With a 25-year record of doing an acquisition nearly every year, it was probably no surprise that M&T Bank (MTB) launched another deal in 2012, though the proposed acquisition of Hudson City (HCBK) is the biggest yet. This deal looks to be strongly accretive for M&T Bank over the long term, just as so many of its past deals have been. Given the bank's solid loan growth, good spread, strong expense control, and well-earned reputation for strong returns on capital, this is a top-notch bank. Sadly, it's also priced like one.
A Slight Miss In Q4, But Most Investors Won't Care Much
M&T's fourth quarter results were just a bit shy of averaged sell-side expectations, but there really weren't any problem areas that deserve real worry.
Operating revenue rose 15% from last year and 2% sequentially, and came in a little stronger than expected as both credit income and fee income were solid relative to estimates. Net interest income rose 8% and 1%, a good outcome relative to other large regional banks like Comerica (CMA), Wells Fargo (WFC) and U.S. Bancorp (USB). Net interest margin fell only 3bp sequentially and is very good (relatively speaking) at 3.74%, as the company's earnings yield has held up well. Fee income rose 26% and 4%, with strong mortgage banking results (M&T is relatively unusual quarter-to-date in showing sequential strength here).
While expenses were up 2% sequentially and higher than expected, the efficiency ratio of 54.5% is very good, as was the bank's 2% sequential pre-provision net revenue growth. It was those aforementioned higher expenses that fueled the miss this quarter, but it's hard to get too worked up about given the company's efficiency ratio relative to other Northeast banks.
Growing The Business, Mainly With Strong Commercial Lending
Most banks have been showing low single-digit loan growth for the fourth quarter (2% seems to be a very popular number), but M&T delivered 4% growth. Growth was strongest in the commercial lending category (up 7% sequentially), but commercial real estate lending kept pace (up 4%) and residential mortgages also rose 4%. Yields were pretty strong - declining only 6 bp to 4.28% (helped by the bank's high-yielding CRE and consumer loan businesses).
To fund this lending expansion, M&T ran down its securities portfolio (down 26% from last year and 85 sequentially) and added deposits. While deposits rose 3% from the third quarter, non-interest deposits increased 5% (to about 37%) and the cost of deposits fell to just under 0.17% - down from 0.25% last year and 0.18% in the prior quarter.
Credit quality is okay, although there are still some "legacy assets" here that need cleaning up. Non-performing loans rose 10% sequentially and the NPA ratio increased from 1.53% in the third quarter to 1.59%, a single borrower ($64 million in loans) seemed to make the difference, though management stated that those loans are fully secured by residential real estate. The net charge-off ratio was basically steady from the third quarter.
Here Comes Hudson
M&T's bid for Hudson City was bold, and with MTB stock doing pretty well since the announcement, it's getting a little more expensive. Still, even at current levels and valuations the deal makes sense. Although M&T will run down HCBK's portfolio (particularly the residential side), simply swapping in M&T's cost of capital will add value, to say nothing of the long-run potential of "M&T Bank-ifying" Hudson's branch base in New Jersey and New York.
This move puts M&T into even greater competition with Bank of America (BAC), Wells Fargo and Toronto-Dominion (TD), but that should frankly worry them more than M&T. Likewise, as M&T continues to expand it seems destined to run up against banks like PNC Financial (PNC), JPMorgan (JPM) and BB&T (BBT) more often, which will be an interesting head-to-head (to head...) meet-up of some of the best-run branch bankers.
Back to Hudson City, I like how this deal adds capital to M&T at an attractive price, not to mention building the bank's presence in densely-populated (and business-rich) downstate New York and New Jersey. I see a lot of potential for M&T to strip out costs and improve operations, and while running down the HCBK portfolio makes sense, I do think a bit more residential mortgage exposure would be a total negative for M&T over the long term.
The Bottom Line
Buying Hudson City pretty much ties up M&T's capital for the next year or so, so a large buyback, dividend increase, or additional deal is not very likely. Moreover, while this seems like a good collection of assets at a good price, there's always integration and execution risk with deals - though M&T's history with fixing up troubled targets suggests that any problems found will be dealt with effectively and quickly.
With the accretion potential of the HCBK deal and a re-review of the bank's performance and prospects, I'm comfortable bumping up my long-range ROE target on M&T Bank to 13%. Factoring in the post-HCBK balance sheet, that suggests a fair value of about $115 with a very similar blended discount rate as used for Wells Fargo, U.S. Bancorp and BB&T. Looking at tangible book value and returns on equity (and returns on tangible equity), a multiple of around 2.2x to 2.4x seems fair, suggesting a fair value of about $112.
Either way, then, while M&T Bank may be slightly undervalued today, it's not undervalued by a lot and some potential investors may be demotivated by the below-average prospects of higher dividends in the next 12 months. While this is certainly a good hold, it's hard to argue for buying this stock today over U.S. Bancorp or Wells Fargo (or BB&T) unless you have a very strong feeling about gaining exposure to the Northeast and/or an argument for a higher long-run ROE.