M&T Bank Corp
NYSE:MTB
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M&T Bank Corp
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Welcome to the M&T Bank Third Quarter 2022 Earnings Conference Call. All lines have been placed on listen-only and the floor will be opened for questions following the presentation. [Operator Instructions] Please be advised that today's conference is being recorded.
I would now like to hand the conference over to Brian Klock, Head of Markets and Investor Relations. Please, go ahead.
Thank you, Gretchen, and good morning. I'd like to thank everyone for participating in M&T's third quarter 2022 earnings conference call, both by telephone and through the webcast. If you have not read the earnings release we issued this morning, you may access it, along with the financial tables and schedules by going to our website, www.mtb.com. Once there, you can click on the Investor Relations link and then on the Events and Presentations link.
Also, before we start, I'd like to mention that today's presentation may contain forward-looking information. Cautionary statements about this information, as well as reconciliations of non-GAAP financial measures are included in today's earnings release materials, as well as our SEC filings and other investor materials. These materials are all available on our Investor Relations webpage, and we encourage participants to refer to them for a complete discussion of forward-looking statements and risk factors. These statements speak only as of the date made, and M&T undertakes no obligation to update them.
Now, I'd like to turn the call over to our Chief Financial Officer, Darren King.
Thank you, Brian, and good morning, everyone. As we reflect on the past quarter and the first nine months of the year, we're pleased with the progress we have made executing on the plans we laid out in January.
Through the first three quarters of the year, we have been actively putting our dry powder to work. We deployed $6 billion of cash into net investment securities growth, investing at consecutively higher yields, thereby limiting the impact on accumulated other comprehensive income, and at the same time, we began to rebuild our derivatives hedging portfolio.
Excluding the impact of the acquired loans and PPP loans, we've grown commercial and industrial loans by $3 billion, consumer loans by about $640 million, while the $2.8 billion decline in CRE balances reflects our decision to serve our commercial real estate customer base in a slightly different way.
All of these efforts have led to a reduction in our asset sensitivity, helping to protect our net interest margin from future rate shocks and making our balance sheet more capital efficient.
In terms of capital, we restarted common share repurchases in this year's second quarter and have now repurchased $1.2 billion in common stock, representing 4% of outstanding shares. And we closed the acquisition of People's United Bank and began the process of integrating this valuable franchise.
Looking back through the first nine months of this year, this hard work has translated into strong financial results. We generated positive operating leverage and 27% growth in pre-tax pre-provision net revenue. And the trend has grown stronger each quarter as we generated pre-tax pre-provision net revenue of more than $1 billion in the third quarter of this year, representing 9% positive operating leverage compared to the linked quarter.
Tangible book value per share has also remained relatively stable during 2022, despite the rising rate environment and the impact that can have on accumulated other comprehensive income. We ended the third quarter with a CET1 ratio of 10.7%, which exceeds the median peer bank level by a wide margin.
But our work is not done. We continue on the path set out at the beginning of this year to build a more capital-efficient, less asset-sensitive balance sheet that will produce predictable revenue and earnings. A key element of our plan is to recognize the value created from the combined franchise. We're excited about our expanded footprint and the benefits that our combined company can bring to our shareholders, customers, employees and communities.
Now, let's review our results for the quarter. Diluted GAAP earnings per common share were $3.53 for the third quarter of 2022 compared with $1.08 in the second quarter of 2022. Net income for the quarter was $647 million compared with $218 million in the linked quarter.
On a GAAP basis, M&T's third quarter results produced an annualized rate of return on average assets of 1.28%, and an annualized return on average common equity of 10.43%. This compares with rates of 0.42% and 3.21%, respectively, in the previous quarter. Included in GAAP results in both the second and third quarters, were after-tax expenses from the amortization of intangible assets amounting to $14 million or $0.08 per common share.
Pre-tax merger-related expenses of $53 million related to the People's United acquisition were included in these GAAP results. These merger-related charges translate into $39 million after-tax or $0.22 per common share.
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.
M&T's net operating income for the third quarter, which excludes intangible amortization and merger-related expenses, was $700 million compared with $578 million in the linked quarter. Diluted net operating earnings per common share were $3.83 for the recent quarter compared with $3.10 in 2022 second quarter.
Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholders' equity of 1.44% and 17.89% in the recent quarter. The comparable returns were 1.16% and 14.41% in the second quarter of 2022. In accordance with the SEC's guidelines, this morning's press release contains a reconciliation of GAAP and non-GAAP results, including tangible assets and equity.
Next, we'll look a little deeper into the underlying trends that generated these results. Taxable equivalent net interest income was $1.69 billion in the third quarter of 2022, an increase of $268 million or 19% from the linked quarter. The increase was driven largely by approximately $250 million of impact from higher rates on interest-earning assets, inclusive of the effect of interest rate hedges. Also an $8 million increase from one additional day in the quarter and a $6 million increase in interest received on non-accrual loans.
The net interest margin for the past quarter was 3.68%, up 67 basis points from 3.01% in the linked quarter. The primary driver of the increase to the margin was higher rates, which we estimate boosted the margin by 55 basis points. In addition, the margin benefited from a reduced level of cash held on deposit with the Federal Reserve which we estimate added 10 basis points. All other factors added two basis points to the margin.
Next, let's discuss the average loan balance trends during the quarter where you'll be able to see the progress we continue to make transitioning to a more capital-efficient balance sheet.
Average loans and leases were $127.5 billion during the third quarter of 2022. The essentially unchanged with the linked quarter. Looking at the loans by category, on an average basis, compared with the second quarter, commercial and industrial loans and leases increased $504 million or 1% to $38.3 billion, with $458 million or 2% growth largely coming from core commercial banking clients and $353 million or 17% growth in average dealer floor plan balances. This growth was partially offset by a decrease of approximately $304 million in PPP loans.
Excluding PPP loans, total average C&I loans and leases grew by $808 million or 2% quarter-over-quarter. PPP loans ended the third quarter at only $168 million and are not expected to have a material impact on loan growth going forward.
With the People's United acquisition, we have two new business lines that impact our balance sheet. Growth in average equipment financing continues to be solid, growing $165 million or 3% sequentially. However, this growth was offset by a $171 million or 13% decline in average mortgage warehouse line usage.
During the third quarter, average commercial real estate loans decreased by $946 million or 2% to $46.3 billion. Permanent commercial mortgages and construction loans equally contributed to the decrease.
Our construction exposure continues to decline as projects reach completion and the decline in the permanent commercial mortgages is due in part to converting some of these loans into off-balance sheet financing facilitated by our M&T Realty Capital Corporation subsidiary.
Residential real estate loans increased $201 million or about 1% to $23 billion, due to the continued retention of new originations that we hold on the balance sheet for investment, partially offset by normal amortization.
Average consumer loans were up $167 million or about 1% to $20 billion. Recreational finance loan growth continues to be the main driver of growth. These average loans grew by $303 million or 4%. That growth was partially offset by a $236 million or 5% decline in average auto loans.
Average earning assets, excluding interest-bearing cash balances, which is inclusive of cash on deposit at the Federal Reserve increased $1.5 billion or 1% and due largely to the $1.6 billion increase in average investment securities.
During the quarter, we completed various balance sheet restructuring actions to optimize the funding base of the combined bank. These actions utilize some of the excess cash available and resulted in a decrease in deposits. We expect cash balances to remain relatively stable into the end of this year.
Average interest-bearing cash balances decreased by $8.9 billion to $30.8 billion during the third quarter of this year, due largely to the decline in deposit balances and the cash deployed to purchase investment securities. Average deposits decreased by $7.4 billion or 4% compared with the second quarter.
The decline in deposits reflect the impact of market conditions and planned balance sheet management actions. Some of these, include; a $1 billion decline in escrow and mortgage warehouse related deposits, reflecting lower levels of activity associated with the rising rate environment. $600 million reduction in trust demand deposits resulting from lower levels of capital markets activity compared with the second quarter; there was a $1 billion planned reduction in non-core high-cost deposits; and a $1.6 billion reduction in municipal average balances as customers pay down lines and shifted to paying off some higher-yielding higher balance products.
$1 billion in commercial mortgages was a reduction of $1 billion in commercial balances as customers move to off-balance sheet sweep as well as a reduction in line utilization. And $2 billion in lower time deposit balances and other rate-sensitive products.
Customer operating account balances have stabilized. Average non-interest-bearing deposit balances declined 2% during the third quarter of this year. However, these deposit balances grew by $648 million or 1% on an end-of-period basis.
Turning to non-interest income. Non-interest income totaled $563 million in the third quarter compared with $571 million in the linked quarter. Mortgage banking revenues were $83 million in the recent quarter, unchanged from the linked quarter.
Revenues from our residential mortgage business were $55 million in the third quarter compared to $50 million in the prior quarter. Residential mortgage loans originated for sale were $47 million in the recent quarter compared with $77 million in the second quarter.
Both figures reflect our decision to retain a substantial majority of the mortgage originations for investment on our balance sheet. Commercial mortgage banking revenues were $28 million in the third quarter compared with $33 million in the linked quarter, that figure was $50 million in the year ago quarter.
Trust income was $187 million in the recent quarter, down 2% from $190 million in the second quarter. The decrease was due largely to the impact of lower market valuations on assets under management and assets under administration.
In addition, recall that the second quarter included $4 million in tax preparation fees, which did not recur in the recent quarter. These declines were partially offset by an incremental $5 million and recapture of money market fee waivers. These fee waivers are now fully recaptured.
Service charges on deposit accounts were $115 million compared with $124 million in the second quarter. The decline primarily reflects the waiver of service charges in September on acquired customer deposit accounts.
Turning to expenses. Operating expenses for the third quarter, which exclude the amortization of intangible assets and merger-related expenses were $1.21 billion compared to $1.16 billion in the linked quarter. The increase was due largely to higher salary and benefit costs resulting from one additional business day and the investment in talent that -- in an investment in our talent that affected approximately half of our organization as well as increased incentive accruals tied to improved bank performance.
We also saw an increase in FDIC insurance expense, reflecting the impact of acquired loans deemed to be criticized. The efficiency ratio, which excludes intangible amortization and merger-related expenses from the numerator and securities gains or losses from the denominator was 53.6% in the recent quarter compared with 58.3% in 2022 second quarter and 57.7% in the third quarter of last year.
Next, let's turn to credit. Despite the supply chain disruptions, labor shortages and persistent inflation, credit remained stable. The allowance for credit losses amounted to $1.88 billion at the end of the third quarter, up $52 million from the end of the linked quarter. In the third quarter, we recorded a $115 million provision for credit losses compared to $60 million in the second quarter.
Note that this amount in the second quarter excludes the $242 million so-called CECL double count provision related to the non-purchase credit deteriorated acquired loans. Net charge-offs were $63 million in the third quarter, compared to $50 million in this year's second quarter.
The reserve build was largely due to changes in economic assumptions included in our reserve methodology as well as growth in our consumer portfolios. As forward interest rate curves were adjusted to reflect the rising interest rate environment, the baseline macroeconomic forecast experienced a deterioration in the third quarter for those indicators that our reserve methodology is most sensitive to, including unemployment rate, GDP growth and residential and commercial real estate values.
Non-accrual loans decreased to $2.4 billion, compared to $2.6 billion sequentially. At the end of the third quarter, non-accrual loans represented 1.9% of loans outstanding, down from 2.1% at the end of the linked quarter. As noted, net charge-offs for the recent quarter amounted to $63 million. Annualized net charge-offs as a percentage of total loans were 20 basis points for the third quarter, compared to 16 basis points in the second quarter.
Loans 90 days past due, on which we continue to accrue interest, were $477 million at the end of the recent quarter, down from $524 million sequentially. In total, 89% of those 90-day past due loans were guaranteed by government-related entities.
Turning to capital. M&T's common equity Tier 1 ratio was an estimated 10.7% compared with 10.9% at the end of the second quarter. The decrease was due largely to the impact of the repurchase of $600 million in common shares, which represented 2% of outstanding stock.
Reflecting the common share repurchases, tangible common equity totaled $14.6 billion, a decrease of 3% from the end of the prior quarter. Tangible common equity per share amounted to $84.28 down $1.50 or 2% from the end of the second quarter.
Now, turning to the outlook. With three quarters in the books, we'll focus on the outlook for the fourth quarter relative to this year's third quarter. First, let's take a look at the outlook for the balance sheet. We continue to expect to grow the investment securities portfolio by $2 billion in the final quarter of this year. Keep in mind, this cadence could accelerate or slow depending on market conditions and customer loan demand.
Turning to the outlook for average loans. We expect average loan and lease balances to be largely in line with the third quarter average of $128 billion. We expect growth in average C&I, residential mortgage and consumer loans and anticipate a slight decline in average CRE balances sequentially.
As we look to the income statement, we're excited about the continued growth in pre-tax pre-provision revenue in the fourth quarter. Fourth quarter net interest income is expected to be $1.9 billion, plus or minus $25 million. The variability in this guidance reflects the uncertainty of the speed of interest rate hikes by the Fed as well as the reactivity of deposit pricing and the deployment of excess liquidity and loan growth.
Turning to our fee businesses, we expect fourth quarter fee income to be essentially flat compared to the third quarter. We anticipate operating expenses which exclude both merger-related costs and intangible amortization. We expect them to also be flat from the third quarter. We do expect a further realization of merger synergies to be reflected in a decline in the salary benefit line. However, we expect this decline to be offset by elevated professional services and advertising and promotion costs as we continue to work to integrate both franchises and to introduce M&T to our new markets.
Turning to credit. We continue to expect credit losses to remain well below M&T's legacy long-term average of 33 basis points. For the fourth quarter, we estimate that net charge-offs for the combined company will be in the 20 basis point range. Our provision follows the CECL methodology, which is heavily dependent upon macroeconomic assumptions. Any change in our allowance for credit losses would be reflective of any changes in the economic outlook and their assumptions.
Turning to capital. We believe the current level of core capital exceeds that needed to safely run the combined company and to support lending in our communities. We plan to return excess capital to shareholders at a measured pace. M&T's common equity Tier 1 ratio of 10.7% at September 30, 2022, comfortably exceeds the required regulatory minimum threshold, which takes into account our stress capital buffer, or SCB.
We anticipate ending this year with a CET1 ratio slightly above the 10.5% range we have been targeting previously. With a solid starting CET1 ratio, and the potential to generate additional amounts of capital over the next years, we do not expect to change our capital distribution plans. We anticipate continuing to repurchase common shares at the pace of $600 million per quarter under our current capital plan.
All right. Now let's open up the call to questions before which Gretchen will briefly review the instructions.
[Operator Instructions] We'll take our first question from Ebrahim Poonawala from Bank of America.
I guess just some…
I think you're on mute, sir.
Thank you. Good morning.
Good morning.
I guess maybe just, Darren, talk about NII a little bit. Obviously, I think third quarter was a little shy of expectations, fourth quarter seems in line. As we think about the outlook from 4Q onwards, how do you see NII growing from there into 2023, given your outlook on the balance sheet, should we expect a steady lift higher given tailwind from rates and your view -- any question around.
Sure. Let me kind of take those in sequence for -- and I'll go in reverse order. So for 2023, we'll come back in January with the full outlook. But obviously, where we expect to end the year at about $1.9 billion, we think is a good jumping-off point for thinking about 2023. When we look at the third quarter and where we ended up versus where we might have anticipated, the difference is really in the cash balances. And as we've been looking forward for 2022, we've been talking about deploying that excess cash and managing down some of the high-cost funding. And it was our objective to get to basically the level that we're at, at the end of the third quarter, at the end of the fourth.
And so the reason why the fourth quarter expectation is broadly in line with where we were before is because that's the cash level that we're at. And before we would have expected a little bit more cash on the balance sheet in the third quarter. And what I would say is when we look at what's been happening with our client base, and I think you see broadly across the industry is the third quarter was really a big inflection point for deposit movement in deposit betas. And that we saw a number of balances move into off-balance sheet or money market funds. And I think what we see going forward is, as we talked a little bit about Barclays that we start to see deposit betas move up a little bit. And so we'll still get some benefit from the rising rates. It might not be what we've seen in the prior quarters but should still be positive. And then as we get into 2023 we'll see where the outlook is. But part of what we've been working on is some of the balance sheet restructuring we've talked about to try and help protect those margins and lock them in. And you'll probably start to see the growth in net interest margin slow down.
And so as we get into 2023, we'll be looking at the combined balance sheet and the various businesses that we have in there. It feels like we're getting to a point where for the balances that are tied to interest rates and fees that are tied to rates. Think about the two mortgage fee businesses as well as the mortgage warehouse lending business that we're getting towards bottom and that they should be at that level going forward. And then we'll continue to work on building our presence in the new geographies and taking advantage of our new organization. And so we'll get back to -- or not deposit loan growth levels that look more like our combined firms delivered pre-pandemic. But we'll come back with more specifics for you in the first -- in the January call.
Okay. Thank you and helpful.
Our next question comes from Betsy Graseck from Morgan Stanley.
Hi, good morning.
Good morning, Betsy.
I wanted to understand how you're thinking about just the capital levels. I know you have a significant amount of excess capital. But in this environment, do you anticipate leaning into loan growth?
And then maybe you could help us understand how you're going to be funding that loan growth, or would you be looking to do the opposite. I know you gave us the buyback amount, but does it make more sense to buy back more? And grow loans less? Just a little bit of that dynamic and how you're thinking about it would be helpful? Thanks.
Yeah, sure. Happy to talk about that. The way we think about lending and always have at the bank is we're -- number one, we only can provide loans that are demanded by our customers. We can't create loan demand for them. And so we're always there for clients and our communities to support their investment needs.
And as we work through that, we're always trying to find the right balance between making sure that we're providing capital that our clients need with earning a return on the capital that our shareholders have entrusted to us. And so we always start with returns. We look at those returns not just at each individual loan level, but across the whole relationship. And that is the governor that dictates the pace, at which we grow the combination of what returns look like and what demand there is in the marketplace.
And so capital is really an outcome from thinking about it that way, meaning we will hold capital to be able to support clients and their growth, and that which we don't need to support lending. We'll look to return to the shareholder, typically through a combination of dividends and buybacks with a little bit of an emphasis on buybacks.
The only thing that I think is a change that we've started to see this quarter that will all, I think, be cognizant of is the macroeconomic forecast got a little worse, which means the provision is up, but provision is capital by another name. And so we'll be thinking about the combination of what's sitting in the allowance and what our capital ratios are to make sure that we feel like the bank is well protected. But we're here to support growth in our communities, and anxious to be that provider of capital. And so, over a long period of time, it's kind of what happens with real GDP growth in the communities is generally the growth rate that you see. And so, that's kind of how we think about it and the trade-offs that we try to make, and we'll be back, as I said, with a little more color in January with how we feel about 2023.
Right. That makes sense to hear how you're thinking about it. I'm just also wondering in this higher rate environment, higher inflation environment, does that tilt at all the decisioning? And part of the question comes from how we're fund, how you're thinking of funding the loan growth. It's obviously not just through capital, but also through either deposits or wholesale funds, et cetera. So, does that change the dynamic at all? Thanks.
No. We kind of -- we try to think about both sides of the balance sheet on a match-funded basis. So we think about deposits on kind of what we could sell the math, so to speak, on a match-funded basis and lending on the same -- from the same perspective. When we look forward, one of the things that I think you're seeing in the industry, and you'll see with us as it relates to liquidity is starting to put in some longer-term funding on the balance sheet from a liquidity perspective. And so, we've talked about the balance sheet we had going back for the last probably three or four quarters, that we have way more cash than we think is efficient, and we've been working to put that to work and keep the deposit cost relatively low, which I think has been the case.
And then as we go forward, as we continue building out the balance sheet, we'll have a different mix of cash and securities. But part of the funding will definitely be some wholesale funding in there. You could see this past quarter, we did $500 million at the holding company, and that was to replace some holding company financing that came with the Peoples merger. And then from a liquidity perspective, we'll look to add some other wholesale funding into the balance sheet over the course of the fourth quarter and into 2023 in all likelihood.
Got it. Thank you.
Your next question comes from Ken Usdin from Jefferies.
Thanks. Good morning. Darren, just a follow-up on the deposit side. You mentioned that we're just kind of starting to see that change in beta. So I was just wondering, if you can just talk about -- just update us on your thoughts around where betas go to incrementally from here? And also, any thoughts different in terms of where you expect them to go cumulatively over the cycle.
Sure. I guess, as I mentioned, we're expecting to see a little bit of a ramp up in deposit betas. We expect it to be led largely in the commercial space, as well as in the wealth and institutional space, meaning the trust demand deposits. Those tend to be the most price sensitive and start to become priced off of Fed funds. And so, we've seen some movement there.
As we look at what's on balance sheet sweep, what's off-balance sheet, I think we'll see some more pressure on balance sheet sweep, as well as just commercial checking pricing, which will move up the total cost of interest-bearing deposits. We're not seeing a huge pressure on consumer deposit accounts, either or now. We are starting to move a little bit and see some movement in the CD portfolio. And that you can see has been happening in the marketplace, again, not just for us but for others and so, we expect that the fourth quarter, we start to see an uptick, mainly in the interest-bearing space and checking driven by those categories that I talked about.
And we're probably looking at deposit betas in the quarter that maybe are 50% to 100% up from where they were in the last quarter, which I think will remind you the that's in the kind of the 10% range. And so, they'll pop up to the 20% to 30% range, which is still really low on a cumulative basis through the cycle, right?
And we fundamentally believe that the deposit pricing will catch up as the Fed slows down and that we should expect cumulative betas through the cycle that look like the last rising rate environment. It might take a little while to get there. But as we had talked about at Barclays that we fundamentally believe that margins will not stay above 4% for a long period of time. They might get there for a few quarters but over time, obviously, the market is efficient, and those betas will catch up.
Great. And that was going to be my follow-up, Darren, is that prior point you had made at Barclays just about, your line of sight in terms of how long into next year that you think the margin can continue to go up based on what we see in the forward curve right now. Can it continue to rise throughout next year?
I think you probably, I think there's been a lot of talk that I've been reading the press about peak rates and peaks. I think you see a little bit more into next year. But I think it starts to peak in either the first or second quarter and come down a little bit.
But when you look at what the average is likely to be for 2023 versus 2022, it's going to be up and it probably exits the year at a pretty solid level. But it will start to work its way down as we go through 2023 and into 2024. But compared to where we've been for the last few years and really since the great financial crisis, it's nice to see some spread back in the business coming off of those zero Fed funds that we dealt with for so long.
Yes, absolutely. All right, thanks a lot, Darren.
The next question comes from Erika Najarian from UBS.
Hi, good morning.
Good morning, Erika.
My first question is just going back to the dynamics of the third quarter net interest income, you mentioned a smaller balance sheet from some of the rebalancing in deposits, but also I think your commercial real estate yields are probably less – had a lower beta than investors were expecting.
Could you maybe talk a little bit about how your hedge book had impacted that loan beta in the third quarter? How we should expect that hedge book to impact the loan beta in the fourth quarter and how your hedging strategy, I believe there's $10 billion in notional that set to expire at the end of first quarter. What's sort of the strategy and replacement from there?
Sure. So a bunch of things in there to unpack, when we look at the CRE loans in particular, we've talked a lot in the past that those loans are generally the ones where the cash flow hedges are applied.
The characteristics of those loans set them up best to get the right accounting treatment for the derivatives. And when you look at what has happened in the course of the year, we've started to rebuild the hedge book.
We started in the first and second quarter as we saw -- excuse me some steepness in the curve. And so we started to put on some of those hedges, some spot and some forward starting. And what's happened is, in the short-term, from when we put those original hedges on as rates moved up faster than what those curves at the time were implying.
And because the rates in the market moved up faster than what was in the forward curve when we put the hedges on, they're actually negative right now. And so they're impacting the margin on those commercial real estate loans in a negative way.
And if we just look kind of quarter-over-quarter, the impact of the hedges moved about $45 million, where the hedges were a positive in the second quarter, and they became a negative in the third. And given the pace of increase from the Fed, that negative probably continues into the fourth quarter as well.
Net-net, we're happy that the rates are moving up faster, because so much of the portfolio is, is tied to those rates and not hedged. And eventually, the curve that we locked in when we put the hedges on, it will catch up to where the Fed is and the negative impact will start to go away. But that's kind of really what's going on there with those commercial real estate margins in the portfolio.
And if you look at the hedging and the hedges that are out there, we expect the notional amount that's actually in place to decrease as we go into the first quarter. The fourth quarter will be down a little bit from around $21 billion to about $17 billion of notional. And that will step down to the $10 billion range through 2023.
That's based on what we have today, as we're watching what's going on in the world with the Fed and the forward curves. We may well put on some additional spot and forward starting as we go through the fourth quarter and go through next year. But based on what's on the books today, that's kind of how things look.
Got it. My follow-up question is sort of a two-parter. Number one, just confirming the received fixed rate on the remaining book is about 1.3%. And the second question is, as a follow-up to Ken, there was a lot of debate in the marketplace in terms of what you meant about NIM peaking at four then going back down. So I wanted to sort of clarify that.
If I assume that earning assets are flat in the fourth quarter versus third quarter that will get me to a NIM of about four and 415 to get to $1.9 billion. And so if we think about, the forward curve, with the implication that the Fed stops, raising rates in February.
Are you saying to us that I think we all understand that if the Fed stops in February, then margin will peak in first quarter, second quarter and then go down. And in that case, do we have some NIM expansion in the first quarter? And then do we get back below four by year-end. I guess that's what we're trying to clarify do we get a three handle back in the NIM at some point in 2023?
Right. So your thought process on the fourth quarter is pretty solid. That's kind of in the range of where we expect things to be. And so when we look into next year, we expect that we'll -- given the is increases that are being anticipated right now in the fourth quarter and the fact that betas are moving, but they're still not obviously 100%. We do expect to see, as you pointed out, some expansion into – into the fourth quarter and into early 2023.
And really, I think the question and the thing that we've been trying to point out is that unless you go back to earlier than 2000, when Fed funds stayed above 6% for a long period of time. We haven't seen sustainably -- margin sustainably above 4%. And so I guess part of what we're trying to communicate is that we shouldn't -- we don't expect that to be the case at M&T. And we're not trying to set up the bank and our expense base and how we think about the bank and how we think about our capital levels assuming that 4% plus will live forever.
Will it turn? We believe it will. What's the timing? It's sometime, I think, and we think, in 2023, like I said, is it the second quarter, third quarter. I don't know exactly where it goes. Some of that will depend on what the funding looks like at the bank, how quickly deposit betas move what have you. But it probably does start to reach its peak in 2023 and start to inch its way down. Does it go below four by the end of the year? It could but it's going to move back in that direction over the long term, probably not until 2024 and beyond would be my guess.
Thank you.
Our next question comes from Bill Carcache from Wolfe Research.
Good morning. Darren, I wanted to ask if you could give us an update on your CRE exposure any concerns over potential downgrades across your different geographic regions? And any color you can give on conversations that you're having with customers, particularly on the office side?
Yes, sure. So in CRE in general, we've seen an improvement in our criticized, mainly driven by continued improvements in the hotel space as well as retail. When we look at retail, I think back in early 2020, the belief was that there would never be anyone shopping in a store, again, it would all be online. And lo and behold, here we are back to the similar mix of online and in-person sales.
And so as that has happened, rents have been paid on a steady basis. And so the cash flows for the landlords of retail customers have improved, and we've seen improvement in those – those real estate assets, similar experience in hotel. There has been a lot of capacity that's come out of the system. But overall, hotel performance is very strong, and we continue to see improvements in that sector.
The places that we've got our eye on are twofold. One is in healthcare. And when we look at independent living and assisted living, those places are having some challenges with staffing. It's obviously well documented the challenges in staffing in the industry in general and those in particular. And so in the short term, they've been doing in discussions with our clients there. They're having to use agencies to help with some of the staffing. And so that's increasing the cost in the short term, which is challenging their debt service coverage.
But we're still looking at the portfolio, we feel really good about the LTVs. And so, so far, not seeing a lot in loss content. And we have seen some continuing increases in occupancy rates there. So I would describe it as stabilizing some positive trends and some that are a little concerning.
But overall, we're feeling okay about that portfolio. And office is really the key place where, as you point out, folks are focused now. And we're still watching to see what's happening with return to office and the mix of kind of full-time remote -- full time in the office and hybrid situations.
And so we are seeing leases being renegotiated, but not eliminated. There's some a little bit of pricing pressure there. But when we look at our portfolio in particular, we see that much of our exposure really sits in 2024 and beyond. The percentage of our portfolio has lease expirations in 2022 and 2023 is really about 15% of the portfolio and 80% of the portfolio plus would have an expiration date on the leases 2024 plus.
And so we're obviously actively engaged with those clients. to understand what's going on and understand the likelihood of renewals, what the occupancy rates are, how stable the rents are per square foot and therefore, obviously, the debt service coverage and so their ability to cash flow.
But while we've seen some decrease in asset values in office, we haven't seen them come down anywhere near where our current LTV sit. And so it's a portfolio that we've got our eye on. I wouldn't call it anything more than the normal lens you would expect where it's where some of the challenge has shifted over time, and we're actively engaged with the clients to make sure that we're working with them to keep them in business.
That's very helpful. And following up on the sequential increase in the reserve rate due to modestly less optimistic macro forecast. Can you give a little bit more color on how your baseline compares versus your other scenarios, how you're weighting them and where you'd expect -- or where we should expect the reserve rate to sort of settle your fund employment were to go to, say, the 5%, 5.5% range?
So when we wait the scenarios, the baseline is the bulk of the weight. We consider a worse economic situation as well as a better one. And depending on where we are in the cycle, we kind of weight them differently. So if things are good, the likelihood that they get better, we would feel is less. And so we put a little bit more weight on the downside. The reverse would be true.
If you look at what happened this quarter and the change this quarter. There were two things that drove the $52-odd million addition. And about one-third of it was just because of the change in mix on our balance sheet and where the growth came from. We had a little bit more growth in the consumer portfolios. The consumer portfolios tend to be longer dated. And so with the CECL methodology, the amount that you put aside is more for longer-dated assets. And so, that drove about a-third of the increase. And then, the other two-thirds was really just a function of the changes in the macroeconomic assumptions.
And so, just to give you a sense, I don't think it's linear. But the biggest driver was an increase in the unemployment rate in our macroeconomic assumption from 3.6% to 4%. And so, 40 basis points added, call it, $50 million. I don't think it's linear. But if you did that math, you kind of go up by 2.5 times to get to 5%. So maybe you add another $200 million -- or sorry, $150 million, if it goes that high, right?
And so, it also depends on what's the mix of the portfolio, right? And so, there's a bunch of factors to keep in mind. That's one of the biggest drivers, but you've got GDP in there. You've got asset values both for mortgages, for consumers, as well as for commercial real estate. And so, there's a number of things at play. But, obviously, the model is sensitive to changes in those factors and unemployment is one of the key ones.
Well, it’s a complex topic, but that’s very clear -- very clear explanation. Thanks. Appreciate you taking my questions.
The next question comes from Gerard Cassidy from RBC Capital.
Hi, Darren.
Good morning, Gerard. How are you?
Good. A couple of questions for you. First, coming back to your thinking on the net interest margin and you made reference to pre-2000 where the Fed funds rate was 6% for an extended period of time, which kept the margin over 4%. Is the Fed chooses a terminal rate of 5%, let's say, but stays there well into the middle of 2024, let's say.
So they get there in the spring of 2023, they don't touch it for 12 to 18 months. Can you give us your thoughts after the trickle down from maybe over 4%, does the margin then stabilize, I'm not going to put you on the spot and say 390, 370, but the thinking is what I'm more interested in.
Sure. Well, I feel like you're putting me on the spot, Gerard, but that's okay, I’ve never shied away from being on the spot. So to have some margin it helps to have a higher Fed funds, right? Because so much of the asset book prices off of LIBOR, well, not anymore, so for MTB, which is very, very highly correlated to Fed funds. And so, once you've got a spread over the reference rate, really so from a loan perspective, what -- how is competition and what's the spread over the reference rate? And so that kind of affects the yield on the asset side.
And on the deposit side, it's really two-fold. One is, what's your loan-to-deposit ratio, right? And so there's still a lot of liquidity in the system and loan-to-deposit ratios are low, which takes off a little bit of pressure on deposit pricing.
The other thing that's happened a lot in the last few years, particularly in retail banking, there's just been a change in how customer pricing works and the mix of fees versus spread. And so, what I think you see a little bit in the industry is, as fees have come down.
Think about maintenance fees, think about overdraft fees, think about other service fees that have come down and been competed away. I think that starts to put a little pressure on how fast and how high rates might go on -- at least on the new accounts and savings accounts. I think time deposits are generally viewed as almost a discretionary asset in the industry.
Our view on it is we need to provide a great checking account experience that it's all about transactions and convenience. And that core operating account, whether it's a consumer, whether it's a small business, whether it's a commercial customer, that's the core of your bank and your funding base, and then you make decisions about some of the other interest-sensitive products based on that.
And when you've got that core funding base, it gives you the ability to price those other rate-sensitive products a little bit differently. And we try to make sure that we're giving a fair rate to our clients and manage the overall relationship profitability. But one of the definite benefits in the margin, in general, is what the mix of deposits is and that core funding base is a critical element and a big part of M&T.
And so, when you look across the industry, what's a normalized industry margin, it's going to matter a lot what your funding mix is and what percentage of core deposits funded. But, I guess coming back to the point that's got a lot of attention, obviously, is that we're just in a place where we haven't been for a long time in terms of the margin and in terms of Fed funds.
And it seemed like, if the industry in general was getting a little euphoric that things were just going to keep going up and up, and that's just not the case. We know that, especially folks like us or you, Gerard, have been around for a long time, the sage old veteran that, that doesn't happen in competition as pressures the margins and things normalize.
Flattery will get everywhere with me. And then second, as a follow-up, Darren, can you give us an update on just how the People's deal is moving along? And if you don't mind, can you update us on just the trend line of the one-time charges and then cost savings.
And then as part of that cost, the one-time charges, I happened to receive in my mailbox last night since you guys new to this territory, an enticement to open up an account, they would pay me, I don't know, $450, I guess it was. But, is that an ongoing marketing expense that you talked about, or is that part of your one-time charges?
Sure. So Gerard, you're a very special prospect. So, $450 we only get to our most important prospects.
Thank you.
Yeah. Okay. You cut my sarcasm. So, a bunch of things in there. As we're progressing along with the integration, obviously, we completed the system conversion over Labor Day and have spent September stabilizing things. And stabilizing when I say that, is really working through with all of the clients to make sure that they have access that they understand how the tools work and they're able to perform the basic functions that they look for on a Tape Day basis.
And whenever you go through a massive change like this, there's always some things where there's some confusion. But overall, we feel really good about how things have gone. We convert nearly a million customers. And while there have been some hiccups, the complaints have been less than 1%. Even with that, we're not happy until everyone has the access that they're looking for. And we've been working with those clients on a one-on-one basis to solve their individual issues.
And so, from a one-time perspective, really, when we look at the marketing, we would think of marketing expense as a one-time pretty much in the month of the conversion. And then beyond that, we would think about it as operating expense. And so when you look at those cash bonus incentives, those become part of marketing expense on an ongoing basis.
And when we talked about what we'll do in the fourth quarter, obviously, we'll ramp up a little bit what we're spending on marketing, including some of those promos to introduce ourselves to those folks like you who don't know us as well in the markets and then to our existing clients to hopefully reconfirm their purchase decision to stay with us and as well to entice them to think about other products that M&T can provide because we think our product set is very competitive as well as our pricing. And so you'll see some of that.
And then the other thing was just be some lingering effects of stabilizing the systems or completing some of the conversions. I shouldn't say stabilize in the systems. The systems are fine. They've actually worked completely exactly as expected. It's more stabilizing the expectations of folks and doing some little cleanup that will linger into the fourth quarter.
But when you look, what you'll start to see is you will see the impact of the acquisition and the salary and benefit line. And so we always have some dislocations at the time we closed the deal. And then we have dislocation starting after the system conversion. And those are typically the conversion date plus 30 days, 60, or 90. And so those folks, there's no change in those decisions.
In fact, if there's any change, some people have elected to stay when they were originally going to be where we're going to separate. But overall, the expectation of decline is in line with what we thought it would be and that will start to show up in the salary and benefit line in the fourth quarter.
Great. Thank you so much.
Thanks Gerard. We look forward to you being a customer.
Okay.
We have reached our allotted time. I will now turn the call back over to Brian Klock for closing remarks.
Again, thank you all for participating today. And the Investor Relations group will reach out for those that are still in the queue. And as always, if any clarification of any items on the call or in the news release is necessary, feel free to contact Investor Relations Department at area code 716-842-5138. Thank you and have a good day.
Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect.