Banks are tricky things: you can't live with them, and you certainly can't live without them. They're absolutely necessary components of the economy and no matter how much you might hate them, they're never going away. And yes, just in case you're wondering, I'm talking about the same banks that nearly brought the world to financial collapse; we still need those guys kicking. But while some of the megabanks that you've grown to know all too well were placing big bets in abstract "financial instruments", some of the smaller players out there were doing what banks are supposed to do, the boring stuff.
Nevertheless, when the Great Recession hit, every bank was affected. As a result of the ensuing financial chaos, many banks received government aid through the Troubled Asset Relief Program (TARP). In December 2008 M&T Bank Corporation (MTB), in return for the U.S. Treasury's $600 million investment in preferred stock, issued 10-year warrants to the Treasury. These warrants grant the holder the right to purchase one share of M&T Bank common stock for each warrant held. The current strike price is $73.68, and the strike price is adjusted down by the amount in excess of a quarterly dividend that is greater than $.70. The warrants expire on December 23, 2018 and trade under the symbol MTB-WT.
We're going to take a look at how M&T's warrants compare to those of The PNC Financial Services Group (PNC), Comerica Incorporated (CMA), Bank of America Corporation (BAC), and American International Group, Inc. (AIG). The key metric to observe here is the warrant premium. The warrant premium is the cost of purchasing stock via warrants as opposed to purchasing the stock outright.
|Stock Price ($)||$117.71||$73.64||$40.90||$14.33||$46.81|
|Exp. Date||Dec. 23, 2018||Dec. 31, 2018||Nov. 14, 2018||Jan. 16, 2019||Jan. 13, 2021|
|Years Until Exp.||5.44||5.46||5.33||5.50||7.50|
|Warrant Price ($)||$43.80||$15.68||$14.08||$6.25||$18.90|
|Strike Price ($)||$73.68||$66.33||$29.40||$13.30||$45.00|
|Warrant Premium ($)||($-.23)||$8.37||$2.58||$5.22||$17.09|
|Warrant Premium (%)||(-.20%)||11.37%||6.31%||36.4%||36.5%|
What's amazing about M&T warrants is that there is no warrant premium built into the price, and the warrant premium is actually slightly negative as of writing. This means that theoretically (but please don't do this) you could be saving 23 cents per M&T share purchased through warrants relative to purchasing M&T stock outright at market prices (excluding commissions of course).
What does this mean going forward? Well, since there is no warrant premium, M&T warrants should appreciate on par with M&T common stock until the time of expiration. So, for example, let's say that M&T common shares appreciate $11.77 from $117.71 for an even 10% gain. In lockstep, M&T warrants should appreciate the same $11.77, this time not for an even 10% gain, but rather for a cool 26.9% gain. $11.77 is a much larger piece of $43.80 than it is a piece of $117.71.
In the following table (inspired by Adam Jones' wonderful articles) you can see what the next 5+ years could look like for M&T common stock and, by extension, M&T warrants. For these calculations I used the industry average Price/Book ratio of 1.7, which is probably conservative for such a high quality bank. Additionally I assume that the current dividend of $.70 per quarter is not raised through 2018.
|M&T Common Stock||M&T Warrants|
|Stock Price ($)||$117.71||--|
|Warrant Price ($)||--||$43.80|
|Years Until Exp.||--||5.44|
|Book Value Per Share ($)||$75.98||--|
|Industry Avg. P/B||1.7||--|
|Price ($) if stock trades at 1.7x BV w/ 7.5% annual growth in BV||$191.43||$117.75|
|Return (%) w/ 7.5% annual growth in BV||62.63%||168.84%|
Price ($) if stock trades at 1.7x BV w/ 10% annual growth in BV
|Return (%) w/ 10% annual growth in BV||84.30%||227.05%|
These returns look extremely attractive, especially when you consider that they may be conservative estimates as the economy continues to recover and strengthen. If you need proof, just look to the company's second quarter earnings, which are up nearly 50% from last year. Also, look to M&T's upcoming Hudson City Bancorp (HCBK) deal to significantly grow the banks footprint in New Jersey, where $25 billion in deposits, $28 billion in loans, and 135 branches are waiting.
M&T Bank is one of the few banks that sticks to what it knows, and that conservatism surely paid off during the Great Recession and will continue to pay off in the future. Oh, did I forget to mention? M&T not only remained profitable in 2008 and 2009, but also maintained its dividend throughout the recession, a testament to the strong fundamentals that the company employs. So if you are a patient investor looking to gain a leveraged position on a fundamentally sound bank, you needn't look any further than good old M&T Bank warrants.