Remarks to Annual Meeting of Shareholders: April 16, 2013
Yesterday, we announced our earnings results for the first quarter of 2013. Net Income amounted to $274 million, an increase of 33% from $206 million in last year’s first quarter. Diluted earnings per common share for the quarter were $1.98, up 32% from $1.50 a year ago. The quarter's earnings reflect higher net interest income, strong fee revenues, a lower provision for credit losses and lower operating expenses.
The demand for loans remains steady, with comparatively strong, high single-digit growth in commercial loans being offset by continued softness in loans to consumers. Credit performance remains solid, with net charge-offs as a percentage of loans outstanding in the first quarter amounting to 0.23%, a level well below our long term average of 0.37%. Overall, the quarter reflected the trends observed in the year past. More on that topic later.
However, before turning to the rest of my remarks, let me briefly talk about an important development that was discussed in our press release last Friday. As you may have already read, we have had a setback on our way to closing the Hudson City transaction.
The Federal Reserve has identified certain regulatory concerns with M&T’s procedures, systems and processes relating to Bank Secrecy Act and anti-money-laundering (or BSA/AML) compliance. Although no situation was identified where M&T Bank may have been used as a conduit for money laundering, the scope and depth of our BSA/AML program must be enhanced before we can obtain regulatory approval for the proposed merger. Accordingly, we have commenced a major initiative, including the hiring of an outside consulting firm, intended to fully address the Federal Reserve’s concerns.
Additionally, in view of the potential timeframe required to implement this initiative and demonstrate its efficacy to the satisfaction of the Federal Reserve, M&T and Hudson City believe that the timeframe for closing the transaction is likely to be extended beyond the date previously expected. As such, we have agreed to extend the termination date of the Hudson City merger agreement from August 27, 2013 to January 31, 2014. The delay is unfortunate. Nevertheless, I take this matter seriously and take full responsibility. Let me assure you that M&T’s executive management, as well as our Board of Directors, is fully engaged and committed to resolving the BSA/AML matter and completing the Hudson City transaction.
Hopefully, I have addressed the first question on your mind. Now, if you permit, I will continue with the rest of my remarks for today. I think it is fair to say that, in the years since the 2008 financial crisis, I have had a lot to say about a lot of things, both in the annual Message to the Shareholders and to this annual meeting. But, having offered my views on the major accounting firms, ratings agencies, the Big Six Banks, Fannie Mae, Freddie Mac, bank regulators and regulation—I find myself with few topics left to address, at least few that I know anything about. Moreover, the forum dictates that this should be an occasion for me to address not the State of the Union but, rather, the state of the bank.
By almost any measure, despite the setback mentioned before, that state is currently a good one. As noted in the annual report, our net income reached a new high last year. We continued our record, unbroken throughout my tenure, even during the course of the financial crisis, of neither reducing nor missing a single quarterly dividend payment. We announced the acquisition of Hudson City Bancorp, completed a smooth exit from the U.S. Department of the Treasury’s TARP program, and witnessed unprecedented growth in markets surrounding our home town.
These are all, clearly, indicators of good health, and I am confident, will help us continue our record of long-term performance. Yesterday’s earnings announcement marked the 147th consecutive quarter or more than 36 years without reporting a loss through several economic downturns that put the resiliency of the banking industry to the test.
I have always attributed our steady performance and success to the basic tenets of M&T’s culture—which revolves around carefully-underwritten lending predicated on local knowledge, a focus on returns not volume, and the loyalty and effort of experienced employees who act as owner-operators. To these factors, I would add, and will elaborate on here today, prudent capital allocation—how we have invested or distributed our earnings over the years. I do so to offer another way to review and evaluate our business approach.
A bank may utilize its earnings in a number of different ways. It can reinvest it in projects or opportunities that are expected to provide commensurate returns and hence augment the value of the firm and future earnings for shareholders. In absence of suitable investment opportunities, a bank may also choose to return its earnings to its shareholders in the form of cash dividends or share buybacks. While banks typically use a combination of these methodologies for deploying capital, a careful balance between these different approaches is often needed for an efficient allocation of capital in different times.
In the case of M&T, I noted our long history of quarterly dividend payments. However, it is important to understand that, as consistent as our dividend payments have been, our strategy of capital allocation has been adaptable, changing in response to the prevailing economy and business environment. It has been our view for a long time that if there are not enough good opportunities for investment, it is better to return capital to shareholders, who may find better and productive use of that capital elsewhere. Put differently, dare I say, we have deployed capital where and when it made sense. We have been careful in identifying investment opportunities and have not pursued growth for its own sake. Let’s look at some numbers:
Over the past 30 years, we have on average retained 37 cents of every dollar earned. That retained capital has been deployed both for organic growth—which entails extending credit in our existing markets as well as investments in internal, operational improvement—and the 23 acquisitions which have complemented our organic growth. During those 30 years, we returned 63 cents of every dollar earned to our shareholders either through dividends or share repurchases.
But that average figure fails to capture an important variation. Notably, during the last ten years, we have seen two contrasting environments for capital deployment. During the five years preceding the crisis, between 2003 and 2007, the U.S. economy was going through an expansion phase, experiencing an unprecedented housing boom, a real Gross Domestic Product that grew at a 2.8% compounded annually, unemployment rates that bottomed to 4.4%, and a new record high point for the blue-chip stock market. We were fortunate to earn a cumulative total of $3.8 billion during this period. Yet, we could find suitable investment opportunities for only 20% of those earnings.
The rising stock market combined with the credit bubble meant that banks were trading at high multiples—providing limited opportunities for appropriate return on investments. Many banks were willing to relax loan pricing and credit standards to partake in the growth—distorting the risk-return equation of credit intermediation. The lower interest rate environment combined with the intense competition for growth—sometimes at the expense of sensible underwriting—had resulted in cheap credit and thinner margins for banks.
I wish I could say that we understood exactly what was happening in the market place at that time. We did not. But, we were certainly skeptical of the tectonic shift that was taking place in the world of credit extension. And, for the most part, beyond those unforced errors referred to in the 2009 Message to Shareholders, we had the discipline to walk away from some opportunities, which, in the aftermath, proved to be fool’s gold. At the peak of the housing boom in 2006-07, M&T grew loans at roughly half the pace of its large cap regional bank peers—willing to sacrifice market share to preserve underwriting discipline.
From 2004 through 2007, commercial real estate loans at all FDIC-insured institutions grew by a compounded annual rate of 13.6% compared to 7.5% for M&T’s total commercial real estate portfolio and just 5.7% for our New York City portfolio. It was a period in which our size was relatively stable and our acquisitions limited to small additions to our market footprint and branch network. In other words, it was our judgment that there were few prudent opportunities for growth and investment—that it was more important to return earnings to our shareholders. Accordingly, we returned 80% of the $3.8 billion earned to shareholders in form of dividends or share repurchases.
In contrast, the past five years, since the advent of the financial crisis, have been notably different. Since 2007, we have earned the same $3.8 billion altogether and maintained our dividend without fail—but we have adopted a different posture relative to our earnings— returning only 49% and retaining 51%, or more than twice as much as in the previous five years. Here’s why.
Although it has been an era of tough credit and difficult economic conditions with unemployment reaching as high as 10.0%, it has proved opportune for M&T and its shareholders and employees. Those long-term tenets of our operating model that I mentioned before had positioned us well heading into the crisis. As I mentioned in our annual report, our stable performance over the long-term and during the crisis gave us the capacity to take advantage of a range of opportunities that a troubled economy and changing business environment had made available during the past five years.
Our strength during the crisis period allowed us to keep our credit window open for new customers and new loans at a time when there was widespread concern about credit availability. Indeed, we witnessed organic loan growth of $7.6 billion or 15.9% during that five-year timeframe—including $569 million or 12% commercial loan growth last year in our Western New York markets, where we benefited from a once-in-a-generation opportunity caused by the market disruption.
In addition to supporting the organic growth, the retained capital has also been utilized to undertake a series of acquisitions which have complemented our own strengths—filling out our presence in the markets in which we do business and adding expertise and experience in areas in which we had not been as strong as we might have been.
I think here of the acquisition of Provident, which gave us a dominant market share in Baltimore and the State of Maryland, and Wilmington Trust, which not only expanded our footprint into a state contiguous to those in which we already did business—but which also brought us assets and employees with blue chip experience in the growing and significant business of wealth management. It broadened and diversified our revenue stream by expanding our product offerings in Wealth Management and Trust services—making us the 9th largest trust company among U.S. bank holding companies.
So, too, has our proposed acquisition of Hudson City, which is expected to bring us important new strengths. With its extensive branch network in New Jersey, where we have no retail presence, Hudson City provides great potential for growing our small business, middle market, and commercial real estate portfolios.
It will mean, too, the addition of an experienced work force which has long made Hudson City one of the nation’s most successful residential mortgage lenders. Its conservative underwriting culture, similar to that of our own, insulated Hudson City from the substantial credit losses suffered by the industry during the crisis. Indeed, as recently as 2008, before reversals owed to the prolonged low interest rate environment that almost no one anticipated, Hudson City had been judged by the Wall Street Journal to be the second-ranked bank in the U.S., based on five-year stock performance.
The proposed combination of Hudson City’s retail franchise with M&T’s wider array of banking products, and its already established commercial lending presence in Hudson City’s markets will provide a strong foundation on which to build in one of the country’s most densely populated geographies. More importantly, we hope to begin a new phase of growth with a capital investment of $2.7 billion in a franchise that is expected to provide over 18% return.
We have laid the groundwork for realizing a goal of that magnitude while, at the same time, setting aside additional capital to adapt to the changing demands of our regulatory environment. Even as a good portion of the retained capital has been put to use toward organic and acquisitive growth, the need of capital preservation in the last five years was also driven by the increased capital requirements imposed on the banking industry.
At 2012 year-end M&T’s tangible common equity to asset ratio was 7.20%, representing an increase of 219 basis points or $2.6 billion between 2007 and 2012. However, despite that higher capital level, we earned a 19.42% return on tangible common equity during 2012. So, while we have retained a larger portion of the earnings during recent times, we have been deploying that in an efficient manner—reinvesting it back in our franchise when bank stocks have been trading at historical lows.
It is worth noting that, even as the economic downturn, combined with our financial stability, has given us tremendous acquisition opportunities, we have stuck to our knitting—focusing, opportunistically as I like to say, on acquisitions that strengthen our community banking model of lending based on deeper knowledge of markets where we live and work.
Some interesting figures tell the story. If one looks back to 2007, the distance between our northernmost branch in Watertown, New York and our southernmost in Snow Hill, Maryland, was 406 miles. Our footprint had a radius of 203 miles and it was centered at Herndon, Pennsylvania, a small town with population of 325 people, 40 miles north of Harrisburg. Following the Hudson City transaction, we will have more than doubled in size and added 157 branches since 2007, but the radius of our markets will have grown by only 27 miles—and will still be centered in central Pennsylvania—at Lake Harmony, population 439, just over 100 miles northeast of Harrisburg.
What has changed then? Our presence has become denser, more deeply-ingrained in places we already know. These are the Middle American cities and towns where our model of prudent lending and personal service fits so well with cultural values of thrift and hard work. The increased density of our branch network, combined with M&T’s long-tenured management that has strong ties to these markets, gives us more opportunities to efficiently serve our customers. More importantly, we are able to do so without stretching ourselves too thin, which may be the case with some distant geographic acquisitions.
As I mentioned earlier, we were relatively well positioned as we entered the crisis, and our financial stability and strength helped in our continued growth. Consider a few numbers. Our market share, for instance, has increased in Baltimore from 10.2% in 2007 to 23.3% and in Buffalo from 21.1% to 24.3%. In the state of Delaware, we now command the highest retail presence with 27.3% market share, and we have improved our market share in Maryland from 7.4% to 14.9%. Nor is such growth limited to specific markets; our overall book of business has grown dramatically.
In 2007, we served 9,330 middle market customers who on average had $2.4 million in loans and $0.9 million in deposits with us. Today that figure has grown to 10,584 clients, with an average relationship size of $3.5 million in loans and $1.8 million in deposits. We have seen the same growth among small business clients. In 2007, we served some 143,000 such customers and ranked as the 17th largest provider of U.S. Small Business Administration (or SBA) loans. Today, that figure has grown by 19% to nearly 171,000 small business customers and M&T is the 5th largest provider of SBA loans, nationally.
Finally, through our most public face, that of the retail banking front, we now serve 1.8 million households, compared to 1.6 million in 2007. On average, these households use M&T as a service provider for three of their banking needs, such as deposit accounts, loans, credit cards, wealth management services, et cetera.
Our strength and growth has, in some ways, also helped our communities. In Baltimore, our employee base has grown to 1,717 from 1,591 in 2007 and during the same time frame we have added 496 jobs in Western New York. M&T’s recent decision to begin subservicing certain mortgages from Bank of America and to assume lease of its mortgage facility in Amherst, New York will transfer 600 jobs to M&T, mitigating some of the job loss from the announced shut down of Bank of America’s local mortgage processing operations. In addition, M&T currently has 957 job openings listed across its footprint. These are all indicators of our broader capabilities and deepening relationship with our customers and communities.
The proposed acquisition of Hudson City in New Jersey adds yet another important community banking region, right in the middle of our market footprint, an area which includes, for instance 7,500 middle-market businesses and 300,000 small businesses. It will bring us 282,000 customer households—one in five of which have greater than $1 million in investable assets. Hudson City, in other words, like Provident and Wilmington Trust, our other major acquisitions since the advent of the crisis, lets us serve more deeply a market in which we were already present but could have benefited from a stronger foothold.
While not as big, equally important were the addition of K Bank and Bradford Bank in the Greater Baltimore metropolitan area, where M&T came to the FDIC’s assistance in resolving these failed banks. Each of these transactions represented an opportunity to acquire an ailing institution—an approach that dates back further than the recent crisis and that has been good for both M&T and the banking system overall.
To elaborate further, over the past twelve years, we have experienced two such periods of acquisitive growth, each characterized by economic stress. During 2000 to 2003, following the “tech bubble” and the subsequent recession, institutions were under stress. We completed two major acquisitions: Keystone in Harrisburg and Allfirst in Baltimore, where a rogue trader had caused $691 million in foreign exchange trading losses. The second burst of activities was during 2008 to 2012, again a period categorized by economic turmoil and a slew of bank failures.
So, most of our acquisitions have been completed or announced during periods of economic distress and in most cases, stressed institutions approached us due to our relative strength. In summary, it is not our goal to just grow through acquisitions, but rather to focus on our core strength of credit intermediation in our communities. It is that focus and adherence to our basic tenets that have enabled us to remain strong during periods of crisis and take advantage of opportunities to acquire and mend troubled institutions.
I have spoken here, as befits this meeting, of the ways in which our expansion into new markets and the deepening of ties to our established ones have worked out well for M&T. But I like to think that the case can be made that our presence is good for the communities we serve, as well. Those places are, in fact, doing well. In our markets overall, unemployment has been lower than the national average and economic growth has exceeded it. During the five year period between 2007 and 2012, the increase in real GDP in M&T’s footprint was 3.5%, topping the 2.5% average gain for the U.S. overall. Over that period, the average jobless rate in its footprint was 6.8%—nearly a full percentage point below the 7.7% at the national level.
Now we cannot claim all, or even most of the credit for that sort of good news.
As I wrote in the Message to the Shareholders, the Middle American markets where we predominantly do business are characterized by deep ties of civic and religious life which help to undergird the long-term health of local economies. But I am confident that our approach to banking—the very manner in which we conduct business—plays a constructive role, as well.
It is not mere happenstance that our loan charge-off rate is nearly one-third of our peers. And it is not just because we are somehow picking only the good customers. We are, rather, developing the sort of personal relationships and deep knowledge of the businesses to which we are extending credit such that we can do more than suggest or push cookie-cutter products. Rather, by understanding and analyzing specific businesses and their plans, we can suggest appropriate lending terms and structure. We might even suggest that this might not be the right time to take on as much debt as originally requested.
Our relationship with borrowers, in other words, goes well beyond a simple yes, no or how much. We believe that if we know our customers and understand what they need, we can help them achieve their goals. We have served, I hope, not just as a source of capital but as a constructive influence—one which reinforces the prudent qualities of our clients and leads to higher growth and lower loan charge-offs for both M&T and its customers.
I recognize, however, that with growth comes the need to reinforce our infrastructure and risk management. To that end, we have strengthened our management team with the addition of seasoned executives in key risk control roles, and we continue to invest in our data management and reporting capabilities. Two years ago, we began a significant enhancement of our primary and back-up data centers with a planned investment of $60 million—of which $40 million has already been spent. Our technology and systems improvement budget has more than doubled from $35 million in 2009 to a projected $75 million in 2013.
That said, there is clearly much more to be done, as evident from the Federal Reserve’s recent assessment of our BSA/AML compliance program. I see this as an opportunity to further strengthen our risk management discipline before embarking on an acquisition that is expected to make a meaningful contribution to our prospects. This investment in enhancing our compliance procedures, systems, and processes is essential in preparing for the future. I am personally committed, and confident in our management’s ability to achieve a timely resolution of the matter.
Successes of the past, as they say, are not predictors of future performance. But M&T’s track record does matter. So, too, does our corporate culture. In my own view, our success in navigating the perilous times in which we have been living reflects the combination of prudence, restraint, and willingness to take risk when we judge it to be appropriate which have characterized us historically. Whether in approaching an acquisition opportunity or a small business loan, we follow no formula nor algorithm, but rely, instead, on our best judgment, following careful evaluation. The fact that so many of our employees, and members of our management team, are also M&T shareholders reinforces our resolve to take good care of what we have built to date—and which we will, loan by loan, branch by branch, continue to build in the years to come.
Robert G. Wilmers
Chairman of the Board
and Chief Executive Officer