WAL - M&T Bank Looks Like A Relative Safe Haven In A Very Nervous Market

2023-04-13 14:57:44 ET

Summary

• M&T Bank has a stronger deposit franchise than many of its peers, with less reliance on large uninsured deposits, more "Main Street" depositors, and lower than average deposit costs.
• Credit quality in the CRE portfolio is likely to be a key watch item given M&T's above-average exposure, and particularly so in the office portfolio.
• Growth drivers are harder to come by, as loan growth is likely to soften further and operating costs could head higher on higher compliance costs.
• M&T looks undervalued on a long-term basis, but investors will need reassurance that the deposit/liquidity situation is well in hand and there are no negative surprises on credit.

Fear in the banking sector has been front page news for weeks, driven by the failures of SVB and Signature (SBNY), and regional bank stocks are down more than 20% as a group since the start of the year as investors price in a host of challenges for the sector. While liquidity and the ability to attract and retain sufficient deposits is arguably foremost in investors' minds now, other issues like funding cost, loan growth, fee income growth, expenses, credit, and regulatory burden are weighing on earning expectations.

Down 25% since my last update , M&T Bank ( MTB ) has been a modest laggard, and I believe investor worries around its commercial real estate (or CRE) portfolio and operating cost leverage could be driving at least some of that underperformance. I'm still bullish on this stock for the longer term, and if anything, I'm relatively more bullish now given the bank's better deposit base and its opportunity to leverage post-deal M&A synergies from the People's United transaction. I think it will take some time for investors to bid up the bank sector again, but I think this is a name to consider below the $150s.

A Better Deposit Base

Investors have been rudely reminded of the importance of liquidity and the quality of bank deposit franchises since the failure of SVB and Signature. Although I don't necessarily expect to see M&T benefit from the flight of large uninsured deposits from banks like First Republic ( FRC ) Signature, SVB, and Western Alliance ( WAL ) (relative, at least, to banks like Bank of America ( BAC ), I do think M&T's deposit franchise still stands out positively.

Deposit flight has been driven in large part by large uninsured deposits (venture capital and corporate deposits in particular), but M&T's ratio of uninsured deposits to total deposits is around average, and comfortably better than the likes of First Republic, Comerica ( CMA ), and Synovus ( SNV ). Likewise, I'd note that M&T's average deposit size (around $52K) is below the average of regional peers, including Western Alliance and First Republic (both above $200K) and Synovus (around $60K). I believe, then, that this translates into meaningfully lower risk that M&T is going to see a large-scale rush to the exits from depositors that would threaten its ability to continue as a business.

I'd also note that M&T's deposit costs are better than average, with interest-bearing deposit costs about two-thirds of its peer group. I absolutely expect to see deposit costs rise from here, but M&T does at least have the advantage of a better starting point. Likewise, M&T remains more liquid than average with cash making up around 13% of earning assets at the end of Q4'22.

I expect investors to be keenly interested in what happens with deposit flows and costs in the quarter. Systemwide deposits declined about 3% from the fourth quarter of 2022 in the first quarter of 2023, and investors will definitely hope to see better-than-average performance here. Likewise, while higher deposit costs are a near certainty, just how much M&T will have to pay to maintain a comfortable liquidity position is a key unknown.

Keep An Eye On Credit

Deposit flows (and costs) and overall liquidity are likely to be the most discussed topics around bank earnings apart from changes to earnings guidance (almost certainly lower for the large majority of banks). That's understandable given the recent circumstances, but it does lead me to wonder if credit and provisioning costs could loom as an under-appreciated risk - perhaps not so much in Q1'23 but later in the year.

There has been growing concern about bank CRE portfolios, particularly loans collateralized by office properties, and that's definitely relevant to M&T.

CRE loans are about 34% of M&T's portfolio, above the almost 30% exposure for its peers and 23% for the banking system as a whole. Office loans, though, are about 4% of total loans, and while that's more in line with the peer average, M&T's office loan portfolio does represent a little more than a third of the bank's tangible equity. Should office CRE loan credit quality deteriorate at a more rapid rate (not an unreasonable concern given post-pandemic changes in work habits and a slowing economy), credit losses could become a more material concern. M&T has historically been a good, conservative underwriter, and I don't think the bank suddenly lost underwriting discipline in the last few years, but I wouldn't ignore the risk and I hope management offers more detail on credit quality within the portfolio.

The Outlook

I'm not really concerned about M&T's deposit situation given the quality and granularity of the deposit base (basically meaning a larger number of accounts with smaller balances). Likewise, this bank doesn't rely overly much on securities as a source of interest income - securities were around 13% of average earning assets in Q4'22 vs. 28% at U.S. Bancorp ( USB ), 27% at KeyCorp ( KEY ), and 25% at Comerica. That lower reliance on securities also means that the bank doesn't have the same vulnerability to unrealized losses that helped sink SVB - unrealized losses are less than 10% of tangible common equity (versus almost 40% at USB).

Unfortunately, I don't see a lot of positives for the regional bank group today where earnings drivers are concerned. The sector as a group is going to need to boost liquidity, and that means paying more for deposits (and other sources of funding) and cutting back on lending. That, in turn, will pressure earnings, as well weaker fee-based business trends. Expenses, too, are a threat, as wage inflation seems persistent for now and regulatory/compliance costs are almost certainly going to head higher from here.

I've already lowered my '23 and '24 core earnings expectations by 9% and 13%, respectively, ahead of Q1'23 results and guidance and my long-term core earnings growth rate declines to around 4% (from 5%), as I expect tougher regulations and higher compliance costs over time. I likewise expect management to be more conservative regarding lending and capital returns for the foreseeable future.

The Bottom Line

Between discounted core earnings and a P/E-based approach, my fair value for M&T drops to the high $150s. That still offers good upside from here, and I think M&T is one of the better-positioned banks for this environment given its well-earned reputation for conservatism, it's high-quality deposit franchise, and it's opportunity to offset at least some operating cost pressure with merger-driven cost savings. That said, even for a bank like M&T I do see elevated risk and uncertainty going into first quarter earnings and I think the market will need a fair bit of reassurance to bid up the name again.

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