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Remember how dicey it was to pick a bank stock in 2009, when the difference between a drowning institution and a cheap one was still anyone’s guess? Conservative investors can be forgiven if they took a pass on the sector.

Today, the banking landscape is a lot more palatable for risk-averse investors. Last week, industry regulators announced that the vast majority of financial institutions had recovered from the credit crisis that threatened to kill them just two years ago. The chances of putting a Washington Mutual in your portfolio have gone way down. The possibility of picking a bank that will book rising profits has gone way up.

The trouble now is finding an undervalued share in the sector. Of the biggest names in banking, YCharts Pro has only JP Morgan Chase (NYSE:JPM) tagged as undervalued. But as we’ve said here before, big banks come with some complicated baggage.

There are some bargains among the very small regional banks, but historically, smaller lending portfolios has meant higher risk.

Buffalo, N.Y.-based M&T Bank Corporation (NYSE:MTB) provides a better comfort level for investors. M&T is a 155-year-old institution with $68 billion in assets, some 700 branches and a market capitalization of about $11 billion, making it one of the 20 largest regional institutions. The bank ranks first in earnings per share for its industry and has reported 30 straight quarters of profits. Warren Buffett has owned its shares for years.

M&T Bank Stock Chart by YCharts

Moreover, YCharts Pro says M&T shares are undervalued. That’s a distinction none of the other $10 billion-plus regional banks has.

One likely contributor to M&T’s lagging share price is the wild ride it got last summer when Spain’s Banco Santander (STD) toyed with the idea of a takeover. The deal is officially off, according to Santander. Unlike other financial institutions recently, M&T has traded below S&P 500 gains since then.

MTB, SPY Chart by YCharts

M&T’s book value makes that sell-off look like an overreaction. Over the past 20 years, bank stocks have traded at about one and a half times their book value. M&T currently trades slightly below that average, and we can see here that it historically trades at a much higher premium.

M&T Bank Stock Chart by YCharts

M&T’s earnings should rise as it integrates recent acquisitions of troubled competitors. M&T bought the failing Provident Bankshares Corp. in Baltimore and its $5.1 billion in deposits in 2009. In August 2010, it announced the acquisition of Delaware-based Wilmington Trust Corp. and its $10.4 billion in assets for roughly half its market value.

M&T has shown a willingness to steadily increase its dividend, and it looks due for a boost.

M&T Bank Stock Chart by YCharts

Growing earnings make it easier for the company to raise its dividend, which currently has a modest 3.1% yield. Lately, the company has been using about 44% of net income to pay dividends. That payout rate was about 65% a year earlier.

M&T Bank Stock Chart by YCharts

The elephant in the room with M&T is a roughly $1 billion bill from TARP, the government’s Troubled Asset Relief Fund. M&T borrowed $600 million in TARP money during the 2008 banking crisis and added to that debt, incidentally, when it took over other institutions.

Repaying TARP funds is a sticky proposition for the banks that hold them. Unless the institution’s capital position is unusually strong, TARP funds have to be replaced with other capital. It’s unclear how much capital M&T would have to raise – and therefore how much shares would be diluted – when that money is paid back.

M&T management has handled questions about TARP by pointing to its very strong capital position and indicating that it will come up with some plan “in the near term” to get rid of the loans. It’s a vague explanation that makes valuing the shares short-term difficult. Shareholders aren’t likely to see much change in the dividend or other direct shareholder enhancements from management until the TARP funds are gone.

Still, with the company’s strong fundamentals and capital, and a share price that’s lagged recent rallies, M&T looks like a good way into a sector that’s expected to show significant gains.

It would have been nice to have bought M&T shares back in 2009, when they were trading at well below half of half their current price. But this should not be the lament of the conservative investor, whose job includes knowing when the water is too dangerous to wade in. Unlike in 2009, M&T now offers investors clear potential for growing value. And a far less risk of drowning.

Disclosure: None

Source: M&T Bank: A Rare Undervalued Bank Stock