M&T Bank Corporation (MTB) Q1 2018 Earnings Conference Call Transcript

M&T Bank Corporation (MTB -0.72%)
Q1 2018 Earnings Conference Call
April 16th, 2018, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome to the M&T Bank first quarter, 2018 earnings conference call. It is now my pleasure to turn the floor over to Don MacLeod, Director of Investor Relations. Please go ahead, sir.

Don MacLeod -- Administrative Vice President and Director, Investor Relations

Thank you, Laurie. Good morning. I'd like to thank everyone for participating in M&T's first quarter, 2018 earnings conference call, both by telephone and through the webcast. If you have not read the earnings release we issued this morning, you may access it, along with the tables and schedules from our website, www.mtb.com, and by clicking on the Investor Relations link and then on the Events and Presentations link.

Also, before we start, I'd like to mention that comments made during this call might contain forward-looking statements related to the banking industry and to M&T Bank Corporation. M&T encourages participants to refer to our SEC filings, including those found on forms 8-K, 10-K, and 10-Q for a complete discussion on forward-looking statements.

Now, I'd like to introduce our Chief Financial Officer, Darren King.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Thank you, Don, and good morning, everyone. M&T's results for the first quarter largely reflect a continuation of the economic environment we've been operating in over the past five or six quarters and the financial trends that have emerged. The results are characterized by the following -- strong year over year growth in net interest income reflecting continued expansion of the net interest margin combined with modestly lower loan balances as growth in commercial and consumer loans was offset by our continued runoff of the residential mortgage portfolio acquired in the merger with Hudson City.

Fee revenues were comparatively stable with trust fees continuing to be a highlight. We experienced our usual seasonal uptick and compensation-related expenses during the first quarter associated with equity compensation and employee benefits cost. Aside from that, expenses continue to be well-controlled.

The credit environment remains very good to excellent. As announced in early February, M&T amended its capital plan for the 2017 CCAR cycle. After receiving no objection from the Federal Reserve, M&T's board of directors authorized an additional $745 million of share repurchases to be completed by the end of this year's second quarter.

Let's look at the specific numbers for the quarter. Diluted GAAP earnings per common share were $2.23 for the first quarter of 2018 compared with $2.01 in the fourth quarter of 2017 and $2.12 in the first quarter of 2017. Net income for the quarter was $353 million compared with $322 million in the linked quarter and $349 million in the year ago quarter.

On a GAAP basis, M&T's first quarter results produced an annualized rate of return on average assets of 1.22% and an annualized rate of return on average common equity of 9.15%. This compares with rates of 1.06% and 8.03% respectively in the previous quarter.

Included in GAAP results in the recent quarter were after tax expenses from amortization of intangible assets amounting to $5 million or $0.03 per common share, little change from the prior quarter.

Consistent with our long-term practice, M&T provides supplemental reporting on its results on a net operating or tangible basis from which we have only ever excluded the after tax effect of amortization of intangible assets as well as any gains or expenses associated with mergers and acquisitions when they occur.

M&T's net operating income for the first quarter, which excludes intangible amortization was $357 million compared with $237 million in the linked quarter and $354 million in last year's first quarter. Diluted net operating earnings per common share were $2.26 for the recent quarter compared with $2.04 in 2017's fourth quarter and $2.15 in the first quarter of 2017.

Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholder's equity of 1.28% and 13.51% for the recent quarter. The comparable returns were 1.12% and 11.77% in the fourth quarter of 2017. In accordance with the SEC's guidelines, this morning's press release contains a tabular reconciliation of GAAP and non-GAAP results including tangible assets and equity.

Both GAAP and net operating earnings for the first and fourth quarters of 2017 as well as the first quarter of 2017 were impacted by certain noteworthy items. Included in the first quarter of 2017's results was an $18 million tax benefit that arose from revised accounting balance for equity compensation. This amounted to $0.12 per common share. Included in last year's fourth quarter results was a contribution to the M&T charitable foundation amounting to $44 million. That contribution equaled $27 million after tax effect or $0.18 per common share. The contribution exceeded the $21 million of realized securities gains recognized during the fourth quarter.

M&T's effective tax rate for the fourth quarter was also impacted by changes to US corporate tax rates. M&T's provision for income taxes for the quarter was increased by approximately $85 million as a result of the tax law changes reflecting a revaluation of the corporation's net-deferred tax assets. This amounted to approximately $0.56 per common share.

In aggregate, these items lowered net income for the fourth quarter by $98 million or $0.65 per diluted common share. During the recent quarter, M&T increased its reserve for litigation matters by $135 million to reflect the status of preexisting litigation. That increase on an after-tax basis reduced net income by $102 million or $0.68 of diluted earnings per common share.

Also, during the first quarter of 2018, M&T received a cash distribution of $23 million from Bayview lending group, which is reflected in other revenues from operations. This amounted to $17 million after tax effect or $0.12 per diluted common share. Similar to last year, M&T's results for the first quarter included a $9 million tax benefit relating to the new accounting guidance for equity compensation. That amounted to $0.06 per diluted common share.

That benefit coupled with the lower corporate income tax rate reduced M&T's effective tax rate for the quarter to just shy of 23%. Earlier, I noted $21 million of realized security gains in last year's fourth quarter which arose primarily from the sale of a portion of our GSE-preferred stock holdings. Our results for the first quarter reflect a $9 million unrealized loss on our portfolio of equity securities primary comprised of our remaining holdings of GSE-preferred stock.

New accounting guidance requires equity securities to be revalued through the income statement instead of through other comprehensive income. Looking ahead, the impact from this accounting change on holdings of equity securities could result in some volatility and securities gains or losses.

Returning to the balance sheet and to the income statement, taxable equivalent net interest income was $980 million in the first quarter of 2018, little change from the linked quarter. The comparison with the prior quarter reflects the impact from two fewer days in the recent quarter, partially offset by expansion in the net interest margin to 3.71%, up 15 basis points from 3.56% in the linked quarter.

The increase in short-term interest rates resulting from the Fed's December and March rate actions ended a benefit to the margin of as much as nine basis points in 2018's first quarter. This was in excess of our projections as the LIBOR rate rose more rapidly than the Fed fund's target rate. A lower level of average balances of funds placed on deposit with the Fed had an estimated 4 basis point positive effect on the margin. The lower cash balances were primarily the result of some seasonal volatility and commercial deposits as well as fluctuations and trust-related deposits.

As is usual, the two-day shorter first quarter compared with the previous quarter reflected an estimated 2-basis point benefit to the margin arising from the impact of 30 over 360 interest basis assets. Average loans declined by less than 1% compared with the previous quarter. Customer sentiment appears to be stronger while paydown activity seems to be slowing. Commercial real estate activity is picking up slightly.

Looking at loans by category on an average basis compared with the linked quarter, commercial and industrial loans were roughly flat compared with the linked quarter. Commercial real estate loans were up approximately 2% or roughly 6% annualized compared with the fourth quarter. Funding of new construction loans was a primary driver. As noted, residential real estate loans, which are largely comprised of mortgage loans acquired in the Hudson City transaction continued the planned rate of paydown. The portfolio declined by some 4% or approximately 14% annualized consistent with previous quarters.

Consumer loans were up 1%. Growth in indirect and recreation finance loans continued to outpace declines in home equity lines and loans. Regionally, growth and floor plan balances was offset by softness in C&I activity elsewhere, which was fairly uniform across our footprint, while CRE demand was a little better in New Jersey, Upstate New York, and our metro region, which includes New York City.

Average core customer deposits, which exclude deposits received at M&T's Cayman Islands office and CDs over $250,000.00 declined an estimated 3% compared with the fourth quarter.

Turning to non-interest income, non-interest income totaled $459 million in the first quarter compared with $484 million in the prior quarter. As noted, the recent quarter included $9 million of unrealized securities losses, while 2017's final quarter included $21 million of realized securities gained. As I noted, included in other revenue from operations for the recent quarter is a $23 million distribution from Bayview Lending Group.

Mortgage banking revenues were $87 million in the recent quarter, compared with $96 million in the linked quarter. Residential mortgage loans originated for sale were $625 million in the quarter, down about 10% from $696 million in the fourth quarter. Total residential mortgage banking revenues, including origination in servicing activities were $62 million, essentially flat compared with the prior quarter.

Commercial mortgage banking revenues were $26 million in the first quarter compared with $34 million in the linked quarter, reflecting seasonably lower originations activity. That comparable figure in the first quarter of 2017 was also $26 million.

Trust income was $131 million in the recent quarter up from $130 million in the previous quarter and 9% above the $120 million earned in last year's first quarter. New business generation continues to be strong and results were aided by the appreciation in the equity markets. Service charges on deposit accounts were $105 million down seasonally from $108 million in the fourth quarter.

Turning to expenses, operating expenses for the first quarter, which excludes the amortization of intangible assets for $927 million. The first quarter's operating expenses included the $135 million addition to the reserve for litigation matters, while last year's fourth quarter results, included a $44 million contribution to the M&T charitable foundation.

Operating expenses for the recent quarter also included $56 million of seasonally high compensation costs related to the accelerated recognition of equity compensation expense for certain requirement eligible employees. The HSA contribution, the impact of annual incentive compensation on the 401(k) match and FICA payments as well as the annual reset in FICA payments and employment insurance. Those same items amounted to an approximate $53 million increase in salaries and benefits in last year's first quarter. As usual, these seasonal factors will not recur as we enter the second quarter.

Next, let's turn to credit. Overall credit quality continues to be in line wit our expectations, matching the benign trends seen over the past four years. Annualized net charge-offs as a percentage of total loans were 19 basis points for the first quarter compared with 12 basis points in the fourth quarter, which included a higher level of recoveries on previously charged off loans. Charge-offs in last year's first quarter also equaled 19 basis points.

The provision for credit losses was $43 million in the recent quarter, exceeding net charge-offs by $2 million. The allowance for credit losses was $1 billion at the end of March, the ratio of the allowance to total loans was unchanged at 1.6%. Non-accrual loans decreased by $18 million at March 31st compared with the end of 2017. The ratio of non-accrual loans to total loans declined by one basis point, ending the quarter at 0.99%.

Loans 90 days passed due on which we continue to accrue interest excluding acquired loans that have been marked to a fair value discounted acquisition were $235 million at the end of the recent quarter. Of these loans, $224 million for 95% were guaranteed by government-related entities.

Looking at capital, M&T's common equity tier one ratio was estimated 10.59% compared with 10.99% at the end of the fourth quarter, which reflects earnings retention during the first quarter, share repurchases, and the impact from the net decline in end of period risk-weighted assets. During the first quarter, M&T repurchased 3.8 million shares of common stock at an aggregate cost of $721 million.

Turning to the outlook, based on first quarter results, our outlook with 2018 remains consistent with what we shared with you on the January conference call. To reiterate those thoughts, we expect 2018 overall to look much like 2017. With growth and total loans ranging from flat to a low single digit pace.

The net interest margin has widened following the December and March actions by the Fed and the market is expected additional actions over the remainder of 2018. Based on the current level of interest rates and reflecting the impact of the interest rate hedges we entered into last year, we continue to estimate that a hypothetical future 25-basis point increase in short-term rates should result in a 5 to 8-basis point benefit to the net interest margin.

This also embeds a series of assumptions on resultant deposit pricing reactivity for various deposit categories. So far, deposit pricing reactivity continues to be less than we have modeled. Based on those balance and margin assumptions, we expect modest, year over year growth in net interest income.

The higher interest rate environment has impacted residential mortgage loan originations, both volumes and gain on sale margins. Residential mortgage banking revenues could be pressured, absent our ability to acquire additional servicing or subservicing business. We do anticipate seasonal improvement in commercial mortgage banking revenues as the year progresses.

The outlook for the remaining fee businesses remains stable with growth in low to mid-single digits. Notwithstanding the addition to reserve for litigation matters, we expect low nominal growth and total operating expenses in 2018 compared to last year. As noted, we expect the seasonal surge in salaries and benefits we saw in the first quarter to normalize in the second quarter. Our outlook for credit remains little changed. There are no apparent significant pressures on particular industries or geographies. However, one factor in most of the stress credits we're seeing at present is leverage.

As to capital, we continue to execute on the 2017 capital plan. With $475 million of repurchase capacity remaining through the end of the second quarter. We have submitted our capital plan for the 2018 CCAR cycle to the federal reserve and await the stress-testing results, which should be published late in the quarter.

Of course, as you're aware, our projections are subject to a number of uncertainties and various assumptions regarding national and regional economic growth, changes in interest rates, political events, and other macroeconomic factors, which may differ materially from what actually unfolds in the future.

Now, let's open up the call to questions, before which Laurie will briefly review the instructions.

Questions and Answers:

Operator

At this time, I would like to inform everyone if you would like to ask a question, please press *, then the number 1 on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue, press the # key. Our first question comes from the line of Ken Zerbe of Morgan Stanley.

Ken Zerbe -- Morgan Stanley -- Analyst

Great. Thanks. Good morning.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Good morning, Ken.

Ken Zerbe -- Morgan Stanley -- Analyst

I guess just starting off with loan growth, you mentioned that sentiment is picking up and your end paydowns are slowing, but the guidance for loan growth still seems pretty -- I may not say tepid for the flat single digit pace given the runoff of the res mortgages, of course. When you look at first quarter numbers, were you expected first quarter to be fairly weak with a stronger half-pickup? I'm trying to get a sense of if this trend is in line with your expectations for loan growth. Industry loan growth, as you probably can imagine, is pretty weak overall.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure, Ken. What's happened in the first quarter is pretty consistent with how we expected the year would unfold. When we were looking at 2018, it was our view that the trends that we'd seen in the back half of 2017 would start to moderate a little bit, meaning that paydowns would likely slow down a little bit, but not enough for the originations to materially outrun them. We see slower growth in the first half of the year and it would pick up in the back half of the year as the impact of most importantly the tax changes goes through and businesses have a where GDP is heading and how they choose to invest.

It seems like there has been more optimism within our customer base since the tax reform. I guess the only thing that's dampened that a little bit of late has been some of the traditional and tariff conversation that's going on. I think there's a little bit of uncertainty now based on those comments or those actions that are ongoing. Overall, the mood is definitely more positive than what we saw in the second half of last year and where the first quarter ended up is very consistent with our expectations that we had coming into 2018.

Ken Zerbe -- Morgan Stanley -- Analyst

Great. Second question -- could you just give a little bit more detail about what those equity securities were that you were holding on balance sheet that drove some of the volatility? I guess also the question is like why are you still holding them or what's the rational for holding them given that they will introduce additional earnings volatility going forward?

Darren J. King -- Executive Vice President and Chief Financial Officer 

So, those equity securities are almost entirely GSE preferred, so Fannie and Freddie. Those are securities that we've had since, I think, about 2007 and we wrote them down pretty dramatically in '09 or '10. I have to get the exact date for you, but they're pretty much fully written down. When we were going through the fourth quarter of last year and looking at the changes to the tax law, we sold down a substantial portion of those, but we kept a little bit because of where the pricing had moved and where we thought the real value was.

There's a little bit left over and it's down to, I don't know, $18 million or less than that, $9 million. The current value, I think, is around $18 million. There's not a lot of downside in the valuation and if we get some GSE reform, maybe the investment will pay off down the road.

Ken Zerbe -- Morgan Stanley -- Analyst

Got it. Okay. Great. Thank you very much.

Operator

Your next question comes from John Pancari of Evercore.

John Pancari -- Evercore ISI -- Analyst

Good morning.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Good morning, John.

John Pancari -- Evercore ISI -- Analyst

On the deposit side, I just want to see if you can give us a little more color on the decline in the non-interest bearing. How much of that was the seasonal factor and how much of that was the trend the quarter and how much of that was expected in terms of that type of move? Thanks.

Darren J. King -- Executive Vice President and Chief Financial Officer 

So, John, on deposit balances and movements in the quarter, there are three factors, one of them trust-related and two of them related to commercial. So, trust balances, as you guys know, move around quite a bit depending on the activity in the capital markets. It was a little bit slower in the first quarter than what we'd seen in the fourth quarter. That moves a reasonable amount from one quarter to the next depending on what's going on.

Within the commercial book, we do see a seasonal decline in commercial deposit balances, usually every first quarter. What tends to happen is commercial companies will build up their deposit balances coming into the fourth quarter as they prepare for their distributions to their principles and to employees and as that gets paid out, you see those balances go down.

We are starting to see a little bit more interest in sweep balances as rates have moved up. Corporate treasurers have shown a little more interest in managing the return they're getting on their balances. You're seeing that in some movement into sweep and discussions about that, some movements in rates and the combination of those two things, commercial and trust-related deposits that moved the non-interest bearing down in the first quarter.

As we look forward, we also see in some of our interest bearing checking accounts, likely some movement there in the future quarters related to escrow balances, where we were expecting some of those escrow balances to move from M&T to other organizations, which those balances we pay pretty much Fed funds on them. So, we'll replace them with a like deposit instrument at a similar cost. So, we're not anticipating any change materially to our cost of funds, but there will be some geography movement in terms of where the balances sit on the balance sheet in future quarters.

John Pancari -- Evercore ISI -- Analyst

Okay. Alright. And then secondly on the expense side, I know in terms of your outlook nominal growth there. You had previous indicated approximately 2% or so, give or take, in terms of year over year expense growth for the year of '18. Is that still intact? Is that the best way to think about nominal?

Darren J. King -- Executive Vice President and Chief Financial Officer 

Yeah. That's the best way to think about it, John. When we talked about this on the fourth quarter -- we'll hold the litigation reserve to the side -- what he had talked about was kind of what we would describe as normal quarterly expenses, which tend to appear most in the second and third quarter. If you annualize those and kind of grew those around 2% and then add on the reason compensation costs that we just discussed and happened in the first quarter, which they always do, that was the math behind the expense number and the target.

John Pancari -- Evercore ISI -- Analyst

Got it. So, the positive operating leverage, the expectation is still intact.

Darren J. King -- Executive Vice President and Chief Financial Officer 

The positive operating leverage expectation is certainly intact.

John Pancari -- Evercore ISI -- Analyst

Got it. Alright, Darren. Thank you.

Operator

Your next question comes from Ken Usdin of Jefferies.

Ken Usdin -- Jefferies & Company -- Managing Director

Thanks, good morning. If I can just follow on on the balance sheet -- given that there is still some remixing to the point about the deposits, does this quarter kind of mark the bottom for the average earning asset base given that flush out that you'd had and your points about some of the ins and outs that might go forward. So, do earning assets grow from here or is there still a net down that could still happen?

Darren J. King -- Executive Vice President and Chief Financial Officer 

So, Ken, when you think about the earning assets, it can be a little tricky quarter to quarter just because of the dollars that sit at the Fed that are trust-related. We've seen some large moves quarter to quarter on those that they can move by $1 billion, $2 billion. At the end of 2016, they actually moved by $2 billion or $3 billion a quarter. If we hold those to the side because they're a little bit less predictable and we just look at the lending and loan balances, we're close to the bottom. I don't know that we're quite there yet, but we're close. The reason I'm not quite culling the bottom right now is depending on the rate of pickup in commercial loan growth.

So, we saw some nice uptick in commercial real estate balances this quarter and we saw C&I balances kind of flatten out, which is a good thing, but in aggregate, we've got the runoff of that residential real estate portfolio and just the normal amortization and pay down, which looks like we've been seeing the over the last few quarters around 13% to 14% annualized, until that portfolio gets a little bit smaller, the dollars that we need to add in other categories, meaning in C&I and CRE or in other consumer loans, needs to be kind of $600 million a quarter-ish for us to see absolute growth in total loan balances.

It's the combination of those factors, I think we're close. If we get a little bit more uptick in investing activity in our commercial customers and commercial real estate, then I think we'll see that turn sooner. If not, then we'll probably be flat-ish through the year, which is why we gave the overall guidance for the year a flat, kind of low single digits.

Ken Usdin -- Jefferies & Company -- Managing Director

Okay. As a follow-up to that, you mentioned expectations for expectation for modest NI growth, but even with the FTE adjustment delta, you're up six and change already just based on this December hike pulling through. So, if we continued to get the Fed funds curve moved forward and the type of pull through on that 5 to 8 basis points, it would seem that you could do decently better than "modest." I don't know if you could help us talk through a zone of expectations on that front or to any extent would be helpful. Thanks.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure. So, as we look forward at the net interest income and future Fed moves, what's left in the forward curves today I think is an increase in late summer, mid to late summer and one right at the end of the year. So, the one at the end of the year will have not a material impact on our net interest income for the year. So, there's on more rate increase.

I think when we originally came into 2018, we were expecting two, one of which we thought would happen in January and it happened in December. So, the rate of increase in Fed funds rates is a little bit faster than what we thought and as long as we can maintain loan balances in line with the guidance that we gave and what we've seen so far, there's probably a little bit more upside in net interest income, but I wouldn't think a ton, meaning we don't anticipate seeing as much of a gain in dollars and net interest income in 2018 as we saw in 2017.

Ken Usdin -- Jefferies & Company -- Managing Director

Right. That makes sense. Okay. Thanks, Darren.

Operator

Your next question comes from Matt O'Connor of Deutsche Bank.

Matt O'Connor -- Deutsche Bank -- Managing Director

Good morning.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Good morning, Matt.

Matt O'Connor -- Deutsche Bank -- Managing Director

I was wondering if you could talk a bit about your technology spend and your thoughts on whether you have to further ramp it up looking out the next couple of years. Obviously, your cost guidance this year was pretty clear. Conceptually, how are you thinking about investment spend as you look out the next couple years?

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure. So, technology spend has been increasing at the bank pretty consistently for the last three to five years, certainly over the last four. When we look back at where we have spent and our trajectory into 2018, in total, our IT spend has been growing 10% to 13% a year. That's both on new technology as well as on maintaining plant and equipment. When you think about the categories that we're investing in, it's very broad. I tend to think about it in terms of customer-facing tools that we're investing in.

We've talked about our mobile app and upgrades we've made to the mobile app and the website. This year, we'll see Zelle go live late second quarter, early third quarter. We're making some improvements to the tools that our commercial customers use for their cash management. So, things to help make it easier for customers to work with the bank. We're investing in employee enabling tools. We're making a major investment in our commercial loan origination systems, which are intended to help the RMs spend less time in front of their computers doing loan spreads and putting packages together and give them more time with customers, helping advise them on their business needs.

In the consumer space, we're improving our account opening tools and procedures so that the amount of time it takes to open a checking account or a credit card account can be dramatically reduced so our team members can spend more time giving advice to customers during that interaction rather than taking information and preparing the application.

And then there's investments that we're making in infrastructure that we need to make just because we're a bank. We've been investing a lot in data quality and our data warehouse. We, of course, invest in privacy and cybersecurity to make sure that we're buttoned down. When you add up investments along those dimensions, that's where we've been investing our technology dollars and will continue to.

What has been happening, though, which is a wash in the expense numbers is that as we make those improvements or we make those investments, there are other parts of the bank where we're becoming more efficient, where changes to process and business model are helping us reduce our costs and therefore, you don't see as clearly in the numbers a big spike in technology investment.

I think the other thing that we've talked about before is you don't tend to see that big spike. For us, we're very measured in the pace that we deploy new technology and we find that that's an important way to minimize risk and it minimizes risk in two fashions. The less change you introduce to the system or the more measured you are, if something goes wrong, it's easier to correct and fix and identify because there's only a couple of things that have changed at any one time.

The other important aspect of risk management is the change that you introduce to your employees and your customers. Too much change all at once can cause service disruptions or can cause short-term pain while employees adapt to the new way of doing business and for that reason, we try to be very measured and consistent in terms of the pace in which we're investing in and deploying new technology.

Matt O'Connor -- Deutsche Bank -- Managing Director

Okay. That's helpful. And then just separately, if we look at your CET1, obviously very strong at 10.6. What are your thoughts on where you need to be longer term in this new regulatory environment that we're in? It seems like there's been soften for banks in general, in particular for you, banks your size and risk profile.

Darren J. King -- Executive Vice President and Chief Financial Officer 

So, where we sit with our CET1 ration today is, I would say, middleish of the peer group based on where we saw everyone's CET1 ratios through the end of last year. As we've talked about for the last few years, our objective is to operate toward the bottom end of that peer range. That's a bit of a moving target. When we look at, as you pointed out, our business model and the strength and lack of volatility in our earnings, we think that's a good target and place for us to be.

As the rules get sorted out and the changes come through, as we see the changes that were proposed by the Fed last week as well as the bill that's in the house right now, as more clarity comes from those bills in the direction, we'll obviously continue to assess where we're operating and what we think makes sense for M&T.

Matt O'Connor -- Deutsche Bank -- Managing Director

Okay. Thank you.

Operator

Your next question comes from Steven Alexopoulos of J.P. Morgan.

Steven Alexopoulos -- J.P. Morgan -- Analyst

Hey, good morning, Darren.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Good morning, Steve.

Steven Alexopoulos -- J.P. Morgan -- Analyst

I wanted to first follow up on C&I. When you talk to your C&I customers, what are they saying they're likely to do in the short-run from the benefit of a lower tax rate and are they at least signaling that an increase in CapEx and investment is coming at some point?

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure. So, based on our conversations with our C&I customers in particular over the last 90 or so days, I mentioned there's been a definite movement up in terms of their optimism and there has been more discussion with our relationship managers about investment in property plant equipment. So, those discussion are starting, which I take as a positive sign because that hadn't been the case during 2017 and before. So, I think there's a little bit more optimism that GDP growth rates will stick where they are at least for a long enough time horizon to get customers comfortable making those investments and adding that fixed expense, so to speak, to their income statement.

So, definitely a little more positivity and we're optimistic that that will translate into some more loan demand as we go forward through the year.

Steven Alexopoulos -- J.P. Morgan -- Analyst

And are you seeing an increase -- maybe not drawing on lines, but an increasing in commitments wanting to get the lines in place at this point?

Darren J. King -- Executive Vice President and Chief Financial Officer 

During the quarter, we saw some uptick in commitments. We probably saw a little more increase in the rate of utilization and the rate of commitment during the first quarter, but that's not atypical.

Steven Alexopoulos -- J.P. Morgan -- Analyst

Okay. Separately on the deposit side, you saw a very modest increase in deposit loss again in the quarter. I saw a few other banks indicating they're starting to see deposit competition stepping up a bit here. Are you seeing a shift in the environment and what you'll need to pay on deposits? Thanks.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure. Deposit competition, I would say, is starting to show signs of moving. It depends, again, on which category we're looking at. If we look at our wealth business and affluent customers, pricing has mattered to them and their advisors for a long period of time. Nothing is really new there other than the absolutely rate as Fed funds move.

In the commercial space, we're definitely seeing business treasurers thinking a lot more about how they're getting paid for their excess balances and there's more conversation about what kind of earnings credit rates are appropriate given the balances that they have and the discussions of moving more balances, those conversations are happening more frequently than they were two quarters ago. So, you can see that coming.

On the consumer side, when we look at what's going on there, there continues to be less action in interest checking and savings and decidedly less in the money market space, with the exception of the online banks. That, from our experience, is pretty typical at this point in the cycle, that when rates start to move up, the action tends to be in certificates of deposit and that's where we've kind of seen most of the competition. We've talked a little bit about that over the last couple quarters that so far, the price competition has tended to be at the shorter end of the curve where there's some steepness. It's tended to be 12 months or less.

You start to see a little bit of creep toward 18-month CD prices, both otherwise, not much at the longer end of the curve given the relative flatness of it. So, those are the kind of the places I think we're starting to see it. When we run our sensitivity models, we think in 25 basis point increments. We're about where we thought we'd be, maybe slightly slower with the last 25 basis points, but you can definitely feel things are starting to get a little closer to when we'll see it turn.

Steven Alexopoulos -- J.P. Morgan -- Analyst

If that's the case, your NIM response has been at the upper end, typically of the 5 to 8 basis points in response to a Fed move. Do you think we start moving toward the lower end of that range?

Darren J. King -- Executive Vice President and Chief Financial Officer 

I think each one is appearing to be unique unto itself, but we continue to believe that somewhere in that change is the right place for the next 25 and likely the 25 after that. If something changes, we'll let you know, but I think that's good expectation.

Steven Alexopoulos -- J.P. Morgan -- Analyst

Thanks for taking my questions.

Operator

Your next question comes from Erika Najarian from Bank of America.

Erika Najarian -- Bank of America -- Managing Director

Hi, good morning.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Good morning, Erika.

Erika Najarian -- Bank of America -- Managing Director

My first question is a follow-up on the excess capital question. As you think about where the stock is training today on book, how should we think about how M&T's thinking on buybacks are evolving as valuation changes. Maybe a better way to ask it is could you help us get a sense of what your IRR is or earn back period is on stock buy backs at current levels.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure. I guess as we look at our capital position and we think about where we sit, well, we start from a macro perspective, which is we want to deploy that capital, obviously, in the business. The best way to deploy it is through customer growth and loan growth. We know where that's been for the last few quarters, although we did see some uptick. We always think about how much capital we have on the balance sheet we have, but future growth. After that, we have excess and the question then is how best to deploy it between dividends and share repurchases or special dividends.

When you look at our dividend right now, it's set to increase by $0.05 a share this quarter. That was approved in last year's capital plan, but after the tax rate changes, our dividend payout ratio is going to be probably around 25%, maybe slightly below 25%. We've historically been higher than that in the 27% to 33% range. So, we should expect some movement there.

Then we've got what's left over. We've never been an organization that has held on to excess capital just in case. If there's no loan growth, then the only other place to deploy it is on M&A. Given the prices of other organizations and the risk involved, we think it's a better risk return trade-off right now for us to buy back our own stock than it is to either sit on it or go chasing ill-advised deals. So, that's how we think through our buy back from the top of the house and where we get to our decision to deploy and to buy.

Erika Najarian -- Bank of America -- Managing Director

Thank you for that. That was very clear. Just a follow-up to all the margin questions that you've gotten, could you remind us on the asset side. Your wholesale variable rate exposure -- is the benchmark rate more one-month or three-month LIBOR? While it's small for you, I'm also wondering on the long-term borrowing side, if some of that in exposure has been swapped out to floating rate and if so, if it's headed to one-month or three-month LIBOR?

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure. On the debt side, that's easy. It's all been swapped to floating. It's based on three months. When you look at he asset side of the balance sheet, generally, our book is priced off of one-month LIBOR. There are some consumer loans, obviously, which are priced off of prime, which is really Fed funds, but one-month LIBOR tends to be the pricing basis for other loans.

Erika Najarian -- Bank of America -- Managing Director

Great. Thank you.

Operator

Your next question comes from the line of Geoffrey Elliott of Autonomous Research.

Geoffrey Elliott -- Autonomous Research -- Analyst

Hello. Good morning. Thanks for taking the question. When you were talking about credit, you touched on leverage as being a driver of the issues that you have seen even though at this point, they're pretty infrequent. Could you just elaborate a little bit on that leverage comment? What specifically have you been seeing?

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure. If you happen to read Rene's letter to shareholders, we talked a lot, he talked a lot in the letter about changes that are happening the structure of the market and covenant reductions and leverage. When we've gone through our credit, which we do at the end of every month and look at the various situations that are challenged, leverage has tended to be a place where we haven't charged anything off, but that's where things are criticized and where we've got an eye on it.

It tends to be where the credit to EBITDA and the debt service coverage ratios are moving into a range where they're certainly above what you would think or where we've seen traditionally our book and on both of those measures. That's really where the comment came from. For the things that we're seeing, that's the common theme and it's inconsistent with some of our observations about the macro market in general. Thankfully, we have less in our book than the average.

Geoffrey Elliott -- Autonomous Research -- Analyst

Thanks. And then maybe following up on that, do you guys have a sense of where we think we are in the macro cycle. I know it's clearly something that matters a lot to you. There are indicators that you watch internally that you think are helpful in giving a stare on that that you can talk about.

Darren J. King -- Executive Vice President and Chief Financial Officer 

I guess there's not a specific internal measure that we look at and say we're early, mid, or late in the cycle, but I'll give you some thoughts because it's a source of internal debate about where we are and I think some of the macro signals are giving us different messages about where we are in the cycle. So, when we're -- the number one thing that has always kept us out of trouble and kept our charge-offs where they are is our focus on returns.

Because we think about returns, when we're looking at and evaluating credit decisions, we need to get comfortable with the risk reward for the decisions that we're making and we've seen some challenges over the last six months. It seemed like things got a little bit better after-tax reform, but when we were looking at pricing and covenants and collateral levels, there were some signals saying things were getting a little bit challenged.

When you compare that to where GDP is and how much of a rebound there has been in total economic activity since the last recession, this recovery is still not all the way back. To what you would see typically post-recession. But when you look at the time since the recession, it would suggest that we're way far along and that we're toward the end. So, we've got some signals saying we've still got room to go and obviously we've got the backdrop of the stimulus that's happened from Washington on the positive side, meaning there's still some room to run.

Then when you look at where spreads are moving and where covenants are moving, these things tend to happen later in the cycle when people start grasping for growth. So, that's the thought process and the observations that we have behind where we are in the cycle. Out own view is probably we're at least mid and moving toward late, but I don't think we're all the way toward late yet given all the changes that recently have gone through in Washington.

Geoffrey Elliott -- Autonomous Research -- Analyst

Great. Thanks very much.

Operator

Your next question comes from the line of Brian Klock of Keefe, Bruyette, Woods.

Brian Klock -- Keefe, Bruyette & Woods, Inc. -- Analyst

Good morning, Darren and Don.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Good morning, Brian.

Don MacLeod -- Administrative Vice President and Director, Investor Relations

Morning.

Brian Klock -- Keefe, Bruyette & Woods, Inc. -- Analyst

So, Darren, sorry to ask another question around the guidance on NII, but I think when you guys gave guidance on the fourth quarter call, you said about 3% was the year over year modest NII growth. Is that the same level when you say modest year over year growth?

Darren J. King -- Executive Vice President and Chief Financial Officer 

I think when we gave that, we were anticipating a slightly slower rate of increase in Fed funds and therefore what we might see on margin expansion. When we look over the course of the year, I guess we're probably thinking 3% to 4%, probably more like 4% given rates have gone, offset a little bit by the flattish balance sheet, which expectation hasn't changed that much from where we were at the end of the year, maybe a little more positive on net interest margin given where Fed funds have gone and are projected to go.

Brian Klock -- Keefe, Bruyette & Woods, Inc. -- Analyst

Got it. That makes sense. On average earning assets, obviously, you talked about some of the movement in with some of the trust deposits, etc., but the expectation was today, you said average long growth should be flat to slightly up. Do we still think average earning assets could be flat year over year?

Darren J. King -- Executive Vice President and Chief Financial Officer 

It's a tough one to handicap, Brian, just because of the movement in that one category of assets that are sitting at the Fed. Those relate to trust demand, which is really a function of market activity that we have within our WISD businesses and our global capital markets business. That's really what adds a lot of volatility to the total asset picture. The good news is when those assets drop, the margin goes up, but obviously the reverse is true.

When you look at their impact on NII, it's really not that great. Where we spend most of our time watching is the core loans and loan categories and where we anticipate that coming out over the course of the year. That's really where we expect that flat to modest increase back end weighted like we've been talking about today and January.

Brian Klock -- Keefe, Bruyette & Woods, Inc. -- Analyst

That makes sense. Great. Thanks for the color. I appreciate your time.

Operator

Your next question comes from Peter Winter of Wedbush Securities.

Peter Winter -- Wedbush Securities -- Analyst

Good morning.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Good morning, Peter.

Peter Winter -- Wedbush Securities -- Analyst

End of Peter loans were still slightly below the first quarter average and I'm just wondering if you could talk about what loan growth did in the month of March?

Darren J. King -- Executive Vice President and Chief Financial Officer 

So, our loan growth in the quarter was pretty consistent with what was in the H8 data from the Fed in that it was a little bit back-end loaded, a little bit better in March than we saw in January and February. You can get some movement in end of period balances depending on some business that sits within our business realty capital corp, where assets are waiting to go off to Fannie and Freddie and that can cause some end of period fluctuation. Overall, during the quarter, we saw progressively better loan growth, particularly in C&I as the quarter went on.

Peter Winter -- Wedbush Securities -- Analyst

Very quickly, will the tax rate go back to that range of 25% to 26% going forward?

Darren J. King -- Executive Vice President and Chief Financial Officer 

Yeah. Over the course of the year we think that's a good range. Obviously, we gave that range because the effects and specifics of the tax ranges were unknown. This quarter was impacted by that accounting change that went into effect last year. Otherwise, we think that's still an appropriate range to be thinking about.

Operator

Your next question comes from Marty Mosby of Vining Sparks.

Marty Mosby -- Vining Sparks -- Analyst

Thanks. Quick statement and then a question -- I think we've chased our tail around on this margin and balance sheet, when in reality, you have transient deposits that go in and out. My margin was off 10 basis points but earning assets were too high. Once you make that adjustment, our NII number was exactly what you came out with this quarter. It really is just these pop in and out that create incremental low-yielding low assets that didn't mess with the margin but not net interest income.

Then my question is you've got about 40% of your funding that comes from free funds, which is one of the highest among our coverage. If you look at that on the bottom of your rate page where you have interest-free funds, it was 19 basis points last year and it's up to 24 basis points this year. Is that five basis points, which I think has been a positive and will continue to be a positive lift to your margin included in this 25 basis point Fed gives you 5 to 8 basis point or is that kind of a lagging effect that you get after the fact as your asset yields roll higher?

Darren J. King -- Executive Vice President and Chief Financial Officer 

Marty, thanks for the statement. You nailed it with that comment about that relationship between the margin and the earning assets. As it relates to the contribution of interest free funds, that's something we think about when we're going through our asset liability models and sensitivity and has factored into the 5 to 8. The impact you see down here is the effect after all the changes that happen in the other categories calculated into the net interest margin. That effect will obviously change quarter to quarter depending on what percentage of the funding those balances make up.

As you pointed out, we've got a very strong percentage of the balance that's sitting in non-interest bearing deposits, a function of our strong commercial balances as well as some of those trust demand balances that will go in there and move around from quarter to quarter. When we look at that on a go forward basis and we think about it in our asset liability modeling and in our sensitivity, we probably spend more time there thinking about will those balances shift into other categories like sweet or interest bearing as opposed to obviously paying a price there, paying rates specific for them. That's how it gets factored into that 5 to 8.

Marty Mosby -- Vining Sparks -- Analyst

It can take longer for that to be realized and that 5 to 8 feels like an instantaneous next quarter kind of projection. It could be we're getting a little more toward the upper end of that range because some of this is still spilling over from prior hikes we're getting down the road. Thanks and I appreciate the feedback.

Darren J. King -- Executive Vice President and Chief Financial Officer 

I think there's a little bit of that, Marty. Don't forget the other thing that happened this quarter in particular was how one-month LIBOR moves so far in advance of Fed funds that that helped in a good way push us above that target range or that range we had given as a rule of thumb. I think without that, we probably have been more 8, certainly not down to the 5, but that had a positive impact on the margin this quarter.

Operator

Your next question comes from Paul Martinez of UBS.

Paul Martinez -- UBS -- Analyst

Hi, everybody. Just building on the commentary about leverage, I guess it's a bit of a broader question, but to what extent is elevated leverage among commercial borrowers already negatively impacting credit demand and limiting the extent to which loan growth rebounds or can it limit the extent to which loan growth rebounds even if we do see paydowns normalized, even if we do see the economy and GDP growth perk up and CapEx pick up. Are we at a point where maybe commercial loan growth is more subdued than nominal GDP growth because leverage has built up in the economy over a number of years?

Darren J. King -- Executive Vice President and Chief Financial Officer 

It's a great macroeconomic question. When you look at the banks versus the non-banks, the rules on leverage and what's considered an HLT by the Fed would have pushed a lot of leverage that might have existed in the banking system into the non-banking system. Since the rules changed, how much that's impacting loan growth, perhaps at the higher end of the C&I spectrum, where they would have accessed the public markets and capital markets to issue bonds and use leverage.

I think as you move down the spectrum, you would tend to see a little bit less of that impacting demand. Obviously, the big balances come from those larger customers. You're probably on the right track with your thesis of overall loan growth being impacted by that because of the impact of customers and bigger balances. It makes sense that when you look at where loan growth is, large banks versus small banks, I'm sure that's why you see that difference in this two categories.

Paul Martinez -- UBS -- Analyst

Thanks. I guess more of a mundane question -- any update on the runoff of the highest cost Hudson City deposits, where we are in that process and how much of a tailwind from a funding cost standpoint there is still left?

Darren J. King -- Executive Vice President and Chief Financial Officer 

We are getting largely through that portfolio We're down to about 25% of our Hudson City time deposits that have yet to reprice. So, we're three-quarters of the way through that. What's interesting is when you look at the movement in Fed funds and slow increase in the price we're paying or rate we're paying on what we would call legacy or non-Hudson City time deposits, they're creeping up.

The Hudson City ones have been creeping down. We're almost at the point where they're in sync. There's probably more tailwind on Hudson City and their impact on our total cost of funds, but we're getting to a point where those two are going to converge. Likely at some point this year, we'll see time deposits bottom out and start to go the other way just because of where we are in the rate cycle.

Paul Martinez -- UBS -- Analyst

That's helpful. Thank you.

Operator

Your next question comes from Gerard Cassidy of RBC.

Gerard Cassidy -- RBC -- Analyst

Hi, Darren.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Morning, Gerard.

Gerard Cassidy -- RBC -- Analyst

If we take a look at your history, you've done a good job at making acquisition. I know they're opportunistic and episodic, but can you give us some color on what you're seeing out there for potential acquisitions? I know you guys don't get into bidding our auction wars or so on and so forth, but what's your guys feel on what you're seeing for an opportunity to maybe get back into mergers and acquisitions in the next 12 to 18 months?

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure, Gerard. We're certainly hopeful that the market starts to come back. From what we see and hear, there's some discussions, but nothing that really seems serious at this point. I think there remains to be a bit of a discrepancy between seller expectations versus buyer expectations with regard to price. That's probably not unreasonable, given where we are in the credit cycle and the rate cycle, that credit is as good as it's going to be and everyone thinks that will continue on forever. Rates are going up and margins continue to expand.

So, people are feeling pretty good about their prospects for the future, which is impacting the price they might be willing to partner with M&T or any other buyer for that matter. So, we're certainly hoping to be back in the game, but as Bob always said and those words ring clear -- things are sold, not bought, and you need a willing seller for something to happen. Based on where things are right now, it seems like there will be continuing discussions, but I suspect not a lot of action in the short-term.

Gerard Cassidy -- RBC -- Analyst

Thank you.

Operator
Your next question comes from Christopher Spahr of Wells Fargo.

Christopher Spahr -- Wells Fargo -- Analyst

Thank you for taking the question. This is regarding your technology strategy and your measured approach. Could you compare that to your approach with the AML issue. Are you using a lot of in house or third-party people to execute that? Follow-up question -- can you give some metrics so we can see the progress, such as the number of users that are active online or mobile users? Thank you.

Darren J. King -- Executive Vice President and Chief Financial Officer 

Sure. So, when you think about how we execute technology projects, we have a combination of in house resources and outside contractors and the mix probably around 60/40, 60% inside, 40% outside, but that can vary dramatically based on the nature of the project that's being worked on. There are some instances where we need to augment our team with more outside expertise and then part of the mission of the project is to have knowledge transfer from the outside party to inside and then there's others where it's primarily inside. If we have some that have been care and feeding of that system over the years, then those upgrades and changes and enhancements would be done primarily with inside folks.

As you look out at everything that's going on in the world and the pace of change was also a comment in Rene's shareholder letter that we're thinking more about outside partnerships and reevaluating those as a way to move a little bit more quickly. So, there you would see a slightly different mix than we might have in the past between inside and outside resources, but in general, 60%/40% is probably a good way to think about it.

When I think about mobile adoption -- I'll have to have Don get back to you about what the exact number is, but our mobile adoption rates continue to grow each quarter. I want to say we're in the mid-30s percent of active checking account users that are active on mobile and active would mean they'd sign on more than once in a month, but we can go back and we'll get some more exact figures on that.

Operator

Your next question comes from the line of Frank Schiraldi of Sandler O'Neill.

Frank Schiraldi -- Sandler O'Neill & Partners, L.P. -- Analyst

Hi, guys, just a couple quick ones. I just wondered if you had any color on geographic trends you're seeing in long-growth in the quarter, any surprises there where you're seeing the long growth, either positive or negative?

Darren J. King -- Executive Vice President and Chief Financial Officer 

We had some -- when we look at long growth by geography, both C&I and CRE, we didn't really see a ton of difference by geography for C&I, versus CRE, we saw a little bit more growth in New Jersey and Upstate New York and in Metro or New York City. When we looked more by industry or type rather than by geography, that's when we saw some interesting trends. We see continuing demand for warehouse space for multi-family and also growth in assisted living and skilled nursing.

I guess when we stood back after we went through those and thought about some of the macro trends that were going on, it actually made a lot of sense. As retail gets impacted and business shifts to the internet, warehouse capacity is more in demand because that's how customer needs are being fulfilled. As the population ages, obviously you need more assisted living and skilled nursing and then one of the other macro trends that continues is people coming back into urban centers, particularly the millennials and the empty nesters. That's driving demand for multi-family. That made a lot of sense for us when we looked back at where some of the action was.

Frank Schiraldi -- Sandler O'Neill & Partners, L.P. -- Analyst

Okay. Great. Then finally, I wondered if you could give any color on what I'd call the non-core items in the quarter, the increase in the litigation reserve was fairly sizable, I thought, especially given recent disclosure on the 10-K in terms of potential liability from ongoing litigation. Then secondly, just the Bayview distribution, if we should just look at that really as just a one-off here. Thanks.

Darren J. King -- Executive Vice President and Chief Financial Officer 

So, on the litigation expense, I really don't have any other comment on that other than what we said in the call and in the earnings release as it relates to ongoing matters. When you look at the Bayview distribution, that was a distribution we hope will happen on an annual basis, but it's going to be based on the performance of that organization. We have an ownership stake and as they make distributions to the other partners, we get a proportional distribution as well. We hope they will continue but the timing and magnitude are hard to predict.

Frank Schiraldi -- Sandler O'Neill & Partners, L.P. -- Analyst

Did that distribution come back or the positive outcome, I guess you saw, is that reflective of the securitization coming back and their core business coming back to Bayview?

Darren J. King -- Executive Vice President and Chief Financial Officer 

Not really. When you look at Bayview over the course of the last decade, I guess, since in the change in the financial crisis, they've kind of reinvented themselves in how they run their business. They took a lot of the expertise they had in mortgage lending and changed it into other related activities and that's part of what we're seeing in the turnaround and results and us receiving the distribution.

Operator

Thank you. I will now return the call to Don MacLeod for any additional or closing remarks.

Don MacLeod -- Administrative Vice President and Director, Investor Relations

Thank you all for participating today. As always, if any clarification of any of the items on the call or news releases necessary, please contact our investor relations department at (716)842-5138.

Operator

Thank you. That does conclude the M&T Bank first quarter 2018 earnings conference call. You may now disconnect.

Duration: 72 minutes

Call participants:

Darren J. King -- Executive Vice President and Chief Financial Officer 

Don MacLeod -- Administrative Vice President and Director, Investor Relations

Ken Zerbe -- Morgan Stanley -- Analyst

John Pancari -- Evercore ISI -- Analyst

Ken Usdin -- Jefferies & Company -- Managing Director

Matt O'Connor -- Deutsche Bank -- Managing Director

Steven Alexopoulos -- J.P. Morgan -- Analyst

Erika Najarian -- Bank of America -- Managing Director

Geoffrey Elliott -- Autonomous Research -- Analyst

Brian Klock -- Keefe, Bruyette & Woods, Inc. -- Analyst

Peter Winter -- Wedbush Securities -- Analyst

Marty Mosby -- Vining Sparks -- Analyst

Paul Martinez -- UBS -- Analyst

Gerard Cassidy -- RBC -- Analyst

Christopher Spahr -- Wells Fargo -- Analyst

Frank Schiraldi -- Sandler O'Neill & Partners, L.P. -- Analyst

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