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In a recent column about M&T Bank's (NYSE: MTB ) acquisition of Hudson City Bancshares (Nasdaq: HCBK ) , my friend and colleague John Grgurich noted that investors in the latter "have found themselves in the unusual position of being able to sit back, count their significant winnings, and stop beating themselves up over why they ever thought financial stocks were a good idea in the first place."
While I agree with John's sentiment and his rationale, as M&T paid a double-digit premium for Hudson City's pre-announcement stock price, this deal stands only to reaffirm any doubt that shareholders had about the financial industry.
Make no mistake about it, this was not a harmonious combination of equals. As I discussed previously, if you examine the data and read between the lines of Hudson City's last few quarterly financial filings, it seems probable that the bank was on the verge of receivership. Its balance sheet was imploding and the quality of its loan book was deteriorating at an alarming clip.
As a result, the question isn't why Hudson City would agree to such a deal, but rather, why would M&T?
A lesson in corporate biology
The inclination to expand and grow is one of the most immutable characteristics of the modern corporation. Andrew Carnegie put it best: "To put off expanding would mean retrogression."
In some instances this unerring pull is tied to ego, as it appears to have been the case in Ken Lewis' expansion of Bank of America (NYSE: BAC ) . In others it's prompted by the more defensible purposes of scale and production efficiency, as it arguably was in Carnegie's time.
In M&T's case, it was likely a combination of these two factors plus one that dominated them all: Hudson City was cheap. Very cheap.
A nice adage in the banking industry is to "buy at half and sell at two," meaning to buy a bank at half of its book value and sell it at two times the same. While M&T didn't buy Hudson City "at half," it got about as close as one could expect, acquiring the troubled lender for a mere 77% of book value.
It's for this reason that I previously termed the deal an "unfortunate bookend" from the latter's perspective, as selling out at such a discount is a startling and disgraceful conclusion to its more than 150 years of proud and independent operation.
A lesson in corporate necessity
A second key to understanding the acquisition lies in M&T's need for capital.
One of the principal regulatory obligations of a bank is to maintain adequate levels of capital, and particularly what's known as tier 1 capital. Yet despite M&T's numerous relative strengths, this is one area in which it fell short, recording a 9.32% tier 1 capital ratio relative to the industry average of 13.21%. On the other side of the table, meanwhile, Hudson City sported a hefty 19% ratio. Once these are combined, in turn, it's believed that the latter will add a much needed 0.3 to 0.4 percentage points to M&T's figure.
Although investors haven't been concerned about M&T's capital ratio, as evidenced by its own stock's premium to book value, regulators are no longer similarly assuaged. In the first case, both the Federal Reserve and the Office of the Comptroller of the Currency are requiring that banks prove they can maintain healthy capital levels even when the markets are under extreme duress.
And in the second case, the baseline capital requirements themselves are becoming more stringent. Under the new standards set to take effect over the next few years known as Basel III, it's estimated that M&T's pre-acquisition regulatory capital level falls to only 5.4%. This compares extremely unfavorably to competitors such as US Bancorp (NYSE: USB ) , which estimates its own Basel III ratio at 7.9%.
Foolish bottom line
Regardless of the factors that motivated M&T's decision to buy Hudson City, the fact remains that many of the latter's shareholders will likely feel cheated by the deal. Thus, the reason I agree with John's sentiment, though not his characterization, is this -- For all the Hudson City shareholders who are disappointed, take it from somebody who owned stock in a bank that went to zero: It's better to get 77% of book value than none at all.
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