On Monday, August 27th, Buffalo, NY-based M&T Bank Corporation (MTB) announced its acquisition of Paramus, NJ-based thrift Hudson City Bancorp (HCBK). The reported deal value was $3.8 billion, making it by far the largest banking acquisition announced in over a year.
MTB is paying 0.85x tangible book value per share ("TBV-PS") for HCBK. A recent article in SNL Financial suggested that the low price might attract competing bids, perhaps from Toronto-Dominion Bank (TD) or New York Community Bancorp (NYB). On a conference call for the deal, HCBK CEO Ronald Hermance, Jr. told analysts that "it wasn't a competitive sales process". My understanding is that MTB tries to avoid auctions, because of where deal pricing can end up in an auction.
Some bank stock investors (and even some bank CEOs) believe that no banking institution is ever worth less than TBV-PS. Did MTB "steal" HCBK?
I don't think so. I think MTB paid a fair price, for several reasons. First, HCBK's asset base has shrunk, from a peak of $61 billion in Q1 2010 to $44 billion in Q2 2012. Many banks have experienced low or zero asset growth in recent quarters; few banks have experienced 29% asset shrinkage in the last two years.
HCBK's second-stage conversion from a mutual holding company structure was completed in June 2005. The conversion increased equity by more than $4.0 billion, from $1.4 billion to $5.5 billion, causing HCBK's tangible common equity/tangible assets ("TCE/TA") ratio to balloon from 6.81% to 21.05%. HCBK has worked to deploy this excess capital, by growing assets, by spending $1.3 billion on share buybacks from 2005 to 2007 at an average buyback price of about $13 per share (HCBK closed at $6.44 on the day prior to the deal announcement), and by acquiring Sound Federal Bancorp in 2006 for $265 million in cash, paying 2.23x TBVPS and 49x estimated earnings. With a TCE/TA ratio in Q2 2012 of 10.38%, HCBK is still overcapitalized, but its Q2 2012 TBV-PS of $9.08 is below the $9.53 of TBV-PS immediately after the June 2005 second-stage conversion.
As a thrift, about 99% of HCBK's loans are 1-4 family senior mortgage loans. Only 67% of HCBK's interest-earning assets are loans. And only 65% of its interest-bearing liabilities are deposits. Both figures are low relative to peer medians, and that negatively impacts HCBK's net interest margin ("NIM"), return on average assets ("RoAA") and return on average tangible common equity ("RoATCE"). HCBK's Q2 2012 NIM was an extremely low 2.12%; it hadn't been above 3% since Q4 2002, when it was 3.02%. And excess equity capital helps NIM. I estimate that HCBK's Q2 2012 "normalized" RoAA (adjusted to reflect the lower level of loan loss provisions that would apply in better economic times) is 0.75%. At HCBK's current TCE/TA, this would translate into an RoATCE of about 7%. If we remove excess equity capital (let's assume anything over an 8% TCE/TA is excess) and recompute RoATCE using the same RoAA (which is generous), we get RoATCE of about 9%. Is a 9% RoATCE bank worth more than 1.0x TBV-PS? Only if you believe the appropriate discount rate is below 9%. Hence this deal's pricing at a discount to HCBK's TBV-PS.
I should at least briefly mention asset quality. HCBK's NPAs/assets have been steadily increasing in recent quarters, to 2.50% in Q2 2012. For many banks, MTB included, loan quality seems to have taken a turn for the better.
Given all this, I believe MTB priced the HCBK deal rationally. MTB has a history of paying sensible prices for acquisitions and integrating them competently. Each takes discipline, and failure on either front can end up costing the acquirer's shareholders dearly. And rather than hold out for a crazy price that might never materialize, HCBK struck a deal that should generate meaningful benefits for its shareholders. HCBK shareholders should be relieved.
The big question now is whether some other acquirer will try to "steal" HCBK at a materially higher price. Some full prices have been paid for some very weak banking franchises recently, so it wouldn't surprise me if it happened. I wouldn't want be long their shares.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.