M&T Bancorp A Stable Top-Tier Stock To Buy For Income
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The first big banking deal of 2012 recently occurred, when beleaguered Hudson City Bancorp (NASDAQ: HCBK) agreed to be purchased by M&T Bank (NYSE: MTB) in a deal valued at about $3.7 billion, a 12% premium to Hudson City's closing valuation the day before the merger was announced.
It saddens me how Hudson City has reached this point. Not so many years ago, it was earning over $500 million per year, and as recently as 2010, it reported record earnings of $1.09 per share. It did this by specializing in originating mortgage loans on multi-family dwellings in New York, and keeping its efficiency ratios the lowest of any bank out there. But in this era of ultra-low long-term interest rates, it found it just could not be adequately profitable by that business model. So, with no real end in sight to the Federal Reserve's low interest rate plan, management figured it was time to seek a deal. I cannot really blame management, yet recall when this thrift was trading at some $25 per share a few years ago, and was the largest American bank not to take loans during the TARP bailout program. Now it is a shell of its former self, and the buyout amount comes to a little over $7 per share.
M&T is getting itself a fine franchise of 135 branches, two thirds of which are in New Jersey. The deal will add about $28 billion to M&T's loan portfolio, and $25 billion to its deposit base. New Jersey in particular, the nation's number three state in per capita income, holds great promise. And the deal dovetails nicely into M&T's existing footprint, giving it a more or less uninterrupted chain of retail branches from Western New York, to the New York City area, down the Atlantic Seaboard to Virginia.
The deal will also vault M&T a few notches in the list of the nation's largest banks. At the time of the deal, Hudson City has about $44 billion in assets, which after planned asset sales from Hudson City's portfolio will increase the size of M&T's balance sheet to about $110 billion in assets. M&T management has plenty of experience acquiring banks as it spent over $350 million purchasing Wilmington Trust in 2011, and another $400 million buying Provident Bank in 2009.
M&T's first order of business in the Hudson City purchase is cleaning up its $13 billion in long-term debt by liquidating its similarly sized investment portfolio. The deal is to be financed 60% in stock, and 40% in cash. This will cause a $2.2 billion dilution of M&T shares. The good news, for M&T at least, is that the purchase price is less than 80% of Hudson City's tangible book value. And regardless whether Hudson City was experiencing profitability problems, no one ever questioned its capitalization. At the end of the second quarter, its total risk based capital was nearly 21% of assets. That rich capitalization will inure to M&T's benefit.
I have liked M&T for a long time, as it was one of the banks least impacted by the recent recession, and never even came close to losing money in any year in the last fifteen. Hudson City was on pace to earn about $280 million in profits this year, and therefore, even with the $2.2 billion dilution, the deal should be immediately accretive to M&T. M&T stock jumped about 7%, or 4 points, the day the deal was announced. I am looking for earnings for this year to advance only about five percent from 2011, but aided by the Hudson City deal, to advance much more sharply in 2013. I do not believe analysts have valued future earnings of M&T favorably, and I look for earnings of over $8 per diluted share next year. Combined with its dividend yield of over 3% and I believe M&T is a top tier selection among bank investors seeking stability and income.
Cleveland based KeyCorp (NYSE: KEY) competes across much of M&T's geographical footprint. It is struggling in 2012, largely because it enjoyed a $60 million reserve reversal in 2011. Even though reserve provisions are at modest levels so far this year, there will be no more reversals. Through the first six months of 2012, Key's earnings were $0.44 per share, versus $0.47 in the first half of last year. And there has been no meaningful revenue growth this year either in interest or non interest categories.
Key will be able to expand its profitability going forward even if it does not grow its loan portfolio as it has about $7 billion in high cost CD's expiring between now and the end of 2013. It also redeemed $707 million in trust securities in July. Between those interest savings, and management's desire to wring another $150 million to $200 million of non-interest expenses out of the system to drive its efficiency rate down from 69% closer to 60%.
Key's earnings per share are still well below half of what they were before the recession, and its stock price has languished consistent with those depressed earnings. In the absence of a commitment to grow the loan portfolio, I see little hope for meaningful revenue improvement at Key, and for that reason, see this as an unenthusiastic proposition. I wish the bank well, but it bores me with its average dividend yield and unexciting growth prospects. You can do better.
The 800 pound gorilla of Great Lakes area banking is U.S. Bancorp (NYSE: USB). In its second quarter, it grew revenues by 8% from the year earlier, reduced non-interest expenses, maintained excellent capital ratios, and grew its earnings by 17.6%. U.S. Bank is without peer as an efficient and well run bank and merits a higher price to earnings ratio than its current 12. For those seeking safety and decent income in a banking issue, there is no better choice than U.S. Bancorp.
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