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Moody's Harshes M&T's Deal Mellow: Street Whispers

Corrected to show that while M&T's common shareholders need to approve the amendment to the former TARP preferred shares, the U.S. Treasury approved the amendment before the public offering, so the new preferred shareholders will not be voting on the preferred dividend rate of 6.375%, effective on November 15, 2013.

NEW YORK ( TheStreet) -- Moody's is trying to crash a bank merger party.

Following a very positive equity market reaction to a merger deal between M&T Bank Corp. (BBT) of Buffalo, N.Y., and Hudson City Bancorp of Paramus, N.J., Moody's Investor Service late on Monday placed M&T and its subsidiaries on review for a possible credit rating downgrade.

Moody's said its review would "primarily focus on the credit profile of Hudson City, an unrated thrift holding company, and the integration challenges that it presents," as "the acquisition of Hudson City will substantially heighten M&T's exposure to residential mortgages through the addition of its $28 billion portfolio." The ratings agency said it "will analyze the acquired residential mortgage portfolio for potential losses versus M&T's estimated credit mark of 1.5% and its overall capital position."

Moody's currently has a senior debt rating of A3 for M&T, while main subsidiary Manufacturers & Traders Trust Co. has a bank financial strength rating of C+ and a baseline credit assessment of a2.

M&T early on Monday announced that it would acquire Hudson City for $3.7 billion in cash or stock, or $7.22 a share. This represented a 12% premium from Friday's closing price of $6.44, and Hudson City's shares rose 16% on Monday, to close at $7.45. M&T was up 5%, closing at $89.82.

Despite Moody's concern about Hudson City's credit quality, the thrift's big problem -- which eventually led to the sale -- has been a narrowing net interest margin, as the company struggled to disengage from its long-term leverage strategy of investing wholesale borrowings into mortgage-backed securities. 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.

Hudson City remained profitable on a core basis, with second-quarter earnings of $72.3 million, or 15 cents a share, for a mediocre return on average assets of 0.66% and a return on average equity of 6.19%. With mortgage loan rates continuing to decline, the second-quarter net interest margin was a low 2.12%, declining from 2.15% in the first quarter, and 2.14% in the second quarter of 2011.
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