09 March 2017

Ours is a company that has consistently sought steady improvement in earnings, reliable returns to shareholders, and the provision of credit and financial advice to our communities through both times of prosperity and times of uncertainty. The past year was among the more uncertain and eventful in recent memory. Political change, both domestically and internationally, buffeted equity and bond markets, with implications for monetary policy. No bank can be insulated from such volatility. But neither can a prudent bank overreact to such gyrations. As we have throughout our history, we at M&T sought, this year past, to resist the temptation to respond to events in haste, and instead based our decisions on what we believed was best over the long term.

The U.S. equity markets, as measured by the Dow Jones Industrial Average, began 2016 by dropping as much as 10.1%, only to recover fully by the middle of March. The “Brexit” vote in June shocked world markets, sending long-term U.S. Treasury yields downward to historically low levels before recovering at year end. The U.S. presidential election triggered still more volatility in the financial markets, most notably in the banking sector.

In no instance did we rush toward action. Instead, we sought to maintain a consistent focus on long-term returns. The results that follow reflect continued improvement at M&T, even as we dealt with our particular challenges. Here are the specifics.

Net income under generally accepted accounting principles (“GAAP”) totaled $1.32 billion in 2016, improving 22% from $1.08 billion in 2015. Results reflect a full year of operations acquired in our merger with Hudson City Bancorp, Inc. (“Hudson City”), versus just two months in the prior year. Diluted earnings per common share amounted to $7.78, or 8% higher than $7.18 in the previous year. The 2016 results, expressed as a percentage of average assets and average common equity, were 1.06% and 8.16%, respectively.

Since 1998, M&T has provided its results to investors on a “net operating” or “tangible” basis, which have consistently excluded only the after-tax effect from any gains or expenses realized in connection with mergers and acquisitions as well as the impact from intangible assets recorded in those mergers. We believe that these figures give investors a better view of how merger activity affects our reported results on both the income statement and balance sheet. M&T recognized $22 million, after tax effect, of Hudson City merger-related expenses in 2016. This compares with $61 million in 2015, when the merger was consummated.

Net operating income amounted to $1.36 billion last year, an increase of 18% from the year prior. Net operating income per diluted common share increased to $8.08, improved by 4% from $7.74 in the previous year. The net operating results expressed as a percentage of average tangible assets were 1.14% and expressed as a percentage of average tangible common equity were 12.25%. The net operating results highlight the value of the Hudson City transaction and the accretive nature of that combination.

Net interest income—interest collected on loans, securities, and other investments, less interest paid on deposits and borrowings, expressed on a taxable-equivalent basis—totaled $3.50 billion in 2016, representing an increase of 22% from $2.87 billion in the previous year. Average loans increased by 25% to $88.6 billion last year, reflecting the full-year impact of the loans acquired with Hudson City as well as the increase from those originated across our footprint. Average earning assets increased by 23% to $112.6 billion. Slightly offsetting the growth in balances was a decrease in the net interest margin, or taxable-equivalent net interest income divided by average earning assets, to 3.11%, a decrease of three basis points from 3.14% in 2015. The net interest margin has been continuously pressured by the low interest rate environment that prevailed over the past decade and competitors’ response to the same.

Credit performance in 2016 essentially mirrored the results seen in 2015 and 2014. Net charge-offs, which represent loan balances written off as uncollectible, less recoveries of amounts previously written-off, totaled $157 million in 2016. Notably, net charge-offs expressed as a percentage of average loans equaled 0.18% in the past year, compared with 0.19% in each of 2014 and 2015. These credit metrics reflect consistent, yet slow, economic growth as well as the results of prudent underwriting. Credit losses remain at a level about half of M&T’s long-term average loss rate of 0.36%. The provision for loan losses was $190 million in 2016, exceeding net charge-offs by $33 million. The allowance for loan losses increased to $989 million, or 1.09% of loans outstanding at year-end.

Noninterest income, which represents fees for services and other revenues, amounted to $1.83 billion this past year, unchanged from the previous year. M&T’s three largest fee categories, namely, mortgage banking, trust income, and service charges on deposit accounts, were each little changed from 2015. Over the past few years, significant strides have been made in growing businesses that complement existing banking activities and enhance overall returns. Mortgage banking, both commercial and residential, as well as the Wealth and Institutional Services Division, which generates trust income, are positioned to grow.

Noninterest expenses were $3.05 billion for 2016, an 8% increase from $2.82 billion in 2015. The increase largely reflects the full-year cost of operating the acquired Hudson City branches, partially offset by the lower merger-related expenses previously mentioned. The efficiency ratio, which expresses noninterest operating expenses as a percentage of total revenues, and which reflects the cost to produce a dollar of revenue, was 56.1% in 2016, improved by nearly two percentage points from 58.0% in 2015. Investments continue to be made in new technology, risk management infrastructure, and new business development, including growth in New Jersey.

M&T’s performance during 2016 enabled the company to grow both its capital base and tangible book value, while also returning a greater amount of capital to shareholders. Common shareholders’ equity at the end of 2016 increased by $313 million from the prior year end to $15.3 billion. The ratio of tangible common equity to tangible assets increased from 8.69% at year-end 2015 to 8.92% at year-end 2016. Tangible book value per share ended 2016 at $67.85, up $3.57 from the prior year, representing an increase of more than 5%. During the year, M&T also returned an aggregate $1.08 billion of capital to shareholders through common stock dividends and the repurchase of 5.6 million shares of its common stock at an average price of $114.37 per share. Prudent use of shareholder capital remains our most important priority, as we seek growth opportunities that enhance returns while also looking to distribute excess capital to shareholders.

One is justified, then, in counting 2016 as a productive year for M&T. Despite the ups and downs of the financial markets, we are well-positioned and poised for growth.

Performance during our 160th year provides ample cause for optimism. The year past saw the full integration of the recently-acquired Hudson City, through which we added $37 billion in assets, 217,707 consumer households, and 135 branches in New Jersey, Connecticut, and New York. We continue to believe that this is an acquisition both prudent and promising, one which, like others we have undertaken, builds upon our historic presence in contiguous markets. Dealing successfully with the logistics of such a merger could not be taken for granted. Experience has taught us the rigor with which these tasks should be embarked upon. After years of planning and preparation, 1,070 dedicated M&T bankers went to work, integrating Hudson City’s systems and welcoming new colleagues. Doing so required the commitment of a brigade drawn from many divisions and geographies throughout M&T, completing work over and above what would ordinarily have been asked of them. Converting a thrift into a commercial bank is a process measured in years, not weeks, but early results are encouraging. M&T knows New Jersey, and now New Jersey knows M&T.

We also made continued crucial progress in another multi-year project: building out our risk management infrastructure. Such ongoing investments will do more, however, than meet regulatory requirements; they will help lay the groundwork for securing and increasing our market share in our growing footprint. It should be a source of satisfaction to M&T colleagues and shareholders that we were able to accomplish these sorts of crucial but not flashy projects while maintaining healthy earnings per share and low net loan charge-offs, even as commercial real estate, commercial, and consumer lending all grew.

Optimism, in other words, is altogether justified. We are mindful, however, that the year past could just as well be characterized as good—but not-quite-great. We continued to outperform our peers but the bar for doing so remains low. Perhaps it is only to be expected that bank earnings would be increasing slowly at a time of tepid economic performance. But the specific reasons why our growth has been relatively constrained matter. These same factors have also worked to the detriment of the consumers, businesses, and communities we serve.

A TIME FOR REFLECTION: This is an unsettled and, for some, an unsettling time. There is no doubt, however, that the U.S. is poised for significant policy adjustments, with important effects on key levers impacting the economy. Understanding past constraints is worthwhile as new political leadership contemplates change. With that in mind, this is not the time to focus this Message to Shareholders narrowly on the prospects and accomplishments of M&T, as proud and as optimistic as we are about them. Rather, the goal of what follows is to put our own situation in a broader context. It is, all told, a picture that one wishes were brighter.

One could address a wide range of economic indicators and policies, but in recent years, two far-reaching forces—monetary policy and business regulation—stand out in their importance. Both have a self-evident relationship with bank revenues and expenses. Ultra-low interest rates, of course, make it more difficult to realize traditional rates of return on bank lending and investment. Banks have seen exactly these effects upon measures such as their net interest margins, and in the buildup of liquidity to levels well above historical norms. Furthermore, the raft of new financial industry regulation—embodied in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) but not limited to it—has necessitated that banks hold much higher levels of capital, while pushing compliance costs to record levels. It has not only become more costly, but taken an increasing number of forms that require reporting to an increasing number of regulatory bodies. Banks are now called upon to undertake such varied tasks as monitoring the activities of vendors that we do not control, systematically collecting and sharing information regarding certain customer transactions with law enforcement authorities, and ensuring that our mortgage products and services meet a range of complex standards specified by numerous agencies that do not always work in coordination.

But the focus of concern about the effects of policy should not, first or foremost, be on banks and banking—but, rather, on consumers and communities. And it is therein that recent “results” are alarming. The markets that M&T serves are, in the main, those of historically middle class communities with historically vibrant local economies, often manufacturing-based. Economic and survey data, as it pertains to them, are concerning. On so many measures of economic well-being and security, the so-called middle class has been losing ground for many years. Since 1973, total median household income from all sources, including wages, which comprise more than 80% of income for middle class families, has increased only 13%. In fact, earnings for the typical family actually peaked in 1999. Even as the overall economy, as measured by GDP growth, has approached recovery to a pre-recession level, the typical family has yet to make up the earnings lost in both the 2001 and 2008 recessions. It is no wonder that a declining share of households even consider themselves to be part of the middle class; 63% did so in 2001. By 2015, that number had fallen to just 51%.

Numbers alone cannot fully convey the effects of such stagnation, effects our colleagues observe among their neighbors and in the communities surrounding our branches—whether in college enrollment foregone, retirement postponed, even modest vacations put off. It is worth considering what effects the macroeconomic policies that impact banking referenced above might also have on the hopes and plans of families, workers, and small business owners.

To appreciate fully the current state of the economy, it is important to understand the events that led to this point. Recall, the Great Recession, as it has come to be known, was, unlike prior recessions, precipitated by the aftermath of a broad-based credit bubble spurred by excessive housing-related debt. The severity and unique nature of this downturn necessitated policy responses not previously employed—the effects of which were not well understood. While these responses proved effective early on at stabilizing the economy, their lingering effects continue to weigh on middle class households and communities.

The standard playbook in a normal recession calls for government to pursue structural expansion in fiscal support—elevated government spending and investment coupled with tax relief—while also reducing interest rates. These responses would work in concert to stimulate the economy and reverse its decline, to the advantage of businesses and consumers generally.

In December of 2007, a nearly twenty-year period characterized by generally consistent economic growth ended abruptly, and the economy began to suffer to an extent not experienced in any prior post-World War II recession. The loss of confidence in the financial system led to a state of near-panic. The unprecedented problems posed by this recession demanded unprecedented solutions—bold and drastic action was needed. Unconventional policy responses were implemented, while other heretofore standard responses were not. The government’s most significant fiscal measures were structured not as a general stimulus, but programs specifically aimed at the parts of the economy under the greatest duress. In particular, enormous sums were spent on providing temporary liquidity and capital to rescue key institutions that were at risk of failure, in hopes of limiting collateral damage to the rest of the economy. Such measures were to the direct benefit of large banks, insurance companies, and auto manufacturers—the failure of which could have spurred broader, catastrophic effects.

With comparatively limited support from the usual fiscal measures that would follow a recession, monetary policy bore the burden of stimulating the economy, necessitating a series of measures that were extraordinary and untested. Policymakers were compelled to reduce rates time and again, ultimately reaching a practical limit as short-term rates approached zero, the lowest level ever in the U.S., and remained there for more than seven years. The march into uncharted territory continued. To address the crisis and its aftermath, the Federal Reserve directly infused cash into the economy by purchasing more than $3 trillion of securities, equivalent to nearly a year of federal government spending. This unparalleled use of monetary policy helped to avert a depression.

The responses in the years following the worst of the crisis were also unconventional. Rather than spending to promote growth, the government instead enacted legislation and regulation that in practice restricted it—effectively, a form of negative fiscal policy. Put forth in the name of preventing a recurrence of the circumstances that led to the financial crisis, the plethora of new regulations intended to limit taxpayer risk have ultimately proved a drag on growth. Regulation took many shapes and forms across all sectors of the economy, affecting not only the financial sector but also industries as diverse as energy, healthcare, housing, and construction. Businesses were no longer willing or able to take the prudent risks that even moderate growth expectations demand.

With the benefit of hindsight, it appears the economy in recent years has fallen out of balance—overly reliant on monetary policy not accompanied by traditional fiscal stimulus. Policies designed to benefit the majority have perversely only benefited a few. The impacts of these decisions or non-decisions are real. In particular, the middle class and small businesses are losing ground. So, too, are their communities. The details that follow illuminate trends that should be of concern to all.

This extended period of ultra-low interest rates no longer benefits the average U.S. household. The majority of the wealth of the typical M&T customer, like that of most Americans, takes the form of equity in their homes, retirement savings, bank deposits and, to a lesser extent, stock market investments. Low rates initially provided middle class households with relief both by lowering monthly mortgage payments and supporting a recovery in home values. However, the investments of these same families have suffered. Indeed, many middle class families, frightened by the precipitous market decline of 2008, responded by pulling out of the market. Only half of these households today hold any stocks or mutual fund shares; before the crisis, fully 72% did so. Crucially, without stocks and the growth in value and dividends they can provide, most households must rely on interest from their investments to save for college, a down payment on a home, or to prepare for and navigate retirement. It is here that they have felt the sting of near-zero interest rates.

Interest income for households has declined sharply in the aggregate. In 2014, it had, compared to 2005, fallen by some $64 billion. This disproportionately affected households with an income less than $100,000; their interest income declined by $44 billion, or 68% of the total decrease for all households. There are, to be sure, some who can take such a drop in stride—those, for instance, fortunate enough to hold dividend-paying stocks. Dividend income in 2014 was, in fact, $162 billion higher than it had been in 2005. But 95% of that increase in dividend income has accrued to households whose income was greater than $100,000. Indeed, only $9 billion of the $162 billion increase in total dividend income has found its way to households with annual earnings under $100,000—not enough to offset the lost interest income.

Investments managed on behalf of the typical American family are not immune to these economic trends. At the heart of the issue is the declining rate of return on investments—particularly secure investments like bonds. The practical implications for the alternatives through which typical households preserve and grow wealth, such as insurance, retirement accounts, and pensions, are troubling.
Indicative of what has happened in the marketplace, insurers that have traditionally invested premiums in safe, long-term instruments such as government securities and high-quality corporate bonds have come under pressure. The average yield on 10-year U.S. Treasury bonds since 2010 has, unfortunately, declined to a level 274 basis points, or 53%, below the 30-year average. Insurers ultimately have limited options to offset sustained low yields on their investments. Should rates remain low, it will eventually be necessary to raise prices or invest in assets that offer higher returns but also carry higher risk. Neither outcome would benefit middle class families.

Pension plans sponsored by employers, long a pillar of retirement savings for many workers, face similar pressures. Low rates that pension funds earn on investments mean either that businesses and governments must set aside more to ensure future benefits, or put those benefits at risk by under-funding them. The trend is disconcerting. Although, at the end of 2007, corporate pension plans showed a modest surplus, they had, by the end of 2016, developed a $408 billion deficit. Not even public sector employees can remain confident in the health of their pension plans, as some major state pension funds reduce their estimated rates of return and contemplate reductions in benefits. To offset the impact of low returns and still deliver on their promises to consumers, investment professionals are increasingly turning to alternative investments such as hedge funds and private equity that offer the potential for higher returns, but come with more risk.

Given these costs and challenges, many businesses have responded by transitioning away from offering pensions altogether, instead sponsoring programs such as 401(k) accounts through which employees largely bear responsibility for determining the amount they save and the manner in which they invest. Workers then confront the same difficult choices as investment managers, weighing the tradeoff between accepting low returns or undertaking greater risk with their hard-earned savings.

No wage growth. No investment earnings growth. No wonder families are stretched and stressed. We should hardly be surprised, then, to see a sharply increased rate of savings—fully 1.5 percentage points higher than that in 2000-2004. Accompanied by lower interest income, this has led middle class families to spend less, dampening economic growth. Simple math suggests that a 1.5 percentage point increase in the savings rate equated to nearly $200 billion in consumer spending—spending that did not occur as families instead saved more to make up for their lost income. Monetary policy was intended to act as an accelerant for an economy in recession, and did in fact accomplish that goal early on; however, its benefits have waned, if not reversed, over time.

Similar to the experience of American families, the response to the financial crisis has contributed to a dichotomy between the performance of the largest American firms and the smaller businesses that form the backbone of the communities we serve.

By many measures, the performance of large businesses following the recession has been impressive. Between 2007 and 2012, the receipts of firms with 500 or more employees increased, in real terms, at an annual rate of 2.4%. Employment levels for such firms have fully rebounded from the Great Recession and then some; as a group, they employed 2.4 million more workers in 2014 than in 2007. So, too, we saw the profit margins of the corporations in the S&P 500, the nation’s largest public companies, exceed pre-recession levels and reach their highest level in the past three decades, increasing from less than 6% near the end of the Great Recession to 9.2% in 2014.

This recovery in the fortunes of large businesses is not all that it seems, however, when one looks more closely at its underpinnings. In effect, the largest firms—and their shareholders—have benefited disproportionately from a recovery fueled by monetary policy based on inexpensive access to financing and historically low interest rates. Large businesses have taken full advantage of the availability of credit at low cost, which, for such firms, has never been more favorable. Highly-rated corporations issued more than $1.2 trillion of debt in 2016 alone, the highest level ever recorded. Indeed, the level of debt as compared to earnings before interest, taxes, depreciation, and amortization has reached its highest level since 1980.

It is also instructive to examine what large firms are doing with this tsunami of cheap capital. One would hope, of course, that the debt issued would be used to support the sort of investment in tools, technologies, and research and development that has historically improved labor productivity and consequently created well-paying jobs for middle class families. That, however, has not been the case. Unfortunately, due to the stagnant economy, firms are left with no choice but to return their earnings to their shareholders, few of whom are middle class families. Indeed, in 2015, S&P 500 companies returned $978 billion of their earnings to shareholders through dividends and share buybacks, exceeding the $923 billion they invested in capital goods and research and development of the sort that would lay the foundation for future growth.

These large firms have also taken advantage of low interest rates and their own appreciating share prices to acquire smaller competitors. The average valuation of the large firms in the S&P 500 has increased by 37% from 12.9 times annual earnings in 2011 to 17.7 times in 2016, providing them with a strong currency to fund acquisitions. During 2015, the S&P 500 companies alone spent more than $400 billion on such acquisitions. This is all the more concerning because, to the extent that we have seen job growth, it has come on the payrolls of the largest firms. Job growth that is bought, not hired, is not net job growth for the community.

Implicit in the story of how larger businesses and their shareholders have benefited from economic policy is the less-than-happy but related tale of how small businesses have not. By small businesses, we mean the 5.7 million firms employing fewer than 100, the types of businesses we customarily serve at M&T—small and start-up manufacturers, car dealers, construction firms, and retailers, among others.
Historically, small business has been the engine of new job creation and, indeed, even the womb in which new American industrial sectors were incubated. However, over the past four decades, the role of such enterprises has been steadily diminishing, to the nation’s detriment. While U.S. businesses have added more than 44 million jobs since 1980, small businesses accounted for less than 12 million jobs, or just 26%, of this growth. The severity of the Great Recession and its aftermath only exacerbated this trend. Where large businesses have seen employment grow by 2.4 million since 2007, small business employment is down by 1.9 million over the same period. Payrolls in real dollars have retreated by $85 billion at small businesses but are up $245 billion at their larger counterparts. As the number of large businesses has grown, the ranks of smaller firms have declined by 224,000 since 2007. We have seen small business growth wither and its independence threatened, with implications for communities and the overall economy.

Small businesses, like their larger brethren, are reluctant to invest and expand despite the historically low interest rates. There is more to this story than just the stagnant economy. At M&T, we surveyed our small and medium-sized business clients in an effort to understand the challenges they face. One might expect them to express traditional concerns—such as the cost of materials or the pressure of competition. Instead, 55% cited the cost of employee healthcare benefits as their greatest hurdle, while 36% cited the not-unrelated challenge of complying with government regulation. To underscore: notwithstanding the slow-growth environment of the post-recession economy, our own business clients view regulation as a greater concern than sales growth, the lifeblood of any business. As we have found in our own markets, so has a national survey conducted by the National Federation of Independent Business (“NFIB”). Indeed, since 2009, that survey has cited regulation as the single greatest challenge facing small businesses across the country. This suggests that their core problem is not a lack of opportunity, but government-imposed obstacles that limit their ability to capitalize on the opportunities they identify.

If concern over new regulation seems justified and plausible, the record confirms this. It shows that a bloom of regulation and regulators has accelerated since the 2008 recession. The extent of the growth in regulation is both impressive and staggering. Since 2010, the average number of pages of new regulations issued has exceeded 25,000 annually, up nearly 60% from the level of the 1980s. The total length of the Federal Register, the official repository of federal rules, reached 178,277 pages in 2015, up from some 151,973 ten years earlier and just 71,224 in 1975. The cost to the private sector of the regulations promulgated in 2015 alone has been estimated by the regulators themselves at $23 billion. The estimated annual cost of rules enacted since 2009 exceeds $108 billion, or fully 0.6% of U.S. gross domestic product. The scope of regulation facing the businesses we serve has dampened and diverted their energies. It is very much uncertain whether the benefits of the ever-growing volume of regulation outweigh its drag on economic growth.

One especially worrisome insight from a 2012 NFIB study: 55% of small business owners would not again choose to open shop. The declining rate of small business formation reflects this growing caution on the part of would-be entrepreneurs. The number of new small businesses has declined from an annual average of 529,055 during the period 2003-2007 to 399,483 during 2010-2014—a 25% decline. Even more worrisome is the fact that the average number of new jobs created annually by new small businesses decreased from 2.8 million during 2003-2007 to 2.0 million during 2010-2014—a 26% decline.

To make matters worse, many of the smaller companies that we serve have capitulated, selling to distant investors and larger competitors with the scale to withstand the onslaught of regulation. Private equity firms in particular have been aggressively consolidating industries, buoyed by capital from pension funds and insurers and leveraged by low-cost financing. During 2015 alone, private equity firms acquired more than 4,100 businesses at a cost of $737 billion, surpassing even the number of such acquisitions in the boom years preceding the financial crisis. Nationally, the number of businesses owned by private equity funds has increased by 46% since 2009. The pace of growth in private equity acquisitions has only stabilized in the past two years as a different type of buyer surged—larger publicly-traded firms. This is not the kind of data one associates with healthy, long-term economic growth, nor an economy that can pull discouraged workers back into the labor force or encourage them to improve their skills.

Employment and economic growth have been held back not just by regulation and monetary policy but by what the economists would call human capital deficits—a shortage of qualified potential employees to fill available jobs in healthy industries. Nearly 30% of small businesses, for instance, report that they have been unable to fill open positions, double the rate of five years earlier. The number of positions across the country that remain unfilled has grown from less than 2.2 million in the depths of the financial crisis to more than 5.5 million today.

This is not an abstract point to us at M&T. It is one made regularly by perplexed and frustrated business owners with whom we meet, whether in western New York, central Pennsylvania, New Jersey, or Maryland. These are firms that would like to hire—but cannot find the right kind of employee. Somehow, the combination of primary and secondary education systems, and post-graduate training, is failing both employers and their potential employees. Our own survey found that 61% of all small businesses reported difficulty in hiring qualified entry-level employees. The picture is most bleak in the construction industry, where we found that 64% of small business owners had difficulty finding skilled labor. Indeed, the number of open positions in the construction industry relative to overall industry employment continues to increase and now exceeds its pre-recession peak. In our own markets, we hear reports that upstate New York construction firms must look as far away as California to find qualified applicants. This is, without doubt, a problem that goes beyond M&T’s markets. In a national survey, fully 44% of businesses seeking to hire reported that they could not find employees with the skills needed. At a time when elected officials signal the prospect of a major national investment in infrastructure construction and reconstruction, a lack of skilled tradesmen must be viewed as a pressing concern.

The effects of slow economic growth, a shortage of qualified labor, and the growing regulatory burden can express themselves in ways that transcend specific firms and business sectors. These impediments cloud the prospects of entire communities. Locales with long traditions of industry and industriousness, innovation and livability, have found themselves buffeted by a perfect storm of business regulation, business takeovers, and subsequent exits. Left in its wake, these communities face a lower tax base but greater social service needs, at the same time the business and corporate philanthropy that was once a bedrock of local charity has shriveled.

This is a downward spiral that starts with what has happened to many small and middle market firms we find in our footprint—whether in central or western New York, central Pennsylvania, or Delaware. It is tempting to believe that the shuttering of once-thriving independent middle market businesses in so-called Rust Belt communities is an inevitable side effect of much larger economic factors. We do not subscribe to this view. Policy matters. The cost and complexity of regulation helps to make these communities and their smaller employers vulnerable to takeover by outsiders, both public and private, with the scale necessary to prosper in the face of ever-greater regulation. Following such takeovers, headquarters offices depart, and local employment—and, quite possibly, technological innovation—withers. Local tax revenues of all types—whether based on home values or business offices—decline. Ancillary businesses, whether lunch counters or parts manufacturers, are at risk as well. This is how communities with great histories, a willing workforce, and affordable housing are passed by and hollowed out.

The effect in our own communities has been both substantial and concerning. Consider some specifics. M&T surveyed the impact of business acquisitions by non-local investors in Syracuse. Like so many of the markets we serve, this city has historically been a hub of manufacturing, home to dozens of firms in industries such as specialty steel, fasteners, and custom machining. Such are the firms that are being shuttered or diminished. We found that, since 2004, at least 55 small and middle market firms in the Syracuse area alone were acquired by firms headquartered outside the region. After being acquired, these firms subsequently reduced employment by 40%, or 7,687 jobs. The jobs lost just by these firms represent 2.4% of all jobs in the Syracuse area. This is no isolated case. Across our markets from upstate New York to Maryland, we identified at least 407 local businesses that were sold to buyers headquartered elsewhere—employment at these businesses later declined by an average of 25%.

Beyond the jobs and families directly affected, we looked at the impact of this loss of local companies upon some of the largest charities in our mid-sized markets. In city after city, from Buffalo to Syracuse, from Rochester to Harrisburg, the same pattern emerged. Research showed that, for local companies that were acquired by out-of-town firms, associated corporate and employee donations have declined by 59% to 89%. This is in contrast to the trends for companies that preserved local ownership, where philanthropic giving remained essentially flat or, in some instances, modestly increased. Membership of business leaders on not-for-profit boards declined—robbing the community of not just dollars but advice and expertise. Such local businesses have not only created new jobs but also groomed generation after generation of leaders for their communities, a critical role that distant acquirers cannot easily fill. So it is that we see the sinews of healthy communities atrophying, the quality of life for their citizens deteriorating.

No single factor is to blame. The tides of change cannot altogether be held back, to be sure—nor should they be. But the policy decisions made in the aftermath of the Great Recession also matter—and have made crucial differences. The growing weight of regulation and the low interest rate environment that has outlived its usefulness have added impetus to this wave of takeovers. In their own way, they have held the economic recovery in check.
Beyond these detrimental effects upon the businesses and communities that we serve, the scope of regulation has, in many respects, reshaped entire sectors of the economy. Consider just a few key industries that have been disproportionately affected by regulation. Energy, healthcare, housing, and finance, which in combination contribute 29% of U.S. economic output, have together faced a total of 7,260 new regulations just since the beginning of 2009. The effects of such regulation are sweeping and often severe—its deployment invariably well-intentioned, yet its implications often unappreciated or misunderstood. As just one example, a recent survey suggests that, on average, regulation adds nearly $85,000 to the cost of developing and constructing a new home. Perhaps not coincidentally, fewer new homes were sold in 2016 than in 1973, a time when the U.S. was one-third less populous than today. It is instructive to consider the ways in which regulation has transformed the industry with which we are most familiar—our own.

Regulation, more than any economic force in memory, has changed the face of banking. And because the fates of banks and the communities they serve are so intertwined, the regulatory impacts borne by regional banks are inextricably linked to the repercussions experienced by their customers. When oversight efforts made in good faith to alleviate one perceived problem inadvertently create another, the consequences, unintended as they may be, are tangible and far-reaching.

In the wake of the financial crisis, legislators and regulators imposed a wide array of new laws and regulations, ostensibly to instill confidence in the U.S. financial system by limiting the amount and type of risks the largest financial institutions could undertake. So cataclysmic was the crisis, lawmakers felt pressured to react swiftly. It was decided, abruptly and arbitrarily, that banks whose assets exceeded a $50 billion threshold would be subjected to the most demanding requirements of the subsequently enacted Dodd-Frank legislation, regardless of an individual bank’s complexity or the nature of its business activities.

Of course, not all banks are of equal size and complexity and not all companies that would call themselves banks are actually in the business of traditional banking—taking deposits and making loans to support community growth. Nonetheless, regional banks such as M&T find that they must meet the same onerous requirements as the largest global systemically important banks or “G-SIBs”—essentially those banks that have been deemed too big to fail. Significantly, these large banks generate a substantial portion of their revenue both through trading activities and lending to some of the largest companies in the world. To wit, just five of these large banks account for 90% of the industry’s total trading revenue with total notional derivatives exceeding $200 trillion, or more than 11 times U.S. GDP—a mix of business that differs drastically from the community-focused approach employed by regional banks.

The differences between the largest banks and their regional counterparts extend not just to their business models but also to the ways in which they are executed. Indeed, there is compelling evidence to suggest that the regulators themselves would concur with such assertions, as evidenced by the sheer volume of regulatory sanctions and fines that these large firms have distinguished themselves by incurring. Particularly concerning are the instances where institutions or their employees placed their interests before those of their own customers. In the past decade, five large banks alone were subject to at least 187 legal settlements and fines totaling $158 billion, with at least another 89 investigations and lawsuits currently pending. The magnitude and frequency of these events have brought the wrath of the public upon the entire industry, creating a perceived necessity for more regulation. Leadership has an obligation to set a moral tone.

What’s more, regional banks pursuing straightforward, traditional business models have been determined to pose low levels of risk, as measured by the scorecard designed by the Basel Committee on Banking Supervision to assess the risk that any given bank poses. This measure considers a host of factors including a bank’s size, complexity, interconnectedness, and international exposures. The commendable marks for regional banks stand in stark contrast to those of the largest banks, which operate across the globe and have much higher risk scores. If M&T and our 10 regional bank peers that individually have total assets between $50 billion and $500 billion were combined into a single institution spanning the country, the systemic risk score of that entity would not be nearly as large as that of any one of these five large banks.
But despite the fundamentally lower risk that regional banks pose to the financial system as judged by the regulators’ own yardstick, they are still subject to nearly the same number of regulators and volume and character of regulations that rightly apply to their much larger and far more complicated brethren, with all of the attendant costs.

One-size-fits-all rulemaking has thus created an uneven playing field, to the particular disadvantage of regional banks. The largest banks can bring their vast resources to bear in addressing these new measures of oversight, while the smallest banks escape many of the most punitive regulations altogether. This arbitrary approach confers, as well, a distinct benefit on an emerging class of non-bank lenders—a group indirectly empowered by regulation that has ensnared traditional banks. These lenders have subsequently capitalized fully on the cost advantage resulting from their lesser regulatory burden. Such firms participate in many facets of banking. To understand the damage, consider mortgage banking, where non-banks originate more than half of new U.S. residential mortgage loans, compared to just 9% seven years ago.

Regional banks are penalized at the starting line, paying dearly to try to narrow the gap but not always succeeding. At M&T, our own estimated cost of complying with regulation has increased from $90 million in 2010 to $440 million in 2016, representing nearly 15% of our total operating expenses.
These monetary costs are exacerbated by the toll they take on our human capital. Hundreds of M&T colleagues have logged tens of thousands of hours navigating an ever more entangled web of concurrent examinations from an expanding roster of regulators. During 2016 alone, M&T faced 27 different examinations from six regulatory agencies. Examinations were ongoing during 50 of the 52 weeks of the year, with as many as six exams occurring simultaneously. In advance of these reviews, M&T received more than 1,200 distinct requests for information, and provided more than 225,000 pages of documentation in response. The onsite visits themselves were accompanied by an additional, often duplicative, 2,500 requests that required more than 100,000 pages to fulfill—a level of industry that, beyond being exhausting, inhibits our ability to invest in our franchise and meet the needs of our customers.

The sheer magnitude of this cost and requisite management focus diverted to compliance with expanding regulations overextends traditional banks’ finite resources—thereby hindering their ability to introduce new products and technologies, or pursue other projects that might be in the best of interests of their shareholders, customers, and communities. But as substantial as the compliance cost burden may be, regulatory consequences extend far beyond mere dollars and hours. Regulation has altered the fundamental underpinnings of traditional banking activities, including prudent decision-making regarding lending and, ultimately, the efficient allocation of capital.

A STRESSED ECONOMY: Perhaps the most notable and intrusive regulation is the Comprehensive Capital Analysis and Review (CCAR) “stress test” exercise, an annual activity in which regulators forecast whether a bank is capable of withstanding an economic downturn more severe than the Great Recession of a decade ago. Results of these tests are widely publicized—giving banks a compelling incentive to pass and avoid the potential reputational damage that might accompany a failing grade.

The stress test considers many types of risk, but for regional banks, which focus on lending rather than trading, credit risk (the risk that borrowers will not be able to repay their loans) is the most salient. Its inclusion in the vitally important stress test calculus has forced a fundamental change in the way that lending decisions are made, reshaping the historically symbiotic relationship between regional banks and businesses.

To understand the nature of the change wrought by regulation, one must understand the traditional loan underwriting process. Regional banks base decisions to grant loans not just on such empirical (and universally available) factors as credit scores, but on local and personal knowledge, as well: the established reputation or known character of the applicant, or on the unquantifiable value that business owners bring to the table through their proven experience or entrepreneurial expertise. Yet the regulators’ models do not acknowledge the full range of valuable skills and local market knowledge that banks have long used in prudently determining whether to extend loans to worthy borrowers. Instead, banks are forced into a regulator’s Procrustean bed, called upon to follow an altogether formulaic process for reporting the characteristics of each loan. Regulators then evaluate the potential risk of default for each transaction using only financial models that use a prescribed set of variables, including the borrower’s credit score, the age of the business, and the type of lending product in question. Banks are not called upon to provide, and presumably the stress test models cannot consider, other pertinent information that reflects the true risk of individual small businesses. Such information would provide a more accurate and meaningful picture—the tale that a set of one-dimensional numbers cannot possibly tell.

The implications of these regulatory shortcomings are not inconsequential. Forced to compete on an already skewed playing field, regional banks are diverging from what they do best by making lending decisions based not on their wealth of local knowledge and experience, but primarily through the narrow lens of the factors considered in the regulators’ models. Ever-looming stress test consequences have forced traditional banks to deploy a cold and calculated rubric that fails to comprehensively evaluate the ineffable quality of loans they make to small businesses. A recent industry analysis demonstrates the extent to which the stress test may distort the allocation of capital. The study suggests that, in the context of the stress test, banks must effectively hold as much as 140% more capital for a small business loan than for a loan to a larger firm—remarkably, small business loans are actually treated more punitively than even the potentially risky trading assets predominantly held by the largest banks.

Deprived of their competitive advantage, regional banks must reconsider whether to make otherwise prudent loans that might face even the possibility of running afoul of the stress test models. The effect was all but inevitable: small business loan originations by regional banks subject to the stress test have not grown at all since 2009.

The stress test process has wrested decisions regarding the allocation of capital from regional banks that have a vested interest in the health of their communities and placed them in the hands of distant regulators. A small business owner’s experience and the informed perspective of a bank have been discounted to the detriment of all involved.

A CAPITAL BIND: While stress tests have hindered banks’ ability to properly serve their customers, they are hardly unique in inflicting collateral damage in the name of mitigating risk to the U.S. financial system. Heightened liquidity requirements have also constrained deployment of capital that might otherwise help expand the economy. Once again, in the name of risk mitigation, these provisos require banks to use the funds entrusted to them by their customers to purchase government securities classified as “liquid.” In other words, banks are effectively mandated to use deposits to fund the needs of government rather than those of businesses and consumers.

Banks typically prefer to use the vast majority of the deposits they gather to support new loan growth. The total deposits of M&T and our 10 regional bank peers that individually have total assets between $50 billion and $500 billion increased by $733 billion during the past decade. Of these monies, $308 billion, or more than 42%, were diverted to purchase securities such as government bonds or simply stored at the Federal Reserve rather than being deployed in the community as loans.

Worse still, liquidity regulations do not treat all deposits equally. Deposits by consumers are considered to be “sticky” and are preferred to those emanating from businesses large and small, which are in turn preferred to deposits of governments or other financial institutions. As a result, the largest banks have begun to aggressively compete for consumer deposits—often in markets where they had not previously been active—because they allow the bank to hold a lower percentage of government securities in offset.

The largest banks have used technology and advertising to increase their market share in these communities. During 2016 alone, three of the largest banks grew their combined deposits by more than twice as much as M&T has grown its deposits during its entire 160-year history, including through 24 acquisitions in the last 30 years. Again we bear witness to an all-too-common theme: large banks gaining ground at the particular expense of community-focused institutions.

Other regulations such as the so-called living will, a mechanism intended to assist regulators in coping with the potential failure of one of the largest global banks, have also been inappropriately applied to regional banks with simpler business models. Such a rule may be sensible for the largest institutions; just five of these large banks each have, on average, 1,977 subsidiaries. In contrast, at M&T, in a structure more typical of regional banks, the total number of such entities is only 41. But despite their comparative simplicity, the limited degree to which they change year-over-year, and the much lesser degree of risk they pose to the financial system, regional banks are subject to the same costly living will preparation process as the larger banks.

FORWARD OVER LOST GROUND: We have directly observed the fundamental changes that regulation, as presently structured, has wrought upon our own industry, whether to the competitive balance between large and small banks or the nature of the relationships between banks and our customers. To the extent that our experience is mirrored across the many other industries impacted by regulation, it is no surprise that the performance of the economy and the sentiment of businesses and families has, until recently, remained subdued. Innovation has been stifled. The rewards of entrepreneurship may, in many instances, no longer outweigh its risks and its higher costs.

With the crisis long past, the time for meaningful change—call it reform of the reforms—has arrived. Policies implemented over the past decade have needlessly impaired the ability of businesses of all stripes to perform their core function. Regulation meant to protect Americans has unwittingly inflicted unintended consequences across the country—the profound impacts of which are only now coming to be fully appreciated by the public and understood by the legislators themselves.

Our own core function as a regional bank has long been to lend the deposits entrusted to us to support productive investments by families and businesses, which ultimately create not just jobs, but a better standard of living for our citizens. Thoughtful reform would help us to better fulfill this important role. For instance, communities throughout America could benefit if legislators reconsidered the undiscriminating manner in which capital and liquidity regulations have been applied to banks with little regard to their regional scope or the limited risk that they truly pose to the financial system. This is not to suggest that one should ignore the pain that the Great Recession inflicted on so many, nor to assume that some measure of change has not been beneficial. However, a more tailored approach to regulation would benefit both regional banks and their communities, helping to recover the ground lost over the last decade.

We welcome some of the recent trends in that regard—those that recognize the lesser degree of systemic risk that regional banks pose, such as the elimination of the qualitative objection to the stress test for regional banks and the increased differentiation in capital and liquidity requirements for the largest banks that truly pose systemic risk. At the same time, we also recognize that, in practice, the tailoring of regulations implemented to date has not significantly alleviated the burden borne by M&T and banks of a similar ilk.

More can be done. Consumers, small businesses and, ultimately, our communities will be the better for it. Change was needed but now change is needed again.

I cannot conclude my recollections of the past year without pausing to acknowledge the passing of two members of our Board of Directors, men who we considered more than business colleagues. They were like family.

Richard G. King joined the boards of both M&T and M&T Bank in 2000, following M&T’s acquisition of Keystone Financial. Rick brought a wealth of knowledge gained through his diverse leadership experience. His business acumen was often prescient and always helpful. So much of what we know about our Pennsylvania communities comes via the relationships he cultivated.

Patrick W.E. Hodgson was among the longest-tenured directors of M&T, having joined the board of M&T Bank in 1984. A man of great integrity, his quiet dignity and sound judgment helped ensure that we never lost our way. Much of our culture and character can be traced back to Pat. His guidance and experience were invaluable over three decades of growth and change at M&T.

We will greatly miss their counsel, contributions, and their friendship. These are men I am proud to have known.

This is now my 35th year in a management role at M&T. In many ways, I marvel at the pace and character of change that has occurred—not only at the bank but in banking itself. What was once community and regional competition has increasingly become national and international. Products and services once offered only by specialists are now provided by a broad array of firms. Just as many one-time competitors have fallen by the wayside, so, too, new ones have emerged—often enabled by new technology. Yet I remain convinced that the hallmarks of the M&T way of doing business will continue to be relevant and successful. We worry today about robots and algorithms replacing humans the same way we worried yesterday about ATMs and the Internet. Time has taught us that technology and humans are complements, not substitutes. Time has also taught us that successful underwriting and investment require sound, non-predictable, non-formulaic judgment—an essential element of the M&T culture.

Without question, the results we’ve achieved in decades past and the progress we hope to make in those to come would not be possible without the tireless efforts of the 16,972 M&T bankers I’m proud to call my colleagues. It’s a group whose character and commitment to customers and to one another is without peer. From Jamestown to Ocean City and Watertown to Richmond, these employees are the heart and soul of our bank. In recent years, these faces have grown increasingly diverse—reflective of our changing communities. We are stronger for their many and varied perspectives—not just welcoming, but embracing the value and contribution of each of our colleagues.

I well understand that, every year—indeed, every day—the relevance of this traditional approach, complemented by new technologies, will be tested. Still, I remain confident that M&T’s people and culture position us not merely to endure but to prosper in the face of new challenges.

It was just as this Message went to print that, after a long illness, we lost Mark Czarnecki, our President and Chief Operating Officer. We mourn him as colleague, friend, family man, mentor and community leader.

In many ways, Mark personified both the roots and growth of the bank. A Western New York native, he joined M&T 40 years ago— when we had but 61 banking offices in and around Buffalo. His own career followed—and enabled—our subsequent growth. As a young graduate of the State University of New York at Buffalo he began at M&T as a “platform assistant” at what was then our Main Tupper branch—the first of 24 positions he would hold. From his next post as assistant branch manager he would ultimately go on to become President and COO, along the way serving as a branch manager, business banker, commercial lender and head of the investment group. He could understand—and mentor, as he loved to do—both colleagues and newcomers throughout the bank because he had been in their shoes.

To understand Mark’s career is to understand his character. For Mark, no detail was too small and no job was too large. He related easily to everyone, whether a teller at his local branch, business leaders on a community board or presidents of other banks. His humble, approachable style made others feel cared about and comfortable.

Mark knew how to bring the right people together and teach them the skills to succeed, not just in their current job, but in the one they could have tomorrow. He never stopped cultivating talent and that legacy will last longer than his storied career.
Mark set an example as a community leader in the town where he was born—pointing the way for those in the many towns and cities we serve today. Nothing animated or inspired him more than his work as chairman of the Westminster Community Charter School. He was not the businessman who just showed up for meetings; he aspired to help build a better school for Buffalo’s disadvantaged and went the extra mile—in raising funds and recruiting talent—to help make that happen. Throughout Buffalo, there are many whose lives were changed and enriched by Mark Czarnecki.

Mark’s influence on the community is surpassed only by the inheritance of love he left as a husband and father. My deepest sympathies go out to his wife, Elizabeth, his sons, Christopher and Gregory, and their entire family. We’re grateful to them for sharing Mark with  us.
May his memory be a blessing to them.

Throughout the bank and our community, Mark’s success felt like our own—and showed what we all might do. It’s only seven tenths of a mile from the Main Tupper branch to headquarters, but Mark’s path inspired the hopes and dreams of many. Others may assume his duties but he will never be replaced.

Thanks for everything. Rest in peace, dear friend.

Robert G. Wilmers
Chairman of the Board
and Chief Executive Officer
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