Yesterday,Hudson City Bancorp Inc. (HCBK) announced the completion of its balance sheet restructuring. The restructuring condensed higher-cost structured borrowings, which are expected to increase net interest income in the coming quarters as interest expenses goes down. 

As a part of restructuring, Hudson City paid off $12.5 billion in structured quarterly putable borrowings. The funds for the payment were arranged through the sale of $8.7 billion of securities and $5.0 billion of new shorter-term fixed maturity borrowings with an average cost of 0.66%.

Recent market proceedings and the United States government’s participation in both the mortgage markets, through the government-sponsored enterprises (GSEs) such as Fannie Mae (FNMA) and Freddie Mac (FMCC), and the maintenance of low market interest rates, resulted in an environment that has caused balance sheet to be less responsive to the existing market conditions. In the presence of extensive low interest rate environment, Hudson City hastened prepayment speeds 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 reprice during this extended low rate environment, have resulted in interest rate risk and margin compression concerns for the company.

Due to the existence of low interest environment, banks are facing increased interest rate risk and liquidity concerns. Therefore, Hudson City has reduced its borrowings to address such concerns. The company restructured its balance sheet at an appropriate time when market interest rates started to increase with the intention of protecting shareholders’ equity as much as possible and increase earnings potential in the forthcoming quarters.

By reducing the disparity of investing and funding rates, Hudson City will be well positioned to gain from a rising interest rate environment and by growing assets. Further, Hudson City’s strong business model, solid capital position and conservative underwriting will boost financial position of the company.

HudsonCityexpects the transactions to negatively impact first-quarter 2011 after-tax earnings by roughly $644 million or $1.30 per share.  For full-year 2011, the loss from the restructuring will be reduced by four quarters’ earnings, excluding the restructuring charge.

HudsonCityanticipates restructuring transactions to have no effect on Tier 1 leverage capital ratio. However, excluding restructuring, the ratio is expected to increase to more than 8.0% by March 31, 2011, attributed to first-quarter 2011 earnings.  Further, the restructuring transactions will improve the net interest margin at least by 40 basis points for the second quarter of 2011 compared with the fourth quarter of 2010.

In April, Hudson City’s board of directors is expected to announce the dividend rate to be paid to the shareholders, considering the restructuring action.

JPMorgan Chase & Co.(JPM) acted as adviser to the company on the balance sheet restructuring plan.

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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