This week, we learned Hudson City Bancorp (NASDAQ:HCBK) was acquired by M&T Bank (NYSE:MTB) for $3.7 billion. But what investors might not know is that the motivation of this deal isn’t as simple as growing operations just for growth’s sake.
Yes, profits and revenue are a motivator for M&T. But so are looming regulatory safeguards that require a higher level of capital.
This from Peter Eavis at Dealbook:
“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. Its 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 said the deal could add 0.3 to 0.4 of a percentage point to its Tier 1 common ratio.”
In short, this wedding was in part due to the dowry Hudson would bring to the table. That cash will pad M&T’s Tier 1 capital.
For starters, what is Tier 1 common capital? It’s basically a measurement of how much real money is lying around when you back out risk-weighted assets and money that is expected from loans but not actually in the bank vault. It also excludes any preferred shares, making this the most stringent standard for capital reserves.
Recent regulatory accords place much higher burdens on Tier 1 common capital. Specifically, the Basel III standards pushed around the globe make a 6% Tier 1 common ratio the standard — with a mandate of zero risk to that cash from dividends — as the standard.
Obviously, M&T was above this threshold, according to the Dealbook analysis. But one bad year could upend that, and clearly the bank would be at risk.
Consider that big bank Bank of America (NYSE:BAC) has a Tier 1 common ratio of 11.2% according to June 30 numbers. Wells Fargo (NYSE:WFC) is at 10.1%, according to its recent quarterly report. These banks don’t want that ugly “too big to fail” phrase to crop up again, and have made big moves to go above and beyond safeguards as a way to prove they are solvent — both to investors and regulators.
Among regionals, the number is lower, but M&T still is below its peers. Regions Financial (NYSE:RF), for instance, had a reading of 10% for its Tier 1 common in a July report. Regional banks are not at greater risk than the big financials, per se, but there is a concern that percentage needs to be shored up just to be proactive and avoid negative impacts.
I’m talking negative impacts from regulators as much as another financial crisis.
So all in all, M&T made a shrewd move here to head toward a more conservative business model. Even though it relies heavily on commercial real estate lending and Hudson City might be a bit outside comfort zone, the move is a good one long-term for the bank.
Maybe that’s why M&T is one of Buffett’s Top 10 dividend stocks.
Final note: If you really want to respect M&T’s nod toward regulators, consider that only last week the financial stock managed to pay back the government its bailout money. Such an acquisition couldn’t take place with Uncle Sam as part-owner — so this sequence of events might have been in management’s back pocket for a while.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own any of the stocks named here.