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On Friday, Moody's Investors Service, the ratings arm of Moody’s Corp. (MCO - Analyst Report), downgraded its outlook on M&T Bank Corporation (MTB - Analyst Report) to ‘Negative’ from ‘Stable’. The downward revision was propelled by the uncertainty over the closure of the pending acquisition of Hudson City Bancorp, Inc. (HCBK - Analyst Report) by M&T Bank.

However, the firm affirmed the long-term issuer rating of A3 for M&T Bank. Moreover, the bank's standalone bank financial strength rating (BFSR)/baseline credit assessment (BCA) was confirmed at C+/a2 along with the reaffirmation of long and short-term deposit ratings at A2 and Prime-1, respectively.

Rationale Behind Downgrade

The downgrade action by the rating agency follows the delay in the acquisition of Hudson City, announced in Aug 2012 in cash and stock deal worth $3.7 billion – the largest deal that year. The deal has been impeded twice – in April & December 2013.

In Apr 2013, the Federal Reserve detected loopholes in M&T Bank's efforts to fight money laundering and halted the acquisition. The U.S. regulatory body had pointed out several discrepancies in M&T Bank’s risk-management agenda that were a violation of federal anti-money-laundering regulations. The Fed also raised questions about M&T Bank's procedures, systems and processes relating to M&T's Bank Secrecy Act and anti-money-laundering (BSA/AML) compliance program.

The bank was successful in reaching an agreement with the Fed to improve compliance in relation to risky activities and was focused in this respect and making considerable progress. However, in Dec 2013, the companies anticipated regulatory approvals to take more time, which would consequently push back completion of the proposed merger.

Amid fundamental pressure in the banking sector related to profitability, Moody’s believes the delayed transaction is a distraction for management from key issues. Further, the agency expects the delay to undermine the expected strategic benefits for M&T Bank to augment its top line by leveraging on Hudson City’s retail network as well as product and balance sheet diversification.

Moreover, the impediment to the deal along with legacy issues related to the acquisition of Wilmington Trust Corporation in 2011 has added to the bank’s woes.

Therefore the rating agency has come up with the downgrade. However, based on the improving asset quality, strong profitability, less volatile earnings and a solid capital position, Moody’s has reaffirmed the abovementioned ratings.

Our Viewpoint

The rating revisions are valuable for companies as this play a major role in preserving investor confidence in the stock and help boost its creditworthiness in the market.

Though a sound capital position, improving credit quality and growing core deposit will bode well in the long run for M&T Bank, we believe the sluggish economic recovery, regulatory issues and low interest rate environment will remain near-term headwinds.

Currently, M&T Bank carries a Zacks Rank #3 (Hold). A better-ranked bank includes The PNC Financial Services Group, Inc. (PNC - Analyst Report) with a Zacks Rank #2 (Buy).

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