Hudson City Bancorp: Counting Chickens And Eggs

Hudson City Bancorp (HCBK) shareholders should be reminded right now of that old saying about 'not counting your chickens before they hatch'. Nearly a year and a half ago, HCBK announced they were being acquired by M&T Bank (MTB). At the time there was a lot of talk about M&T getting a good deal on HCBK since they paid only 0.85X book value for the firm. That was back in August of 2012.

Fast-forward sixteen months and the deal still hasn't closed. Both HCBK and MTB have indicated that they are interested in proceeding with the acquisition, but regulatory scrutiny and concerns over MTB's internal systems have kept the deal from closing. Now, only two weeks ago on December 17, 2013, MTB and HCBK announced that the merger closing date is delay again and that M&T does not expect Fed approval for the deal until the second half of 2014. The deal originally had a termination date of January 1, 2014, but that date has been moved back to December 31, 2014. HCBK shareholders can be forgiven if they are beginning to like a lovelorn teenager who keeps being led on by an unrequited crush (or perhaps kept from their crush by stern father Mr. Bernanke who shows up at the door looking menacing). So far though, shareholders seem to be keeping the faith. Frankly, like that lovelorn teen, maybe it's time they became a bit more skeptical about excuses and promises about next time.

In theory, HCBK shareholders are supposed to receive 0.0843 shares in MTB for every share of their own stock. At that fraction, HCBK shares are theoretically worth around $9.80 based on recent MTB closing prices. Currently HCBK shares trade around $9.43, roughly a 4% discount to the price they would receive if the deal closed tomorrow. Truthfully this is probably too small a discount. At a minimum, HCBK shareholders are likely to have to wait another six months for the deal to close, and it is starting to look possible that they may have to wait forever.

(click to enlarge)

If the deal falls apart, it is very likely that HCBK shares will drop dramatically (Hudson City shares saw a 15% jump when the deal was first announced). In the meantime, both HCBK and MTB have poured tremendous amounts of time and energy into this deal, and as a result, management at both companies has seemed understandably distracted. Unfortunately for shareholders in both companies, this distraction has been quite costly. While MTB and HCBK have largely moved in lockstep over the last year, both firms have significantly underperformed the broader backing sector, perhaps because their operational performance has been lackluster. As the chart below shows, while the financial sector ETF (XLF) rocketed up by 30% last year, both MTB and HCBK saw returns around half that level. Thus, while shareholders in both companies may not have seen any direct cost from the merger delay, both groups have seen a significant opportunity cost compared with other banking investments they might have held. (In the chart below, HCBK is in blue, MTB is in green, and XLF is in orange.)

(click to enlarge)

Hudson City has started to proceed with its alternate plan of action in case the merger does not ultimately close including rolling out various "strategic actions" throughout the course of 2014. That said, it's hard to see how the bank can fully focus on either charting its own path as an independent company, or planning for its integration with M&T given the uncertainty in the situation. Given this level of unavoidable dysfunction, I have no idea why anyone would want to be long HCBK at these levels. Almost any other bank investment has to be better than one where management's head is only half in the game after all.

Frankly, HCBK shareholders are probably in a bit of a lose-lose-lose situation at this point. Assuming the merger were called off, the stock would likely drop dramatically due to merger disappointment, and then it would drop further as shareholders gradually became aware of the competitive challenges and mortgage run-off problem that Hudson City faces. Both of these issues have been under-addressed by the firm over the last year and a half in my view because of the magnitude of sweeping changes that would occur anyway if the merger closes.

If the merger discussions with the Fed continue to drag on, the situation will continue to distract management of both MTB and HCBK leading to continued under-performance both operationally and within the context of the share price. MTB is simply running into the new post-crisis reality for banks that regulators will be all over you any time they have even the slightest concern. This is a sad truth across the entire financial sector for banks, insurance companies, and everyone else, and Dodd-Frank will make the situation worse not better as it is implemented over the course of the next year.

Finally, if Hudson City and M&T eventually manage to struggle through the finish line and complete the merger, shareholders of the new entity may find themselves nostalgic for the good old days. Hudson City shareholders are not likely to love the relatively weak capital reserves of M&T (normalized ratios look low compared with peers under both Basel 1 and Basel 3 regulations at 8.8% and 8.4% respectively by my estimates). M&T shareholders will also discover that Hudson City's loan book is not as attractive as they would like. The HCBK book suffers from a high degree of loan runoffs and weak net interest margin, and as a result, the combined banking entity would have less benefit from increases in short term interest rates than many of its peers. Without HCBK M&T would likely see a 3.8% or 7.5% increase in net interest income as a result of a 100 bps and 200 bps rate increase. With the HCBK merger completed, the rates would only be 2.9% and 5.5% by my estimation. In comparison, ZION would see 8.5% and 18% increases in NII for example.

It didn't have to be this way. The HCBK acquisition started out as a good move at a good price for MTB. Unfortunately a lot can happen in a year and a half, and it seems that shareholders of both companies have dramatically underestimated the regulatory cost and burden associated with getting this merger completed. That full cost is still not known as the press release on December 17th made clear. There is still no guarantee when or if the HCBK/MTB transaction will ever close. Given that, HCBK's minor 4% acquisition price discount looks too low. Shareholders of the firm should be watching their dwindling number of eggs carefully rather than counting chickens.

Source: Hudson City Bancorp: Counting Chickens And Eggs

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

This entry passed through the Full-Text RSS service — if this is your content and you're reading it on someone else's site, please read the FAQ at fivefilters.org/content-only/faq.php#publishers.