Analysts are Underestimating This Bank

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In the banking industry, there are several banks that have so many divisions and different units that reading their earnings reports alone is a tedious exercise. This is one reason I was positively surprised looking through M&T Bank's (NYSE: MTB) recent quarterly report. The company essentially reports the numbers that investors need without splitting the information into a thousand divisions. After all, in the banking industry it really comes down to deposits and loans, as well as credit quality. M&T also benefits from significant fee income, which helps diversify the bank's income stream. Looking at the company's recent results, it's clear that M&T has emerged as one of the better banks in the country.

M&T showed solid results across the board in the current quarter. Probably the most impressive number was the company's diluted earnings-per-share,  increasing 46% year-over-year. Other banks have seen a jump in EPS due to mortgage originations. However, even excluding mortgage, the company still would've earned 33% more than the prior year. The bank's income is derived 60% from interest income and 40% from fee income. This is a huge positive, as the bank doesn't rely as much on the direction of interest rates to make money. With net interest income up 7% and fee income up 21%, you can see M&T is gaining business in loans, deposits, and fee based revenue.

When it comes to lending, M&T showed one of the strongest loan growth performances among its peer banks. The bank increased total loans 10% on a year-over-year basis, and its only competitor to report better results was PNC Financial (NYSE: PNC) with an 18% increase. While both PNC and M&T had acquisitions over the last year that contributed to loan growth, in this economy double-digit increases are hard to come by. Other competitors, such as BB&T (NYSE: BBT) and U.S. Bancorp (NYSE: USB), showed good loan growth of their own. BB&T posted loan growth of roughly 10%, and U.S. Bancorp reported average loans up 7.3%.

The biggest difference between BB&T and U.S. Bancorp is that these two companies generated this loan growth without a major acquisition. It will probably be a year or so before we know if PNC's and M&T's acquisitions will continue to drive stronger growth, but for now let's give M&T the benefit of the doubt. The bank's lending increased significantly in commercial loans and consumer real estate loans in particular. In fact, general commercial loans were up 10%, and consumer real estate loans increased 53%. Mortgage banking revenue also increased 180% on a year-over-year basis. In order for M&T to continue growing its loans effectively, the company will need to attract more deposits. Through organic growth and from an upcoming acquisition, the bank's management has a plan to make this happen.

There are two different ways that a bank can grow its deposit base. First, the bank can attract more deposits in its existing market area. Second, the company can choose to acquire another institution. M&T is expanding both ways by growing its organic deposits and through the planned acquisition of Hudson City Bancorp. On an organic basis, total deposits were up 8%, and the biggest jump was in non-interest bearing deposits, which grew 17%. Interest-bearing deposits, on the other hand, increased just 1%. In addition, M&T is expecting to add about $25 billion in additional deposits through its Hudson City acquisition. However, roughly 84% of these funds are in money markets and CDs. Since these type of accounts represent the most costly source of funds, M&T will have to walk a fine line to allow run off and maintain balances.

This acquisition will also heavily weight the bank towards interest-bearing deposits and could harm the company's net interest margin. On a positive note, the bank has been steadily retiring its long-term borrowings. Since the company's long-term debt carries a cost of about 4.3%, if the bank continues to pay this down, net interest margin should improve. M&T will need to be very careful how it manages this acquisition, as its net interest margin is just below two of its three peer banks. In the current quarter, M&T's net interest margin was 3.77%.

By comparison, only U.S. Bancorp showed a lower net interest margin at 3.59%. BB&T and PNC reported margins of over 3.9% and 3.8% respectively. If M&T manages the Hudson City acquisition appropriately and maintains its net interest margin, this will be a huge win for shareholders. However, there is risk as well, because many of these interest sensitive customers may leave for competitors if they don't like the rates being offered. This is something for investors to keep their eye on over the next several quarters.

Long story short, M&T has an opportunity coming up to improve results for shareholders beyond what analysts may expect. With the addition of roughly $28 billion in loans, and $25 billion in deposits from Hudson City, the bank can tremendously improve its net interest income. Since the stock already pays a yield that exceeds its competition, the only question is whether the bank can exceed earnings expectations as well. Analysts generally expect roughly 9% growth from M&T in the next few years. This is very close to what analysts are calling for at both BB&T and U.S. Bancorp.

PNC is the clear laggard of the group with expectations of just 4% earnings growth. While M&T is slightly more expensive on a forward P/E ratio basis than its peers, the Hudson City acquisition has the potential to ramp up the bank's growth rate. Analysts don't seem to be giving the bank enough credit for this relatively cheap acquisition. Don't let analysts' potential mistakes become your mistake too. Use this information as a starting point for your own research, and check into this seemingly undervalued opportunity in the banking sector.


MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of PNC Financial Services. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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