Oct 18, 2017
Operator
Welcome to the M&T Bank Third Quarter 2017 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
Thank you, Paula and good morning everyone. I'd like to thank you for participating in M&T's third quarter 2017 earnings conference call both by telephone and through the web cast.
If you have not read the earnings release we issued this morning, you may access it along with the financial tables and schedules from our web site, www.mtb.com, and by clicking on the Investor Relations link and then on the Events and Presentations link. Before we start, I'd like to mention that comments made during this call might contain forward-looking statements relating 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 of forward-looking statements. Now, I'd like to introduce our Chief Financial Officer, Darren King.
Darren King
Thank you, Don, and good morning everyone. As we noted in the earnings press release this morning, M&T's results for the third quarter continued to reflect solid performance in the current operating environment.
We saw further expansion of the net interest margin and decent growth in net interest income. Consistent with the trends we have seen over the course of 2017, loan growth remained a challenge.
Fee revenues were solid, and core expenses continue to be well controlled. Credit remains stable, with charge-offs at the best levels of the current credit cycle.
And M&T's capital levels are strong, even as we execute our 2017 capital plan. Looking at the numbers; diluted GAAP earnings per common share were $2.21 in the third quarter of 2017, down 6% from $2.35 in the second quarter of 2017 -- excuse me, we were at $2.21 in the third quarter, $2.35 in the second quarter.
The third quarter results are up 5% from $2.10 in the third quarter of 2016. Net income for the quarter was $356 million compared to $381 million in the linked quarter and $350 million in the year ago quarter.
Included in GAAP results in the recent quarter or 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 reports 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 third quarter, which excludes intangible amortization and merger related expenses from the relevant periods was $361 million, compared with $386 million in the linked quarter and $356 million in last year's third quarter.
Diluted net operating earnings per common share were $2.24 for the recent quarter, a decrease of 6% from $2.38 in 2017's second quarter and up 5% from $2.13 in the third quarter of 2016. On a GAAP basis, M&T's third quarter results produced an annualized rate of return on average assets of 1.18% and an annualized return on average common equity of 8.89%.
This compares with rates of 1.27% and 9.67% respectively in the previous quarter. Net operating income yielded annualized rates of return on average tangible assets and average tangible common shareholder's equity of 1.25% and 13.03% for the recent quarter.
The comparable returns were 1.33% and 14.18% in the second 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 third quarters of 2017 and 2016 were impacted by certain noteworthy items. On October 9th, Wilmington Trust Corporation reached a settlement with the U.S.
Attorney's Office in Delaware, that required a $44 million payment that was not deductible for income tax purposes. As of September 30, we increased the reserve for legal matters by $50 million.
That increase, coupled with the non-deductible nature of the $44 million payment reduced M&T's net income in the recent quarter by nearly $48 million or $0.31 of diluted earnings per common share. In addition, recall that the results of the third quarter of 2016 included $28 million of net pre-tax securities gains, that equated to $17 million after-tax effect or $0.11 per common share.
Those gains pertain to a variety of TruP CDOs, the required divestiture under the so-called Volcker rule. Turning our attention to the balance sheet and the income statement; taxable equivalent net interest income was $966 million in the third quarter of 2017, improved by $19 million from the linked quarter.
The net interest margin improved to 3.53%, up 8 basis points from 3.45% in the linked quarter. As was the case last quarter, the wider margin was predominantly driven by the full quarter impact from the Fed's mid-June action to increase short term interest rates.
Average loans were down approximately 1% to the linked quarter. Looking at loans by category, on an average basis compared with the linked quarter, we saw commercial and industrial loans were about 3% lower than in the linked quarter.
That included $228 million of seasonal decline in loans to auto dealers to finance their inventories. Excluding the floor plan loans, C&I balances were down some $388 million or approximately 2%.
Commercial real estate loans were roughly flat with the second quarter. We continue to allow our portfolio of residential mortgage loans to pay down without replacement.
As a result, the portfolio declined by 3%, consistent with previous quarters. Consumer loans were up 3%.
As has been the case for some time now, growth in indirect auto and recreation financed loans are outpacing declines in home equity lines and loans. Regionally, we saw paydown activity in the C&I portfolio, distributed fairly broadly across our footprint, as well as across industries.
While the commercial real estate portfolio was flat, we experienced declines in our East Coast markets, which include New York City and Washington DC. The primary driver of those declines was construction loans being taken out with permanent financing from other mostly non-bank lenders, and condo loans being repaid through the sales of the properties.
Offsetting those declines was growth in our upstate New York and New Jersey regions. Average core customer deposits, which exclude deposits received at M&T's Cayman Islands office, brokered deposits and CDs over $250,000 were some $1.1 billion lower than the second quarter.
Primarily reflecting the continued run-off of high rate time deposits acquired with Hudson City. It's interesting to note that our cost of interest bearing deposits is up by just 2 basis points for the year-to-date 2017 compared with the same period last year.
Looking at non-interest income; non-interest income remained strong at $459 million in the third quarter, little changed from $461 million in the prior quarter. Mortgage banking revenues were $97 million in the recent quarter, improved from $86 million in the linked quarter.
Residential mortgage loans originated for sale were $757 million in the quarter, down about 2% compared with the second quarter. Total residential mortgage banking revenues, including origination and servicing activities were $63 million, improved from $61 million the prior quarter.
Commercial mortgage banking revenues were $34 million in the recent quarter, up $9 million from the prior quarter, reflecting higher volumes of loans originated for sale and the associated gain on sale revenues. Trust income was $125 million in the recent quarter, compared with $127 million in the second quarter and recall that included in the second quarter are approximately $4 million of seasonal tax preparation fees.
Service charges on deposit accounts were $109 million, improved by $4 million compared with the second quarter, reflecting seasonally higher levels of customer activity. Other non-interest revenues declined by about $10 million compared with the prior quarter, reflecting lower levels of commercial loan fees, predominantly syndication fees.
Turning to expenses; operating expenses for the third quarter, which exclude the amortization of intangible assets, were $798 million compared with $743 million in the previous quarter. Salaries and benefits were essentially unchanged from the prior quarter at $399 million.
Notwithstanding the legal related costs I mentioned earlier, other expense categories remain well controlled. The efficiency ratio, which excludes intangible amortization from the numerator and securities gains in last year's third quarter from the denominator was 56% in the recent quarter compared with 52.7% in the previous quarter and 55.9% in 2016's third quarter.
Looking at credit; our credit metrics continue to be relatively stable. Net charge-offs for the third quarter were $25 million compared with $45 million in the second quarter.
Annualized net charge-offs as a percentage of total loans were 11 basis points for the third quarter, improved from 20 basis points in the second quarter. The provision for credit losses was $30 million in the recent quarter, exceeding charge-offs by $5 million.
The allowance for credit losses was approximately $1 billion at the end of September. The ratio of the allowance to total loans increased slightly to 1.15%.
Non-accrual loans declined slightly at September 30th compared with the end of the prior quarter, but the decline of end of period loans resulted in a 1 basis point increase in the ratio of non-accrual loans to total loans, and in the quarter, at 0.99%, just under 1%. Loans 90 days past due, on which we continue to accrue interest, excluding loans that have been marked to a fair value discounted acquisition, were $261 million at the end of the recent quarter.
Of those loans, $252 million or 97% are guaranteed by government related entities. Turning to capital, during the third quarter, we began implementation of our 2017 CCAR capital plan.
Repurchasing $225 million of common stock or approximately one quarter of the plan's $900 million repurchase authorization for the four quarters, starting July 1st, 2017. Those repurchases, net of retained earnings, combined with the reduction of risk weighted assets during the past quarter, brought M&T's common equity, tier-1 ratio under the current transitional Basel-III capital rules, to an estimated 10.98% compared with 10.81% at the end of the second quarter.
Turning to the outlook; as we enter the final quarter, our outlook for 2017 is a little changed. The net interest margin and net interest income have been stronger than expected, following two rate actions from the Fed so far this year.
On the other hand, the loan growth we have seen has been pretty much as expected, which was low single digit growth on a year-over-year basis. For the first three quarters of 2017, average loans are up about 1% compared with the same period in 2016.
On that same basis, but excluding the impact of the run-off in residential mortgages, average loans are up 7% over 2016. As we head into the fourth quarter, there is a little more positive tone from our customers about their businesses, which is being reflected in our loan pipeline.
The implied forward curve, shows a high probability of a rate action by the Fed late in the year. However, any hike would not have a significant impact on 2017's overall results.
Absent any unanticipated moves by the Fed, we expect some of the margin pressures we are seeing to be more apparent in the coming quarter. This includes the full quarter impact from the debt we issued in August and continued pressure on commercial loan margins.
The outlook for the fee businesses has little changed, with some continued softness in mortgage banking, being offset by good momentum in other fee categories. Our expense outlook is also unchanged; excluding the specific litigation related costs in the third quarter, which we noted earlier, we continue to expect low nominal growth in total operating expenses in 2017 compared to last year.
Despite this quarter's strong results, we continue to view credit, more as a downside risk than an upside opportunity. We expect to see a slight uptick in criticized loans when we filed our third quarter 10-Q, but to a level still below the end of last year.
As to capital, given our strong operating performance and our solid capital ratios, we will continue execution of our 2017 capital plan. Of course, as you are 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 Paula will briefly review the instructions.
Operator
[Operator Instructions]. Your first question comes from the line of Ken Usdin of Jefferies.
Ken Usdin
Thanks, good morning. Darren, I was wondering if you could talk a little bit more about a couple of those NII components?
You mentioned that there might be some more parent NIM pressures underneath. Can you just walk us through the combination of that, versus the size of the balance sheet, which continues to shrink as well?
Are we looking at a pause in NII growth ex rates from here, or could that loan pipeline commentary still lead you to see some growth?
Darren King
Sure Ken and good morning. So let's take those two components that you talked about individually.
On the net interest margin side, obviously we benefitted as the industry from the rate increases that have happened this year. As we look forward through the fourth quarter, without anything planned.
It's our anticipation that we will see a slight downtick in the net interest margin, in the fourth quarter, driven mainly by the full quarter impact of the debt that we -- debt offering we did in August, and as we have been talking about before, there is still some slight core margin compression, as new commercial loans roll on at a slightly lower margin than what is rolling off. Now, the good news there is that, we have actually seen stabilization in loan margins over the last several quarters, probably last three quarters.
So we are not expecting anything down, it's just the natural churn that happens, as longer dated loans roll of and the newer ones come on. So a slight margin compression.
When we look forward at the loan balances, we are optimistic that we will see flat to slightly up on loan balances for the fourth quarter. When we think about where -- excluding the residential mortgage portfolio of course.
And when we look at what the drivers are, we see the normal seasonal impact of other floor plan balances coming back on to the balance sheet. We started to see that at the end of September.
And as we mentioned, the pipeline, that we are looking and as we enter the fourth quarter, is at the highest level that has been entering any quarter this year. So we are feeling much more positive about where loan growth might be in the fourth quarter.
I don't think we are going to see anything like we saw in 2016, unfortunately. But it feels like we are in a better spot.
When you put the two together, for NII, for the fourth quarter, we are probably flat to maybe slightly down, but not anything too dramatic.
Ken Usdin
Okay. And I will keep my follow-up just to the other side then of loan growth, if you are expecting the ex-mortgage loan to be flat to slightly up, can you just give us updated thoughts on the pace of the resi book rundown, and how you are expecting that to go, as you look not just to the fourth, but on an ongoing basis, given where rates are?
Darren King
Sure. So you look at the pace of decline in the resi-mortgage book, it has been pretty consistent on a percentage basis, over the last five quarters.
The dollar amount is decreasing as the portfolio shrinks, and we expect that to continue. A large portion of that is just normal amortization of that book, it has a number of 5-1 and 7-1 option arms in there, that would have a normal paydown cycle, obviously, as well as the third year product.
So when we look forward, we expect that that rate of decrease will be approximately the same, and as we get into 2018, we expect that the dollar amount will start to shrink, as the portfolio gets smaller. So we will talk more about 2018 in January, but just to give you a little sense of where we see that going over this quarter and the coming quarters.
Ken Usdin
Got it. Thanks very much.
Darren King
The Hudson City 5-1, 7-1s are hybrid arms, but they are not options.
Ken Usdin
Thank you for the clarification.
Operator
Your next question comes from Ken Zerbe of Morgan Stanley.
Ken Zerbe
Great. Thanks.
Good morning. Could you just talk a little bit about customer deposit behavior?
I get the run-off in the Hudson City loans, but it feels like there might be a little less growth than expected on the deposit side, ex Hudson City piece. Where do you see and what kind of conversations are you having with customers?
Thanks.
Darren King
Sure Ken. So the kind of conversations we are having with customers varies fairly dramatically, depending on which customer base we are talking to, and which balances we are looking at.
If you look in our statements in the press release, you will see some increase in the rate in now balances, and in those balances are some mortgage escrow balances that are tied to the servicing business that we do. Those are all indexed to market.
So obviously, as the market moves up and that's driving up those costs. When we look at and deal with our larger commercial customers, they tend to be the most price sensitive and we are working with each of those customers on an individual basis, to work through deposit pricing.
And the other place where we see a little bit more activity and sensitivity, is with the larger balanced consumer customers, which are typically affluent or private banking types of customers, where because again, the size of the balances are a little bit bigger, they are a little more sensitive to rate. When we look through the rest of the portfolio, in general, on the consumer side and the rest of the smaller and the commercial, including small business; there still seems to be somewhat less of a focus on rate in those customers, and the other thing that we are kind of seeing, when we look at total balances is as rates still haven't gotten back to where they were at the bottom of the last cycle.
Customers in the consumer and small business area are tending to stay short-dated. So when we look at the time book, it's very skewed towards six months and 12 months or under, and people are not really signing up for two year, three year, five year CDs, which is helping keep the yield down, and some people are staying liquid.
So I think you are seeing some shift across categories right now, which is partly helping keep balances flat, and we will obviously be paying a lot of attention to rates and competitive pricing, as we go forward to protect those balances, and make sure we are doing the right thing for our customers.
Ken Zerbe
Okay, great. And just a clarification question, just back on the loan growth piece, the [indiscernible] that you have for growth improving in fourth quarter, was that more on the C&I side, or the CRE?
Because I guess, my question is really more around what are you seeing in CRE, specifically? Because I know those balances have been pretty flat for the last few quarters?
Thanks.
Darren King
Right. So it's really both, but more skewed towards the C&I side.
When you look at our CRE balances, as you pointed out, through the year, they have been fairly flat. And what's going on underneath, is there is a little bit of shift happening from construction to more permanent types of financing, and what -- that's kind of expected.
We had a big run up in construction balances during the latter part of 2016, as projects were nearing their completion. And now we are seeing this year, them reach the conclusion of their normal life, which is they get completed and they turn into a permanent mortgage or the condos get bought, which is a good thing, and that's being replaced by other lending around the footprint, could be owner-occupied, could be other permanent mortgages.
But that churn is what's happening inside, and why you are seeing relatively flat. We expect that will continue and we have seen a little more optimism on the C&I side.
Ken Zerbe
Great. Thank you very much.
Operator
Your next question comes from Brian Klock of Keefe, Bruyette and Woods.
Brian Klock
Hey, good morning gentlemen.
Darren King
Good morning Brian.
Brian Klock
So Darren, again just another follow-up on the loan growth question and on the C&I side of it, I know you mentioned that the average balances were driven a lot by the dealer floor plan seasonal decline. When I look at the end of period balances, you had about a $450 million quarter-to-quarter drop.
I guess, is that -- was most of that related to the dealer floor plan? I guess, maybe on the end of period or spot balances, do you have that information related to the dealer floor plan impact?
Darren King
At the spot balance, it would be less than what the average was for the quarter, because we started to see some of those inventory starting to build and some of those loans starting to come back. So when we looked at the quarter, on average, the ratio was about two-thirds non-floor plan, one-third floor plan.
I think, when you get to the end of the quarter, and you look at the end of the period versus the prior year, probably in the same approximate ratio between those two categories.
Brian Klock
So I guess, on the end of period and the rest of the weakness and that end of period, is that additional sort of paydowns that you -- I guess you guys, and a lot of your peers talked about, with some of the capital markets impact of refinancing or other -- because of where the interest rate environment was, that you saw some paydowns in that core C&I book?
Darren King
Yeah. Paydowns were probably the biggest driver of decreases in the quarter.
When you look at originations, they were down a little bit, but not the biggest driver. The biggest driver was the rate of paydowns.
And across the book, there is a whole host of reasons why those things are happening. Some of it is non-banks, which we mentioned earlier, that's real estate related.
We have seen some of our customers sell parts of their business, because rates are -- asset prices are so strong, and if they do that, then they would tend to pay down their loan balances, and we have seen some of the debt capital markets business coming further down in middle market. So it's -- what's interesting is, when we look at prime, we are not seeing any one particular industry, any one particular geography.
It's kind of more broad-based, and why we feel a little bit more optimistic as we head into the fourth quarter, is when we look at the pipeline, it too is fairly broad-based.
Brian Klock
Okay. And just one quick question and I will get back in the queue; commercial real estate, I know you talked about the declines, but were there anything that was a prepayment in commercial real estate that ended up with a prepayment penalty in the spread income?
Thanks.
Darren King
Prepayment penalties in spread income this quarter were not materially different from what they have been for the past several quarters. There is no step-up.
Brian Klock
All right, great. Thanks Darren.
Operator
Your next question comes from Frank Schiraldi of Sandler O'Neill.
Frank Schiraldi
Good morning. Just first a follow-up to that question, I guess, just on the commercial real estate yields quarter-over-quarter, I was kind of surprised to see the 20 basis point increase.
Just wondering if you could speak to -- that's a swapping out the fixed rate? Is that a decent run rate going forward, that $450 million?
Darren King
I think it's fairly decent run rate as we go forward, when we look at just the straight pricing on those deals and the spread over LIBOR, I think that's probably pretty reasonable to take forward.
Frank Schiraldi
Okay. And then just on the other side of the balance sheet, just in terms of the Hudson City CDs, could you just remind us Darren, that process, how far long?
I mean, how much is left and where that's pricing from and pricing to?
Darren King
Yes. So if you look at where we are in that book, we are about two-thirds of the way through has been repriced, at least once, and don't forget that a lot of what's repriced has been the shorter duration or shorter term product.
We have got about a third of it left to reprice, so that was longer dated, three, four, five year CDs that are rolling off, and they should roll off approximately equal amounts over the next two to three years. And when we look at where pricing has been on those, it's a little bit tricky, because what we are seeing when people are repricing, is they are generally going into a lower term.
So you are coming off of two and three, and then in some cases, five year term, that were carrying rates, in some cases, over 2%. And generally, no one is really signing up for any kind of CD greater than above 12 months.
So we are repricing those down around 90 to 100 basis points, depending on the market, obviously, we have New Jersey, and you are seeing that benefit. But it's not as straightforward as just comparing the current two year CD to a rolling-off two year CD, because people are shifting term buckets as well.
Frank Schiraldi
Got you. Okay.
And I guess, you'd seek to offer that with some longer -- to keep the duration of that book, sort of none at all with CD book, but just liabilities overall, you [indiscernible] something longer, so you know, the duration wouldn't change as much?
Darren King
Yeah. I guess, at this point in the book, the duration is coming down naturally as the mix is shifting.
And I don't think that segment of the deposit balances are enough to materially shift the duration of the whole portfolio. So it's not something that we are as worried about and as focused on, as much as making sure that in those markets, our rates are competitive and that we are trying to retain those balances.
Frank Schiraldi
Okay. All right.
Thank you.
Operator
Your next question comes from Peter Winter of Wedbush Securities.
Peter Winter
Good morning. I was wondering, can you talk a little bit, just the loan growth outlook for 2018?
Do you think you can see maintain that low single digit growth, just given some of the continued pressure on the resi mortgage side?
Darren King
As far as our 2018 outlook, we are going through our work right now, and planning our 2018 operating numbers and looking at the pipeline and where we see 2018 shaping up. So probably a little premature for me to speculate on or forecast what 2018 might be, but we will be back in January with a full outlook for 2018.
Peter Winter
Then just a follow-up, is there a certain level that you would see resi-mortgage, that you would like to see it as a percent of total loans?
Darren King
We definitely will maintain a level of resi mortgage on the balance sheet, just from a -- we supporting the community, many of these are customers that have broader relationships with the bank, and those mortgages we tend to hold on our balance sheet as well, because it helps from a customer service perspective. When we look at the proportion, in terms of the total balance sheet, as I kind of tend to look at what the proportion was, we were running at before Hudson City.
And if you look at the composition of the balance sheet for M&T before we merged with Hudson City, that over time, that's what we would expect the whole balance sheet to start to look like. It will have a similar percentage of CRE, C&I mortgage consumer balances is what we did pre-Hudson City, and that's the transition that we are executing right now of converting that thrift into a commercial bank.
And you know, I think like we talked about earlier, the good news on that portfolio was, as it continues to decline, the headwind, if you will, of the dollars running off, will start to get smaller, as that portfolio gets smaller. And that should help with loan growth, on an absolute basis, on total balance sheet.
Peter Winter
Great. Thanks Darren.
Operator
Your next question comes from Matt O'Connor of Deutsche Bank.
Matt O'Connor
Good morning. Can you talk about your ability and interest in doing bank deals with the AML consent order behind you now?
And obviously, given your strong capital position as well?
Darren King
Sure. So our ability to engage in those kinds of dialogs and thoughts has improved, and we are certainly open to having those conversations.
It takes both a willing buyer, which we are, and a willing seller, so not sure where the world stands from that perspective. But when we look at things that we would be open to discussing, certainly whole bank mergers would make sense, but we are also -- given the construct of the bank, and how it has changed over the last few years, our field of play is a little bit wider, and we continue to look at mortgage servicing, as a place where we can [indiscernible], and then obviously in the fee businesses, our wealth business, and our institutional custody businesses are places that we like the returns, and we like our position and we will be open to talking about those as well.
So the spectrum is a little broader than it was before, and our interest and ability is kind of back to pretty much where it was before. But we have got to keep our eye on prices and our criteria hasn't changed from what it was before, and that is that we always look at what the return -- primarily, interior rate of return on those deals is, and is that at a rate that's higher than our long term cost of capital, and what impact would it have on our earnings per share and our book value per share, and how long could we pay it back.
And all those numbers have to work, along with having a willing seller. So definitely, interested in conversations, but nothing -- really, nothing to report either.
Matt O'Connor
All right. And on the willingness of sellers, I mean, obviously, smaller bank stocks have lagged the bigger ones, kind of generally speaking, and I don't know if that plus kind of slow loan growth, flatter yield curve is making folks more open to partnering.
Do you have any thoughts on that?
Darren King
I guess -- I think there is probably a number of things that tend to make people interested in considering a partnership. The loan growth is one of them.
Expense management is another one that's out there too. When you look at banking and the cost of complying with regulation, and as you get closer to those key thresholds, either $10 billion or $50 billion, that has a material impact on our bank's cost infrastructure.
Not to mention the pace of technology and the ability to spread those costs over a bigger revenue pool, makes people little bit more interested. On the counter side, credit is as good as it has been, and earnings are pretty high, which means valuations tend to be high.
So to the extent there is a seller that's looking at that, if they want to get paid upfront, that's a little tougher. If they want to be long term partners and investors along with us, those are the kind of things that we have tended to do, and both sides have tended to benefit quite nicely from those kinds of combinations.
Matt O'Connor
Okay. Thank you.
Operator
Your next question comes from Geoffrey Elliott of Autonomous.
Geoffrey Elliott
Hello. Good morning.
Thank you for taking the question. The CET1 ratios continue to build, I guess the weaker loan growth, contributing to a lower denominator.
Have you got any more thoughts about putting in a mid-cycle submission and seeing if you can increase the capital return approval that you got in the CCAR earlier this year?
Darren King
Sure Geoff. So we are certainly pleased with the strength of the capital ratios, and as we pointed out numerous times over the last few quarters, that when we look at our consistency of earnings and credit quality and the little volatility that we think we should be running with those ratios much lower than where they are.
And this year's results are not just the balance sheet decline per se, but when we talk about the mix of those commercial real estate loans and the shift, that has a big impact on risk weighted assets, which is helping that ratio. Not to mention, the fact that credit and earnings are so strong, it is helping build capital.
That said to your question, we have mentioned before, that there is a resubmission process that the Federal Reserve has, but anything that is done with the Fed is a non-public event. So we don't have anything to say on that front.
Geoffrey Elliott
Okay. Understood.
And then you mentioned, you'd I guess ideally be at lower capital ratios. What do you think the right number is for CET1 to settle out over time?
Darren King
I think, it's obviously -- your target ratio is a function of the risk in the balance sheet and the mix of the assets that are on there. That said, when we look at where we stand versus the peer group, and given our history, we think we should be operating at the low end of the peer group.
And that can be a bit of a moving target, that every bank I think has -- I know, has to have an internal target, and I suspect they are all running above that, and one of the things that's watched very closely is, your capital ratios relative to your peers. And for us, we think the write-in -- right spot for us, given our history of credit quality and stability of PPNR that we should run at the bottom end of the peer group.
Geoffrey Elliott
Got it. Thank you.
Darren King
No problem.
Operator
Your next question comes from Steven Alexopoulos of JPMorgan.
Steven Alexopoulos
Hey, good morning Darren. I wanted to start, on the margin pressure, you indicated new loans coming on at a lower level than where loans are running off.
Can you give us a sense of the magnitude, what's the size of that, and where do we think market interest rates need to be for that to stabilize?
Darren King
It's a great question, and we are really close. So if you recall, back a year ago, we would talk about core margin compression of kind of 2 to 3 basis points a quarter.
And if we look at where, roll forward 12 months at the mix of what's rolling off or the pace of what's rolling off compared to what's rolling on and the stability we have had in spreads over that time period, it's really close. So we are probably about a difference of one to two basis points, and we don't need much difference, much of an uptick in the spread.
It's really the spread, right, that matters; before that neutralizes and becomes less of an impact.
Steven Alexopoulos
Okay, that's helpful. Thank you.
And just if -- another follow-up on the loan growth. A lot of banks are seeing stronger commercial pipelines, but not seeing this convert into stronger reported loan growth, and you are clearly more optimistic here.
Give us more color, what are you looking at, that gives you this confidence, C&I is going to turn, particularly given how weak it was here in the third quarter? Thanks.
Darren King
Sure. So I guess there is a couple of things.
Number one is just the approved pipeline. And when we look at the approved pipeline coming into the fourth quarter compared to what we saw going into the second and third, it's higher by probably round numbers 15%, 20%, and that's a very good leading indicator.
It has been our history that those tend to show up on the balance sheet, with a two to 2.5 month lag, and because that's up, we are feeling more confident that we will start to see it convert on to the balance sheet. But the wildcard is, is obviously the paydown activity.
And when we look year-over-year, we saw a fairly active paydown from our customers in the second quarter. But as the quarter came to a close, that seemed to be moderating somewhat.
So when we put the two together, we feel a little more optimistic. We feel certainly better from the origination side and believe that the paydowns and payoffs will start to temper a little bit and the combination will lead to a little bit of asset growth, ex the Hudson City runoff portfolio in the fourth quarter.
Steven Alexopoulos
Okay. Thank you.
And if I could squeeze one technical question; what was the balance of floor plan loans at the end of the quarter? I know you gave us a change, but what was the actual balance?
Darren King
It's not something that we have historically disclosed.
Steven Alexopoulos
Well now is your chance, if you'd like to do it.
Darren King
I am okay.
Steven Alexopoulos
No? Okay.
Thanks for the color.
Operator
Your next question comes from Marty Mosby of Vining Sparks.
Marty Mosby
Thanks. I had two minor [ph] questions, but if you look at the net charge-off improvement this particular quarter, I was trying to distinguish between how much of that was just gross charge-offs going down, or maybe the realization of a recovery or two in the quarter?
Darren King
Sure. It's generally Marty, just lower charge-offs in general, not offset by recoveries this quarter.
As we talked about pay-offs and paydowns, one of the nice things about this is, that they don't just affect the business that is performing, sometimes they affect your criticized assets as well. And so we had a very strong charge-off quarter, but it was not the result of outsized recoveries this quarter.
Those recoveries are pretty consistent with what we have been seeing all year.
Marty Mosby
And then the other fee income line dropped to the low end of the range, it was about $10 million off of where it was last quarter. We are just curious if there was anything unusual about that particular -- those line items this quarter?
Darren King
The big drivers there Marty were really loan related fees, syndication fees and other advisory fees as well as some of the kind of letter of credit fees. And as the -- we saw a little bit of a slowdown in the loan book, we saw a slowdown in the fee activity, they tend to go together.
Not to mention, in the second quarter, we had a really outsized performance in the syndication books. So quarter-over-quarter, they looked a little bit -- it's short of a big decline.
Probably, if you are thinking about going forward, if you take third and second quarter and average them, you are probably in a better spot.
Marty Mosby
Good. And materialization of that approved pipeline probably helps out as well?
Darren King
We are counting on it, yeah.
Marty Mosby
Right. Thanks.
Operator
Your next question comes from John Pancari of Evercore ISI.
John Pancari
Good morning.
Darren King
Hi John.
John Pancari
On the -- back on the charge-off topic there, if it was not influenced by recoveries and a just more general improvement, what is a fair run rate here for next quarter, and potentially into 2018? Are we looking at staying in that 10 to 15 basis point range for the ratio, or is it back to the 20 basis point ballpark?
Darren King
So we will talk about 2018 in January. But if you look at the average of the last, probably eight quarters, if not 12, we have been pretty consistently between 18 and 20 basis points of charge-offs.
We had one quarter, where I think we went to 22. I think we did have one other quarter, where we did have a bunch of recoveries, where it was 11.
But generally, even in that range, and I think that's probably a safe range to be thinking about, at least for the next quarter.
John Pancari
Okay. All right.
Thanks. And then, separately back to the M&A topic, so what is your sweet spot that you are looking at, in terms of target assets, if it was going to be a whole bank deal?
And then, what regions of the U.S. would you prioritize?
And then I know, you were asked about some of the metrics, and should we say, the earn-back? What is something that you would view as a digestable earn-back period that you would consider when doing a deal?
Thanks.
Darren King
Sure. So I guess, in general, if you look at our history through time with M&A, we have been pretty opportunistic.
And when you look at our field of play, it's pretty much anywhere where we do business today and states that are contiguous to that. We have tended to always be in footprint or somewhat overlapping in a contiguous footprint.
It has not been our history to add a bank, let's say in the Midwest, where it's not connected to our footprint. Generally, we like things that are close by, for two main reasons; one is, it tends to be -- give us a chance to leverage our brand.
But more importantly, it allows us to leverage our people. And one of the most important ingredients we believe to our success, is the leadership in the folks of the bank which bring that culture, particularly our credit culture and our expense culture to that new institution, and therefore proximity helps us leverage our management resources into those acquired operations.
When you look across the footprint, we are interested in pretty much any geography. And really the challenge on size is in any acquisition that needs to be big enough to have an impact on your financials, such that it's worth the investment that you make to complete an acquisition, and on the upper bound, it can't be so big that you can't manage the risk of combining the two organizations.
Not to give hard numbers, but our history has been that generally, we'd like things that are 20% to a third or 40% of our size, but we have done smaller, and where it makes sense in footprint, where it's a strong combination, and where the returns make sense, we are definitely open to it and we have done those. So it's a little bit big, but that's kind of generally how we look at things, and we will pretty much talk to anybody, if they have got a compelling story to think.
And our return measures, I mentioned earlier, I will reiterate them. We are looking for combinations, where the value created is -- results in a return that's greater than our long term cost to capital.
So number one thing is being earning a return for our shareholders, and part of the other metrics that we look at, that help us feel comfortable with that are the dilution or a lack thereof, hopefully, to earnings per share and tangible book value per share. And then we look at the payback period, and obviously, the faster the better, because you are more certain with the cash flows that you project one year out compared to the ones that you project five years out.
So there is not one metric necessarily that we hold more dear than the others. But if you make that combination of metrics work, you tend to have good success.
John Pancari
Got it. Thank you, Darren.
Operator
Your final question comes from Erika Najarian of Bank of America.
Erika Najarian
Yes, thank you. Just two quick follow-up questions.
Appreciate all the color on the loan yield and deposit pricing outlook; I am wondering, with the market pricing in over 80% probability of a December rate hike, how should we think about NIM expansions for the first quarter of 2018? Sort of putting all those dynamics together?
Darren King
So I guess, if you think about the first quarter of 2018 and you think about the NIM expansion. We have mentioned through the last number of quarters, that 25 basis points tends to be worth about six to 10 basis points on the NIM, and obviously that range is affected by deposit betas and pricing changes.
And when we look forward, we think that that still holds for the next 25, which we will get beyond, I am not sure. But that should give you a good range, under which to think, at least through the end of the year.
Erika Najarian
Got it. And in your prepared remarks, you reiterated the low -- no change in the expense outlook, which is low expense growth year-over-year in 2017.
Should we take out the $50 million legal reserve build, when we think about that trajectory?
Darren King
Yes.
Erika Najarian
Got it. Thank you.
Operator
We have time for one more question. Your final question comes from Gerard Cassidy of RBC.
Gerard Cassidy
Hi Darren.
Darren King
Hey Gerard.
Gerard Cassidy
I apologize I got disconnected, so I don't know if you were asked this question; but can you give us some color? I think I heard you say in your prepared remarks, that criticized loans, when you file in your Q will be up this quarter.
If so, by about how much, and can you give us any color behind what's driving that?
Darren King
I did mention that, and it was mostly just making sure that there were no surprises for you all, when you look through the numbers. They are up a little bit versus second quarter, but when you look compared to where we ended 2016, they are actually going to be below that.
So certainly don't read this as the sky is falling, we are not trying to be chicken little here, more just transparent. When we look through the criticized book and some of the changes and much like our loan trends, there is nothing specific that we are seeing.
There is nothing that we are seeing in terms of any industry concentration, any geographic concentration. It's just -- if there is anything that kind of tends to pop up and this is a small piece.
So again, let's not overreact, is balance sheets, where companies tend to be highly leveraged. And when you end up in some of those highly leveraged transactions, those present a little bit more risk.
But it's not enough for us to ring the alarm bell. But if there is anything that kind of jumps out, it's that kind of thing.
But overall, the change in criticized is fairly broad based.
Gerard Cassidy
Good. Thank you for the clarity.
And then as a follow-up, Bob talked about it in your shareholder letter this year, about the elevated costs due to regulatory compliance that M&T had to handle. Now you announced of course the Wilmington settlement.
On a go forward basis, operating expenses, should we see the rising 1% to 2% a year, or can you give us some flavor for -- now that these big issues are behind you guys, we just maybe see lower expense growth on a go forward basis?
Darren King
I mentioned before, we are doing our work on the 2018 operating plan, and we will be back in January with some better outlook for you. But in general, when we look at the cost of compliance and the like, in our income statement.
The increase that we experience going through the written agreement, is largely baked into our run rate now. And there shouldn't be any large increases as a result of that.
We are hopeful that as we continue to hone our operations and get more effective at it, that we can manage the growth in those. But when you look at our expense base, and you got a half to slightly more as people expenses, and with what's going on in labor markets and salary increases, that there is just going to be some upward pressure on that.
We think that's manageable. But it's probably going to be difficult to see that go down.
Gerard Cassidy
I appreciate the color. Thank you.
Operator
This concludes today's question-and-answer session. I would now want to turn the floor back over to Don Macleod for any additional or closing remarks.
Don MacLeod
Again, thank you all for participating today. And as always, if any clarification of the items on the call or news release is necessary, please contact our Investor Relations department at area code 716-842-5138.
Thank you and good bye.
Operator
Ladies and gentlemen, thank you for your participation in today's conference. This concludes today's call.
You may now disconnect.