HCBK (MM)

Last Friday, Hudson City Bancorp Inc. (HCBK) announced that it has paid off $4.3 billion debt as part of its effort to restructure the balance sheet. This restructuring would condense higher-cost structured borrowings and in turn boost net interest income in the coming quarters as interest expenses goes down. However, this action is projected to result in a loss in the fourth quarter. Its dividend strategy however would likely remain untouched.

Hudson City paid off $4.3 billion of structured putable borrowings, which had a weighted-average cost of 4.21%. The company funded this with existing cash balance, reducing the balance sheet by $4.7 billion. The transaction is projected to have a roughly $440.7 million or 89 cents per share negative impact on fourth-quarter after-tax earnings, and consequently result in a loss.

Notably, Hudson City expects restructuring transactions to have no effect on regulatory capital ratios but boost the net interest margin by as much as 20 basis points for the first quarter of 2012 from the third quarter 2011 level of 1.97%.

Earlier in 2011, Hudson City had to opt for a major restructuring. At that time, the company paid off $12.5 billion in structured quarterly putable borrowings. This led to a $649.3 million charge and a $555.7 million net loss. The company also had to slash its dividend to 8 cents per share from 15 cents.

Hudson City invests primarily in mortgage-backed securities issued by Ginnie Mae, Fannie Mae (FNMA) and Freddie Mac (FMCC), as well as other securities issued by government-sponsored enterprises (GSEs). Recent market proceedings and the United States government’s participation in both the mortgage markets, through GSEs, and the maintenance of low market interest rates, resulted in an environment that has made its balance sheet less responsive to the existing market conditions.

In an extensive low interest rate environment, Hudson City has hastened prepayment on mortgage-related assets, which resulted in reinvestment in these instruments at the current low market interest rates. These lower-yielding assets and higher-cost borrowings, which did not re-price during this extended low rate environment, have resulted in interest rate risk and margin compression concerns for the company.

Consequently, the company’s calls of securities in its investment portfolio and mortgage pre-payments have provided it with excess liquidity. However, with expectations that normal interest rate environment will not return until 2013 and coupled with the regulatory atmosphere, the company has lesser choice for redeploying this excess liquidity. Therefore, the company found it appropriate to reduce its higher-cost debt.

Hence, this debt pay off is a strategic fit for Hudson City. Further, the company's strong business model, solid capital position and conservative underwriting will boost its financial position.

Hudson City currently retains its Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Also, considering the fundamentals, we are maintaining a long-term “Neutral” recommendation on the stock.

 
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