3 Bank Stocks You Don't Have to Babysit

Markets Motley Fool

Bank stocks are notoriously fickle, driven by the performance of the economy and ever-changing interest rates. But some banks require less babysitting than others. Here's why U.S. Bancorp (NYSE: USB), Bank of New York Mellon (NYSE: BK), and M&T Bank (NYSE: MTB) are excellent picks for buy-and-forget bank investors.

Continue Reading Below

The fee-based banker

U.S. Bancorp is one of the nation's most stable banks because only half of its earnings come from traditional lending. It generates roughly half of its revenue from non-interest sources, with business lines that include wealth management and payment processing. (It owns one of the largest merchant acquirers in the United States.)

U.S. Bancorp is also a lean operator, with an efficiency ratio of about 55%, putting it among the most efficient banks in the country. Its fee-based business lines play a part in efficiency, but its scale helps, too. The bank has about $150 million in assets per branch, giving it a major advantage on banks that aren't able to scale their expenses across a larger pool of assets.

But the biggest advantage that U.S. Bancorp has it that it simply doesn't write many bad loans. Historical loan losses have been a fraction of its peers, even during the 2008 Financial Crisis, when it had roughly one-third of its loan book in home equity and credit card loans that sent its rivals to the brink of insolvency. Net charge-offs peaked at just 2.2% of loans during the financial crisis, which says a lot about its underwriting capabilities, given so much of its loan book was invested in higher-risk loans that decimated many of its peers.

U.S. Bancorp rarely sells at an obviously attractive price. Shares trade at about three times tangible book value, and given its size, earnings are unlikely to grow at their historical average. But as far as bank stocks go, U.S. Bancorp is perhaps one of the most solid banking institutions in the United States due to its expense management practices and impressive underwriting record.

Continue Reading Below

The service company masquerading as a bank

Bank of New York Mellon is a bank in name only. It holds tiny amounts of capital, makes very few loans, and doesn't have retail branches. Instead, Bank of New York Mellon is a custody bank that earns the bulk of its earnings by providing basic custody and asset management services to some of the world's largest institutional investors. As a result, fees make up about 80% of its total revenue, making it an outlier in the banking industry.

Institutional investors rely on Bank of New York Mellon to handle all the less attractive functions of asset management. A fund company might hire the bank to keep its stock assets safe, manage the accounting for its funds, and provide other simple services that are best outsourced than kept in house. But it's not just small firms that make up its customer base. Even massive asset managers like T. Rowe Price, which has more than $700 billion of assets under management, find it preferable to let Bank of New York Mellon handle the back-end administrative and accounting functions than to try to replicate the operations in its own offices.

Scale is the name of the game. With more than $30 trillion of assets under custody, Bank of New York Mellon has the scale to provide support to asset managers at a lower price than it could be done internally. It's also something of a specialist. By performing the same services day in and day out, it has a better institutional understanding of how to comply with a changing regulatory environment than perhaps any other financial company in existence today. That kind of experience has tremendous value for the company, and its customers.

Of course, Bank of New York Mellon's status as a bank you don't have to babysit comes at a price. It rarely trades cheap, especially on traditional banking valuation metrics. Shares currently trade at about 3 times tangible book value, and 15 times earnings. That's expensive for a bank, but if you appropriately look at it as a services company, rather than a financial institution, a 15 times multiple for a company that could reliably grow earnings at a single-digit rate for a long time to come is more than reasonable.

One of the best-performing stocks ever

M&T Bank is one of the best at basic banking -- taking deposits and making profitable loans. The company primarily operates as a commercial lender, with the majority of its loan book invested in commercial and industrial and commercial real estate loans, which make up roughly half of its earning assets.

Like U.S. Bancorp, M&T has a diversified mix of interest and non-interest revenue, which gives it a stable source of income during periods of weak loan performance. The company generates about one-third of its net revenue from fee-driven businesses including wealth management, mortgage banking, and simple service charges on its depositors' accounts. These diversified sources of revenue help it maintain its advantage in cost efficiency, as its efficiency ratio recently stood at just 57%, despite an increase in expenses due to a recent acquisition.

What makes M&T stand out from the rest of the banking industry is its extraordinary underwriting record. Net charge-offs peaked at just 1.01% of average loans during the financial crisis. The bank's net charge-off ratio recently stood at just 0.20%, and has been below 0.50% in every year since 2011, which reflects its conservative underwriting culture.

At 2.4 times tangible book value, M&T Bank is the least expensive banks on this list, which reflects the fact it generates a substantially larger share of its earnings from cyclical activities like lending. That said, its smaller balance sheet enables it to be nimble. Upside will likely come in the form of acquisitions. Despite its tussles with regulators during its most recent acquisition of Hudson City Bancorp, it retains its status as a preferred acquirer for smaller banks when the credit cycle eventually turns.

10 stocks we like better than M & T Bank
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and M & T Bank wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of June 5, 2017

Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.