M&T Bank Corporation (MTB) Q1 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the M&T Bank First Quarter 2020 Earnings Call. At this time, all participants have been placed in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I will now turn the call over to Director of Investor Relations, Don MacLeod. Please go ahead.

Thank you, Brandy and good morning. I’d like to thank everyone for participating in M&T’s first quarter 2020 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 and then on the Events & Presentations 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 on Forms 8-K, 10-K, and 10-Q including the Form 8-K filed today in connection with our earnings release for a complete discussion of forward-looking statements and risk factors. Now, I'd like to introduce our Chief Financial Officer, Darren King.

Thank you, Don and good morning everyone. Before we start, I'd like to take a moment to acknowledge the extraordinary efforts put forth by M&T's employees in response to the COVID-19 pandemic that over the past few weeks has impacted virtually every aspect of our economy. I'd like to share a story about our branches. When I first heard from Washington, D.C., but when I have since heard multiple times from across our footprint. In mid to late March, all of our relationship bankers began reaching out to customers to ensure they had appropriate access to their money with a particular focus on customers who infrequently use mobile and web banking. At the end of one such conversation, our banker asked the customer, if there was anything else we could do to help her. The customer said, I need food, my husband passed away. I lost my job and I have no food. I'm hungry. Natalie, quickly brought this to the attention of her branch manager who in turn, shared the story with the rest of the team, and they decided to do something about it. After closing the branch for the day, the team went shopping and on their way home delivered a significant supply of groceries to help our customer through her difficult time. Having previously managed the branch network, I can assure you this procedure is not covered in the branch operations manual. Next, I'd like to share some metrics that we believe highlight how M&T is operating in the current environment, while practicing safe social distancing, helping customers and enabling commerce. As of last Friday, 708 of our 733 full-service domestic branches are open and operating with a few restrictions. Drive-through windows and ATMs are operating normally and branch lobbies are on an appointment-only basis. For commercial and consumer customers, M&T has provided a host of relief options, including loan maturity extensions, payment deferrals, fee waivers and low interest rate loan products. Our mortgage servicing group has worked to help customers seeking payment relief for loans we own or for those we service for others. So far, we've provided assistance to over 70,000 customers whose loan balances total some $13 billion. Just under 90% of those balances are serviced for others. In total, we've assisted an approximately 10% of the mortgage loans we service. Similarly, for customers with other consumer loans, auto and recreation finance, credit card and home equity loans, we've provided nearly 17,000 customers with some form of payment relief. These customers hold balances of over $500 million and represent just under 4% of our consumer loan portfolio. M&T has been helping small business customers to access the government's Paycheck Protection Program or PPP. This program offers loans backed by the small business administration, intended to sustain monthly business expenses, such as paychecks for employees, who would otherwise be laid off, rent and utilities. In total, M&T associates helped a total of 27,711 clients get approved for PPP loans totaling more than $6.4 billion. Over 2,000 M&T bankers worked around the clock to make that possible for our customers. Those companies collectively employ more than 600,000 workers. And if additional funding is made available, we have a backlog of additional clients we are ready to help get approved. For other business customers, large and small, and who entered the pandemic in good standing, we are offering short-term payment deferrals or other modifications to their existing credit agreements to help them manage short-term cash flow challenges. So far, we've provided modifications to nearly 6,000 businesses with an aggregate principal balance of $11 billion. And last week, we began receiving funds from the treasury department for deposit of COVID-19 stimulus payments into our customers' accounts. We know there will be more to do in the coming weeks, and our team stands ready to be a source of strength for our customers and our communities. Next, let's look at the financial results for the quarter. Diluted GAAP earnings per common share were $1.93 for the first quarter of 2020 compared with $3.60 in the fourth quarter of 2019 and $3.35 in the first quarter of 2019. Net income for the quarter was $269 million compared with $493 million in the linked quarter and $483 million in the year ago quarter. On a GAAP basis, M&T's first quarter results produced an annualized rate of return on average assets of 0.9% and an annualized return on average common equity of 7%. This compares with rates of 1.6% and 12.95%, respectively, in the previous quarter. Included in GAAP results, in the recent quarter were after tax expenses from the amortization of intangible assets amounting $3 million or $0.02 per common share, little change from the prior quarter. Consistent with our long-term practice, M&T 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 when they occur. M&T's net operating income for the first quarter, which excludes intangible amortization, was $272 million. This compares with $496 million in the linked quarter and $486 million in last year's first quarter. Diluted net operating earnings per common share were $1.95 for the recent quarter compared with $3.62 in 2019's fourth quarter and $3.38 in the first quarter of 2019. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 0.94% and 10.39% for the recent quarter. The comparable returns were 1.67% and 19.08% in the fourth quarter of 2019. In accordance with the SEC's guidelines, this morning's press release contains a tabular reconciliation of GAAP and non-GAAP results, including tangible assets and equity. Recall that both GAAP and net operating earnings for the first quarter of 2019 were impacted by a noteworthy item. Included in that quarter's results was, in addition to our legal reserves of $50 million, relating to a subsidiary's role as a trustee for customers employee stock ownership plans. This amounted to $37 million after-tax effect or $0.27 per diluted common share. Turning to the balance sheet and the income statement. Taxable equivalent net interest income was $982 million in the first quarter of 2020, down by $32 million from the linked quarter. This comes as the result of a lower level of average interest-earning assets combined with a nearly stable net interest margin. Margin for the past quarter was 3.65%, up 1 basis point from 3.64% in the linked quarter. As we indicated on our January conference call, a more favorable mix of earning assets, including a lower absolute level of average funds on deposit with the Fed, combined with a higher proportion of loans, provided a benefit to the margin of an estimated 11 basis points. Further declines in interest rates caused about three basis points of pressure to the margin, a relatively modest decrease, helped by an 11 basis point decline in the cost of interest burning -- interest-bearing deposits. As a result of higher forecasted prepayments, accelerated premium amortization on residential mortgage loans acquired in the Hudson City acquisition and on mortgage-backed securities accounted for another 4 basis points of pressure. Several other factors combined to contribute to a net three basis point margin reduction. Those factors include the lesser day count in the quarter compared with the prior quarter and non-accrual loan interest, which includes the change in the recognition of interest income on acquired loans as a result of our adoption of CECL. Average interest earning assets declined by just over 2%, reflecting a 31% decline in deposits with the Fed and a 9% decline in investment securities, partially offsetting those declines was a 2% increase in average loans outstanding 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 3%, including growth in dealer floor plan loans. Commercial real estate loans also grew by 3% compared to the fourth quarter. Residential real estate loans, which include mortgage loans acquired in the Hudson City transaction continued to pay down, consistent with our expectations. The portfolio declined by more than 2% or approximately $400 million. 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, commercial and industrial loans increased by $2.4 billion or more than 10%. We estimate that draws on previously undrawn contractually committed lines accounted for nearly $2 billion of that increase, as the COVID-19 crisis led many customers to access funding sooner rather than later to manage their own liquidity. Average core customer deposits, which exclude deposits received at M&T's Cayman Island office and CDs over 250,000, declined less than 1% or nearly $630 million compared to the prior quarter. There were multiple factors that drove the change. Lower average mortgage escrow deposits a decline from seasonally high commercial deposits, in the fourth quarter and time deposit maturities. Those factors were partially offset by draws on credit lines, being immediately deposited back into customers' operating accounts, lower levels of off-balance sheet sweep activity by customers as lower rates have made sweeps, less attractive, and a moderate flight to quality as customers view funds on deposit at M&T as safer than other alternatives. On an end-of-period basis, core deposits were up 7%, reflecting new inflows of mortgage escrow deposits, as well as the redeposit of line draws. Lower levels of off-balance sheet sweeps and the flight to quality issues, I just mentioned. Foreign office deposits decreased 3% on an average basis and nearly 28% on an end-of-period basis. With sweep rates nearing historic lows, we expect to see less on balance sheet sweep activity by commercial customers, consistent with our experience during the zero rate environments over the first half of the prior decade. Instead, funds would likely remain in their operating accounts, either DDA or interest checking. Turning to non-interest income, non-interest income totaled $529 million in the first quarter, compared with $520 million -- $521 million in the prior quarter. The recent quarter included $21 million of valuation losses on equity securities, largely on our remaining holdings of GSE preferred stock. While 2019's final quarter, included $6 million of similar losses. Mortgage banking revenues were $128 million in the recent quarter, compared with $118 million in the linked quarter. Residential mortgage loans originated for sale were $919 million in the quarter, up more than 25% from $727 million in the fourth quarter. Total residential mortgage banking revenues, including origination and servicing activities were $98 million in the first quarter, improved from $91 million in the prior quarter. The increase reflects the higher volume of loans originated for sale combined with a stronger gain on sale margin. Commercial mortgage banking revenues were $30 million in the first quarter, compared with $27 million in the linked quarter. And the comparable figure in the first quarter of 2019 was $29 million. Trust income was $149 million in the recent quarter, down slightly from $152 million in the previous quarter. Results for the first quarter were solid through the first two months, but were then dampened by the March collapse, in equity markets. Service charges on deposit accounts were $106 million compared with $111 million in the fourth quarter. The decline from the linked quarter reflected some normal, seasonally lower levels of customer activity in addition to the COVID-19 driven slowdown in payments activity. During the first quarter of 2020, M&T received a cash distribution of $23 million from BayView Lending Group; M&T's results in the first quarter of 2019 included a similar distribution amounting to $37 million. Turning to expenses, operating expenses for the first quarter, which exclude the amortization of intangible assets, were $903 million. As noted, $889 million of operating expenses in the first quarter of 2019 included the $50 million addition to the litigation reserve. Operating expenses for the recent quarter included approximately $67 million of seasonally higher compensation costs related to the accelerated recognition of equity compensation expense for certain retirement-eligible employees, 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 $60 million in last year's first quarter. As usual, we expect those seasonal factors to decline significantly as we enter the second quarter. Excluding those seasonal factors, salaries and benefits were a little changed from the prior quarter. The year-over-year increase reflects the higher headcount as we've been deepening our bench of talent, which as we've previously noted, has allowed us to reduce our reliance on outside contractors and bring new products and services to our customers more quickly. Other cost of operations for the past quarter included a $10 million addition to the valuation allowance on our capitalized mortgage servicing rights. Recall, that there was a $16 million reduction in the allowance in 2019's fourth quarter. The efficiency ratio, which excludes intangible amortization from the numerator and securities gains or losses from the denominator, was 58.9% in the recent quarter compared with 53.1% in 2019's fourth quarter and 57.6% in the first quarter of 2019. Those ratios in the first quarters of 2019 and 2020 each reflect the seasonally elevated compensation expenses. Next, let's turn to credit. What had been a relatively healthy economy at the end of 2019 and early this year has deteriorated faster than most of us would have expected. While the first quarter 2020 changes in non-accrual loans and net charge-offs were still fairly benign, we are preparing for the likelihood of increased credit costs as the economic impact of the pandemic and the unprecedented stimulus programs unfold. At the end of 2019, in accordance with the then prevailing incurred loss accounting standard, M&T's allowance for credit losses amounted to $1.05 billion or 1.16% of loans. In connection with the adoption of the current expected credit loss standard, M&T added $132 million to the allowance, reflecting higher lifetime loss expectations under CECL. Those expectations included certain assumptions such as economic growth, unemployment and other factors. The provision for loan losses in the first quarter amounted to $250 million, exceeding net charge-offs by $201 million and increasing the allowance for credit losses to $1.4 billion or 1.47% of loans. The allowance currently reflects an updated series of assumptions, reflecting a more adverse economic scenario. Those assumptions include a significant deterioration of future macroeconomic indicators used in our reasonable and supportable forecast, including an unemployment rate, approaching double digits and a significant contraction of the GDP in the second quarter. The assumptions reflect a moderate recovery in the second half of 2020. Non-accrual loans amounted to $963 million or 1.06% of loans at the end of 2019. In connection with our adoption of the CECL accounting standard on January 1, 2020, M&T reclassified $171 million of loans that were previously acquired at a discount as non-accrual loans. Non-accrual loans as of March 31 amounted to $1.1 billion, an increase of $99 million from December. Thus, except for the accounting reclassification, non-accrual loans declined during the past quarter. At the end of the quarter, non-accrual loans as a percentage of loans was 1.13%. Net charge-offs for the recent quarter amounted to $49 million. Annualized net charge-offs as a percentage of total loans were 22 basis points for the first quarter compared with 18 basis points in the fourth quarter. Loans 90 days past due, on which we continue to accrue interest, were $530 million at the end of the recent quarter. Of those loans, $464 million or 88% were guaranteed by government related entities. Turning to capital, M&T's common equity Tier 1 ratio was an estimated 9.2% compared with 9.73% at the end of the fourth quarter, and which reflects the net impact of higher loans, and earnings net of dividends and share repurchases. During the first quarter, M&T repurchased 2.6 million shares of common stock at an aggregate cost of $374 million. Now, turning to the outlook. To start, it goes without saying, but I'll say it anyway, that the outlook and any forward-looking statements we made on the January earnings conference call are no longer applicable. As far as the balance sheet goes, our liquidity assets, short-term investments and the deposits with the Fed will be somewhat fluid as shorter term deposits, particularly from the servicing operation, expand or contract with refinancing activity. We wouldn't expect to make any significant purchase of investment securities in this environment. Future balance movement will be impacted by the pace and breadth of the economic restart, once the pandemic is believed to be under control. Holding government programs aside for a moment, average loans for the year will expand somewhat faster than previously expected as the line draws at the end of the first quarter roll into the average as well as the impact of any principal deferrals. As showrooms are mostly closed around the country, automobile sales and inventory are stalled as are those of recreational vehicles, although to a somewhat lesser extent. Focusing on government programs and their impact on the balance sheet, the most certain is the PPP program. While the balances that will be added to our balance sheet are known, as is the yield, there is a great degree of uncertainty as to the duration of these loans. These are extensively two-year loans, but prepayments in forgiveness will result in many loans being on the balance sheet for less than that time, introducing uncertainty into the size of the loan portfolio and the net interest margin in the coming months. The details of the Main Street Lending program are still being finalized and as such, our level of participation in the program, if any, remains unclear. Fees held up well in the first quarter. However, we are closely monitoring trends in interest rates, equity markets and pandemic responses to assess their impact on our businesses. Residential mortgage applications continue to be very strong with rates as low as they are. Trust income will be impacted by the state of the equity markets by a likely resumption of waivers of money market mutual fund management fees, while the zero rate environment persists and the potential for an extended slowdown in debt capital markets activity. Payment volumes in aggregate are down slightly. And we're offering fee waivers to our consumer customers. Certain industries, such as restaurants, travel and other leisure activities are being more heavily impacted by locally-mandated social distancing lockdowns. Lower payments activity will likely persist while those restrictions remain in effect. We expect the seasonal salaries and benefits surge we had in the first quarter to normalize as it does every year. We have significantly curtailed hiring in this environment and have been actively redeploying team members around the bank to address shifting business needs. Like other businesses around the country, shelter in place mandates will impact other aspects of our expense base, such as the use of contractors and travel and entertainment expense. Credit costs are difficult to predict. But as mentioned earlier, we are preparing for a challenging environment. While our consumer customers navigate through the forbearance period and our larger commercial customers work through a period of temporary debt restructuring, the ultimate impact of recent events on credit will not likely be clear for several months. Turning to capital, the current environment has not caused us to reconsider our long-standing capital allocation philosophy. Our primary use of capital is to support the economic activity of our customers while serving as a source of strength in the communities we serve. We will maintain prudent levels of capital to support that objective. Of course, as you are aware, our projections are subject to a number of uncertainties and various assumptions regarding national and regional economic growth, changes in interest rates, political events and other macroeconomic factors, which may differ materially from what actually unfolds in the future, as we've just learned. Now, let's open up the call to questions, before which Brandy will briefly review the instructions.

[Operator Instructions] Your first question comes from Ken Zerbe of Morgan Stanley.

Thanks. Good morning guys.

Good morning, Ken.

So, it sounds just in terms of your CECL assumptions, it almost sounds like you're using the Moody's baseline from the end of March, which I guess, has gotten materially worse since the end of March. Could you just talk about what you might expect for provision? Or how you're thinking about that as we go into second quarter?

Sure. If you look at the Moody's, which we do look at their various scenarios, we consider a range of their scenarios. The baseline is primary. But if you look at this quarter, I think it's there -- the S-3 scenario was also considered in our thought process when we were thinking through the assumptions in the CECL. And I guess, I'd just remind you that the economy and the expectations for the future are certainly in flux. And we looked at those and considered those when we were going through our work at the end of the quarter. At that point, we're probably expecting a sharp turn down and maybe a sharper recovery than what would appear to be the case today, but as we go through the next 90 days, we'll know more. And we'll see how things unfold. How quickly a restart happens or doesn't. And how those affect the future projections both from what we're seeing and what Moody's is seeing as we go through the quarter and as we think about things at the end of this quarter.

Got you. Okay. No, I understood. That does help. I guess, maybe an easy question, just given what's happened to the rates. I know you talked a little bit about the margin and the factors that affected it this quarter. But how are you guys thinking about margin going into 2Q?

Well, it's our expectation that the margin's probably moving down in the quarter. When you look at the -- while LIBOR has held up well, it did move down at the end of -- well, as we went through the quarter. And it's important to keep in mind, when pricing changes happen in the loan portfolio. And so -- well, the benchmark rate or the reference rate gets updated usually in the first few days of the month. And so any changes in that later in the month don't get reflected until the following. And so as you look at what happened this quarter with the drop of 150 basis points coming after the first week in March, most of that will start to get reflected in April and through the second quarter. The only other thing that I'd just remind folks is we think about margin in the second quarter is the PPP loans are going to have an impact on the margin. At 1%, those are low-yielding loans, although they carry a zero risk weighting. That's a substantial portfolio that will come on stream in the next several days and we'll have a material impact on the margin. So, I try to think about it a little bit both in terms of the margin, but also in focus on net interest income and the dollars of net interest income, and how those are likely to unfold over the course of the next three, six and nine months.

Perfect. And if I can just fit--

Your next question comes from the line of Dave Rochester of Compass Point.

Hey, good morning guys.

Good morning.

Hey, back in March, you guys gave some disclosure on some of the loan buckets you're watching a little more carefully. Can you just give an update on the reserving you've done in those buckets? And maybe some of the credit metrics around those? I know you mentioned LTVs in your hotel book of about 54%. But if you could just talk about the $6 billion or so, you haven't seen your housing or assisted living centers and maybe the $7 billion in retail, just trends you're seeing there? How you're thinking about reserving? That would be great.

Yes, I guess, if you look at the various portfolios, the ones that we're paying a lot of attention to hotel, retail, restaurants, leisure, and to some extent, the healthcare facilities. What we're seeing so far is still early in terms of their economic performance. And when you look at -- we don't have first quarter financials yet. When you looked at where things were at the end of last year, they were still pretty strong. And so to see a change in the portfolio this early doesn't really happen. But as we look at the -- at forbearance and payment relief, a lot of those industries are places where they're getting some help. And when we look at some of the underlying trends in terms of loan to values, they're still solid. I think it will take a while for loan to values to adjust as well because a lot of times, the value is a function of the cash flows, and it remains to be seen what the ultimate long-term set of cash flows are with many of those industries, hotels being an obvious one. And so it's still a little early to say that we're seeing severe challenges in those industries per se. But as we talked about, when you look at the reserving, we've increased the reserve pretty substantially since the end of the year. And that's the whole idea of CECL is to start to account for the impact of changing economy on various industries. The other thing to keep in mind, which is still hard to really assess is how the stimulus package, which is really unprecedented might impact any of these portfolios. And in particular, the PPP program as a result of that. Many of the industries that we are concerned about have access the PPP program. And for our customers, they should be receiving the funds started over the weekend and should happen through the end of the week. And that should give them some liquidity to help get through the next two and a half months as the program was designed. So, no material regrading at this point as we just spend our time actually working with customers and calling them and making sure that we understand their situation and figure out ways to help keep them operating.

Perfect. I appreciate that detail. Do you happen to have the size of the restaurant book in the leisure segment you mentioned or maybe just the overall portfolio of the segments you mentioned, the hotel as everything combined? Just to get a sense of what the total is?

Yes, when you look through the 10-K, tables five and six outlined a lot of the stuff. You look at hotels, between permanent and construction; it's just about $4 billion. Retail, you mentioned was about $6.3 billion. That covers a broad range of industries. I guess, a couple of things to keep in mind in retail is when you look at C&I retail, a lot of that is multi-unit retail and convenience stores associated with gas stations. And so those have been essential. And those have been open, although I'm sure, operating at lower volumes. And much of the retail book is actually associated with multi-storey buildings in Manhattan. And retail happens to be the first floor, but the way it gets coded, it gets coded as retail. If you look at restaurant and leisure, there are segments that aren't individually big enough that we call them out separately in those tables. Together, they're about $2 billion. So, I give you but they're contained within the other and some of the other line items. But collectively, they're relatively small in the grand scheme of things.

Okay. And then maybe just one last one on the assisted living center piece or the senior living center--

Yes?

Have you talk to those clients; are they starting to see any customer attrition due to concerns around the virus at all or at least maybe reduced interest in new sign ups? And then what general breakeven occupancy -- what's the general breakeven occupancy for those?

So, it's still early in the process, and we haven't heard any mass defections. I think most of the time; people have chosen to stay in place. And try to isolate themselves within the facilities. And many of the owner operators are taking measures to help care for the residents by separating them by floors based on whether they're -- they've tested positive or not. But there's really no other place in many cases for these folks to go. And so they stay where they are. And so we haven't really seen any material change in occupancy rates as of last week.

And then in terms of how full they need to be in order to maintain profitability? Any sense for what that breakeven is?

I think it's hard to give an exact number because it varies by facility, type, and by geography. The one thing, I guess, we do know is we've seen at an industry level, some of the occupancy rates come down just as new builds came online. But that's an industry where those rates move up and down. And the operators are pretty savvy about being able to absorb capacity. So, we haven't seen anything yet where there is an issue with the facility's ability to maintain occupancy rates above their breakeven.

Great, all right. Thanks guys. Appreciate it.

Your next question comes from the line of John Pancari of Evercore ISI.

Good morning.

Hey John, how are you?

All right. Just regarding the reserve and the addition you made this quarter, can you just give us a little bit of color on your through-cycle loss assumption that you baked in to come up with that addition to the reserve? I know the Fed has you at about $6 billion or 6.7% in the 2018 DFAST. Your company run was about 3.7% or about $3 billion. So, how do you -- how are you thinking about that? What's a fair through-cycle loss number? And did you run your 2020 analysis yet?

We haven't run the 2020 -- or updated it since the stress test and the CCAR submission. If you think about the CECL and how it works, you've got a reasonable and supportable period, right, which is a couple of years. And then after that, you revert to the long-term average of the portfolio. And so there's a little bit of a difference between CECL and its calculation of losses versus what the stress test might be in addition to the assumptions made in the stress test about, well, one, how severe it is and how long it is. But so far, the assumptions in CECL would have been almost as severe, although not quite, but certainly not as long. And so there's a change that may or may not happen depending on how the economy restarts. I guess we'll see as we go. But those would be the big factors that would be different between those two. I guess the thing that we focus much or more on what we know to be the quality of the portfolio and the quality of the credits that underlie it. And when you look at the CCAR results, you look at our DFAST, which you mentioned; we are lower than the Fed under stress. And our actual losses in the last crisis were lower than that. And when we think about our reserving, we're obviously adjusting it and taking into account the latest information about what's going on in the economy, but we're also looking at the portfolio and what's happening in the portfolio. And it's so far very, very early on to understand how the impact of the stimulus is going to work, how the -- how quickly the restart is going to impact the portfolio. But just looking at loss coverage, over the average of the last five years, the loss coverage in the allowance is about seven times what the charge-offs have been. And our peak losses as a percentage of loans in the last crisis was 1%. And so there's lots of different ways to kind of triangulate and figure out whether or not you feel reasonable with the reserve. And based on the assumptions that we used, we felt comfortable with the combination of those Moody's scenarios that we talk about. We looked at the quality of the portfolio and how it's performing so far and the history. And looked at the ratios along a number of those dimensions. And based on where we sit right now, we feel comfortable with it and if the outlook changes, then we'll update that at the end of the next quarter.

Got it, okay. Thanks, Darren. And then my follow-up is just around on the capital side. And more specifically, if you could just talk about the sustainability of the dividend here. Do you -- how do you look at that? Do you think there's a potential likelihood of a cut? Or do you think it's fair where it stands right now? Thanks.

Sure. It's interesting how our conversations about our dividend change through time. It wasn't that long ago that 33% payout ratio didn't seem like very large. And we kept saying one day, the world will change, and it will be good to have a lower payout ratio. So, we start from a good spot in terms of the payout ratio. When you look at the PPNR to assets, the ratio of PPNR that we generate compared to the average is at the high end, if not amongst the high end, certainly amongst peer group. And we expect that to continue in the short term. And our capital ratio is even at 9.2%, assuming we don't do any repurchases, is only going to go up. And we have 220 basis points of distance between us and where we would believe we would be under the stress capital buffer framework. And so for now, we feel pretty good that we're generating earnings and have the capital that we need to be able to support lending to creditworthy customers in our community. And so for now, we feel like it's sustainable. And I'll remind you that we worked really hard to make sure it was sustainable through the last crisis as well.

Okay, got it. Thank you.

Your next question comes from the line of Frank Schiraldi of Piper Sandler.

Good morning.

Hi Frank.

Just curious about the levels of -- Darren, if you could just talk a little bit more about the levels of deferment you're seeing, specifically on the commercial side? And if you think about some of those buckets of concern, like restaurant. Just curious where restaurant and your hospitality portfolio is in terms of total deferments at this point?

Yes, just going to get a little more detail on, if I got it by industry. Now, when I look at the work that we've done so far, as you might expected, the deferrals in the commercial book. First, they skew towards a small business customer just because of the numbers. And when you look in there, it's disproportionately restaurants, hotels and parts of the economy that are related to activity and people being out and about. The other thing, though, that's important to keep in mind is when I also look through the distribution of industries that were accessing PPP and were funded through the PPP program, it reflects a very similar distribution in terms of the types of customers that are receiving -- that are receiving funds under that program. It would skew towards restaurants. It would skew towards hospitality and hotels and the like as well as some of the construction that's been shut down. And so when we look at the deferrals that have happened so far, what's interesting, at least to me, is that there is lots of folks, both in consumer and in commercial, who have asked for deferrals, but have not actually exercised it. And so just to give you an example, within the mortgage portfolio, about a-third actually made their April payments. When we look at some parts of the real estate book, in the multifamily space, our customers are reporting that anywhere between 75% and 90% depending on the type of property of the rental payments were made by customers in April. And many of those would have sought some kind of deferral. And so a lot of these programs were implemented and mandated by various state authorities. And people took advantage or at least took the time to call and say, I want you to know that, I've been impacted by COVID. So that, if they choose to take advantage of the deferral or the payment relief that they're okay doing it and there won't be any issues with credit reporting and the like. But in the first month, we were quite pleased and pleasantly surprised with the number of payments that were actually made.

Okay. And just as a follow-up on the PPP program, just wondering how you're thinking about that from -- in terms of customers versus -- I mean, I would imagine you guys have your hands full with prioritizing customers. But if there is a second round, would you open that up to non-customers as well? If you could just maybe talk about how you're thinking about that?

Sure. I think -- we're hopeful that there will be a second round because, obviously, it was in high demand by business customers around the country and a very helpful program. We are in business to help all the customers in our communities, whether they're actual customers today or future ones. I think one of the things that maybe is a little misunderstood around the industry, with relation to whether you look at customers or non-customers, wasn't to say we prefer customers over non, but more to be able to get the money in the hands of folks more quickly, because of AML, BSA know your customer processes, it was much easier to expedite your existing customers because those checks were already done and that you'd already done those verifications. And therefore, you could process them more quickly and had a better chance of helping them get access to the PPP early on. And if the -- if the amount gets increased or Congress passes an additional amount of stimulus, I suspect you will see that more non-customers might look to access funds around the country. But I think the SBA and the Fed did a good job setting up as many banks as possible to be able to provide access for their customers.

Okay. And do you have any expectations, just final question on how much of the PPP would be will ultimately be given in over the next couple of months as opposed to remaining on the books for a longer period of time, perhaps up to two years?

Frank, that's the million-dollar question. It's -- I think -- I guess, we were pleased that the way the program was set up provided an opportunity for there to be forgiveness. And that it was designed in a way to keep as many businesses as possible open and running and with people employed. And so, I would expect that, that as many companies as could demonstrate that they met the criteria for forgiveness that they would choose to try and improve that and take advantage of that. How quickly they're able to do it? I can't handicap. But it seems very unlikely to me that a significant percentage will last the full two years, right? And how many will prepay or seek forgiveness after three months, six months, nine months, I think it's really tough to handicap, which is part of the reason why forecasting balances going forward and forecasting the margin going forward is so difficult just because it's really tough to figure out what might happen. And again, depending on where those customers were and which parts of the country and how quickly those parts of the country restart, I think we'll have a big impact on what percentage of those customers seek and receive forgiveness and over what time period.

Okay. Thank you.

[Operator Instructions] Your next question from the line of Steven Alexopoulos of JPMorgan.

Hey Darren, good morning.

Good morning, Steven.

I want to ask you on the margin. So, just given the sharp move down in interest rates we've seen, what's the new money yield today on loans and securities and loans would be ex-PPP?

Well, so while the rates have come down, what you've seen is spreads have widened. And so when you think about the cost of funding for the banks, while it's down in absolute, the spread that we have to pay is a little bit higher. So, when you think about yields, you're probably seeing a little bit of an increase in the spread to the benchmark or the reference rate was probably in the low 200s, high 100s as we entered the year. You're probably seeing things in the range of 50 to 70 basis points wider on new money coming in right now. But obviously, that varies a lot depending on the collateral and the loan to values in the industry. But the absolute yield for the customers, from their perspective, even though the spreads might be a little bit wider is certainly coming down.

And what about securities?

Well, securities or whatever market is, we don't anticipate adding a lot of securities in this environment just because of the impact that it can have on AOCI as rates go up. And when we look at the yield, we get holding it in at the Fed. It's not much different than what we can invest in. And so just given the uncertainty of the cash flows and how long they might be around, we'll kind of hold them more overnight while we wait for things to settle down.

Okay. Thanks for taking my question.

Our next question comes from the line of Bill Carcache of Nomura.

Hi. Good morning. You guys disclosed that 90% of your commercial loans and leases were secured at the end of last year. Can you discuss how you're thinking about the value of the underlying collateral today relative to history, given the unique nature of the pandemic? More specifically, I'm curious whether you can frame how sensitive you think collateral values would be to either a more extended period of social distancing or just what that sensitivity is? Any color around that would be great.

Sure. Obviously, the -- in many cases, the value of the collateral is directly a function of the underlying business operations, right? So, if you think about a hotel and the value that the property, it's as much a function of its ability to generate cash flow from occupancy and so the value of that collateral in the short-term drops. But its ultimate long-term value will be a function of how that particular geography rebounds from the pandemic, and how quickly the occupancy rates come up. And the other thing that you find is -- and we found in the last crisis is, when these values start to drop and people are stressed, new money comes into the system and buys up those properties. Many of our customers are sitting on cash and hoping that some of these property values come down because they'll see it as an opportunity to get good quality assets at a low price. And so there does tend to be a bit of a floor on many of these things, particularly the real estate assets. And so, I guess the thing that is tricky is, in the short term, there could be an immediate reaction. But in the short term, people don't have cash flow problems. It takes them a while to burn through their cash. And then like we said, they access these various programs to bridge them and get them through. And then we see how quickly they come up and what we need to do to keep them going. And so, when we stress the portfolio, we'll stress LTVs and see what happens with their cash flow. And the impact that has on LTVS, and we'll stress their debt service coverage ratio. And we'll look at how far their income has to fall or rates have to go up or any of the above to look at their debt service coverage ratios. And then, when we put those two together. And historically, when we've looked at the portfolios and we put those two things together, we found that a very small percentage of our customers and outstanding dollars are really challenged and severely stressed when both of those things happen together. And so, we've got certain parts of the portfolio that are impacted more than others based on the pandemic. And then within that, there is different geographies that are impacted differently, and then customer-specific situations that are impacted. And so, it's always a work in progress to figure out what the loan to values might be at any given time. The good news is that it takes a while for the losses and for these challenges to emerge. And so what's interesting is the pace of information around society has gotten really fast. But the pace of change in terms of how these things flow through the economy and impact businesses isn't quite as fast. And so it's going to take a while for this to work its way through the system and through the portfolios before you get into a situation where you're really relying on collateral values to try and bail you out. But as you've heard from us before, when we look at many of our statistics about loan to values in our commercial portfolios, they're very low. When we look at loan value to bone, they get even lower. And so from where we sit today, we feel like we've got a lot of room to be able to protect ourselves. But really, that's the last resort. Our first resort is to work with clients to keep them in business, because that's the best outcome for everybody.

That’s really helpful. Thanks so much for taking my question.

Your next question comes from Peter Winter of Wedbush Securities.

Hi, Darren.

Good morning, Peter.

You were talking about the margin. You expect it to be down in the second quarter, but strong loan growth as well. So, do you think net interest income would grow over first quarter levels?

It's the -- I'm hesitating, Peter, not because I'm dodging the question, but more it's the impact of PPP and how that offsets the impact of the decreased margin against the loan growth, right? And so some of the loan growth we saw at the end of the quarter was really nice. We'll see how long those lines remain drawn, but those will create some net interest income in the second quarter compared to the first, maybe helps minimize some of the decrease. And then the other question is those PPP loans. Adding $6.5 million of principal balance is helpful to net interest income. I mean, even though the yield is low, there are some other fees associated with it. And then we get to the question of how long they stay. And then we'll have a full quarter impact of LIBOR on the other side and its impact. So, absent PPP, net interest income is probably moving down, although not quite at the same rate as margin might be, just because of the loan balance growth. And then you add on the -- whatever your estimate is of PPP on top of that, and how long those loans actually stay on the balance sheet.

Your next question comes from the line of Erika Najarian of Bank of America.

Hi, good afternoon. My questions have been asked and answered. Thank you.

Thanks, Erika.

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

Hey, thanks. Darren, just one on the fee side. Can you just talk about two things within that? First of all, how do you expect the residential mortgage business to act relative to the commercial business in terms of this new environment, in terms of revenue generation? And then secondly, can you detail for us what fee waivers might look like in terms of the trust business and what magnitude that might have as an impact? Thank you.

Sure. I should have wrote this down. Remind me your first question again?

Residential versus commercial mortgage banking?

Yes. So, residential is going to see more activity. I think the -- the commercial business, a lot of the way it works is the pipelines take a while to build. And so the second quarter pipeline will be -- or fees will be a function of how the pipeline was before the economic activity slowed down in the stay at home orders or shelter in place orders came into effect. How quickly things start-up? How construction comes online? How many people try to take advantage of rates will be a function of where they are in the back half of the year. And so I would expect the commercial business from a mortgage perspective to be a little tougher, probably won't be near what it was last year, which the third quarter last year was a record quarter for us. On the consumer side, I think the refinancing activity continues, especially with rates where they are. You haven't seen the rates come down for customers as much as they have in the market just because many of the servicers struggle with adjusting the underwriting and staffing to meet demand. And so a lot of times, what happens is the price gets impacted to manage demand. And so you'll see a little bit of benefit and gain on sale there. The other thing that's a little bit of a question is how many people are in some kind of payment deferral or payment relief, because it would be tougher for them to qualify for a refinance when they're under that situation. And so that will take some people off the table right away. But it will keep the mortgage servicing business a little bit longer. And so I would think that, overall the cash flip there, would be more secure and potentially have some more upside as people look to refi and you get the gain on sale component of that. And I would expect that, the gain on sale margins will stay elevated for at least a little while longer, just because of the ability to get folks, on the phones and able to handle the volume that's coming in. When you get to the trust lines or some of the other fees, when you look at some of the other fees and kind of the service charge category, you'll see the impact of interchange and slower economic activity there, as people are out doing less things and drawing on their account less often. You'll see the instance of NSF come down. That tends to be an activity driven fee. And so you see a decrease there. And then you've got the impact of the equity markets on assets under management and those fees. And then depending on how long rates stay low, you've got the impact on the money market mutual fund fees, and not charging there and subsidizing that, so, on the funds maybe it's, $10 million a quarter, kind of impact. If you look at the equity markets, maybe the same kind of thing. And then when you think about the other fees, you're probably in $15 million-ish a quarter, $20 million a quarter, something like that.

Got it. Thanks a lot, Darren.

Your next question comes from Brian Foran of Autonomous.

Hi. I know you said it was early on credit, so I want to recognize that. But I wonder if you could just speak to geography. Unfortunately, New York City and Westchester are kind of ground zero for the virus. And they're big markets for you. As you look out over the next year and again recognizing the uncertainty. But do you expect a materially different credit performance here in New York versus the rest of your footprint?

Sure. So, I guess, if you look at New York City, we got to break down the different components of what sits in New York City and what percentage of the portfolio it is. If you look in the hotel space, it's now 20% of the portfolio. And obviously, it's completely shut down, and there's not a lot of tourism happening there right now. But if you look at those properties and the value of those properties, we would expect those to hold up pretty well through time. They might drop, but the likelihood that they drop below our loan-to-value for any extended period of time, we don't see as a high probability right now. When you think about the multifamily portfolio, I'll go back to where we talked about payments that were made by renters in April, and that the rates of people paying their rent were quite high from kind of 75% of the payments coming in and maybe our average building in terms of quality, if you were to pitch it that way. The higher end buildings, we're seeing payment rates of more in the 90% range. And so, we would expect those folks to stay in good position. We've mentioned a number of times just about the relationships we have in New York and how long they are and how liquid those customers tend to be that those are the ones that oftentimes in these environments would see opportunity as much as they see risk and would look to be buyers as opposed to sellers. And then when I mentioned some of the retail in New York City, you see in retail probably be the hardest hit there and that the rental rates for High Street properties on Madison Avenue and Fifth Ave., they've been under pressure for a while. And so this probably resets those rates lower. But in many cases, when we look at our properties in Manhattan, where it might get classified as retail because of what those rates had been, many of those, if not all of those properties have multiple floors above the first floor retail space. And they would have office or some residential or mixed use. And the cash flow that comes from the upper floors is enough to sustain the property if retail is vacant or is challenged. And so we feel pretty good that we've got the cash flow covered at least in the short term and totally understandable why New York City is a question. Obviously, given our position there, we pay a lot of attention to it and are in constant contact with the customer base. And it's because of that, that I was able to quote some of those numbers about the rent payments that we're seeing. And so we're on top of it. And based on what we can see right now, are confident that the portfolio will be solid like we saw in the last crisis.

Your next question comes from the line of Gerard Cassidy of RBC.

Hi Darren, how are you?

Doing well. How are you, Gerard?

Good. Thank you. Obviously, many of us have been around for a while covering this industry. And we recall back in the S&L crisis that the government got involved and trying to facilitate in solving first being required by healthy savings banks, which ended up turning into a disaster for those savings banks. We then, of course, had TARP in 2008-2009, where the government change the rules on paying back TARP, having to raise capital. What can you -- how can you reassure us, if you can, that the government’s not going to change the rules on all these lending programs next year sometime? And actually work against the banks in some shape, some form? I know it's nobody's planning on that, but can you put in any safeguards to try to insulate yourself from something like that?

Boy, Gerard, you're dark today. You got to get out of your place.

There you go.

Go take a walk or something. I guess, right now, our first priority is trying to help customers. And make sure that we use the programs as we believe they were intended to try and put the money in the hands of our customers to try and keep them open and running and to help keep employment as high as it can be or paychecks flowing, and to help stimulate the economy to make the impact of this pandemic as low as possible for our customers and our employees and our community. If you look at the programs that are out there, many of the programs are repeats from last time. If you look at the health program or you look at the commercial paper program or you look at many of the other programs, they are repeats and have an outcome that's known. So far, we haven't heard anything about TARP or the likes of TARP. And I think if you look at the outcome of the last crisis and you look at the stress test and you look at the capital levels in the industry and amongst us and the peers, we're all starting from a great place when you look at liquidity, which banks are not that difficult to either fail or survive because of liquidity and capital. And so capital is in a good place and liquidity so far is in a good place. And when you think about the moves that everyone is making to preserve both liquidity and capital, I think we're starting from a good place. And so the industry's need to rely on some of these programs like we had to in the last crisis or some of the other ones that you mentioned, is a little bit less. I think as an industry as these programs are being developed by Congress and by the Fed, we're being asked for input. And we're trying to help provide input to make sure that the programs are structured in a way that make them most beneficial to the customer and so that we can help facilitate them. I think this PPP program other than some of the operational and procedural hiccups that happened, is actually a really good program. And that it was thoughtful and that it was designed to be relatively low documentation, but you had to show that you are covering operating expenses, so it was designed to keep you in business. With the FDA guarantee behind us, it's -- it should be helpful. And then with the forgiveness for the outside world, I guess, probably the thing that if you're going to be cynical and worried, you would worry about the documentation aspect of the PPP program and whether there's a change of heart and how that's looked at. I think you could argue that some of the FHA programs and documentation became a bit of a bugaboo for the industry last time around. But I think that's also partly why you saw some banks, us included, not rush out when the program became final on Thursday night, that Thursday, but go out on Monday so that we could take the time to make sure we had a very good process where we could put the documentation in place. And one of the key components of that was BSA-AML. And so I think there's a lot that the industry has learned to try and protect ourselves from those types of things. We're in a better starting place. And at this time, this isn't a financial crisis. This is driven by something else. And so hopefully some of the relationship, we'll call it between the banking system and Washington isn't at a place that it was in some of those other circumstances where you'd see a change of heart. But I don't want to be overly Pollyanna and say that a change in administration in November could change all that, too. So, it's something I think we all got to keep an eye on. But I think we're starting from a better place and are in a more thoughtful place than we would have been an industry going into the last crisis.

And thank you. That does reach our allotted time for Q&A. I would now like turn the floor back over to Don for any closing or additional comments.

Real quickly. I had one question e-mailed to me asking about the bifurcation of the allowance at March 31, consumer versus commercial. I believe that the number we disclosed that with the adoption of CECL was 55% commercial, 45% consumer. It would be a little a couple -- maybe one or two points higher than that today, but not materially different.

Again, thank you all for participating today. And as always, a clarification of any of the items on the call or the news release is necessary, please reach out to our Investor Relations department at area code 716-842-5138. Thank you and good bye.

Thank you. That does conclude today's conference call. You may now disconnect.