Published March 3rd, 2017 by Bob Ciura
Warren Buffet is a big fan of bank stocks.
Several of the top 20 stocks held by Berkshire Hathaway (BRK-A) come from the financial sector, including banks and insurance companies.
One of Buffett’s bank stock holdings is M&T Bank (MTB).
As of Dec. 31, 2016, Berkshire owned roughly 5.3 million shares of M&T, amounting to a $842 million investment.
M&T Bank is a financial holding company based in Buffalo, New York. At the end of 2016, it had $123.4 billion of total assets. It has 3.7 million customers, representing 5.9 million accounts.
There are many reasons why Buffett would own M&T. It is a pillar of stability, in what is frequently a highly volatile sector.
M&T generated steady quarterly profits like clockwork, for more than four decades running.
It has several advantages that give M&T a wide economic ‘moat’, a term frequently used by Buffett to describe a company’s ability to stave off competition.
This article will discuss why M&T Bank is a classic Buffett stock.
M&T is a regional bank. It operates more than 800 branches, primarily in eight states in the Northeast and Washington, D.C.
Its core business functions include commercial, retail, and business banking. It also has an investment banking and mortgage banking business.
The biggest reason why Warren Buffett owns M&T Bank is arguably its reliability.
M&T Bank has an entrenched industry position and earned a reputation for consistency. It has $95.5 billion of deposits, and is No. 1 or No. 2 in deposits in seven of its 10 largest markets.
Its geographic focus has allowed M&T Bank to dominate its specific regions, including upstate New York.
Source: BancAnalysts Association of Boston Conference, page 13
In fact, M&T has not lost money in a quarter since 1976. This has provided the company the ability to grow earnings-per-share and dividends steadily over the past three decades.
From 1983-2015, M&T generated 13% compound annual growth of operating earnings-per-share.
Source: BancAnalysts Association of Boston Conference, page 19
2016 was another year of steady performance. M&T had earnings-per-share of $8.08, up 4% from 2015. This growth was due to a combination of higher interest income, as well as growth in assets and loans.
Going forward, M&T Bank’s most important growth catalyst is higher interest rates.
As a regional bank that relies heavily on traditional banking activity (deposits and loans), M&T would see a major boost from rising interest rates.
The Federal Reserve raised interest rates last year, and could hike rates as many as three times in 2017.
This would really help M&T’s net interest margin, the spread between interest paid on short-term deposits, versus interest earned on longer duration loans.
M&T is already benefiting from higher rates. Its net interest income rose 9% in the fourth quarter, to $883 million.
For the year, net interest income jumped 22% to $3.5 billion.
In addition, the bank is growing through acquisitions. It is rapidly expanding its footprint in New Jersey, thanks largely to its $3.7 billion acquisition of Hudson City Bancorp in 2015.
Source: BancAnalysts Association of Boston Conference, page 14
Separately, a future growth catalyst for M&T Bank is an improving credit portfolio. Its net charge-offs have declined significantly over the past five years:
- Net charge-offs of 0.30% of average loans in 2012
- Net charge-offs of 0.28% of average loans in 2013
- Net charge-offs of 0.19% of average loans in 2014
- Net charge-offs of 0.19% of average loans in 2015
- Net charge-offs of 0.18% of average loans in 2016
An improving net charge-off ratio has allowed M&T Bank to set aside less money each year to cover credit losses, which leaves more money left over for shareholders.
Lastly, cost controls are a growth catalyst. M&T Bank’s noninterest expense fell 2.2% in the fourth quarter. Another measure for evaluating a bank’s cost structure is the efficiency ratio, which shows the relationship between operating expenses and revenue.
A lower efficiency ratio demonstrates a company’s ability to effectively manage costs. Last year, M&T’s efficiency ratio was 56.1%, a significant improvement from 58.0% in 2015.
Competitive Advantages & Recession Performance
One of the competitive advantages for regional banks is their risk-averse business practices.
Whereas national bulge-bracket banks engaged in highly risky activities that got them into big trouble in 2008, M&T resisted that urge.
It mostly stuck to traditional banking activities—making loans and wealth management—which served it well when the financial sector collapsed.
M&T maintains a low-volatility business model.
Source: BancAnalysts Association of Boston Conference, page 7
Moreover, regional banks are successful because of the relationships they build with their customers.
Since they focus on a particular geographic region of the U.S., they are able to better understand what is important to the local customers and businesses.
These qualities helped M&T stay profitable, even during the depths of the financial crisis. M&T Bank’s financial performance throughout the Great Recession is shown below:
- 2007 earnings-per-share of $5.95
- 2008 earnings-per-share of $5.01
- 2009 earnings-per-share of $2.86
- 2010 earnings-per-share of $5.69
As you can see, while the company’s earnings declined significantly in 2008 and 2009, it bounced back quickly starting in 2010.
By 2011, the bank’s earnings-per-share exceeded its 2007 high.
Valuation & Expected Total Returns
M&T Bank stock trades for a price-to-earnings ratio of 21.8. This is a lower valuation than the S&P 500 Index, which has a price-to-earnings ratio of 26.
However, the stock is valued considerably above both its average and its peer group. Since 2000, M&T Bank held an average price-to-earnings ratio of 15.
And, consider the price-to-earnings ratios held by M&T’s biggest competitors in the regional banking industry:
- M&T: 21.8
- BB&T Corporation (BBT): 17.7
- S. Bancorp (USB): 17.1
- Fifth Third Bancorp (FITB): 14.5
Bank stocks have seen a dramatic run-up since the November elections. For example, M&T Bank shares have rallied 35% since November 8.
The downside of such an impressive rally over a relatively short period of time is that it has quickly elevated M&T’s price-to-earnings ratio.
Consequently, its future returns are less attractive for those buying the stock at its present valuation levels.
A breakdown of expected future returns is as follows:
- 4%-6% revenue growth
- 1% cost cuts
- 1% share repurchases
- 1.7% dividend yield
As a result, expected future returns could reach roughly 7.7%-9.7% per year. Future returns would be less, if the stock experiences a contracting price-to-earnings valuation multiple.
M&T Bank has a slightly below-average dividend yield, due to its huge share price rally since the election.
But, it makes up for this with steady dividend growth and a secure payout. According to M&T, it was one of only two commercial banks—out of 20 in the S&P 500—not to cut its dividend during the recession.
And, now that the economy is back on solid ground, M&T has returned to increasing its dividend payout. For example, on Feb. 22 the company raised its dividend by 7%.
While this does not appear to be a great time to buy the stock, because of its current valuation, M&T remains a high-quality business.