After the first wave of banking collapses last March and some subsequent calming down, the last few weeks have again been dominated by fears about who’s next. The California based First Republic Bank was the next to fall. Its assets were sold to JPMorgan. Stocks of other regional banks got hammered by even 50% in single trading days, as if this were nothing unusual. The search for the next victim is running. M&T Bank so far held up rather well (and managed to stay under the radar). Is it worth a closer look?
Summary and key takeaways from today’s Weekly
– For me, the banking issues are not over. After the fall of First Republic Bank, new victims are looked for.
– With M&T Bank, today I discuss a high quality bank that shouldn’t have issues with its deposits.
– However, I am not so sure on the loan side of things, plus the valuation leaves no room for errors, despite the stock being some 40% down from its highs (even without loan write-down). But it is a watch as there will be winners in the likely coming consolidation.
The prevailing modus operandi on the markets is a “returned” crisis of the banking sector – as if anything would have been solved since the first wave of collapses in March 2023. At the same time, my personal assessment is that media are rather trying to portray a picture that nothing extraordinary has happened so far and only a few smaller banks fell.
While it is true that from time to time banks fail – for whatever reason – and that the big failure of 2008–2009 had entirely different roots (namely highly rated packaged garbage that was sold as lucrative, while financial institutions had way weaker capitalized balance sheets), there are still landmines that could cause another panic.
This is certainly among the last things I wish for.
But if you read my book summary from last week (see here), you will have noticed that human behavior doesn’t change when financial uncertainties are around the corner. This game of solvency and survival is not necessarily about logic and what’s true or not, but about what the majority of people think and how they act correspondingly.
Even if there were no more panic to happen – let’s hope for the best – I am not so sure that the worst for most banks is over. Politicians coming in front of a camera and saying “everything’s fine, our banks are safe” is usually only a tranquilizer – but seldom based on the true state or condition.
Add to that the weaker economical outlook or recession and you see that banks and banking stocks are rather not a good idea at the moment.
At the same time, when to buy when not during a crisis?
While the typical gambler will buy either stocks with the highest dividend yields or those that fell the most percentage-wise – and assuming they had the highest upside potential to bounce back to former highs again – the conservative and fundamentally oriented investor will be risk-averse, as it is rather a sign to stay away where trouble is the biggest.
This way, the goal is to find stocks in a troubled sector that not only have an above average likelihood to survive, but also to thrive after the storm is over and there’s less competition after the clean-up. It can happen that otherwise healthy businesses get caught into a storm, offering rare chances for great bargains.
In other words, it is time to prepare your watchlist.
M&T Bank (ISIN: US55261F1049, Ticker: MTB) is a regional US-bank that spots several quality metrics. It is not only one of the largest regional banks, but one of the largest to choose from in general, and one with solid finances, too.
What really impresses me is management’s approach during the time before interest rates started to rise in 2022, as they stayed away from silly moves to boost returns on the basis of big risks (interest rate moves). Also, MTB was only one of very few banks that did not cut its dividend even during the Great Recession of 2008–2009!
However, there are also some negative points that must be monitored.
This Weekly will analyze this company, and answer the question whether the stock of MTB belongs on the watchlist and what price could be attractive.
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Regional banks still under fire
If you’re observing the markets or maybe spend some time on financial news platforms, you likely will have noticed that over the last few weeks several regional banks have come under massive pressure again, after the March calamities.
First, the stock of now-failed First Republic Bank fell and fell, until the situation must have been so dire, that over the second to last weekend, the FDIC and JPMorgan (ISIN: US46625H1005, Ticker: JPM) arranged a takeover of the operations, whereby JPMorgan bought the assets for some 11 bn. USD, while the FDIC took over the losses and gave guarantees.
A bargain for JPM!
Prior, the dividend suspension by First Republic as well as the announcement of a restructuring, involving the layoff of 20–25% of employees, couldn’t stop the outflow of deposits. The Q1 results were really bad, showing massive multi-billion Dollar deposit outflows that even were above the already dire expectations.
With this, the bank was clearly undercapitalized and depended on further financing.
But who’d have lend them even more (they already received emergency liquidity) or participated in a massive capital increase?
As the uncertainty was high and the bank had many uninsured customers (due to their too high deposits), it is not too difficult to imagine that the deposit outflows continued, up to a point where it was necessary to put the bank under a new ownership.
Otherwise the announcement of a bankruptcy due to insolvency would have been needed. You can imagine that this is not what the public wants to hear.
In the case of a bankruptcy, the message would have been that authorities lost control – likely igniting another round of panic.
This way, the bank was more or less silently “taken over”.
After the situation was cleared, the search for the next victim started. Stocks of regional banks like
- PacWest (ISIN: US6952631033, Ticker: PACW)
- Western Alliance Bancorp (ISIN: US9576381092, Ticker: WAL)
- Comerica (ISIN: US2003401070, Ticker: CMA)
- or KeyCorp (ISIN: US4932671088, Ticker: KEY)
not only suffered heavy losses. These stocks are jumping back and forth like crazy, on one day dropping by 50%, only to surge again by 50% or so the next day. This is not a place you can calmly invest.
PacWest even skyrocketed last Monday after announcing a 96% dividend cut.
In the chart above, you can see what I mean by saying “first wave” or “second wave”.
For me, this is clearly not the time to be brave at this point, trying to catch a bottom that maybe never comes (for some). Also, I am a bit defensive when it comes to stocks that “enjoy” too much spotlight appearance.
Unfortunately, I don’t know the source anymore, but I found a picture where the current banking failures are put in comparison to what happened during the Great Recession (the numbers are the deposit sizes):
This year’s three failures have already been higher – measured by the cumulative size of the deposits these banks held – than all bank failures in 2008!
But why are regional banks under such massive fire to begin with? You can listen to the first half of this interview here, where a blogger colleague discusses the key issues. The key thing you must understand is the different structure (customers, business units and balance sheets) of regional banks compared to the big banks.
First of all, the absolute amounts on the balance sheets of the big banks are gigantic, making it nearly impossible to pull that many deposits, while at a smaller bank it can be done way quicker.
Then, the big banks are more international and have less sensitive divisions like wealth management or investment banking. Although they can of course suffer from less earnings as they depend on the capital markets activity and results, they are not facing the same potential risks of loan defaults.
This way, the big banks are more diversified.
Regional banks are the backbone of the economy and thus more sensitive to slow-downs. Taking it a step further, the balance sheets of regional banks have higher relative shares of residential and commercial real estate loans. The total amounts are higher at the big banks, but the regional banks carry higher risks due to a higher concentration in this regard.
The problem now with real estate is that it in most cases must be refinanced.
However, the higher interest rates now have caused a double-whammy of issues: First, the refinancing costs for borrowers are higher, increasing default risks. Second, at the same time the property values are likely to have declined in many areas, as higher interest rates lead to higher discount factors or cap rates (the reciprocal value of an earnings multiple in percent), lowering the collateral value.
Usually, it was not a big thing to raise equity for banks either to grow or to strengthen their balance sheets. But now is among the worst moments. As you have seen with Silicon Valley Bank, the equity raise ignited the panic that led to its demise – in a matter of hours.
In other words, the first bank that announces a capital raise, spooks investors and depositors, signing its own death-sentence.
This time, the banking crisis is not about subprime (i.e. low-quality) mortgages – it is about the revaluation of assets due to higher interest rates that pressures borrowers the same as lenders.
The other dilemma many especially regional banks have is that their financing in terms of deposit costs is under pressure. These banks get forced to offer higher deposit rates, otherwise money can be pulled, as we have seen with the moves into money market funds or short-term government bonds directly.
This squeezes interest margins.
It is also an issue for the big banks, but many flee regional banks – to big banks for more safety! That is currently their bonus.
Another difference between regional and big banks is that big banks have a lower loans to deposit ratio and diversify more with investments, primarily in either mortgage backed securities and / or bonds. An article from the Wall Street Journal (see here) says that small and regional banks have a loans to deposit ratio of around 80%, while big banks only have 60%.
The advantage of the investments is that although they also suffer from revaluations due to higher interest rates, in most cases the big banks are not forced to sell them to raise cash. If held as available-for-sale, they get marked to market and temporarily pressure equity somewhat. But they come back to par the closer the maturity date. And held-to-maturity investments don’t have to be marked down at all.
If you want to learn the difference between both and also see what led to the fall of the Silicon Valley Bank, see my article “What you should know about the SVB collapse – my premium members were warned” here.
With mortgages or real estate loans, it is a different pair of shoes for the small banks.
The last thing I’d like to mention in this regard is that small banks lend from depositors or other banks, while the big banks have the optionality to refinance via capital markets.
I don’t know whether more banks will fail.
But what I know is that I do not want to hold any of these stocks with questionable outcomes due to disproportionately higher risks on their balance sheets. Keep I mind, survival is one thing. Not being diluted massively the other.
It is about quality and being prepared to strike, when the right moment arrives.
One such candidate could be M&T Bank.
Is M&T Bank a high quality stock to buy?
While under fire banks like Western Alliance temporarily were down by 90% from their 52-week highs, M&T Bank managed to hold up rather well. It’s stock also fell sharply – no question about that – but it wasn’t pulled into the same panic wave, especially not recently with the fall of First Republic Bank.
You can see on the chart that MTB also entered the second wave down, but it is no comparison to the four banks previously mentioned above.
MTB is a New York based bank, comparable in size with the failed First Republic Bank. Having roots back until 1856, this full-service bank has already managend to survive several crises. It is today still a regional bank, however, in total one of the 15 biggest banks in the US. Or in other words, it is positioned somewhere in a sweat spot.
Part of its strategy is to grow via acquisitions. In 2022, MTB had their so far biggest takeover ever, but still staying in their comfort zone in the North-East of the US.
In the following, I am going to show you a few charts, where the historical performance of this community-focused bank (as they describe themselves) can be seen:
First, they show a chart that sums up the long-term financial achievements compared to the median of their peer group. You can see on the following chart that the return on tangible capital employed (ROTCE), the earnings growth, the return on tangible assets (ROTA) as well as the dividend growth have either been superior or on par with the competition.
While the dividend growth is not that important for me here, as they also repurchase shares from time to time and as said do some selective acquisitions, the other three metrics already tell you that this is a high-quality bank.
You can also see on the next chart that MTB didn’t cut its dividend during the Financial Crisis of 2008–2009. This applies only to a very small group of banks. Even if they didn’t raise it until 2019, either, this is a remarkable sign of strength.
The next chart covers some more numbers and the performance of the last five years.
The net interest margin (difference between interest earned and costs) has always been rather high and recently even surpassed the 4% mark – that is not very common and shows that MTB is earning above average interest rates and at the same time is not pressured so much to raise deposit rates! But this must be watched carefully.
Then we see an efficiency ratio below 60% (costs to income), showing that this bank has its costs under control. Below 60% are good numbers. Credit metrics are also strong with no high numbers for delinquencies or even charge-offs. But here again, the trend form now will be important.
Capital returns, as already seen above, here again show strong results. All in all, a confirmation of strong past execution.
I mentioned in the intro section that management impressed me. Here is the reason why (discussion below the chart):
Management didn’t rush into interest- and return-free risk, while interest rates were near zero before the up-cycle started in 2022.
The Silicon Valley Bank did exactly the opposite – to show an extreme. While flush with cash, they bought fixed-yield bonds at the top (top of price, low in interest rates) with long duration to boost returns slightly, however, increasing risks massively.
The devastating outcome is known.
MTB assessed the situation back then as not favorable enough and too risky. So they stayed away from chasing low-yield, but high-risk adventures.
Management stayed short-term and waited, instead of buying overpriced assets, just to deploy their cash. And that is the reason why this bank suffered the least in terms of tangible book value contraction! On the right diagram in the chart above, you can see peers have suffered way more.
MTB wasn’t crippled by silly management decisions.
You can also see that MTB still has a higher share of short-term rates compared to its peer group. Since 2020, MTB has increased its longer-term exposure, taking advantage of the now higher interest rates while peers carry around unrealized losses and securities with low interest rates.
MTB more or less kept its tangible equity during the current banking crisis. This is a true sign of a prudent management.
The overview above shows that MTB did a really great job, second to none!
At least, this has historically been the case. But, is MTB also well-prepared for a banking crisis that not unlikely will see more houses close their doors for good?
When you look at the bottom part of the second to last chart (the five year overview), you can see that indeed we have a loans to deposits ratio of 80% here, as the article from the WSJ wrote. As to the deposits, a bank run is rather unlikely, as the average deposits are comparatively small, both retail as well as commercial, as the screenshot from the annual report shows:
All numbers, single as well as cumulative, are well below the FDIC’s insurance threshold of 250k USD. From the most recent Q1 10-Q 2023, we can see further that MTB holds 15% of deposits and more than 10% of total assets in liquid cash.
Also, since December, total deposits didn’t change that much (there was mainly a shift from checking to interest-bearing). I have seen several way weaker and less liquid balance sheets so far!
There is no reason to fear a liquidity crunch at this bank with these numbers.
Thus, let’s have a look on the second part of the ratio.
While solvency and liquidity were the short-term issues, loans and their possible defaults are the topic to watch over the next months and quarters.
What kind of loans does MTB have on its books? The reason why the stock of MTB also came down is its high exposure to real estate loans, especially commercial.
Commercial real estate loans make around 34% of its total loans.
It is hard to assess how much of it will default, if at all. But this is the issue being around, especially those loans that are collateralized by office property.
Digging a little deeper, we can see by taking the framed number from the second chart below that ca. 11% of commercial loans or 4% of total loans are office-related.
What doesn’t sound like much, maybe becomes clearer if we put that number against what’s really relevant – equity.
Keep in mind that banks are by nature leveraged businesses that have to fulfill certain capital ratios that depend on equity on the balance sheets.
The whole sum of loans outstanding to office properties is equal to 20% of total equity (which includes goodwill from past acquisitions) or – more important – around a third of tangible equity!
Tangible equity is common equity minus goodwill in this case (as there are no other intangible assets).
I am not saying that all office loans are going to go bust. Likely they won’t.
But it is not about all being in danger. Already small write-downs could be sufficient enough to meaningfully harm the tangible equity position and thus the share price of MTB, as the stock represents the (tangible) equity value.
Office is not only an already cyclical area by itself, also the new work from home or from everywhere spirit has the potential to materially reduce office demand! A deterioration in underlying property values is not unlikely! The question will be by how much and to what extend the owners are leveraged to stomach refinancing at now way higher interest rates.
The last part I’d like to look at is valuation.
We assessed the risks and now have to answer the question how much is priced in or the other way around, is there a sufficiently high enough margin of safety at the current price?
The following chart shows MTB’s price to tangible book value over the last ten years.
We can see that the whole bank is valued on a ten year low, taking the 2020-panic out, where the bottom was even a bit lower.
While in good times without big worries, this high-quality bank is good for a 2x–2.5x multiple on its tangible book value, we have now to factor in a whole new interest rate environment and its possible casualties.
I see the deposit side as rather stable, but I cannot answer the question about coming or not property write-downs from the commercial sector. Let’s create several scenarios:
- no write-downs (optimal case): the stock is likely around its historical bottom valuation, however, the stock still has a decent premium on its tangible book value of ca. 30% – this is not low! It is low compared to its historical valuation, but there’s no margin of safety. For a bargain, I’d like to see at least 1x, preferably even below that. During a mass-panic and sell-off of everything, this is entirely possible!
- write-downs of 2% on all loans (base case): this case may already be extreme, but it’s interesting to see the result, as it could be the case in a harsher recession. A 2% write-down on all loans (2.6 bn. USD), results in a reduction of tangible equity (16 bn. USD) of around 16%.
- write-downs of 5% on all loans (bear case): 6.6 bn. USD or 42% damage – this would be really brutal and I think it is not likely, but this example shall demonstrate the leverage effect that works in both directions! Equity could be cut by a substantial amount. However, this wouldn’t happen without a harmful capital increase, as MTB would fall massively below the required capital ratios.
The short answer for me is: Even in the best case scenario, there is currently not a sufficiently high enough margin of safety (if at all).
That’s why I’d pass on this one and why this bank has not made it to an exclusive research report for my members. The quality of this bank, especially its historical performance, are superb. However, there are too many risks around, so I’ll be watching this bank from the sidelines.
Maybe one day, after a small write-down and a sector-wide sell-off, you’ll be able to buy it at 0.8x tangible book value? Without write-downs, this would be a share price with the current balance sheet of 75 USD – a downside of 33% (minus possible write-downs then).
At 1x tangible book and without reduced tangible equity, the share price would have to reach at least 95 USD.
For me, the banking issues are not over. After the fall of First Republic Bank, new victims are looked for.
With M&T Bank, today I discuss a high quality bank that shouldn’t have issues with its deposits.
However, I am not so sure on the loan side of things, plus the valuation leaves no room for errors, despite the stock being some 40% down from its highs (even without loan write-down). But it is a watch as there will be winners in the likely coming consolidation.
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