Hudson City's Chief Says $644 Million Loss on Debt Means No Annual Profit

Hudson City Bancorp, the largest U.S. bank to forgo a government bailout, had a $644.3 million loss from paying off debt and said it won’t report a full-year profit for 2011.

Hudson City bought back $12.5 billion of so-called structured putable borrowings from the Federal Home Loan Bank of New York and some of the “larger Wall Street financial houses,” according to a filing yesterday from the Paramus, New Jersey-based lender. Chief Executive Officer Ronald Hermance said in a phone interview that the transactions will keep the bank from reporting an annual profit.

“We got to the point where we couldn’t keep growing, and this is the result,” Hermance said. “To continue to deliver shareholder value you have to take the one-time hit.”

Hudson City won favor among investors during the financial crisis by posting profits every year since its initial public offering in 1999, and record net income for the 11th straight year of $537.2 million in 2010. The shares have dropped more than 20 percent since March 2, when Hudson City disclosed that regulators were pressing the bank to reduce risk.

Dividend Cut

The stock dropped 4 cents to $9.82 as of 11:35 a.m. in New York on the Nasdaq Stock Market. The restructuring was widely anticipated, so the focus is now on how much Hudson City will reduce its quarterly dividend, according to Brian Foran, an analyst with Nomura Securities International Inc. Foran estimated a cut to 10 cents from 15 cents, according to a note to investors today. That would equal about 50 percent of earnings, the bank’s traditional payout ratio, he wrote.

Hudson City took a pretax charge of $1.17 billion and expects to report a first-quarter net loss. The lender said it borrowed $5 billion and sold $8.6 billion in mortgage-backed securities to retire the debt.

The new debt has an average cost of 66 basis points and will be paid off in increments of $250 million a month, the company said. The retired borrowings had an average rate of 3.56 percent.

Hermance said the bank suffered from a mismatch between its high cost of funds and shrinking yields on investments and mortgage-backed securities. The bank’s plan of retiring debt with new deposits fell apart when the financial crisis hit. The bank still holds about $16.6 billion of the putable borrowings.

Government Action

“When you have a negative carry on $27 billion you have to do something,” Hermance said. Otherwise, “it can only get worse.”

The declining yields were caused in part by “the unprecedented involvement of the United States government in both the mortgage markets, through the government-sponsored enterprises, and the maintenance of low-market interest rates,” Hermance wrote in a separate statement.

The Federal Reserve slashed the overnight lending rate between banks to near zero in December 2008 and purchased more than $1 trillion in mortgage bonds to bolster housing and financial markets.

Hudson City said earlier this month it expected to receive a memorandum of understanding from the Office of Thrift Supervision requiring it to “reduce its level of interest-rate risk and funding concentration,” according to a filing.

Hudson City said it expected the OTS action because of enhanced regulatory scrutiny of banks since the financial crisis and the lender’s “significant growth” since 2005.

Impact on Earnings

The actions announced yesterday may boost net interest margin, the difference between what the bank pays to borrow and what it earns on loans and securities, by 40 basis points in the second quarter compared with the year-end, Hudson City said. It reported a margin of 1.73 percent in the fourth quarter.

The restructuring caused a bigger reduction in tangible book value than Foran expected, to $9 a share, while earnings may be better than expected at 80 cents per share. Foran left his rating on the stock as “neutral” and his price target at $10 a share.

To contact the reporter on this story: Dakin Campbell in San Francisco at dcampbell27@bloomberg.net

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net.

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