Deal Helps a Bank Catch Up in Capital

One of the nation's bigger regional banks, M&T Bank, has had a hectic few days of deal-making.

Last week, the Buffalo-based M&T Bank paid back the government its bailout money, and on Monday, it announced the acquisition of Hudson City Bancorp, a struggling mortgage lender.

The transactions appear to affirm M&T Bank's reputation as a hardy institution that has sought since the financial crisis to avoid hurting the interests of its shareholders.

But the deals also show M&T Bank as a lender in need of more capital.

M&T Bank is paying roughly $3.7 billion for Paramus, N.J.-based Hudson City, which was held up as paragon of sound residential mortgage lending in the midst of the financial crisis. In the last two years, however, Hudson City's earnings have suffered as interest rates have fallen and demand for its mortgages has diminished.

On a conference call on Monday, analysts asked M&T Bank executives how the bank's business, which focuses heavil y on commercial real estate and lending to companies, fits with Hudson City's, which is dominated by residential mortgages.

M&T Bank executives said the Hudson City branches will help M&T attract business borrowers in new areas. They also said M&T can sell wealth management products to Hudson City customers.

Analysts say M&T Bank has managed to successfully integrate recent big acquisitions.

“This acquisition is pretty consistent with M&T's strategy of buying troubled institutions and turning them round,” said Todd Hagerman, an analyst with Sterne Agee.

But another key to understanding the acquisition may lie in M&T Bank's capital.

Since the crisis, regulators have cared most about Tier 1 common equity because it focuses on a high-quality measure of capital. On that measure, M&T Bank scores well below regional peers. M&T Bank's Tier 1 common equity capital was 7.15 percent of its assets in the second quarter. Regional banks of a similar size are typically well above 9 percent.

Investors so far have not worried too much about M&T's lower ratio because of the bank's relatively low losses after the financial crisis.

Bank regulators, however, may be harder to win over. To do well in annual Federal Reserve stress tests, M&T Bank may want to increase its Tier 1 common ratio substantially.

The Hudson City deal helps on that score. On Monday, M&T Bank said the deal could add 0.3 to 0.4 of a percentage point to its Tier 1 common ratio.

There is another capital ratio that M&T Bank may lag on. It is the so-called Basel III common ratio, which comes from the international banking standards that United States banks must start complying with at the start of next year. Deutsche Bank analysts estimate that M&T Bank's Basel III ratio is 5.4 percent. That is well below the 7.9 percent that U.S. Bancorp gives as its estimated Basel III ratio.

M&T Bank has not given out its own estimate of Basel III c apital. M&T Bank's chief financial officer, Rene F. Jones, said on Monday that it was still trying to calculate the ratio, saying the bank had “lots of M.B.A.'s trying to figure out how the rule works.”

But Mr. Hagerman, the analyst, said, “It's frustrating; I am assuming they know what the number is, and it's like M&T to provide limited information and limited transparency.”

M&T Bank executives on Monday stressed the strategic importance of the Hudson City acquisition. The deal will allow M&T Bank to bolster its presence in important markets, particularly New Jersey. In all, M&T will add 135 branches and $25 billion in deposits. Based on the terms of the deal, M&T Bank is paying a roughly 17 percent premium on Hudson City's closing share price on Friday.

“It's a very strategic deal,” said Michael P. Pinto, M&T Bank's vice chairman. “You couldn't draw the map any prettier.”

The deal follows M&T Bank's exit last week from the Troubled A sset Relief Program. Large regional banks that were not crippled by the financial crisis chose to pay off all their TARP investments as soon as they could, often issuing large amounts of common shares to do so. M&T Bank, however, held off on repaying all its TARP investment. It said it wanted to avoid issuing common equity because that can hurt the value of shares held by existing shareholders.

M&T Bank's repayment of $382 million to the Treasury Department had a twist. M&T Bank first negotiated a change in the terms of preferred shares with the Treasury Department, which then sold the modified shares in the market to recoup its initial investment. The preferred shares originally had a provision whereby the dividend would rise to a 9 percent return after November 2013 from 5 percent. M&T Bank was also able to buy back the original preferred shares at will.

The new preferred shares will pay out 6.375 percent after November 2013, and M&T Bank cannot choose to pay t hem off until November 2018. Without the changes, the Treasury might have had to sell the preferred shares at a slight loss, preventing it from recovering all its investment in M&T Bank. As it is, M&T Bank paid the expenses of the preferred sale, ensuring the Treasury recouped 100 percent of its money.

But the TARP deal may not assuage concerns about capital. M&T Bank keeps the new preferred shares on its balance sheet as capital, but they do not count toward the ratios that investors and regulators care most about.

“Their common equity remains below peer averages,” Mr. Hagerman, the analyst, said.