April 15 (Reuters) - M&T Bank posted a 25% drop in first-quarter profit on Monday as higher deposit costs reduced its interest income, and a turmoil in the commercial real estate (CRE) industry prompted it to set aside more rainy-day funds.

Regional lenders have had to pay higher interest rates on deposits to prevent customers from fleeing to higher-yielding alternatives, such as money market funds.

Buffalo, New York-based M&T Bank's net interest income - the difference between what a bank earns on loans and pays on deposits - fell 8% to $1.68 billion in the first quarter from a year earlier.

Net income available to common shareholders fell to $505 million, or $3.02 per share, for the three months ended March 31, from $676 million, or $4.01 per share, a year earlier.

M&T, which has a substantial exposure to CRE loans compared to its regional banking peers, set aside $200 million as provisions for credit losses, compared with $120 million a year earlier.

Changing patterns of remote work have affected demand for commercial properties, while reduced property prices and elevated interest rates have raised the prospect of loan defaults.

The lender, however, has been working on shrinking its CRE portfolio.

"We are off to a solid start in 2024 as we were able to grow certain sectors of our commercial and consumer loan portfolios, while continuing to shrink our commercial real estate exposure," Chief Financial Officer Daryl Bible said.

Last month, ratings agency S&P Global downgraded its outlook on five U.S. regional banks including M&T Bank to "negative" from "stable" due to the possibility of CRE market stress hurting their asset quality.

Separately, M&T Bank also booked an expense of $29 million in the quarter tied to the replenishment of a government deposit insurance fund, which was drained after Silicon Valley Bank and Signature Bank failed last year. (Reporting by Arasu Kannagi Basil in Bengaluru; Editing by Shinjini Ganguli)