M&T Bank (MTB 1.60%) is an eastern regional bank with over 700 offices in eight states and the District of Columbia. Its second-quarter operating results, which were reported on July 21, fell short of analyst expectations. M&T reported $1.46 billion in total revenue. Although this missed the analyst consensus of $1.49 billion for the second quarter, the revenues reported in Q2 2021 told the story of a 0.8% year-over-year increase compared to the $1.448 billion generated in Q2 2020.
Let's dig deeper into what caused M&T's revenue and earnings misses, the state of its balance sheet, and whether the current valuation is reason for investors to consider buying or staying on the sidelines.
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What caused the miss?
Drilling down further into M&T Bank's top-line miss, the company experienced a 1.6% year-over-year decline in its net interest income from $961 million in Q2 2020 to $946 million in Q2 2021. The company attributed a decline in its net interest margin from 3.13% in the year-ago period to 2.77% in the second quarter to "lower interest rates earned on loans and higher amounts of low-yielding balances as the Federal Reserve Bank of New York." Net interest margin refers to the difference between the interest income that a financial institution earns and the amount of interest paid out to its lenders.
The precipitous drop in M&T Bank's net margin was mostly offset by higher consumer balances due to the second and third stimulus payments that were sent to eligible Americans the past seven months, which helped M&T Bank's average earning assets increase 10.9% year over year from $123.5 billion in Q2 2020 to $137.0 billion in Q2 2021.
The second component of M&T Bank's top line is the company's noninterest income, which advanced 5.5% year over year from $487 million in Q2 2020 to $514 million in Q2 2021. M&T Bank's progress within the noninterest income category was the result of higher service charges on deposit accounts ($78 million in Q2 2020 versus $99 million in Q2 2021) and higher trust income ($152 million in Q2 2020 versus $163 million in Q2 2021).
This is impressive because the contracting net interest margin in the much larger interest income category was entirely offset by gains in the noninterest income category, driving overall revenue slightly higher on a year-over-year basis.
While M&T Bank's noninterest expenses rose 7.2% year over year from $807 million in Q2 2020 to $865 million in Q2 2021 due to higher salaries and employee benefits and outside data processing and software, its diluted EPS shot up 96% from $1.74 in Q2 2020 to $3.41 in Q2 2021, the latter of which missed average analyst forecasts by $0.19.
Even using the arguably more reliable diluted EPS figure of $3.33 for Q1 2021 (due to the recessionary challenges faced in Q2 2020), M&T Bank's sequential diluted EPS growth was a respectable 2.4%.
A beneficiary of the economic recovery with a sturdy balance sheet
As a result of the broader economic recovery over the past several quarters, M&T Bank's allowance for credit losses as a percentage of its loans outstanding continued its encouraging downward trend from 1.68% in Q2 2020 to 1.62% in Q2 2021, which indicates that the bank's asset quality is improving and with that improvement, we can expect greater earnings visibility moving forward.
This argument is reinforced by The Conference Board's respective forecasts of 6.6% and 3.8% real GDP growth for 2021 and 2022, which factors in continued reopening, rising consumer confidence, and the new wave of more than $100 billion in checks that are being sent out to families with children.
Regardless of whether the above economic forecast proves to be correct, M&T Bank's steady balance sheet improvement suggests the company is in a better position now to deal with a potential delta variant-induced recession than in prior quarters.
We will use the Common Equity Tier 1 ratio or CET1 ratio to determine M&T Bank's financial condition. Simply put, the CET1 ratio is a ratio that financial institutions must maintain in order to remain solvent in an economic recession or depression.
Given that America's largest banks fared well in the Federal Reserve's 2021 annual stress test, it should come as little surprise that M&T Bank's balance sheet is in a good position as a large-cap regional bank itself. M&T Bank's CET1 ratio improved from 9.5% in Q2 2020 to 10.7% in Q2 2021, which places the company firmly above the 7% floor total CET1 ratio that the third Basel Accord requires from financial institutions, suggesting that M&T Bank maintains more than enough core capital as a guard against an economic downturn.
The Shiller P/E ratio suggests an undervalued stock
Experienced investors will attest to the need to avoid significantly overpaying for even the highest quality stocks to improve the chances of an investment's success in the long-term, and M&T Bank is no exception to this rule.
Fortunately, M&T Bank seems to be trading at a discount to its estimated fair value based on the metric of its Shiller P/E ratio, which accounts for the cyclical nature of corporate earnings and is often viewed as a more reliable metric than the more basic P/E ratio. The Shiller P/E ratio can provide a more accurate picture of a stock's valuation because it's based on inflation-adjusted earnings from the previous 10 years. This gives a more complete picture of a company's earnings capacity over a full economic cycle.
While M&T Bank's Shiller P/E ratio of 13.5 is about in line with the undervalued bank industry's 13.4 (M&T Bank should arguably be a bit higher than its peers given its overall quality), this is well below its 13-year median Shiller P/E ratio of 17.1.
It can be argued that a 13-year time period is often reliable in establishing what a stock is worth in the long-term, because this is the fair value that has been established by millions of buyers and sellers over that time frame, which includes economic booms, busts, and a pandemic.
Even conservatively assuming a fair value Shiller P/E ratio of 15, M&T Bank's fair value would be $148.50 per share, which is well below the current share price of $134 (as of intraday trading on July 30, 2021).
An appropriate pick for long-term investors
Even though M&T Bank's operating results for Q2 2021 failed to meet analyst forecasts, the company's results still show revenue and earnings that are trending in the right direction.
M&T Bank is primed to continue cashing in on the economic recovery that is in progress. The company is positioned to fare well in the event of another COVID-induced recession, with its CET1 ratio well above the requirement for financial institutions.
M&T Bank also appears to be trading at a double-digit discount to fair value based on my assumptions in using the Shiller P/E ratio as a guide of the stock's fair value, which gives investors a chance to benefit from 11% upside. Investors will be rewarded for their patience with a market-beating 3.4% dividend yield compared to the S&P 500's 1.3%.
