Thesis summary
M&T Bank Corporation (NYSE: MTB) is one of the most conservatively managed U.S. regional banks that operates in 12 states. They have a successful operating history and high underwriting standards. Even during the global financial crisis, they were much less affected compared with most other U.S. banks. They have been increasing the dividend payments for three decades, and never have a money losing year. The management team has long tenure and makes sure that the conservative operating philosophy be carried forward. Besides, the company grows the book value by a growth rate twice higher than its peers of regional banks.
However, today such a high-quality regional bank trades at 0.76x P/B ratio and 1.19x P/TB ratio, which I think are exceptionally low. Take a five-year holding period, assign a terminal P/B ratio of 1.3x (lower than average level in the past decade), and assume the company grows its book value by 18%-20% in the next five years (the CAGR of book value in the past decade is 7%+), we can get an annualized return in the high-teens. Given the low multiples and the conservative management, the probability of permanent capital losses is very low for patient money.
Price: $111.66
Market Cap: $18.44
EPS (Forward): $15.88
P/E (Forward): 7.00
Dividend Yield: 4.68%
Oct 26, 2023
Introduction
The U.S. banks hit record profitability levels in FY2022. However, as the rate hikes caught many executives/investors off guard, many started to worry about the banking sector. Such pessimistic investor sentiments peaked in the banking crisis this year and haven’t been truly alleviated yet.
I am not as pessimistic as many fellow investors. It is true that there is always something to worry about in the banking industry- be it rate hikes, rate declines, inflation, deflation, housing crises, commercial real estate crises, and a laundry list of concerns. But taking a step back to have a look at the bigger picture, we will find that the well-managed and conservative banks will weather these ups and downs. In contrast, banks that took on too much risk when life is rosy might face heavy blows when winter comes. M&T Bank Corp’s conservative business philosophy and long-lasting customer relationships enable them to outperform their peers during times of high economic uncertainty.
Background
Company: M&T Bank Corporation is a U.S. regional banks with a significant presence in the Mid-Atlantic and Northeastern regions. It operates 1,000 branches in 12 states across the Eastern United States, from Maine to Northern Virginia. As of FY2023 Q3, the company has $200B+ of total assets, ~$130B of net loans and ~$164B of total deposits. Net interest income currently constitutes 70%+ of revenues before provision for loan losses.
Operating footprint
Source: S&P Global Market Intelligence
M&T Bank Corp has an impressive operating history. If we exclude two data points (two quarters of higher-than-normal dividend payout in 2008! and 2015), the company has been increasing its dividend for more than three decades. It has 15%-20% ROATCE, ~10% annual TSR (not bad given the low valuation of the stock at the moment), and 7% total book value per share growth (2x the peer average). It doesn’t have any money-losing year during the same period. Given the severity of the Global Financial Crisis in 2008, this is exceptional compared with the whole U.S. banking sector. Because of the high-leverage nature of banking business, the most crucial aspect is risk management, and M&T Bank Corp has historically performed much better in this regard compared to other banks.
Source: FY2023 Q3 investor presentation
Concerns about U.S. regional banks: First, I want to touch briefly on the failure of Silicon Valley Bank. As a regional bank offering services especially targeted at the needs of tech industry, Silicon Valley Bank benefited from the extremely low interest rates following the Global Financial Crisis and the surge in technology venture capital investments. However, starting last year, the Federal Reserve suddenly raised interest rates to 5%+ to curb inflation. This severely impacted SVB’s large holdings of long-term U.S. treasury bonds, leading to substantial unrealized losses. Depositors rushed to withdraw their deposits, triggering a domino effect that caused SVB to collapse in less than two days, followed by First Republic Bank and Signature Bank.
There are two main reasons why investors are worried about the outlook of U.S. regional banks: 1) a bank run caused by a sudden drop in deposits 2) a significant increase in credit losses or maybe unrealized losses on securities. For the first concern, there is no guarantee that M&T Bank Corporation won’t see a major decline in deposits in the future. Even though the company has fostered long-lasting relationships with their customers (average relationship tenure is more than a decade for all the main categories of deposits), the nature of bank deposits makes them not very sticky. But at the very least the deposit outflow was minimal (~1%) right after the banking crisis, and the company still sees a positive deposit trend in the past two quarters despite the higher competition around customer deposits. When it comes to uninsured deposits, liquidity sources represent 136% adjusted uninsured deposits, and uninsured deposits represent 41% of the total deposits (35% excluding the collateralized deposits). In the regional bank crisis, Silicon Valley Bank has 94% of its deposits uninsured; Signature Bank has 90% of its deposits uninsured; First Republic Bank has 68% of its deposits uninsured. We should also notice that the company has exceptionally a low level of uninsured deposits and a low percentage of unrealized losses to CET 1 capital. Therefore, I hold the opinion that a large-scale bank run is almost impossible for M&T Bank Corp, although deposits might shrink in the case of a future economic downturn. Even if such deposit shrink occurs, its impact is generally short term, if not destructive.
For the second concern, if the economic situation deteriorates sharply and interest rates remain high at the same time, many banks could suffer considerable credit losses. In such a scenario, banks might take dividend cuts, suspend share buybacks, or raise capital from the secondary market. The impact of dividend cuts and suspended share buybacks on stocks is mostly temporary (although it can be significant), but the dilutive capital raises at extremely low stock prices have a permanent effect on shareholders. Specifically for M&T Bank Corp, it has a significant exposure to CRE (Commercial Real Estate) in terms of loans and New York in terms of geography. Since risks loom on the horizon for the U.S. commercial real estate industry, with many holders of potentially distressed assets pummeled by the higher borrowing cost. If a full-blown CRE crisis comes to materialize, the company may see low single digit NPL (Non-Performing Loan) ratio, which could impact profitability. Given the historical NCO (Net Charge-Off) data and the low weighted average LTV (Loan to Value) ratio, I think this is a manageable number for the company. Without an extremely distressed real estate crisis in which the market value of properties drops by an incredible percentage, most of the NPL value will essentially be recoverable. Even in the global financial crisis, the general NCO ratio peaked at only 1% in 2009, which is best in class among the peer group.
Source: FY2023 Q3 investor presentation
Stock price: After the U.S. banking crisis, the stock plummeted to levels below $120. Over the next few months, the stock remained around this range due to economic and commercial real estate uncertainties, along with potential rate hikes. In these days, the stock price even hit new lows.
Source: Tikr Terminal
Competitive advantage
Traditional banking is a rather commoditized business subject to high leverage. That’s why in most cases, I am reluctant to invest in bank stocks. However, for M&T Bank Corp, I believe they have a decent franchise, and the management is very attentive to maintaining its value for the long term. Additionally, the company’s community-focused approach gives them an advantage in serving local small businesses and retail customers, fostering long-term relationships with them. Moreover, their market penetration in select regions allows them to sustain their competitive edge without falling into the trap of cutthroat competition. To me, this is a much less commoditized business than its peers.
Source: FDIC Summary of Deposits
Financials
M&T Bank Corp had and still has best-in-class efficiency ratio (50%-60%) and ROTCE (15%-20%) compared to its peer regional banks. Its deposits are stickier than many other regional banks. Its loan book is well diversified in terms of industries and maturities. Some may raise concerns of the regional concentration and CRE exposure. I would say that though the concerns are legitimate, and a real estate market collapse is possible, we are nowhere near the situations in global financial crisis. Nowadays, the balance sheets of these banks are much stronger than they were during the global financial crisis.
Net Interest Margin: In the past two decades, M&T Bank Corp’s NIM ranges from 3.0% to 4.0%. Starting from 2021, the NIM for most regional banks dropped below 3.0%, including M&T Bank Corp. Some consider this a structural change due to disruptors like online banking altering the supply-demand dynamics of the traditional banking industry. In my opinion, such narrative is overblown. The deposit cost of the banks doesn’t change much in a few years before rate hikes in 2022, so I will make my argument focused on loans. From the supply side of loans, the banks saw enormous asset growth after COVID largely due to the U.S. government’s COVID stimulus. But the demand for loans didn’t catch up with the influx of easy money. As a result, the overall yield on loans was at a historically low level. After the rate hikes, M&T Bank Corp’s NIM has rebounded to the range of 3.5%-4.0%. I think in the long run, the company can maintain its NIM at a level of 3.0%+ or even 3.5%+.
Capital adequacy ratio: As of FY2023 Q3, the CET 1 (Common equity Tier 1) capital ratio is 10.94%, which is good for a conservatively run bank. So far, I have no concern with capital adequacy.
Net charge-off and nonaccrual loans: The net charge-off ratio is 0.29% in FY2023 Q3, lower than the long-term average 0.33%. However, the nonaccrual loans represent 1.77% of the total loans, whereas the allowance for credit losses is only 1.55% of the total loans. This is really strange at first glance, because the peer banks generally have similar levels of allowance against much lower NPL (non-performing loan) ratio. I tried to figure out the reasons behind the strangeness. First, the nonaccrual loan ratio gets distorted to some extent by the acquisition of People’s United Financial in that ~10% of the acquired loan portfolio was classified as PCD (Purchased Credit Deteriorated) upon the completion of acquisition, which accounts for 20%+ of the nonaccrual loans. Banks need to account for the potential losses associated with these loans differently, often marking them to fair value at the time of acquisition and making provisions for additional reserves later if necessary. Second, a considerable amount of the nonaccrual loans is shown as not holding reserves. I assume that those are the loans that were already written down to the fair value of collateral. Therefore, I think that due to the lack of appropriate disclosure, the net charge-offs and the allowance proportion are better metrics for monitoring underwriting quality. But I can be wrong here.
Management
Incentive plan: The short-term cash incentive is evaluated based on multi-factors such as operating income, EPS, efficiency ratio and returns to shareholders. I think this is reasonable for measuring the short-term NEO performance. As for long-term equity-based incentive, they have PSUs (Performance Stock Units) measured by absolute ROTCE (Return on Tangible Common Equity) and relative ROTCE to peer group. By using absolute/relative ROTCE as a metric for PSUs, the management would pay careful attention to operating efficiency rather than blindly pursue revenue growth. The company has a ROTCE of 15%-20%, which is a great level among U.S. banks. The granting of stock options is mainly based on absolute and relative corporate performance. The metric of stock options is similar to that of short-term cash incentive.
Management: According to statements made by the company in the investor presentation,
The executive management has an 18-year average tenure, and the company has only 3 CEOs, 5 CFOs, and 2 COOs in the past 39 years. For example, the current CEO and chairman of the board, René Jones, took over the position of CFO in 2005 and became CEO and chairman in 2017. This is a good signal mainly for two reasons. First, these executives have led M&T Bank Corp through the global financial crisis, and the impact they endured during that time was minimal compared to other banks. Second, such a low executive turnover rate benefits maintaining the company’s conservative business philosophy, thereby solidifying the value of its franchise. These aspects are often overlooked by many investors.
The management team at M&T Bank Corp is very cautious when it comes to risk taking. For example, in 2022 the management took a relatively defensive stand when many other banks were operating aggressively and boasted of the record revenue and EPS:
As 2022 began, M&T and our peers were still dealing with the impact of the government stimulus, and bank balance sheets were flush with large cash balances with limited options to invest. Loan demand was tepid and yields on investment securities were at historically low levels. As noted last year, we chose to be patient in investing the cash until rates offered a better return and there was less risk to our shareholders’ equity. As yields on investment securities and loans rose to levels meaningfully above those available in 2021, we reduced our interest-bearing cash balance by 40 percent to just under $25 billion at the end of last year, funding loan growth and purchasing investment securities. The timing of these actions allowed us to benefit from rising rates over the course of the year, simultaneously reducing the potential negative impacts of future rate declines.
Source: M&T Bank Corporation 2022 message to shareholders
This is a point I highly appreciate and a prerequisite for my investment consideration in M&T Bank Corp. After all, building a franchise and customer relationships takes years or even decades of relentless effort, but destroying them only takes a few months or weeks. Sometimes idiosyncratic/systematic risks catch everybody off guard. I recalled a story whose source I have forgotten. There was once a long line outside a bank in Hong Kong, and many passersby assumed the bank was going bankrupt, leading to an unfounded panic where “everyone” joined in withdrawing their deposits. Obviously, the customers don’t need advanced knowledge in financial reporting to panic. I personally believe that chances are high for those banks with conservative operation and prudent underwriting standards to win in the long term.
Right after the failure of Silicon Valley Bank, you can meticulously examine the numbers, charts, and footnotes from the 10-k filings of the banking stocks you hold or don’t to figure out the risks they face. However, the fundamental issue lies in the fact that most banking management teams don’t stress test for a rainy day. As a result, when the storm suddenly arrives, you’ll find some corporate executives struggling without umbrellas at hand. Although M&T Bank Corp will also face some rainy days, they at the very least check the weather report and carry an umbrella with them. Having checked the operating history, I have full faith in the CEO René Jones and the CFO Daryl Bible.
Capital allocation
Acquisition: M&T Bank Corp from time to time explores the possibilities of acquiring banks, bank branches and thrifts in the markets it currently serves or in other locations that align with the company’s business objective or geographical expansion plans. Generally speaking, I think the management has proven to be adroit stewards of capital with a great track record. The most recent acquisition was the $8.3B all-stock purchase of People’s United Financial, which was completed in 2022. The company has finished the integration of the merger as of FY2023 Q3, and the potential post-merger benefits will roll out in the next few years.
Dividend: The company has a forward dividend yield of 4.68%. This is much higher than the historical average and is pretty close to the 2020 level. The dividend payout ratio is 29.5%, a sustainable ratio with limited risk of dividend cut.
Source: Tikr Terminal
Share buyback and issuing: The company bought back ~16% of the shares outstanding from 2016 to 2020 at relatively high valuation multiples (high prices), suspended the buyback after the outbreak of COVID (low prices), then massively bought back in 2022 (relatively high prices), and suspended again in 2023 (low prices). This is suboptimal from the perspective of a value investor in that this essentially means they bought their stocks at high multiples and stopped at low multiples. However, don’t forget two things: 1) The low multiples generally come hand in hand with high risks and uncertainty in the industry. It is reasonable to maintain sufficient dry powder to go through ebbs and flows. 2) The whole banking sector trades at much lower multiples relative to the S&P 500. Therefore, the company’s buyback yield is acceptable.
The company issued new shares mainly for acquisitions. In 2015, it pursued an acquisition of Hudson City for stock and cash. In 2022, it acquired People’s United Financial in an all-stock transaction.
Amateur’s edge (opt.)
This is anecdotal, but it might be useful to point out. I have a talk with two customers of M&T Bank Corp this spring. They informed me that the customer services weren’t satisfactory. Still not sure if this is an isolated case.
Valuation
This is a high-quality conservatively run U.S. regional bank that has a growth rate twice higher than its peers. The stock, however, now trades at only 0.76x P/B ratio, 1.19x P/TB ratio, and 7.0x forward P/E ratio.
Fair P/B ratio valuation: The P/B ratio and P/TB ratio are among the historical lows. Here I assume a standard 5-year investment horizon. Assign a P/B ratio of 1.3x to the stock five years out, and also assume that the company grows its book value per share by 18%-20% in the next five years (lower than the historical growth rate of book value). Such assumptions imply a normalized NIM of 3.0%-4.0%. In this case, we are going to see an annualized return in the high teens.
Why this opportunity exists
- Worries about the CRE loans, especially for office
- Worries about the potential deposit outflow
- Uncertainty after the U.S. banking crisis
Risks
- The CRE market could become distressed and bring credit losses to a significantly higher level
Catalysts (opt.)
- The post-merger benefits from People’s United Financial roll out