A Steal of a Deal
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When I read that M&T Bank (NYSE: MTB) was acquiring Hudson City Bancorp (NASDAQ: HCBK), I wasn't surprised until I read about the cost of the deal. In my opinion, to say that M&T got an unbelievable deal would be a massive understatement. If you're an M&T investor, you should be very pleased with your banks decision. However, investors in Hudson City Bancorp are seemingly selling their company for a pittance. Let me walk you through the deal and how I see the numbers playing out.
A recent article by CNBC lays out the basic details. M&T will acquire Hudson City in a cash and stock deal worth about $3.7 billion. For each share of Hudson City they will receive 0.08403 shares of M&T in either stock or cash. Hudson City has about 135 branches in New York, New Jersey, and Connecticut. With very little overlap between the 2 companies, the deal is expected to add to earnings per share and expand M&T's presence. To say that this deal should add to earnings is somewhat of a no-brainer when you look at the assets the company is purchasing versus the cost that M&T is paying.
The main reason this appears to be such an attractive deal for M&T, is the amount of deposit and loan balances the bank is acquiring for this $3.7 billion cost. The company said it expects after adjustments to add about $25 billion in deposits and roughly $28 billion in loans from the buyout. Looking at Hudson City's most recent earnings report, we get a sense of the value of these assets. The bank's average return on their loans is about 4.09%. This means just from the $28 billion in acquired loans, M&T should add about $1.14 billion in interest income on an annualized basis. Where the acquired deposits are concerned, one knock on Hudson City has been the company's reliance on interest-bearing accounts.
As a standalone bank, too many interest bearing accounts can be an issue as it increases the bank's funding costs. As an acquisition however, M&T has the opportunity to manage which accounts it wants to keep, versus which ones it should allow to run off. Roughly 84% of Hudson City's deposit balances are placed in money markets and CDs. Checking accounts are the cheapest funding source for any bank. For this reason, investors should expect that M&T will aggressively attempt to keep the roughly $3 billion in interest and non-interest-bearing checking accounts being acquired. However, what is ironic is the average interest rate on Hudson City's interest checking accounts is 0.62%, versus an average rate of 0.47% in the acquired money market accounts. This means that over time M&T will need to somehow adjust downward the average interest rate on these checking accounts to a more reasonable level. Overall, the acquired deposit accounts carry an average interest rate of roughly 1%. With the expectation of keeping about $25 billion in deposits, a 1% annualized cost works out to about $250 million in additional interest expense. If you look at the comparison between the loans acquired and the deposits acquired you can see a definite positive impact on M&T.
Just using the above assumptions M&T should earn an additional $890 million from the difference between the additional interest income and additional interest expense. In addition, $28 billion in additional loans will increase M&T's total loan portfolio by about 44%. The acquired $25 billion in deposits will increase the banks total deposits by about 40%. One of the best parts of this acquisition is, M&T should be able to pay off Hudson City's long-term borrowings by liquidating the company's investment portfolio. This means in short, a $3.7 billion expense will not only significantly increase M&T's deposit and loan portfolio, but will also add to the company's earnings and expand their presence. This expanded presence and improved financials should help the bank compete more effectively with already larger competitors.
Even with this seemingly cheap acquisition, M&T still lags in size compared to multiple banks the company competes against. Just as an example, after this acquisition M&T will carry about $108 billion in total assets. By comparison, competitors BB&T (NYSE: BBT) and PNC Bank (NYSE: PNC) have $174 billion and $271 billion in total assets respectively. In addition, these two competitors will still maintain far more branch locations, with BB&T operating roughly 1,800, and PNC running over 2,500 branches. As you can see, while this acquisition looks to be a huge positive for M&T, it's going to take multiple other acquisitions for the bank to compete with its larger peers. With increased regulations, bigger banks can operate more efficiently than smaller banks. M&T is still relatively smaller, but this acquisition of Hudson City looks like a steal of a deal.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of PNC Financial Services. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.