Valuation and a recent trend of missing operating expense estimates were my biggest concerns when I wrote about M&T Bank (MTB) last quarter, and even after a big post-earnings pop, the shares haven’t moved much beyond the price of that last article. Since then, though, M&T has posted a pretty good fourth quarter report, including real progress on expenses and commentary that loan run-off pressures should start abating in 2020.
I don’t have any quality issues with M&T Bank, but I still don’t find the valuation compelling for a bank that will likely only produce low single-digit pre-provision profit growth for a couple of years (and 2021 could still see a contraction). M&T is a decent enough hold, but with several quality banks out there trading at meaningful discounts to fair value, I’d shop around before buying this one.
A Good Set Of Results, With No Real Problem Areas
M&T Bank posted a good set of results for the fourth quarter, with beats across most of the important line-items and a bottom-line core EPS beat of about $0.07. Guidance for 2020 was relatively positive, though negative operating leverage could push pre-provision profits down if fee income doesn’t come through.
Revenue was basically flat on a yoy basis and down 1% qoq, beating expectations by about 1%. Net interest income fell 5% yoy and 4% qoq, in-line with expectations, as net interest margin underperformed by 5bp (falling 28bp yoy and 14bp qoq) but asset growth slightly outperformed (up almost 3% yoy and almost 2% qoq). Fee income rose 10% yoy and 1% qoq, beating expectations by 3%, with good performance in the trust business (up 12% and 5%). The ever-volatile mortgage business remains so, up 28% yoy but down 14% qoq.
After a series of disappointing quarters with respect to operating expenses, M&T did better this quarter. Opex rose more than 7% yoy, but fell 3% qoq and was only slightly worse than expected on a core basis (and the core efficiency ratio was 40bp better than expected with the revenue outperformance). Pre-provision profits were still down almost 8% yoy, but improved 1% qoq and beat expectations by about 2%.
Still Not Much Loan Growth
M&T was one of the few banks to actually exceed expectations for loan growth, at least on an average balance basis. Even so, core end-of-period loan growth of around 3% yoy and 2% qoq isn’t exactly scintillating. More positively C&I, CRE, and consumer lending all grew, with C&I and CRE lending outgrowing the average for large banks this quarter.
Yield pressure remains a challenge, with M&T seeing average loan yields decline 21bp yoy and 19bp qoq.
Deposits rose more than 6% yoy and 3% qoq on an average balance basis, though non-interest-bearing deposits were down about 2% yoy (and up 5% qoq). Non-interest-bearing deposit costs rose 15bp yoy and declined 9bp qoq – not one of the stronger performances, but hampered by the fact that M&T already has comparatively low deposit costs.
Credit remains okay. The provision expense was a little higher than expected, but non-preforming loans declined 4% qoq and the charge-off ratio was stable. The NPA ratio is still higher than I’d like to see, but that’s a structural issue that isn’t going to change in a quarter or two.
Not Much Near-Term Sizzle
A meaningful part of M&T Bank’s spending in recent years has gone toward building up its fee-generating businesses and IT infrastructure, and some of those investments should start producing benefits in 2020. Management is looking, at least in part, to past IT investments to help restrain operating costs, with guidance for 1% growth or less in core spending in 2020. Management is also looking for the fee-generating business to grow in 2020, helping offset a modest decline in net interest income. Loan growth is going to remain challenged, with management looking for a low-single-digit growth rate, but noting a likely slower pace of residential loan run-off.
I like the heightened focus on expenses and fee-generating businesses, as they’re among the relatively few controllable drivers banks have to counterbalance spread pressures. The benefits are still limited, though, and I’d expect little-to-no pre-provision profit growth in 2020 (possibly even contraction) before a better result in 2021 and beyond.
I think M&T will be hard-pressed to grow core earnings at more than a low single-digit rate over the next five years, and with limited loan growth opportunities, total payout ratios (dividends plus buybacks) will likely remain above 80% for a few years. Longer term, I think M&T can get back to low-to-mid single-digit core earnings growth. I also believe M&T will return to whole bank M&A, but the timing on any deal is obviously uncertain.
The Bottom Line
Discounting those earnings back, and also using an ROTCE-driven P/TBV valuation approach, I believe M&T shares are pretty close to fair value now. That doesn’t mean that I expect no appreciation in the shares, but rather that the appreciation potential is simply in line with the risks. Long-term shareholders can reasonably expect a high single-digit long-term return, but I think there are better options out there.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.