HCBK Receives A Stern Warning (NASDAQ: HCBK)

NEW YORK - Hudson City Saving Bank, one of the 20 largest institutions in the United States, got a stern warning from the Office of Thrift Supervision yesterday due to its interest rate risk.

HCBK said: "In January 2010, the Agencies released an Advisory on Interest Rate Risk Management (the “IRR Advisory”) to remind institutions of the supervisory expectations regarding sound practices for managing IRR....The Bank is currently out of compliance with the Board established limits regarding its NPV calculations. In addition, we believe our interest rate risk position would be considered significant based on the OTS’ written guidelines regarding NPV analysis. We are working to develop strategies to bring the Bank into compliance with our Board approved exposure limits and to reduce our interest rate risk exposure to be consistent with the OTS’ guidelines. To address our interest rate risk exposure, we are studying the feasibility of restructuring our borrowings to further strengthen our balance sheet and improve net interest margin going forward. The fair value of our borrowings, which is generally the value at which borrowings are extinguished, was approximately 111% of carrying value at December 31, 2010... As a result of the enhanced regulatory scrutiny, our interest rate risk position, our funding concentration in structured borrowings, our significant growth since 2005 and certain regulatory compliance matters, we expect to become subject to an informal regulatory enforcement action in the form of a memorandum of understanding (“MOU”) with the OTS...In addition, the OTS has the authority to establish higher capital requirements for individual institutions, impose restrictions on distributions from the Bank to the Company and restrict the ability of the Company to pay dividends to its shareholders, to repurchase stock and to incur debt"

From the Markets Are Open, on January 23, 2011

"The first red flag is that HCBK has borrowed funds from the Federal Home Loan Bank near $30 billion. It uses these funds to originate loans but also to buy mortgage backed securities (MBS) which yields are above its borrowings causing gains but a low net interest margin. However, because of the recession the yields on the mortgage backed securities have dropped causing in some cases borrowing to be above new mortgage backed securities yields which is impacting profitability. In Q4 the company received $240 million from interest and dividends from MBS's but they paid $300 million for borrowed funds. In 2006 the company received $654 million and paid out $565 in interest payments on their borrowed funds. This made up 1/3 of HCBK's net earnings in 2006. Also it should be pointed out that borrowed funds also go to other loan originations so the amount of profit as a percentage of earnings in 2006 may have been even higher. It is also important to point out that HCBK may not have had a loss in 2010 if a high proportion of these borrowed funds went to traditional loan originations. However it is important to note that Mortgage Backed Securities and investment securities make up $28 billion in assets and borrowed funds make of $29 billion, meaning that they could get rid of their MBS business with borrowed funds.

Since the interest rate spread has changed HCBK no longer makes a profit on this segment of their business. The next problem is the borrowings have increased in value due to the present value of bonds rising when interest rates drop causing a fair value equity hole on their balance sheet which is not reported. Though this event is unlikely to cause a liquidity problem, it is a concern in terms of value. HCBK would need to sell its MBS investments if their borrowings are called which would cause an equity drop of approximately $2 billion."