M&T Bank Corp
NYSE:MTB
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M&T Bank Corp
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Welcome to the M&T Bank Second Quarter 2018 Earnings Conference Call. It is now my pleasure to turn the floor over to Don MacLeod, Director of Investor Relations. Please go ahead, sir.
Thank you, Maria, and good morning. I’d like to thank everyone for participating in M&T's second quarter 2018 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 and 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, including those found on Forms 8-K, 10-K, and 10-Q, for complete discussion of forward-looking statements.
Now, I would like to introduce our Chief Financial Officer, Darren King.
Thank you, Don, and good morning, everyone. M&T's results for the second quarter represent a continuation of the trends that we've been seeing for the past several quarters. These include, continued growth in net interest income, which was up nearly 8% compared with the last year's second quarter, expenses that remain well controlled, not withstanding the steps we’re taking to redirect savings from the lower tax rate and the higher compensation for certain employees, a credit environment that remain stable with further decline in non-accrual loans and the net charge-off ratio at just 16 basis points for the quarter.
These factors, combined with the impact from capital distributions, consistent with our 2017 CCAR Capital Plan and subsequent resubmissions have led to continued improvement in our returns on both assets and common equity.
As announced in late June, M&T's revised capital plan for the 2018 CCAR cycle received no objections from the Federal Reserve. The plan includes 25% increase in the quarterly common stock dividend to $1 per share, which will be considered by the board this quarter.
The plan also calls for $1.8 billion of common stock repurchases to be completed over the fourth quarter period that began July 1st. The board's stock repurchase authorization record [to implement the buyback plan was announced by means of an 8-K filing yesterday.
Now let's take a look at the specific numbers. Diluted GAAP earnings per common share was $3.26 for the second quarter of 2018, improved significantly from $2.23 in the first quarter of 2018 and $2.35 in the second quarter of 2017. Net income for the quarter was $493 million, also up sharply from $353 million in the linked quarter and $381 million in the year ago quarter.
On a GAAP basis, M&T's second quarter results produced an annualized rate of return on average assets of 1.7%, and an annualized return on average common equity of 13.32%. This compares with rates of 1.22% and 9.15% respectively, in the previous quarter.
Included in GAAP results in the recent quarter were after-tax expenses from the amortization of intangible assets amounting to $5 million or $0.03 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 second quarter, which excludes intangible amortization was $498 million, up from $357 million in the linked quarter and $386 million in last year's second quarter. Diluted net operating earnings per common share were $3.29 for the recent quarter, up from $2.26 in 2018's first quarter and $2.38 in the second quarter of 2017.
Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 1.79% and 19.91% for the recent quarter.
The comparable returns were 1.28% and 13.51% in the first quarter of 2017 – 2018, excuse me. 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.
As a reminder, the year-over-year comparisons for both GAAP and net operating earnings were impacted by the reduction in Federal income tax rates for 2018 and beyond with M&T's current effective tax rate some 11 percentage points lower in 2017. GAAP pretax income in the recent quarter improved by 10% from the year ago quarter, while pretax net operating income improved by 9%.
Recall that both GAAP and net operating earnings for the first quarter of 2018 were impacted by certain noteworthy items. During the first quarter, M&T increased its reserve for litigation matters by $135 million to reflect the anticipated settlement of the Wilmington Trust Corporation shareholder litigation. That increase on an after-tax basis reduced net income by $102 million or $0.68 of diluted earnings per common share.
Also, during the first quarter of 2018, M&T received income of $23 million from Bayview Lending Group, which was included in other revenues from operations. This amounted to $17 million after tax effect or $0.12 per diluted common share.
M&T's results for the first quarter also included a $9 million tax benefit related to accounting guidance for equity compensation. That amounted to $0.06 per diluted common share, while reducing the effective tax rate for the first quarter to 22.99%.
Turning to the balance sheet and the income statement. Taxable equivalent net interest income was $1.01 billion in the second quarter of 2018, up $34 million from previous quarter.
The comparison with the prior quarter reflects an expansion of the net interest margin to 3.83%, up 12 basis points from 3.71% in the linked quarter, combined with the impact from one additional accrual day in the recent quarter.
The primary driver of the wider net interest margin was to further increases in short term interest rates arising from the Fed in March and June rate actions. On top of that, one month LIBOR, the index to which a majority of our commercial loans are tied has maintained a wider than normal spread to the Fed funds target rate, and that wider spread persisted for a longer period than was the case last quarter.
In addition, we continue to experience less deposit pricing reactivity than we have been modeling. We estimate these factors added the benefit to the net interest margin of as much as 12 basis points in 2018 second quarter. Other very modest positive factors were offset by the impact from the additional day linked [ph] quarter compared to the first quarter.
Average loans declined by $360 million or less than 1% compared to the previous quarter. The largest factor in the decline is the continued runoff of the Hudson City mortgage loan portfolio. Putting that aside, other loan categories grew less than 1% in the aggregate.
Looking at loans by category. On an average basis compared with the linked quarter, commercial and industrial loans were up slightly about 1% compared with the linked quarter driven by growth in floor plan balances.
Paydowns by commercial customer continue to be headwind. Commercial real estate loans were effectively flat compared with the first quarter. As noted, residential real estate loans, which are largely comprised of mortgage loans acquired in the Hudson City transaction, continued the expected pace of paydowns. The portfolio declined by some 3% or approximately 13% annualized, consistent with previous quarters.
Consumer loans were up less than 1%. Seasonal strength in recreation finance loans were offset by a slight decline in direct auto loans and the continuation of the long-term trend of declines in home equity lines and loans.
Regionally, we're continuing to see good loan growth in New Jersey, where we are still building out our commercial banking franchise from what was Hudson City's historical thrift business model.
Area surrounding New Jersey, including New York City, Philadelphia and Cherrytown, which in the aggregate comprise our metro region were another area of relative strength.
Average earnings assets declined by about 1% or slightly over $1 billion, which includes the $360 million decline in average loans. Average investment securities declined by $610 million, reflecting our preference to place cash flows received from maturities and MBS principal amortization at the Fed, rather than reinvest into securities in the current rate environment.
Average core customer deposits, which exclude deposits received at M&T's Cayman Islands office, CDs over $250,000 and brokered deposits declined an estimated 1% compared with the first quarter. This primarily reflects a loss of commercial escrow deposits – deposits, excuse me, which we noted on the April call.
In addition, we're seeing some flows of non-maturity deposits in the time accounts, which we would expect at this point in the interest rate cycle and we’re having increasing discussions with our commercial customers about optimizing our cash balances.
Turning to non-interest income. Non-interest income totaled $457 million in the second quarter compared with $459 million in the prior quarter. As noted, the first quarter included $23 million of income from Bayview Lending Group.
Mortgage banking revenues were $92 million in the recent quarter compared with $87 million in the linked quarter. Residential mortgage loans originated for sale were $644 million in the quarter, up about 3% from the first quarter.
Total residential mortgage banking revenues, including origination and servicing activities were $61 million, essentially flat compared to the prior quarter.
Commercial banking – sorry, commercial mortgage banking revenues were $31 million in the second quarter compared with $26 million in the linked quarter, reflecting increased to origination activity.
Trust income was $138 million in the recent quarter, up from $131 million in the previous quarter, and 9% above the $127 million in last year's second quarter. Results from the recent quarter and the year-ago quarter, both include some $4 million seasonal fees earned for assisting clients in preparation of their tax returns.
Service charges loan deposits were $107 million, improved from the $105 million in the first quarter. Gains on investment securities were $2 million in the recent quarter compared with the $9 million loss in the first quarter. This volatility comes as a result of changes in the fair value of our GSE preferred stock, which prior to 2018 had been recorded in accumulated other comprehensive income.
Included in other revenues are certain categories of commercial loan fees, including letter of credit and loans indication fees, which remained somewhat subdued in line with the current commercial lending environment.
Turning to expenses. Operating expenses for the second quarter, which exclude the amortization of intangible assets were $770 million, down from $927 million from the previous quarter. As noted, the first quarter's operating expenses included the $135 million addition to the litigation reserve for the Wilmington Trust Corporation litigation matter.
Salaries and benefits declined by $45 million to $419 million, reflecting a return to more normal levels from the seasonally high levels in the first quarter. Partially offsetting these are the initial actions we've taken to deploy some of the savings from lower tax rates into higher wages for certain employees. This program won't reach his full run rate until the fourth quarter.
Excluding last quarter's addition to litigation reserve, other cost of operations increased by approximately $20 million, which includes higher advertising expense, as well as the cost of legal services arising from the Wilmington Trust litigation.
The efficiency ratio, which excludes intangible amortization from the numerator and securities gains from the denominator was 52.4% in the recent quarter. That ratio was 64% in the previous quarter and 52.7% in 2017 second quarter.
Next, let's turn to credit. Credit quality continues to be in line or even slightly better than our expectations. Annualized net charge-offs as a percentage of total loans were 16 basis points for the second quarter, down slightly from 19 basis points in the first quarter.
The provision for credit losses was $35 million in the recent quarter, which matched net charge-offs. The allowance for credit losses was unchanged at $1.02 billion at the end of June. The ratio of allowance to total loans was also unchanged at 1.16%.
Non-accrual loans were $820 million at June 30th, down from $865 million at the end of the first quarter. The ratio of non-accrual loans to total loans fell by 6 basis points, ending the quarter at 0.93%.
Loans 90 days past due, on which we continue to accrue interest, excluding acquired loans that had been marked to a fair value discounted acquisition were $223 million at the end of the recent quarter. Of these loans, $202 million or 91% were guaranteed by government related entities.
Turning to capital. M&T's common equity Tier 1 ratio was an estimated 10.52% compared with 10.59% at the end of the first quarter, reflecting strong earnings retention during the second quarter net of share repurchases and the impact from the end of period of changed in risk weighted assets. During the second quarter, M&T repurchased 2.6 million shares of common stock at an aggregate cost of $475 million.
Turning to the outlook. Based on second quarter results, our thoughts for 2018 remained largely in line with what we shared on both the January and April conference calls.
To reiterate those thoughts, we had previously signaled that we expect the lending environment for 2018 overall to look much like 2017, with growth in total loans ranging from flat to low single digit pace. We currently believe that loan growth for 2018 will be at the lower end of that range. I'll remind you that the third quarter usually reflects seasonal low balances for dealer floor plan customers.
The net interest margin has widened from the December, March and June actions by the Fed, and the market is expecting one to two additional actions over the remainder of 2018.
Based on the current level of interest rates and reflecting the impact of the interest rates hedges we entered into last year, we continue to estimate that a hypothetical future 25 basis point increase in short-term interest rates should result in a 5 to 8 basis point benefit to the net interest margin.
This also embeds a series of assumptions on resultant deposit pricing reactivity for various deposit categories. So far, deposit pricing reactivity continues to be lower than what we have modeled. Based on those balance and margin assumptions, we expect somewhat better year-over-year growth in net interest income, perhaps beyond a mid single digit range.
Residential mortgage banking activity held up somewhat better than expected with origination volumes helped by the summer selling people. We continue to expect additional improvements in commercial mortgage banking revenues as the year progresses, although we are seeing some pressure on margins there.
The outlook for the remaining fee businesses remained little changed, we continue to expect growth in the low to mid single digit range. Excluding the first quarter's $135 million addition to the reserve for the Wilmington Trust Corporation shareholder litigation, we continue to expect low nominal growth in total operating expenses in 2018 compared to last year.
As noted, the wage adjustments tied to the reduction taxes will reach the new run rate by the end of the year. Our outlook for credit also remains little changed. There are no apparent significant pressures on particular geographies or industries.
As to capital, as I noted at the start of the call, we expect to begin executing the 2018 capital plan. Our estimated 10.52% CET1 ratio at the end of the quarter is still in excess of where we believe is necessary to safely operate the bank over the long-term there is room to continue to bring that ratio down.
Of course, as you're aware, our projections are subject to a number of uncertainties and various assumptions regarding national and regional economic growth; changes in interest rates; political events and other macroeconomic factors, which may differ materially from what actually unfolds in the future.
Now let's open up the call to questions, before which, Maria will briefly review the instructions.
Thank you. [Operator Instructions] Our first question comes from the line of Ken Zerbe of Morgan Stanley.
Great. Thanks. Good morning.
Morning, Ken.
Darren, I was hoping you could talk more about the comment you made, do you guys are having more discussions, I got this right, but more discussions with companies about their excess cash. I mean, does that imply that we should start to see a more meaningful reduction in the non-interest bearing deposits going forward? Thanks.
Sure. So by having those conversations Ken, we're looking at the total balances that our commercial customers have. As interest rates go up, we'll see some movement in earnings credit rates, which means that the excess balances that they have available to them they are looking to invest. I think we'll see those balances go primarily in one or two places. One will be in the sweep products, which could be on or off balance sheet sweeps. And the other place you'll see that go and we're seeing some equity is actually into interest-bearing commercial checking accounts, which are now an available option after the repeal Reg Q during the crisis.
So some pieces we're seeing stay on balance sheet with changes to rates and earnings credit rates. And in other cases, it's moving in to other interest bearing categories, some on balance sheet, some off.
So we probably see a little bit of movement there. We saw a little bit in the second quarter, which is really seasonal. We tend to see commercial balances peak in the fourth and first quarters as they prepare to make distributions and pay taxes.
Those balances tend to come down in the second quarter and then start to build back up in the third and fourth. So we'll see a little bit of those two effects counterbalance each other as we go forward through the year.
Got you. And just aside from the balance changes, if we can't tie into the deposit sort of competition or deposit costs, obviously your deposit base seem very low this quarter.
Yeah…
But given those discussions that you're having, given that from several other banks we've heard talk about sort of increased deposit competition and their need to increase their deposit cost to stay competitive.
I mean, does that - it seems that your NIM expectations are fairly unchanged in terms of the benefit of the 25 basis point rate hike, but can you just tie that, that sort of those expectations in with this presumed expectation that from here it sounds like you're going to have a little more increased pressure on your deposit costs?
Sure. So I think there is a number of factors to consider when going through our balance sheet, Ken. First, we have the run-off in the Hudson City mortgage portfolio. And that right away creates unfortunately $400 million or $500 million a quarter balances that are already funded. So that gives us a little bit of a help on deposit pricing.
Obviously, the deposit relationships are important to us and we'll be competitive on those, and we operate in an environment that is one that is competitive and we'll match what our competition is doing there.
And then we also have the Hudson City time deposit portfolio that continues to run down. And as rates have come up, particularly in the CD space, what's rolling off there is almost price to - what the roll on margins are. So we have the benefit of those not actually pricing up.
So for some of the legacy customers who have lower priced money market accounts, we'll see some of those moving into time accounts, which will put some upward pressure on interest costs. Obviously, the conversation that we just had about commercial customers will put a little bit of upward pressure on deposit costs, but we do have some other offsets, which I think, keep us maybe a little bit below where the industry has been.
But I think the pace that we have been on, which was pretty close to zero, I think we're probably past that and we'll start to see a little bit more reactivity in deposit pricing as we go forward. And that's really the five to eight basis points change that we've been talking about, we've just been running above that so far, probably because that the assets are repriced higher, faster than fed funds. And so far, deposit pricing has been a little bit lower than we expected. So that's where we're still comfortable with that range, and hopefully that makes sense.
It does. Thank you very much.
Our next question comes from the line of John Pancari of Evercore ISI.
Good morning.
Morning, John.
On the - just more specifically on the second quarter margin. Given your commentary around the benefit to the margin this quarter, is there anything about the quarterly progression in the margin in the second quarter that could revert at all to the downtime next quarter, given those factors that you flagged?
Yes. The biggest thing to keep in mind there, John is the LIBOR, right? And the assets, the vast majority of our assets are priced off of one month LIBOR, and for the longest - well, for a lot of this year and in particular, in the second quarter, LIBOR ran well in advance of fed funds.
And so as fed funds catches up to LIBOR or vice versa, that will put pressure on the asset yield. But as long as the fed funds that comes up, then there shouldn't be any problem when this LIBOR comes down and makes a little bit of movement down on the yield on those assets, which might put a little bit of pressure on the margin.
But nothing that would take us outside of that range that we've been talking about for the last couple of quarters.
Okay. And that goes for the loan yields as well, that 22 basis point increase linked quarter, same thing, not really outsized there?
Yes, that's right.
Okay. All right. And then separately, in terms of the balance sheet moves, I know you mentioned the ongoing runoff of the acquired Hudson City resi mortgage portfolio. How much incremental runoff do you expect here? Any change in the expected pace of runoff that you see?
We've been running pretty much at this pace for the last couple of years. And the vast majority that drives that is the normal amortization and paydown activity as opposed to prepayment speed.
So our expectation is that we'll continue to run 12% to 13% annualized run down in that portfolio. But don't forget the dollar amount that runs off will continue to shrink as the portfolio gets smaller.
Got it. And the dollar amount that ran off this quarter was what?
Was just about $600 million.
Got it. Okay. That’s it from me., Thanks.
Our next question comes from the line of Steven Alexopoulos of JPMorgan.
Hey. Good morning, Darren.
Morning, Steve.
Just to start to follow-up on the deposit conversation, given how much you guys have lagged, are starting to see one higher pace pricing as you're having conversations with those commercial customers. And two, are you seeing more widespread pressure just to increase deposit rates across the board that we've seen some other banks to recently?
I think when we look at our deposit portfolio and what's going on, it's very customer-specific and somewhat nuanced. So for balances that are municipal deposits, and some of them are mortgage escrows that we talked about, those have generally been tied to fed funds or some market level and have always moved pretty much 100% reactive with those changes, and in some cases might have been more.
And when we talk about those commercial mortgage escrow balances that ran off, they were fairly richly priced, and we can replace them for an equal spread, maybe even slightly less, which is why we're okay with that.
When you get to some of the commercial customers as rates are moving up, as we mentioned, we're seeing more attention being paid to how those balances are earning a return for corporate customers and treasurers.
And obviously, we continue to see larger balanced customers, notably wealth and private banking types of customers very focused on the return they're getting. And those prices have been moving, and I would describe us as pretty much in lockstep with where the market is going.
When you get to a more consumer type of balances, we obviously, we've had that Hudson City time deposit, which really helped us manage the total cost of deposits over the course of the last, I would say, 18 months. And we're at a point now where those 2 rate curves have started to cross, if you will.
With the Hudson City rates coming down and the non-Hudson City rates going up, kind of matched each other. And so we'll stop seeing a decrease in Hudson City, but we don't expect to see a massive increase.
Most of our action in the consumer portfolio has really been in time accounts. And for us and I think pretty much the industry, the consumer still tends to be short in how they are managing their interest rate that they are earning. Mainly because once you get past two years on the CD rates, the incremental earnings you're getting don't really compensate the tieing up your money for the incremental time, and so most of the action has been 2 years and below, really around 1 year. And when we look at our money market rates, our rates are very competitive with those in our markets.
So as mentioned before, I think, we'll start to see a little bit more, but consistent move up in deposit pricing as we go through the rest of the year and into next year. But when we look at the path that we're on and what's happening in the market, we don't foresee a massive spike in one or two quarters. It will be more consistent through time.
Okay. That's helpful. If I can ask you one separate question. Look at C&I loan growth balances, they are basically down over the past year. We think about what business confidence has done, the economy has been really well, you have tax benefits. Just want a big picture of you, why are you not seeing stronger C&I loan growth here?
So Steve, it's a great question. It is - really there's two trends that are going on underneath that are a little bit masking each other. When we look at our origination activity, both last year and this year in the first half, well, in 2017 we were down in originations from '16, but '16 was a blockbuster year.
2018 over '17 is up about 6% to 8% in terms of our originations. What we've seen, and we saw at the back half of '17 and we've seen again in '18 is just an increased level of paydowns and payoffs. And in the C&I space, when we look underneath that what's going on, the vast majority of it is driven by merger and acquisition activity, sometimes facilitated by private equity, sometimes not.
But as customers who are selling their business entirely or selling parts of their business and then taking those proceeds and paying down their loans. So the optimism in the economy does seem to be there, albeit maybe not quite as great it was in 2016, but '18 is better than '17. It's just being masked a little bit by some of the other things that are happening in the economy with the M&A activity.
Got you. Okay. That’s great color. Thanks, Darry.
Sure.
Our next question comes from line of Peter Winter with Wedbush Securities.
Good morning.
Morning, Peter.
I'm just looking loan-to-deposit ratio has increased 98% now. Just wondering what your thoughts on deposit growth going forward?
Well, the loan-to-deposit ratio obviously is a measure that we pay a lot of attention to. I'll say again, that one thing that helps the loan-to-deposit ratio is the Hudson City mortgages that runoff, right? So those create room to replace them with commercial loans, either real estate or C&I without affecting the loan-to-deposit ratio.
And then obviously, we're paying attention to our deposit book, watching how customers are moving balances between categories and looking at other categories that we can grow in, things such as brokered money market and brokered CDs is another place where we can help manage that one.
It's certainly, something that we pay attention to, and we'll be watching through time. And obviously, we'll be paying attention to both sides of the balance sheet, both the loan and our deposits.
Okay. And then just a follow-up [indiscernible] question, but you updated the guidance on the loans coming in more at the lower end of that flat to low single digit. But is there a risk that loans could decline just given you've got that seasonality in the third quarter?
I guess, when you look at both, I guess, think about the back half of the year. There is potential for a little bit of a decline in the third quarter on an average basis, just because of the auto dealer loans, but fourth quarter is usually pretty strong, and we tend to see big upticks in the fourth quarter and those two should cancel themselves out.
Now where June ended was pretty decent, and so far it seems to be holding up into the third quarter. So it's way too early to declare victory there, but it's off to a good start. And then really the wildcard that we've been signaling for the last few quarters is just the rate of paydowns and payoffs.
And that's really hard to predict, and that would be the risk to seeing that -- to seeing some average decline. But we feel good because the pipeline that we ended the second quarter was equal to or slightly better than where we ended the first quarter. So I see a couple of pros and cons.
I guess, we've been signaling this kind of balance sheet growth really since December. And we still feel pretty good about it. There's nothing that I see where I envision us being 3% or 4% growth. But in the current period I don't see 3% or 4% decline either, I think we should be right around that flat to slightly up range.
Okay. Thanks, Darren.
Our next question comes from the line of Gerard Cassidy of RBC.
Hi, Darren.
Morning, Gerard.
Can you carve out for us, if you could take only kind of special issues that you have, and you talked about Hudson City portfolio and then the escrow deposits and stuff? So if you just kind of take those away, what was the core deposit and loan growth on a year-over-year basis would you estimate for you guys this quarter?
So if you take out the Hudson City runoff and you look at all the other loan categories, the average asset - the average loan growth was probably about half to 1%. And if you look at deposits and you factor out the Hudson City runoff, which is a little bit lower, probably deposit growth was flat to down half a percent mainly due to those commercial mortgage escrow balances that we talked about. So those were couple of large things.
Underlying trends, when we look at our consumer accounts and consumer growth, it's pretty steady. You will notice in the other costs that some of those expenses were up, and some increased advertising, which is driving some increased volume in consumers, which doesn't translate immediately into balances, but will generate balances through time as well as fees as those customers activate their debit cards and credit cards and start using them.
And solid growth in our small business customer base, which is one of our core strengths. And then continued movement in commercial customers, we'll just see as we talked about through time probably a slightly different profile of their balances as the mix between what stays in operating accounts or DDA versus what goes into an interest checking versus what goes into sweep. I think we'll start to see some shifts as we go forward.
But underlying core, when we talk just about customers and the balance sheet, we feel really good about where things are.
Very good. And then you guys have been very successful in years past in making acquisitions. I recognize they are episodic, and recognize that you guys tend to be more of a, I don't want to say distressed buyer, but you certainly don't get involved in auctions.
Can you just give us an outlook of what you're seeing on an M&A front? Has your views changed on mergers and acquisitions now that RenA [ph] is at the helm? And just maybe an update of that outlook?
Sure. Well, RenA [ph] is at the helm now, but certainly, an architect of all of the acquisitions we've done in the past. So I'm pretty positive that the stock process can change as the title change.
But our thoughts on acquisitions haven't really changed Gerard, and that we always start with the returns. And in fact that's pretty much how we think about the bank and our shareholders capital. And we think about returns when we're investing in loans, when we're investing in technology, when we're investing in other institutions, and that's really the primary driver.
And if we think there's a combination that makes sense, where we can create value for both sets of shareholders and we've got willing [ph] seller, then we're interested in talking to those folks.
What seems to be the case in banking right now is everyone wants to be a buyer and no one wants to be a seller. So I think there is lots of interest in partnerships, but I think everyone thinking that they are the buyer and not the seller. And I think that's why you're seeing some slower activity than you might expect given some of the changes that have come out recently with the regulations.
Great. Thank you.
Our next question comes from the line of Saul Martinez of UBS.
Hey. Good morning, guys, a couple of questions, just some follow-ups on the commercial environment. Darren, any sense at all that trade friction, geopolitics is hitting sentiment from some of your - hitting sentiment for some of your commercial clients, even those who aren't necessarily involved there in international trade?
I think the short answer is, yes. I think anytime the environment, there is uncertainty in it. It just causes a little bit of inactivity and paralysis. But it's not widespread. It's depending on who really is impacted by those changes. Many of our customers, given our geographies, do trade across borders and can be impacted by, but in different ways depending on whether their imports are finished goods or raw material.
And then obviously, there is many of our customers who aren't directly impacted by, but could be because of big employers in the economy where they operate. It's certainly something that's on their mind from our discussions with the customers. I wouldn't say it's overwhelming them, and that they are obsessing about it.
But it's just the next thing that's on the back of their mind as they think about their business. And for us, the best thing that can happen in any of these environments is just that we have some period of stable certainty or at least as close to as we can get, so people can focus on their business.
And what -- I mean, is it -- do you think it's impacting utilization rates or anything like that? Or is it just sort of not top of mind, but something that folks should be thinking about?
I think it's not top of mind, but definitely on their mind. And again, I think it varies. I would say, we've definitely seen some slight upticks in utilization this year, and we tend to see people focus as much or more on borrowing or working capital, and for M&A types of things as opposed to for CapEx. We have seen a slight increase in CapEx, but really when we look at where the activity is, that's not the place where we've seen it so far.
Okay. Got it. And I think just switch gears a little bit, I think, in the past you've been a bit skeptical of a national digital banking strategy. And then the number of your competitors have talked about that, and launching national digital bank.
But any evolution in your thoughts on that? Whether it would make sense to the client acquisition tool or deposit gathering tool?
To be honest with you, it's really not been something that's been at the top of our list of ways to gather deposits. But if we need to move pricing, we can do that with our existing customers and bring back some of the balances that maybe they don't have at M&T.
And that we can grow balances within our footprint without eating that extra funding source, where generally our experience have been those customers are incredibly rate-sensitive and also not likely to become full relationship customers.
And when you look at M&T and how we've always gone to market and the value we bring, it's been bringing the whole bank of our customers to help solve their needs, whether they are individuals, whether they are small business or whether they're commercial customers, and that's really been and continues to be our focus.
Okay. Great. Thanks a lot.
Our next question comes from the line of Matthew O'Connor from Deutsche Bank.
Hey, guys, There is actually Ricky for Matt. So a quick question on the Trust business. It was a strong quarter, that's great. I was wondering if you can give more color on sort of what drove...
I'm sorry, could you speak up a little bit, Ricky, you're a little faint coming over.
Okay. Can you hear me now?
Perfect. Thank you.
Just a question on the Trust business, I wonder if you can give a little more color on what drove the strength year-over-year? And then how much of an uptick linked quarter was from the seasonal tax fees?
So I'll answer the second one first. $4 million is approximately the increase from first quarter in tax fees, which is also pretty consistent with the increase we saw in the second quarter of 2017 over the first quarter.
When you step back and you look more broadly at Trust fees, there's really two primary drivers going on there. One is, we continue to grow assets under management by adding new customers.
And the other is existing balances are enhancers capital markets move up. It's probably two thirds, one thirds new customers versus capital markets, but both things have been working in our favor. And that's what drove those increases.
Our next question comes from the line of Ken Usdin of Jefferies.
Hi, good morning, This is actually Josh on for Ken. So you guys hold to your guide for low nominal expense growth for this year. But could you help us think through what that implies for the second half?
For the second half, is your question for the second half in relation to the first half?
Yes, my question is based on, I mean, year-over-year growth for this quarter was around 3.5% over the previous 2Q. So I guess, that would imply deceleration of year-over-year growth in the second half. Am I thinking about that correctly?
Yes. So I think you got to look at the total expenses for the year. And when we give the total expenses for the year, that includes the compensation costs in the first quarter of both years. So typically the second half expenses are lower than the first half just because of the seasonal comp expenses that happen in the first quarter. This year, the first quarter was also elevated because of the litigation reserve increase that we had of $135 million.
And I think the whole -- if you take out the litigation and you take out the comp costs, seasonal comp costs, you're probably up 1%. There's some other factors that are in our other cost of operations in the first half. One of the big ones is legal expense, and that was related to the defense of the Wilmington Trust Corporation matter.
And while those should come down in the second half, I am not sure that will be completely eliminated as that goes through the sentencing and appeal process. So there would be a little bit of expense in there. But some of those factors are why we think the total guidance still makes sense for full year to full year.
Okay. Got it. And could you talk through of how you're thinking about layering in additional swaps as we move through the rate cycle?
The swaps that we have on and that we look at, we kind of watch quarter-to-quarter. And when you look at where we've been, we've kind of been 2 years out. And as we've gone through time, the original swaps that we're on when they got to about 18 months remaining on them, we extended them another 6 months. But really, we're trying to just take some of the volatility that can come in our net interest margin, net interest income off the table, and also protecting a little bit of the downside.
How much we do in swap activity going forward will also be a function of how well or how fast the deposit's repriced, because at some point as the deposits price up, that reduces some of that asset sensitivity, we don't need the swaps to take that off the table. So we're kind of looking at how deposits are repricing, how the balance sheet is shifting and the mortgage is paid down. Those things combined give us -- we'll be looked at when deciding what swap activity we might choose to engage in.
Got it. Thanks for your time.
Sure.
Our next question comes from the line of Erika Najarian of Bank of America.
Hi, good morning.
Morning.
I just had a few follow-up questions. Darren, you mentioned during the prepared remarks that the wider spread between LIBOR and fed funds and the outperformance of deposit pricing was 12 basis points the margin. And I'm wondering, as we look forward, you have been recently beating that 5 basis points to 8 basis points range. Could you break down how much of that 12 basis points is due to the LIBOR and fed funds spread versus the outperformance on the deposit side?
So when you look at the 12 basis points, Erica compared to our 5 basis points to 8 basis points, we break it down that of the 12 basis points -- of the difference of 4, probably 3 is LIBOR and may be an additional 1 is because of just lower-than-expected deposit reactivity. When we quote the 5 basis points to 8 basis points, one of the things that drives that range is the pace of deposit reactivity. So deposit reactivity is already kind of built into that guidance.
And really what we've seen for the last couple of quarters is really that one month LIBOR move much sooner than the fed funds, and what we've traditionally seen and what we model, and then just a little bit less deposit reactivity than what might be included in that 5 basis points to 8 basis points.
Including that 5 basis points to 8 basis points, what is the deposit reactivity that you have embedded in there relative to your experience today?
Well, the reactivity we have embedded in there, obviously given where we're going is higher than what we've experienced in the last couple of moves. But the reactivity when we build that up is actually done by deposit category by 25 basis point increment. So when you look at what that's been by category, some categories performed very close to what we expected, like the government balances and some of the mortgage escrow balances.
And when you look at some of the consumers, those have been less. When we look kind of through-the-cycle, what have we experienced in the past, probably 40% to 60% reactivity. Obviously, so far the cycle we've run well below that. But over the long-term, that's probably where we'd expect to run.
But just wanted to clarify, if I think about the overall deposit base, what is embedded in that 5 to 8 basis points? Is that you're already within that through-the-cycle range of 40% to 60%?
No, no. We're running below that. And you can kind of see that in the news in the deposit rates year-to-date.
No, no. Of course. I guess, I was just trying to understand what was in guidance; whether or not, just because it seems like that, that 5 to 8 basis points is relatively conservative outlook relative to what we've seen over the past few quarters.
And so, I guess, what the Street has been getting wrong is perhaps the reactivity on the deposit side. So as we think about taking that guidance forward and taking into account everything that you said about deposit pricing going forward by category, is what's embedded in that 5 to 8 basis points?
An assumption that we're near to through-the-cycle cumulative range? In other words, if we don't believe that we're going 40% to 60% next quarter, then you could outperform the 5 to 8 basis points?
Yes. So when you look at where the -- what the deposit reactivity is, that's in those assumptions that we included in the K and the Q. You're probably closer to the bottom end of that through-the-cycle estimate, and we've been running a little bit ahead of that. Until recently, I think you've seen that pace start to pick up. So we would expect on a go-forward basis that we'd be closer to that 5% -- 5 to 8 basis point range.
The other thing to keep in mind in there is, we brought that range down a little bit because of some of the hedging activity that we had done that we had some caps and some fluids and that the caps would reduce some of the upside as the rates went higher.
And then the other thing that can kind of cause some moment from quarter-to-quarter just in the rate is Trust demand deposits. And as those come on and off the balance sheet, they can cause that net interest margin to move 2 to 3 basis points up or down depending on whether those balances are coming on or off.
Got it. Thank you.
[Operator Instructions] Our final question will come from the line of Brian Klock of Keefe Bruyette & Woods.
Hey. Good morning, guys.
Morning, Brian.
Darren, I got on a little late. So it's -- I guess, wanted the detail on the expense questions. You can just, I guess, give me your read about it [indiscernible] On the expense side, Darren, the other costs, so both the advertising and marketing and the other miscellaneous expenses were a little bit higher than the adjusted sort of third quarter and the other and then just the advertising quarter-over-quarter was a lot higher than normal.
So I know there was a question earlier as far as the second half of the year, so it feels like that those two lines probably should normalize a little bit for the next 2 quarters. Does that make sense?
Yes. So I guess, if you look at the 3 kind of big categories where there was some moment this quarter, salaries and benefits was one of them. And now, we've talked about -- we signaled in January that increase that would start to show up, and it started to show up this quarter, it will continue a little bit into the third and fourth quarters before it reaches kind of a more normalized run rate.
Advertising and promotion tends to be a little bit back-end loaded in the year, and that for us the sales cycle really is February to November. And that things slow down a bunch in December and January. And so the rate that we saw this quarter is probably more typical of what you can expect in the second and third-- sorry, in the third and fourth quarters of the year.
And then in other, there is little bit of, I wouldn't call it onetime, because I don't want misstate it, but things that shouldn't repeat themselves at the same rate, namely, some of the legal expenses that we incurred in getting to the settlement with the Wilmington Trust Corporation matter, we don't know that they would go all the way to zero as we go through the back half of the year, because there will probably still be some sentencing and appeal procedures that will require some expense. But we do expect those to be down somewhat from where they were in the second quarter.
Got it. Okay. So it would make sense to think about maybe a third quarter or the fourth quarter, if you look at your guidance, and I think your nominal year-over-year expense growth adjusting for litigation expense in the first quarter, they're like a 2% year-over-year growth rate, but that's on rate when you say nominal?
Yes. Probably, 2% to 3%.
Okay. So the 2%, it looks like the third and fourth quarter should be lower than the second quarter, I think that's what you mentioned on earlier -- answer to an earlier question?
In that range, yes. Move around a little bit maybe third and fourth, but certainly, when you look at the second half to the first half, in aggregate, the second half expenses should be less just because of the seasonal comp and the onetime litigation. If you take those out, probably it will be pretty close to one another.
Okay. Another question just on the FDIC surcharge. I'm not sure if you talked about it yet, but is there any assumption that this is getting closer to being fully funded now? And it seems like it could grow in the fourth quarter, is that in your guidance at all or is that something…
A great clarification, Brian. We've assumed that, that will go in the fourth quarter.
Okay. So it's about like $10 odd million a quarter, that's the surcharge?
Roughly. Yes.
Okay. And then last question, sorry to run it again, if you answered that, I apologize, but you guys did take some of the tax benefit and increased some wages, is that something that's still going to impacting the third quarter? Or is it in the run rate yet or is it still something that might be in the run rate into the...
It's something that has started to work its way into that line and you will continue to see some movement up there in the third and fourth quarter. And we expect that the fourth quarter run rate will be fully reflective of those changes that are happening.
Okay. And just last question, I promise, can you remind me just how much that is for the full year impact, like $25 million?
On a full year basis, we think it's $20 million to $25 million, probably half of that may be slightly less than half of that in the second half of this year.
Great. Thanks for your time. Appreciate it.
Sure.
That was our final question. I'd now like to turn the floor back over to management for any additional or closing remarks.
Again, thank you all for participating today. And as always, if any clarification on any of the items on the call or news release is necessary, please reach out to our Investor Relations Department at area code (716) 842-5138.
Thank you, ladies and gentlemen. This does conclude M&T Bank's second quarter 2018 earnings conference call. You may now disconnect.