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Hudson City Bancorp: Takeout Winner (Update 1)

Updated with regulatory news, market close information and comment from Deutsche Bank analyst Matt O'Connor.

NEW YORK (TheStreet) -- Hudson City Bancorp (HCBK) was the big afternoon winner among large financial services companies on Monday, with shares rising 16% to close at $7.45.

Hudson City's shares popped after the troubled Paramus, N.J., lender agreed to be acquired by M&T Bank (MTB) for $3.7 billion in cash and stock, or $7.22 a share.

The deal price represents a 12% premium over Hudson City's Friday closing price of $6.44, offering shareholder a way forward, after Hudson City's long-term leverage strategy of increasing wholesale borrowings and investing in mortgage-backed securities backfired.

Hudson City has undergone two recent and painful balance sheet restructurings, the first of which was forced by the Office of Thrift Supervision.

Following a first-quarter 2011 restructuring that included a charge of $649.3 million to prepay $12.5 billion in higher-cost borrowing, the company prepaid another $4.3 billion in borrowings during the fourth quarter of last year, resulting in $440.7 million in charges.

Despite the balance sheet overhaul, Hudson City's second-quarter net interest margin -- the difference between a bank's average yield on loans and investments and its average cost for deposits and wholesale borrowings -- was a stubbornly low 2.12%, declining from 2.15% in the first quarter, and 2.14% in the second quarter of 2011. With long-term rates continuing to see downward pressure, especially for Hudson City's bread-and-butter mortgage lending business, the margin pressure was bound to continue.

Hudson City Bancorp reported second-quarter earnings of $72.3 million, or 15 cents a share, for mediocre return on average assets of 0.66% and a return on average equity of 6.19%.

Hudson City CEO Ronald Hermance said that "Hudson City recently embarked on a diversification of our product lines and our balance sheet," and that "as we combine Hudson City's attractive retail network with M&T's full service commercial banking suite, our stakeholders will participate in the growth of one of the nation's strongest and most successful banking franchises." After the merger is completed, Hermance will remain as a board member for the combined holding company and its main banking subsidiary.

Hudson City has $43.6 billion in assets, with 135 branches, with 97 branches in New Jersey, 29 in New York, and nine in Fairfield County, Conn. M&T has $80.8 billion in total assets, and plans to "repay approximately $13 billion of Hudson City's long-term borrowings by liquidating its comparably sized investment portfolio," after the merger is completed. M&T -- headquartered in Buffalo, N.Y. -- will add $25 billion in deposits and $28 billion in loans, from the acquisition.

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