This month, we've broken down how M&T Bank (MTB 2.93%) makes its cash and taken a closer look at the company's profitability. Today, we're going to unveil this regional bank's secret sauce.
This is the secret. The mojo. The overriding, long-term, No. 1 reason I think M&T Bank is a buy and hold.
And hold. And hold for even longer.
The secret sauce
Before we unveil exactly what makes M&T so appealing, let's take a second to talk about what's wrong with bank investing, in general.
Source: Company website.
Banks are in the business of selling loans or, put another way, money. Banks sell money. What a fantastic product. And the customers don't even have to pay upfront, except for a small fee. Instead, banks allow customers to pay as they go in the form of accruing interest. For customers, that's a fabulous deal. The demand side of the equation isn't the problem. The problem is supply.
Banks, like the rest of society, aren't immune to baser human flaws, like greed. When times are good, it's just too easy for banks to make loans. Employment is high, businesses are profiting hand over fist, and cash flow moves through the system something like a waterfall.
It's just too hard to maintain credit discipline in these times. So what if a person has a bad credit score if he just got a new job that pays a great salary? Give him the loan! This business has only been operating for a year, but it's growing like a weed and needs this loan to fund that growth? What could go wrong?
I hope that the memories of the financial crisis are still fresh enough for all of us to remember exactly what can go wrong.
The economy cycles into a recession, loans go past due, and then they default. Losses mount. Stock prices plummet. Banks suddenly realize the folly of their ways and promise investors they'll never make the same mistakes. "We'll only make good loans from now on! We promise!" they say. Of course, a few years later the cycle takes place all over again.
A rare breed
There is a rare breed of bank that doesn't subscribe to this cycle of boom and bust. These banks are consistent, and they are rigorous in their risk policies and execution. They avoid risk by running a tight ship, ruthlessly managing expenses and maximizing every dime of revenue.
It's in this rare air that you'll find banks such as Wells Fargo and US Bancorp, two longtime holdings of Warren Buffett.
You'll also find M&T Bank.
To be clear, I'm not saying these banks won't take a hit if the markets hit a wall. All stocks go up and down. But I am saying that when the economy starts throwing punches, these are the banks that can take the punch without getting knocked out. These are stocks that fight back.
History repeats itself
Looking back over history, we can show that the same banks stand out again and again as out-performers in tough times.
First, let's look at the most recent recession in 2008 and 2009.
In the aftermath of the financial crisis, all banks struggled. The point here, of course, is that the best banks suffered less, chief among them M&T, Wells, and US Bancorp.
Now, let's move back in time to the end of the savings and loan crisis and the recession of 1991.
Wells Fargo, US Bancorp, and M&T Bank once again outperform the competition, while Bank of America once again lags. The other banks show mixed results.
Jumping back now to a wider view of the savings and loan crisis, the same pattern emerges.
Again, Wells Fargo and M&T Bank led the industry. They did it in the 1980s. They did it in the 1990s. And they've done it so far in the 21st century.
Foolish takeaway
The most important characteristic of top banks is the ability to manage both the boom and the bust of the economic cycle.
When the credit cycle turns once again in the future, my bet will be on the banks that have proved they have this secret sauce. M&T has proved itself time and again in exactly this way, and that is why I think M&T Bank is a long-term buy.
