Remarks to Annual Meeting of Shareholders: April 15, 2008
Earlier this morning, as is our custom, the Company announced its first quarter financial results, which I will now briefly summarize for you. Diluted earnings per share measured in accordance with generally accepted accounting principles, or “GAAP,” were $1.82, 16% higher than the $1.57 per share earned in last year’s first quarter. GAAP net income was $202 million, up 15% from $176 million in 2007’s initial quarter.
As explained in today’s press release, which is available on our website, the company has also historically provided supplemental reporting of results on a “net operating” or “tangible” basis. Net operating results exclude the amortization of core deposit premiums and other intangible assets recorded in connection with past acquisitions and the impact of merger-related expenses.
Diluted net operating earnings per share in the recent quarter were $1.94, 16% above last year’s first quarter. Net operating income was $216 million, or 15% more than in the first three months of 2007.
The Company’s results were aided by its membership interest in Visa where M&T Bank, and many other large banks, received shares of stock in connection with its initial public offering. Member banks were required to redeem a portion of their shares in the recent quarter, which, in M&T Bank’s case, resulted in an after-tax gain of $20 million, or $ .18 of diluted earnings per share.
Visa also established an escrow account to cover pending litigation costs prior to distributing shares to its members. As a result, the company was able to reverse a portion of an accrual that dampened our results in the fourth quarter of 2007 for our estimated share of those costs. That amounted to $9 million, after taxes, or $.08 of diluted earnings per share. All told, the public offering added $29 million to the Company’s first quarter net income, or $.26 of diluted earnings per share.
Taxable-equivalent net interest income rose 6% to $485 million in the recent quarter from $456 million in the similar 2007 period. Noninterest income, excluding securities transactions, was 19% higher than in last year’s first quarter, while noninterest operating expenses rose 6% from the year-earlier period.
The turmoil in the residential real estate marketplace throughout the past year contributed to an increase in net loan charge-offs to $46 million, or an annualized .38% of average loans outstanding, from $17 million, or .16%, in the initial 2007 quarter.
Nonperforming loans rose to $495 million or 1.00% of loans outstanding at March 31, 2008 from $273 million or .63% a year earlier. In response to the higher charge-offs and delinquencies, we increased our provision for credit losses to $60 million for the recent quarter, compared with $27 million for the first quarter of 2007.
In normal times, I might focus mainly this morning on several specific factors which have had the most pronounced effects on our net income. But these are not normal times for the banking industry.
No discussion of any individual bank’s results today can take place without reflecting more broadly—much more broadly—on the extraordinary time in which we find ourselves, a time in which there is a crisis of confidence in the financial services industry.
It is a crisis which has already prompted unprecedented forms of government intervention, but which calls for more—much more—action to ensure the long-term stability of our capital markets.
This is, of course, of more than abstract interest to us: it is just such stability on which M&T, like every other bank, fundamentally relies.
To understand how we should best proceed to restore order, we must understand how we have reached the point at which we stand today. Please permit me to take a big step back and to reflect on how we got here.
A great deal about the situation in which we find ourselves today can be explained by the events—not of the past few weeks or months—but of at least the past several decades. Over the course of that time, there has been nothing less than a sea-change in the world of lending, a change which has helped create the sorts of risk we face today.
To start to understand this change, it’s worth recalling how things used to be.
Just 30 years ago, lending in the United States was clearly and predominantly the province of banks. In 1978, commercial banks and thrifts held 71% of all private, non-governmental U.S. loans. It sounds almost quaint today to describe that highly-regulated time, in which a tranquil, if less-than-dynamic, financial system was almost totally controlled by the Federal Reserve. The amount of credit extended by the private sector (not including banks) between then and the end of 2007 grew almost three and a half times as much as that provided by the banking system.
Many, if not most, of the 8,533 banks and thrifts continue to do business roughly as they always have. But the world of credit and lending we see today has changed around them, as huge flows of capital move around the world—with the Fed and other regulators serving sometimes as little more than bystanders.
When did things begin to change?
Throughout the 1980s and 1990s, a new idea about lending took hold and grew. Securitized credit outstanding grew nearly 50-fold from 1980 to 2000 – compared to a mere 3.7 times for commercial bank loans over the same period.
Its essence: that loans could be sliced, diced and packaged in large groups, to serve as the basis of debt to be sold in the securities markets. This new approach began with mortgage-backed securities, but grew to include a variety of assets.
The concept was little short of revolutionary. It meant that bank deposits would no longer be the only—or even the chief—funding source for credit. Instead, loans of all sorts would effectively be financed by the capital markets—and packaged and sold by Wall Street.
A watershed year, without doubt, was 1998.
That was the first year in which bank lending was surpassed by what some call synthetic products sold in the capital markets by a handful of money-center and investment banks. Securitized credit not held by government-sponsored entities topped $3.3 trillion, compared to $3.2 trillion in loans at all U.S. commercial banks. Capital markets, in other words, began to overtake traditional banks as the major source of credit.
In that same watershed year of 1998, Congress began drafting repeal of the Glass-Steagall Act—and the long-standing legal wall between commercial banking and investment banks eventually fell one year later. Financial institutions would be free to participate in areas which regulation had previously prevented.
Not coincidentally, in that same year, Citibank, the nation’s largest bank, anticipating the change, had already merged with Traveler’s, an insurance company, which had itself already acquired two leading Wall Street investment banks, Salomon Brothers and Smith Barney. It had moved rapidly to take advantage of the new deregulated environment.
Finally, 1998 was the year that the highly-leveraged investments of the previously obscure investment fund, Long Term Capital Management, forced the Federal Reserve to take action to prevent a market meltdown.
For the first time, we saw that an unregulated institution making investments in one area of the economy could have effects on the overall financial system, and that investments in one sector can reverberate—loudly—in another.
In the time since, the events of 1998 have only been magnified. Today, the size and growth of the U.S. securitized debt market far overshadows that of bank lending. At the end of 2007, total outstanding loans at all U.S. commercial banks were $6.6 trillion. At the same date, securitized U.S. debt totaled $12.1 trillion.
In other words, commercial banks are extending credit for only about one-third of all loans in the United States. Moreover, the $12.1 trillion of securitized debt has reached a level of complexity never before seen in the history of our markets—and which bear an “alphabet soup” of names with which we are by now too familiar.
Securities comprised of residential and commercial real estate mortgages known as RMBS and CMBS were originally packaged and sold to investors. As they performed, the market expanded. Today ABS, or asset-backed securities, package credit cards, automobile, home equity and student loans, while commercial loans are securitized into CLOs and corporate bonds become the raw material for CBOs.
As the market expanded so did underwriting and rating agency fees. To feed this appetite, old rules such as income and asset verification gave way to “Stated Income” and “Stated Asset” loans, and eventually even “No Doc” loans became easily securitized, increasing volume and the associated fees. Debt backed by Subprime and Alt-A mortgages doubled to $1 trillion from 2003 to 2007. As these instruments became commonplace, new, more complex, products became available. Securities were eventually resold and repackaged into bundles of thousands of other securities and then sold again as CDOs, or collateralized debt obligations. One can even repackage and resell a CDO to create a CDO-Squared.
Much of this complexity, or risk, was masked once outside the regulated world of traditional banking. SIVs, or Structured Investment Vehicles, kept such transactions off the balance sheets of banks that established them. Indeed, the former head of one of the largest U.S. banks, asked by a leading member of Congress why the bank had kept billions of dollars in SIVs off the firm’s balance sheet, responded that not doing so would have left it at a disadvantage in its new competition with unregulated investment firms, able to operate with higher debt and lower capital reserves.
The securities markets also quickly became the venue of choice for those riskiest forms of credit. According to Standard & Poor’s, non-bank investors (including hedge funds) provided three-quarters of high-yield loans to U.S. corporations at the end of 2006, up from one-third at the end of 1997.
One particularly astounding—and ominous—part of this larger change was the growth in the market for Credit Default Swaps—bets placed on the performance of various exotic derivatives and the institutions holding them. They have grown from less than $500 billion in 1998 to a staggering $45 trillion in 2007—to what effects on the financial markets, no one is quite sure. In these and other deals, investors need not actually hold securities or loans themselves to participate in the markets for them. Nor do they have to put any money down.
Who are the players in these new markets, if not traditional banks?
As the banks became less important, other institutions became more active. Clearly, first and foremost, investment banks were central. So too were mortgage brokerage firms, which grew in number from 9,000 in 1988 to a peak of 54,000 in 2005—overshadowing banks in the mortgage origination business by selling debt directly to capital markets—and having no need to worry about whether the loans they initiated would perform.
Loans would be originated by one firm, packaged by another, sold by a third and serviced by yet another. Thousands of mortgages could be bundled together, then cut into hundreds of thousands of strips of debt.
The number of unique, identifiable hedge funds increased from fewer than 50 in the early 1980s to 22,650 in 2007. In that same period, their assets under management grew from less than $1 billion to $2.1 trillion.
In addition, the major ratings agencies assigned top investment grade status to most if not all of these new securities. According to last Friday’s Wall Street Journal, Moody’s share price quintupled from 2001 to 2006. In 2006, the firm’s revenue from structured finance alone was more than its total revenue in 2001. So it was that those holding debt became far removed from those originating it.
One might indeed say that, over an extended period of time, a great many extremely smart and sophisticated people conspired—without intending to do so—to put our overall financial system at serious risk. All the elements were put in place to turn our financial markets into a virtual casino—in which, ultimately, we would see the collapse of a major investment bank, Bear Stearns.
Casinos rely on easy money—and that’s just what the Federal Reserve began to provide—both during, and immediately following, the recession that began in March 2001 and was exacerbated by the events of September 11 of that year.
Indeed, the Fed lowered interest rates and kept them so low that, adjusted for inflation, the “real” fed funds rate actually remained below zero from November, 2002 to April, 2005—30 consecutive months. In other words, short-term credit was essentially free.
Inevitably, with rates so low there were thousands, indeed hundreds of thousands of homebuyers and homeowners eager to take out mortgages. Between 2001 and 2005, 31 million U.S. homes were sold, and the homeownership rate reached an all-time peak of 69 percent. At the same time individuals and institutions began chasing higher yields, and synthetic investments made it deceptively easy to produce them. New sorts of higher-risk mortgages, promising higher returns, could be packaged into highly rated securities.
The abundance of free money, intended to stimulate the economy, had the effect of constructing an artificial market where the confluence of increasing demand for housing and investors quest for higher yields came together. With the benefit of hindsight, it is now obvious that many who had purchased homes in reality did not have the wherewithal to repay their mortgages. On the other hand, those investors seeking higher returns often made unsound investments that are now worth less — they are left holding the bag.
These events did much to lead to the crisis of confidence in our financial markets, where uncertainty and an abundance of caution now exist. We have seen, for instance, an increasing reluctance on the part of commercial banks to lend to each other because of a lack of confidence in the conditions of each other’s balance sheets. Indeed, some large institutions seem to have trouble determining the quality of their own portfolios, as they drastically wrote down their balance sheets several times in short order.
Let’s also not forget the impact to the value of our dollar and the fact that overseas investors and central banks have lost massive amounts of money from these events. In the United States, some are concerned that our markets are at risk of becoming uncompetitive with international markets due to excessive regulation. That risk pales in comparison to the crisis of confidence that exists in our system today. Left unresolved, this could lead some to question the merits of holding U.S. dollars as a reserve currency, ultimately leading to another source of potential disruption.
How significant a role did the Federal Reserve play in the collapse that has ensued? Keep in mind that the tranquil financial system firmly under the control of the Fed was long gone, as the Fed held sway over a decreasing share of liquid assets.
Lending had shifted so profoundly to the securities markets that the Federal Reserve even stopped reporting M3, once considered a key measure of the money supply, and publicly doubted M2 as a means to measure inflation. Reserve requirements, the system the Federal Reserve uses to influence lenders’ willingness to extend credit to each other had not changed since 1992.
As a result, some of the tools and reach of the Fed are from another era, leaving it no choice but to find new and creative ways to stem the crisis of confidence that exists in our financial system today.
While we don’t have all the details, we have to respect the Fed’s decision to assist in the takeover of Bear Stearns in an effort to avoid a potential meltdown of our financial markets. Nonetheless, it’s also hard for the public to reconcile what will inevitably be viewed as assistance for the wealthy with the fact that there are at present nearly 1 million homeowners in foreclosure proceedings and an additional 2.7 million who are delinquent on their mortgage payments. They cry out for our attention, as well.
What, then, to do? There is no quick fix. However, among the approaches that must be considered are these:
- Restoring the balance of regulatory oversight between commercial banks and investment banks, in exchange for investment banks’ use of the Fed discount window. Doing so will require not just extending regulation, but bringing common sense to the regulation of traditional banks. Our last Annual Report noted that, based on a recent study, it is not unreasonable to estimate annual regulatory compliance costs for the industry’s shareholders to be in excess of $12 billion.
- Establishment of a contemporary equivalent to the Depression-era government-owned Home Owners Loan Corporation to help delinquent home owners refinance their mortgages into new, more affordable ones.
- Extension for Fed member banks, of its short-term financing program to include maturities of longer duration. As their regulator, the Fed has intimate knowledge as to the safety and soundness of each commercial bank. Term lending to member banks would demonstrate confidence in the balance sheets that the Fed examines and thus would restore bank's willingness to lend to each other.
- Re-examination of the appropriateness of mark-to-market accounting for balance sheet purposes, in periods of illiquid markets. The ability to reasonably determine the fair value of certain assets in times like these is, at best, severely limited – for those that previously made markets in such assets, for all practical purposes, have gone fishing.
- Adjustment of the formulaic approaches to loan loss reserve requirements used by accounting policy-makers and regulators—and which has led the banking industry to enter a recession with the level of reserves close to all time lows.
- Review and possibly revamp the securities rating system which has depended for its financial support on those issuing securities, rather than on those who rely on its accuracy to purchase them.
These are just some of the issues that need immediate attention. These issues, when taken together, are so complex that I strongly believe that we need a blue-ribbon commission to chart the way toward a new regulatory regime. Individual changes, made in the absence of a comprehensive analysis, will likely fall short. It is my hope that a thoughtful approach, that revisits the structure and regulation of our financial system, will help restore confidence in the state of our markets and, consequently, re-open credit windows that have closed.
It is important to stress here this morning, however, that we at M&T are not basing our business strategy on special help from Washington or anywhere else. Despite the disarray in the financial markets and the prospect of dramatic changes to the regulatory environment, both of which are reflected in our first quarter results, we believe M&T is very well positioned to weather the on-going storm and to prosper.
Why? Our balance sheet remains strong. Our loan portfolio is a healthy one. Through our community-based approach to banking, one which relies on long-term relationships with our customers, we avoided many of the problems with which many of our peers—and especially the larger ones—must now deal.
We did not originate subprime loans. (Slide: M&T Bank Corporation—As at Loans) The less-than-prime, Alternative-A loans which we kept in portfolio amount to just 2.5% of our loan portfolio.
Our loans to homebuilders and developers, another potential problem area receiving national attention, account for only about 4% of our portfolio -- and substantially all are within our banking footprint to customers we know.
Our home equity business, an area of increasing industry-wide concern, is performing well and is also focused almost entirely within our own markets. We have never purchased home equity loans from correspondents and we fully underwrote for ourselves the small number of loans we originated through brokers.
In our commercial lending business, our conservative underwriting sensibility has meant that we will only offer buyout or recapitalization financing, so called “leveraged-finance”, to our own customers, those with whose business and management we are familiar. As a result, only 1% of our loan portfolio comes from “leveraged-finance”, nor do we hold an inventory of such loans that cannot be sold.
Because of the focus on its own communities, M&T has avoided problems which now plague banks that rely far more on capital markets. We do not manufacture derivatives. We are not in the business of underwriting and selling mortgage-backed securities, CDOs or SIVs. As a result, we have not been stuck with an inventory of such instruments.
At a time when the industry, on the eve of a likely economic downturn, has chosen to reduce reserves for bad loans to historically low levels, we have resisted doing so.
At the end of 2007 our allowance for loan loss ratio to total loans ranks third among a group of 16 of the top 20 U.S. banks we consider to be our peers. (Slide, Allowance to Loans 2007). Indeed, we have never strayed from our traditional approach of carefully, objectively and conservatively assessing the level of losses inherent in our loan portfolios. Our allowance amounted to 6 times our 2007 net charge-offs, which also ranks us third among the same group. (Slide: Allowance to Net Charge-Offs – 2007).
But the good news at M&T goes beyond the fact that we have avoided certain types of bad news. (Slide: Capital Generation, 2007) Crucially, at a time when others face the need to raise capital to cover potential losses, we continue to generate capital.
Indeed, our high returns on tangible equity, combined with our prudent dividend payout enable us to generate new capital at a high rate. In fact, our capital generation rate of 13.5% in 2007 ranked us 4th among our peers. That rate rose to 17.9% during this year's first quarter.
This high rate of capital generation positions us particularly well for investing in our future. At a time when many banks are unable or unwilling to lend and when capital markets have essentially shut down, M&T continues to operate as we always have during downturns.
Our doors remain open for customers who meet our standards. We did not, nor will we, change those underwriting standards during the ups and downs of the business and credit cycles. This allows us to serve reliably our 150,000 commercial clients and 1.8 million depositors.
Indeed, it was our conservative underwriting standards, ingrained in our corporate culture and consistently applied, that buffered our earnings from the uncharacteristic missteps to which we did succumb in the year past.
Although it is clear now in retrospect that the credit cycle shifted in mid-2006, our charge-off ratio for 2007 remained below our historic average. Moreover, because we emphasize the need for secured lending, our loan loss results remained better than most of our peers.
So it is that we remain focused on growth, not damage control. We see the potential to increase our market share both in those markets in which we are already a dominant player—such as our headquarters region of Upstate New York, where we are in the process of building on the recent acquisition of Partners Trust—and in the fast-growing Mid-Atlantic region, where our acquisition of 12 branches has complemented an ambitious agenda of new branch growth to help us serve that region’s dynamic economy.
Our confidence is reflected by recent increases in staffing in both the Mid-Atlantic and metropolitan New York City regions.
This does not mean we are being overly-optimistic. We are fully cognizant of the prospect of a serious economic downturn—and understand that unless systemic issues in the financial markets are addressed, times could get very tough for us—and everyone else.
Indeed, last year was a tough one—the toughest in a long time. M&T shareholders—which include in its ranks all of senior management and many, many other employees—saw the value of their shareholdings or options decline.
It is, however, important to keep in mind the long-term record of this company. It’s a record characterized by consistent performance. Since 1983, our net operating earnings have grown at a compounded rate of 23 percent. Dividends have grown at a compound rate of 18 percent during that same time period—and that includes a 17 percent increase in 2007.
Over the past 24 years, M&T has generated some $6.7 billion in capital, fully two-thirds of which has been returned to shareholders, either through dividends or stock repurchase. The performance of our stock price over the past 10 years ranks in the top ten among the 50 largest banks.
Of course, past performance is no guarantee of future success. But it is far from irrelevant. This is the same old M&T, under same management. We believe we have what it takes—a combination of sound strategy and a talented workforce--to return to form.
Thank you for your attention.
Robert G. Wilmers
Chairman of the Board
and Chief Executive Officer