well, related to high quality credit book, I mean, the long answer is we look at everything, but -- including the expenses. But no, I mean, that was very high quality. That's a book we originally underwrote at the time before we thought about the liquidity efforts we were going to keep those loans and so...

Our final question comes from the line of Marty Mosby of Guggenheim.

We'll wrap it up with a technical question and I have 2 kind of broader kind of scope questions. If you look at the technical side, the other cost in operations was up almost $50 million. You mentioned several things, but it didn't really all add up to the $50 million. I just didn't know if there was something else beside the topics you've been talking about that's kind of loaded into that other expense line. René F. Jones: Did you adjust for the Wilmington accrual issue?

I thought that I had tried to do that, but maybe that's the difference so... René F. Jones: So I mean, that will be a big number, and then there was just a lot of little individual things, nothing that will really -- no one big item that I can really tell you about.

Okay. So nothing else transitory that would come out of that number? René F. Jones: No.

Okay. And then the 2 bigger kind of scope, as you kind of look back and think of all the increased expenses, investment and process that you've had to put in place, really 2 things and with this is, one, what do you think was the primary catalyst? Was it because of your size growing or you're just active in M&A? Or is it just rolling down to smaller and smaller banks getting to be required to be, like you said, at the best of the industry even though your operations were maybe much simpler. But what was the catalysts? And then two, do you think after all is done, do you see improvement in risk management where you've already been one of the best in the industry? But do you see any back end benefit from doing all these exercise that will make you manage the bank differently or better? René F. Jones: Yes. I mean, give me one second -- I mean, I'm just writing your question down -- the first part, I would go at it in 2 ways. I mean, as I said before, particularly on technology front and other areas like that, we were at a stage where we needed to make a fair bit of investment. So well, we hired Mahesh from one of our counterparts -- I don't know, it's almost 2 years ago now, right? And we've hired a number of other people because we realized that we needed to build the infrastructure from a larger bank. We had done 3, 4 or 5 acquisitions, right, recently. So that was what on our mind, the speed of it is clearly the fact that we are about $50 billion and growing. And the expectation is not only that you've got to be top notch in terms of risk management and controls because we've always been top-notch in terms of controls, but you can't do it right now. So if you take those 2 things combined, I think we're probably headed there anyway, but it's been accelerated a bit. The second part of your question, as to whether we can do anything better, the way I would characterize it is that M&T -- so we've had a great track record around control, and part of that is because we're so detail oriented. We focus a lot on people. We like to look under the covers of everything. When we close the books on a monthly basis, if moving expense went up, the question we ask is who moved. So we're very, very detailed. What we're trying to do as we get larger is to sort of overlay an addition sort of processes that let us see across the bank as the bank gets bigger, right? So I think it's probably a very positive thing. I think, does it justify all the cost we're spending? I don't know how you could possibly do that, but will there be some benefit? Yes, sure. Sure, there will be some benefit, especially when it comes to the risk management environment that Truslow is creating. I mean, I'm really looking forward to that. I mean, that's very, very necessary, given the larger size of the bank.

It sounds like this is still like kind of a stepwise, one of those points where you're growing assets on a linear line, but all of a sudden, your resources have to kind of ratchet up, but then they'll level out and you will get the benefit of capacity going forward? René F. Jones: Yes. And then the other thing you realize is that as you -- in that size, whatever size we are, as a regional bank, I mean, it's not like -- I mean, take BSA/AML, it's not like we're going to have a state-of-the-art system that nobody else is going to have. I mean, this is probably the new requirement across the industry just to be in the game. So we figured we better get that done quickly. I hate to be behind in that respect.

And then just lastly, the other kind of broad scope was, earlier you mentioned the increase in your capital ratios with the delay [ph] you've seen in the acquisitions, do you think that, that changes your posturing as you go into the 2014 CCAR and how you think about deployment of capital? René F. Jones: No, we haven't had any change whatsoever in our thinking. I don't know. We think it's just prudent to -- at this stage of the game to have more capital, and we've talked about whether it's now or down the road, as other opportunities come up. We think it's just a prudent position to have today. So I've been really pleased that we've sort of gotten ourselves back to the pack, and have a much, much stronger capital level. But we don't see any reason to change the course that we're on now of adding capital.

And that's where you're kind of patient at looking at how to deploy it comes into play. You know that eventually you'll have that opportunity? René F. Jones: That's exactly right. That's exactly right. So you're thinking about how to do that, and a lot of people early in the process assume that, well, M&T's going to have to have a lot more capital so the return's going to go down. Our job is to manage both sides of that equation, right, and we're trying to rationalize it. As we have more capital, certain things have made sense before don't make any sense anymore. And so far, we're doing a pretty good job at it. We're going to keep working on that trade-off.

There are no further questions in the queue. At this time, I'll turn the call back over to Mr. MacLeod for any closing remarks.

Again, thank you, all, for participating today. And as always, if clarification of any of the items on the call or news release is necessary, please contact our Investor Relations Department at (716) 842-5138.

Thank you. This concludes today's M&T Bank's Third Quarter 2013 Earnings Conference Call. You may now disconnect.