|Shares Out. (in M):||168||P/E||7||8|
|Market Cap (in $M):||19,285||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||19,285||TEV/EBIT||0||0|
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Let me start by saying that I'm effectively asking for your reactivation vote. Let me give you the pros and cons of allowing me back on VIC --
1. I've been around here (with a handful of long pauses) since 2001; encourage you to review my other ideas, including some posts under Topics
2. I've won the best idea competition 3 times (though I had to change my username when I changed employers earlier in my career, so you won't find them all)
3. I might have an idea that is worth your time in the future, though I make no promises.
1. I don't have very many good ideas, mostly because I'm not very smart.
2. There were a couple of occasions where I submitted a mediocre idea to keep my VIC membership up to date. I regret that.
3. Given #1 and #2, I may not last long on here again.
The last two weeks have seen the collapse of two prominent banks (Silicon Valley Bank and Signature Bank), and the collapse of a third not-so-prominent bank (Silvergate). The speed at which these banks collapsed caught investors completely off guard, and there has been a subsequent sell-off in bank stocks. There are legitimate concerns:
1. The Fed has raised interest rates rapidly, crushing NIM for the entire industry.
2. Gov't COVID response, among other things, caused enormous asset growth in the banking system. Many banks used the surge in deposits, which cost essentially nothing at the time, to buy long dated Treasurys and MBS. They took enormous duration risk. The rise in rates has crushed the fair value of those securities impairing capital levels (and ostensibly causing the bank run at SIVB and SBNY -- too many depositors wanted their money, these two banks couldn't sell securities to pay out depositors while keeping their capital ratios healthy.)
3. The inverted yield curve has provided options for depositors, so not only has NIM been impacted, total deposits at US banks are shrinking. The solution, for banks that need to retain deposits, will be materially higher funding costs. Right now, Treasury Direct offers a better deal and more sophisticated depositors are finding better options there (and elsewhere).
4. The combination of these factors, and a very awkward government response to the bank failures has created fear that all but the largest banks (the JPM, BACs of the world) are going to experience a deposit run themselves. Never before have the footnotes to bank 10Ks been so heavily scrutinized as they have the past two weeks. In the case of MTB, I think we have a bank that has a conservative balance sheet with very low risk of losing deposits in enough size to put the bank at risk.
Why M&T Bank?
In my view, any bank analysis should focus on one question -- how greedy is the management team? Banking is a business where growth is relatively easy to achieve. Offer higher deposit rates, or better loan terms, and you'll get growth. Better bankers understand that franchise value is built over decades, cultivating relationships in the communities you serve. This creates at least some stickiness in your deposit base, though I won't delude myself into thinking that customers won't switch if they get an offer that exceeds the inconvenience of making a change (and mobile banking lowered that cost). A banking franchise can lose its value in a matter of months, if they poorly manage the risks on their balance sheet in pursuit of slightly higher yields. SIVB had this problem and collapsed. Others, including FRC (and even SCHW to some degree) have similar problems because of asset decisions made in 2020 and 2021.
Rene' Jones, MTB's CEO, said this in the latest shareholder letter:
"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."
With MTB, we have a $200B asset bank operated by a conservative management team in markets (the northeast, though primarily outside NYC) where the pace of change is a little slower. That does not make them immune to dumb ideas, but it greatly reduces the risk for shareholders. MTB has a culture of conservatism in banking, started by Bob Wilmers and now Rene' Jones. To me, this is critical. If I wasn't sure about the culture of MTB, I wouldn't be interested in this idea.
My view on MTB's conservatism does not mean there are no risks. There certainly are risks, and some risks may prevent investors from buying shares at this price (or any price). MTB has plenty of CRE loans, some of which are secured by properties in NYC. We can all read the headlines about office valuations in NYC. It isn't pretty. I suspect we're going to have writedowns on many of these loans. I do not think it is catastrophic.
Lastly, MTB bought People's United in a transaction that closed April 1, 2022. That transaction increased MTB's operating area, in adjacent states, and brought along plenty of new customers, both depositors and borrowers. The integration has gone well, but not perfectly. There are always hiccups in a bank merger of that size, but I believe it provides significant scale benefits to MTB once they finish the integration (which they essentially have done now).
What is it worth?
In 2022, MTB earned $14.42 per share, stripping out merger related costs and intangible amortization. That figure includes a large increase to their allowance for credit losses that came with the People's United merger (mostly an accounting requirement, but at this point that large allowance is looking much better).The bank has consistently earned mid-teens return on tangible equity. They pay out a healthy dividend, and use excess capital to buy stock.
I'm thinking about valuation like this:
Loans ~$130 billion
Securities ~$50 billion
Earning assets ~$180 billion
Net interest income ~$7 billion (in an 8K released March 7, the company guided NII up 23-26% YoY -- big part of this is full-year of People's United)
Non-interest income ~$2.5 billion
Expenses (before credit provision) ~$5.2 billion -- growth from merger, but no significant merger costs in 2023
Essentially, pretax pre-provision income is ~$4.3 billion
In 2022, the company recorded a credit loss allowance of $517M, and their total allowance is ~$1.9 billion. That credit loss allowance represented 0.39% of loans, bringing the balance sheet allowance for credit losses to 1.5% of total loans.
Let's assume that we have elevated credit losses for the next couple of years. In 2023, I am assuming an allowance of 0.45% of loans, or ~$600M. I am keeping my credit provisions about that high for the next few years, and then bringing it slowly down to "normal".
We pay taxes and preferred dividends, leaving us with net income of ~$2.7 billion. As of the 10K date, there were 167.8 million shares outstanding. Dilution is minimal at current share prices (there are ~2.3M outstanding options struck at ~$149).
That leaves us with diluted EPS of ~$16.2 in 2023 (consensus is $17.8 -- the difference is the credit provision). Running this out to 2024, with similarly high credit provisions, I get 2024 EPS of $15.3 (consensus currently $18.3). I mention consensus numbers only to show that I'm somewhat conservative with assumptions relative to the sell-side numbers currently... though those will likely come down over time.
MTB does two main things with profits -- pay a healthy dividend, and buy back stock. The dividend for 2023 is likely to be $5.20 per share. In my model, I assume they use excess capital to increase their capital ratios and buy back stock. I have decided to use some cash flows to bolster capital rather than just gunning the share buybacks. Hopefully, this is another area of conservatism in my analysis.
Run this out for a few years -- pay out dividends, buy back shares, and it's not hard to see MTB earning north of $20/share in 4-5 years. Is 13x a fair multiple? If so, we're sitting on a $260 stock in that time period and we have collected significant dividends along the way. The IRR is compelling, at least relative to other ideas in our portfolio.
Obviously, the major risk is a significant increase in credit losses. I think that many banks will be forced to suspend share buybacks, reduce/suspend their dividend, and some will need to raise capital. I'm trying to stay away from banks that may dilute me. I don't think suspended share buybacks, or even a reduced dividend hurt me too much as a long-term investor, though clearly the stock will fall on the announcement.
In the case of MTB, I think the risk of a dilutive capital raise is low, but not zero. I'll be wrong if we get to that point. I just think that the nature of this management team, and the current valuation pay me sufficiently for that risk.
On a more granular level, CRE loans are a big risk. We can talk about that in the messages if anyone would like to dig deeper on that. I'm happy to do that, but I'll leave it out of the writeup so this doesn't get too long. Keep in mind that CRE risks don't all show up on the same day. If we have a deep recession, MTB can run with very high credit losses for a couple of years without materially impacting my expectation for returns for a long-term investor. That may not making owning the shares fun through a deep downturn, but I think the reward is worth that risk.
Many people are currently worried that banking has forever changed. I doubt it, but again, I've been wrong before. What has changed is the we are nearing the ugly part of the cycle for the aggressive bankers, and that can spill over to everybody.
Time. We need to see the industry stabilize. I think conservative management teams will shine by the end of the cycle.
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