Shares in both M&T Bank (NYSE: MTB) and Hudson City Bancorp (Nasdaq: HCBK) -- the latter a favorite among dividend investors -- were up considerably today after the banks announced that Hudson City will merge into a subsidiary of M&T. In a deal valued at $3.7 billion, each Hudson City share will receive 0.08403 shares of M&T stock or, at the election of the shareholder, an equivalent amount in cash. While shares in both banks rose on the news, the deal serves as an unfortunate bookend to one of the oldest and largest thrifts in the country.
The demise of Hudson City
Founded in 1856, Paramus, N.J.-based Hudson City grew to include 135 branches and more than $60 billion in assets. It gained notice most recently as one of a handful of midsized banks that turned down funding under the government's Troubled Asset Relief Program. While it was applauded for doing so at the time, it's now clear that decision set the stage for the bank's demise.
At the heart of Hudson City's problems is its deteriorating loan book. In 2009, 2% of its loans were non-performing. By 2010, that number had increased to 2.8%. One year later, the number was 3.5%. And in the most recent quarter it increased again to 3.9%.
This is particularly notable because it goes against the wider trend in the industry. Similar institutions, including Huntington Bancshares (Nasdaq: HBAN) and New York Community Bank (NYSE: NYB), have both reversed the deterioration in their loan books. Huntington's went from 5.2% in 2009 down to 1.2% currently, and NYB's descended from 3.5% in 2010 down to 1.9% today.
Source: FDIC.
Hudson City set out two years ago to stymie this decline by transforming both its business model and its balance sheet. It abandoned a singular focus on the residential mortgage loan business, began shedding assets at an aggressive pace, reworked its funding sources, and raised an additional $8.7 billion in capital through the sale of securities. In the past two years alone, its balance sheet has contracted by nearly a third, going from $61 billion in assets at the end of 2010 down to just $44 billion today.
In July of last year, moreover, the bank was obliged to enter into a "memorandum of understanding" with its then-regulator, the Office of Thrift Supervision. This was later replaced by agreements with the Office of the Comptroller of the Currency and the Federal Reserve. As I noted two weeks ago in an article about the threat to Hudson City's now-nonexistent dividend, these agreements "are often the kiss of death for both a bank's dividend and the underlying institution itself."
One bank's sorrow is another bank's joy
On the other side of the deal, the acquisition serves as a transformational coup for M&T Bank. Despite Hudson City's financial woes, it's still one of the largest and best-known residential mortgage providers in the New York City metropolitan area -- not to mention that it's the nation's second-largest thrift by assets, after only New York Community Bank.
M&T's physical footprint and financial might will increase markedly. With Hudson City's branches, the combined network now boasts 870 branches stretching from Connecticut to Virginia. And after all is said and done, M&T expects to gain approximately $25 billion in deposits and $28 billion in loans, giving it the fourth-largest deposit share in New Jersey, after only Bank of America (NYSE: BAC), Wells Fargo, and TD Bank.
Finally, though perhaps most importantly for current M&T shareholders, the deal is being done for a song. At M&T's Friday closing price, the deal values Hudson City at 77% of book value and 85% of tangible book value, well below the 2 times book that healthy banks sell for. As a result, according to the companies' announcement, "[t]he transaction is expected to be immediately accretive to the combined company's capital ratios, capital generation and tangible book value per share, as well as its GAAP and operating earnings per share."
When a dividend seems too good to be true ...
In a recent Wall Street Journal column discussing a particular breed of high-yielding dividend stocks, Jason Zweig started out with the prescient warning: "Investors reaching for yield should always bear in mind the warning label on stepladders: 'DANGER: DO NOT STAND ON TOP STEP." While Hudson City wasn't in Zweig's sights at the time, it nevertheless serves as poignant example of what he called the "most basic laws of financial physics. ... Those who stretch too far for yield will probably topple."
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