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HCBK > SEC Filings for HCBK > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for HUDSON CITY BANCORP INC

Form 10-Q for HUDSON CITY BANCORP INC


7-Aug-2014

Quarterly Report


Item 2. - Management's Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary

During the first six months of 2014, we continued to focus on our consumer-oriented business model through the origination of one- to four-family mortgage loans. We have traditionally funded this loan production with customer deposits and borrowings. Market interest rates remained at historically low levels during the first six months of 2014 which provided limited opportunities for the reinvestment of repayments received on our mortgage-related assets which account for 84.1% of our average interest-earning assets for six months ended June 30, 2014. As a result, we continued to reduce the size of our balance sheet and we continue to carry an elevated level of overnight funds. Federal funds and other overnight deposits amounted to $5.32 billion, or 14.1%, of total assets at June 30, 2014. We believe that while carrying this level of overnight funds adversely impacts our current earnings, it better positions our balance sheet for future strategic initiatives such as a balance sheet restructuring. Our total assets decreased $906.7 million, or 2.4%, to $37.70 billion at June 30, 2014 from $38.61 billion at December 31, 2013.

Our results of operations depend primarily on net interest income, which, in part, is a direct result of the market interest rate environment. Net interest income is the difference between the interest income we earn on our interest-earning assets, primarily mortgage loans, mortgage-backed securities and investment securities, and the interest we pay on our interest-bearing liabilities, primarily time deposits, interest-bearing transaction accounts and borrowed funds. Net interest income is affected by the shape of the market yield curve, the timing of the placement and repricing of interest-earning assets and interest-bearing liabilities on our balance sheet, the prepayment rate on our mortgage-related assets and the puts of our borrowings. Our results of operations may also be affected significantly by general and local economic and competitive conditions, particularly those with respect to changes in market interest rates, credit quality, government policies and actions of regulatory authorities. Our results of operations are also affected by the market price of our stock, as the expense of our employee stock ownership plan is related to the current price of our common stock.

The Federal Open Market Committee of the Board of Governors of the Federal Reserve System (the "FOMC") noted that growth in economic activity rebounded in the second quarter. The FOMC noted that the unemployment rate declined. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remained slow. The national unemployment rate decreased to 6.2% in July 2014 from 6.7% in December 2013 and from 7.5% in June 2013. The FOMC decided to maintain the overnight lending target rate at zero to 0.25% for the third quarter of 2014.

Beginning in August 2014, the FOMC decided to reduce the pace at which it will add to its holdings of agency mortgage-backed securities to $10.0 billion per month from $15.0 billion per month and to reduce the pace at which it adds to its holdings of longer-term Treasury securities to $15.0 billion per month from $20.0 billion per month. The FOMC noted that its sizeable and increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative.

Net interest income decreased $42.2 million, or 26.4%, to $117.7 million for the second quarter of 2014 from $159.9 million for the second quarter of 2013 reflecting the overall decrease in the average balance of interest-earning assets and interest-bearing liabilities, the continued low interest rate environment and a

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continued increase in the average balance of short-term liquid assets, including U.S. Treasury securities and Federal funds sold and other overnight deposits. Our interest rate spread decreased to 1.00% for the second quarter of 2014 as compared to 1.38% for the second quarter of 2013. Our net interest margin was 1.29% for the second quarter of 2014 as compared to 1.64% for the second quarter of 2013.

Net interest income decreased $87.2 million, or 25.9%, to $250.0 million for the first six months of 2014 as compared to $337.2 million for the first six months of 2013. Our interest rate spread decreased 39 basis points to 1.07% for the six months ended June 30, 2014 as compared to 1.46% for the six months ended June 30, 2013. Our net interest margin decreased 36 basis points to 1.35% for the six months ended June 30, 2014 as compared to 1.71% for the six months ended June 30, 2013.

The decrease in our interest rate spread and net interest margin for the three and six months periods ended June 30, 2014 is primarily due to repayments of higher yielding assets due to the low interest rate environment and an increase in the average balance of Federal funds and other overnight deposits which yield 0.25%.

The increase in the average balance of Federal funds and other overnight deposits was due primarily to the repayments on mortgage-related assets and the lack of attractive reinvestment opportunities due to low market interest rates as available short term reinvestment opportunities continue to carry low yields, and medium and longer term opportunities are creating more significant duration risk at relatively low yields.

Mortgage-related assets represented 84.1% of our average interest-earning assets at June 30, 2014. Market interest rates on mortgage-related assets remained at near-historic lows primarily due to the FRB's program to purchase mortgage-backed securities to keep mortgage rates low and provide stimulus to the housing markets. Given the current market environment and our concerns about taking on additional interest rate risk, we expect to continue to reduce the size of our balance sheet in the near term.

There was no provision for loan losses for the three and six months ended June 30, 2014, as compared to $12.5 million and $32.5 million for the three and six months ended June 30, 2013, respectively. The decreases in our provision for loan losses were due primarily to improving home prices and economic conditions, a decrease in the size of the loan portfolio and a decrease in the amount of total delinquent loans. Early stage loan delinquencies (defined as loans that are 30 to 89 days delinquent) decreased $62.0 million to $411.4 million at June 30, 2014 from $473.4 million at December 31, 2013. Non-performing loans, defined as non-accrual loans and accruing loans delinquent 90 days or more, amounted to $1.01 billion at June 30, 2014 as compared to $1.05 billion at December 31, 2013. The ratio of non-performing loans to total loans was 4.35% at both June 30, 2014 and December 31, 2013. Notwithstanding the decrease in non-performing loans, the foreclosure process and the time to complete a foreclosure, while improving, continues to be prolonged, especially in New York and New Jersey where 76% of our non-performing loans are located at June 30, 2014. This protracted foreclosure process delays our ability to resolve non-performing loans through the sale of the underlying collateral and our ability to maximize any recoveries.

Total non-interest income was $21.2 million for the second quarter of 2014 as compared to $9.6 million for the second quarter of 2013. Included in non-interest income for the second quarter of 2014 were $19.5 million in gains from the sale of $565.6 million of mortgage-backed securities. Gains on the sales of securities amounted to $7.2 million in the second quarter of 2013. The remainder of non-interest income is primarily made up of service fees and charges on deposit and loan accounts.

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Total non-interest income was $38.9 million for the first six months of 2014 as compared to $12.1 million for the same period in 2013. Included in non-interest income for the first six months 2014 were $35.5 million in gains from the sale of $984.9 million of mortgage-backed securities. Gains on the sales of securities amounted to $7.2 million for the six months ended June 30, 2013.

We sold these mortgage-backed securities during 2014 to take advantage of current market demand and prices in advance of an anticipated rising interest rate environment.

Total non-interest expense decreased $3.5 million to $73.1 million for the second quarter of 2014 as compared to $76.6 million for the second quarter of 2013. This decrease was due to a $6.5 million decrease in Federal deposit insurance expense partially offset by a $3.5 million increase in other non-interest expense.

Total non-interest expense decreased $5.1 million to $152.8 million for the six months ended June 30, 2014 as compared to $157.9 million for the six months ended June 30, 2013. This decrease was due to a $16.7 million decrease in Federal deposit insurance expense partially offset by increases of $9.2 million in other non-interest expense and $1.8 million in compensation and employee benefit expenses.

Net loans decreased $937.9 million to $23.00 billion at June 30, 2014 as compared to $23.94 billion at December 31, 2013. Our loan production (originations and purchases) was $813.4 million during the first six months of 2014 offset by $1.72 billion in principal repayments. Loan production declined during the first six months of 2014 which reflects our limited appetite for adding long-term fixed-rate mortgage loans in the current low market interest rate environment. In addition, our loan production has been impacted by the new qualified mortgage regulations issued by the CFPB which went into effect in January 2014. We discontinued our reduced documentation loan program in January 2014 in order to comply with the CFPB's new requirements to validate a borrower's ability to repay and the corresponding safe harbor for loans that meet the requirements for a "qualified mortgage". During 2013, 22% of our total loan production consisted of reduced documentation loans to borrowers with acceptable credit and larger down payments resulting in loss ratios similar to our full documentation portfolio.

Total mortgage-backed securities decreased $1.65 billion to $7.30 billion at June 30, 2014 from $8.95 billion at December 31, 2013. The decrease was due primarily to securities sales of $984.9 million and repayments of $769.0 million of mortgage-backed securities during the first six months of 2014. We sold these mortgage-backed securities to take advantage of current market demand and prices in advance of an anticipated rising interest rate environment. The proceeds from the sales have been invested primarily in short-term liquid assets with some invested in mortgage-backed securities. While this further increases our levels of low-yielding, short-term liquid assets, we believe this better positions our balance sheet for future strategic initiatives such as a potential balance sheet restructuring. During the first six months of 2014, we purchased $94.4 million of mortgage-backed securities issued by U.S. government-sponsored entities.

Total deposits amounted to $20.51 billion at June 30, 2014 as compared to $21.47 billion at December 31, 2013. The decrease in deposits was due to our decision to maintain lower deposit rates that allow us to manage deposit levels at a time when we are experiencing excess liquidity from prepayment activity on mortgage-related assets and limited investment opportunities with attractive yields.

Borrowings amounted to $12.18 billion at June 30, 2014 with an average cost of 4.59%. During the first quarter of 2014, we modified $800.0 million of FHLB repurchase agreements to be FHLB advances. This reduced our collateral requirements related to the repurchase agreements, which use securities as collateral. FHLB advances are secured by a blanket lien on our loan portfolio. The modification resulted in a slight increase in the weighted average cost of the borrowings that were modified.

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On August 27, 2012, the Company entered into the Merger Agreement with M&T and WTC, pursuant to which the Company will merge with and into WTC, with WTC continuing as the surviving entity. As part of the Merger, the Bank will merge with and into Manufacturers and Traders Trust Company.

Subject to the terms and conditions of the Merger Agreement, in the Merger, Hudson City Bancorp shareholders will have the right to receive with respect to each of their shares of common stock of the Company, at their election (but subject to proration and adjustment procedures), 0.08403 of a share of common stock, or cash having a value equal to the product of 0.08403 multiplied by the average closing price of the M&T common stock for the ten days immediately prior to the completion of the Merger. The Merger Agreement also provides that at the closing of the Merger, 40% of the outstanding shares of Hudson City common stock will be converted into the right to receive cash and the remainder of the outstanding shares of Hudson City common stock will be converted into the right to receive shares of M&T common stock.

On two occasions, M&T and the Company announced that additional time would be required to obtain a regulatory determination on the applications necessary to complete the proposed Merger. Most recently, on December 17, 2013, M&T and the Company announced that they entered into Amendment No. 2 to the Merger Agreement. Amendment No. 2 further extends the date after which either party may terminate the Merger Agreement if the Merger has not yet been completed from January 31, 2014 to December 31, 2014, and provides that the Company may terminate the Merger Agreement at any time if it reasonably determines that M&T is unlikely to be able to obtain the requisite regulatory approvals of the Merger to permit the closing to occur on or prior to December 31, 2014. Amendment No. 2 also permits the Company to take certain interim actions, including with respect to our conduct of business, implementation of our Strategic Plan, retention incentives and certain other matters with respect to our personnel, prior to the completion of the Merger. While Amendment No. 2 extends the date after which either party may elect to terminate the Merger Agreement from January 31, 2014 to December 31, 2014, there can be no assurances that the Merger will be completed by that date or that the Company will not exercise its right to terminate the Merger Agreement in accordance with its terms.

As part of our Strategic Plan, we are continuing to explore ways to reduce our interest rate risk while strengthening our balance sheet, which may include a further restructuring of our balance sheet during 2014. The Company previously completed a series of restructuring transactions in 2011 that reduced higher-cost structured borrowings on the Company's balance sheet. Management is continuing to consider a variety of different restructuring alternatives, including whether to restructure all or various portions of our borrowed funds and various alternatives for replacement funding. No decision has been made at this time regarding the timing, structure and scope of any restructuring transaction. Decisions regarding any restructuring transaction are dependent upon, among other things, market interest rates, overall economic conditions and the status of the Merger. We expect a restructuring to result in a net loss and reduction of stockholder equity, though we also expect an improvement in net interest margin and future earnings prospects. Any restructuring will focus on the prospects for long-term overall earnings stability and growth. Any restructuring will likely reduce our excess cash position, but will not adversely affect the liquidity we need to operate in a safe and sound manner.

The Bank is currently subject to the Bank MOU. In accordance with the Bank MOU, the Bank has adopted and has implemented enhanced operating policies and procedures that are intended to continue to (a) reduce our level of interest rate risk, (b) reduce our funding concentration, (c) diversify our funding sources, (d) enhance our liquidity position, (e) monitor and manage loan modifications and (f) maintain

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our capital position in accordance with our existing capital plan. In addition, we developed the Strategic Plan which establishes objectives for the Bank's overall risk profile, earnings performance, growth and balance sheet mix and to enhance our enterprise risk management program.

The Company is currently subject to the Company MOU. In accordance with the Company MOU, the Company must, among other things support the Bank's compliance with the Bank MOU. The Company MOU also requires the Company to: (a) obtain approval from the FRB prior to receiving a capital distribution from the Bank or declaring a dividend to shareholders and (b) obtain approval from the FRB prior to repurchasing or redeeming any Company stock or incurring any debt with a maturity of greater than one year. In accordance with the Company MOU, the Company submitted a comprehensive Capital Plan and a comprehensive Earnings Plan to the FRB. These agreements will remain in effect until modified or terminated by the OCC (with respect to the Bank MOU) and the FRB (with respect to the Company MOU).

Comparison of Financial Condition at June 30, 2014 and December 31, 2013

Total assets decreased $906.7 million, or 2.4%, to $37.70 billion at June 30, 2014 from $38.61 billion at December 31, 2013. The decrease in total assets reflected a $1.65 billion decrease in total mortgage-backed securities and a $937.9 million decrease in net loans, partially offset by a $1.13 billion increase in cash and cash equivalents and a $605.7 million increase in investment securities.

Total cash and cash equivalents increased $1.13 billion to $5.45 billion at June 30, 2014 as compared to $4.32 billion at December 31, 2013. This increase is primarily due to repayments on mortgage-related assets and the lack of attractive reinvestment opportunities in the current low interest rate environment as available short term reinvestment opportunities continue to carry low yields, and medium and longer term opportunities available to us are creating more significant duration risk at relatively low yields. We have maintained lower deposit rates to allow a reduction in our deposits to help alleviate the pressure created by our increasing cash position. Accordingly, we have used a portion of our excess cash inflows to fund these deposit reductions.

Net loans decreased to $23.00 billion at June 30, 2014 as compared to $23.94 billion at December 31, 2013 due primarily to a decrease in loan production. During the first six months of 2014, our loan production (origination and purchases) amounted to $813.4 million as compared to $1.73 billion for the same period in 2013. Loan production was offset by principal repayments of $1.72 billion for the first six months of 2014, as compared to principal repayments of $3.55 billion for the first six months of 2013. The decline in our loan production during the first six months of 2014 reflects our limited appetite for adding long-term fixed-rate mortgage loans to our portfolio in the current low market interest rate environment. In addition, loan production has been impacted by the new qualified mortgage regulations issued by the CFPB. Effective in January 2014, we discontinued our reduced documentation loan program in order to comply with the new requirements to validate a borrower's ability to repay and the corresponding safe harbor for loans that meet the requirements for a "qualified mortgage." During 2013, 22% of our total loan production consisted of reduced documentation loans to borrowers with acceptable credit and larger down payments resulting in loss ratios similar to our prime portfolio.

Our first mortgage loan production during the first six months of 2014 was substantially all in one- to four-family mortgage loans. Approximately 79% of mortgage loan production for the first six months of 2014 were variable-rate loans as compared to approximately 81% for the corresponding period in 2013. Fixed-rate mortgage loans accounted for 54.5% of our first mortgage loan portfolio at June 30, 2014 as compared to 55.4% at December 31, 2013.

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Our ALL amounted to $255.0 million at June 30, 2014 and $276.1 million at December 31, 2013. Non-performing loans amounted to $1.01 billion, or 4.35% of total loans, at June 30, 2014 as compared to $1.05 billion, or 4.35% of total loans, at December 31, 2013.

Total mortgage-backed securities decreased $1.65 billion to $7.30 billion at June 30, 2014 from $8.95 billion at December 31, 2013. The decrease was due primarily to security sales of $984.9 million and repayments of $769.0 million of mortgage-backed securities during the first six months of 2014. We sold these mortgage-backed securities to take advantage of current market demand and prices in advance of an anticipated rising interest rate environment. The proceeds from the sales have been invested primarily in short-term liquid assets with some invested in mortgage-backed securities. While this further increases our levels of low-yielding, short-term liquid assets, we believe this better positions our balance sheet for future strategic initiatives such as a potential balance sheet restructuring.

Total investment securities increased $605.7 million to $942.0 million at June 30, 2014 as compared to $336.3 million at December 31, 2013. The increase was due primarily to purchases of $600.8 million of U.S. Treasury securities with a remaining term to maturity of approximately 18 months. These securities were purchased to be used as collateral for our outstanding borrowings.

Total liabilities decreased $977.0 million, or 2.9%, to $32.89 billion at June 30, 2014 from $33.86 billion at December 31, 2013. The decrease in total liabilities primarily reflected a decrease in total deposits of $958.5 million, while total borrowed funds remained unchanged.

Total deposits decreased $958.5 million, or 4.5%, to $20.51 billion at June 30, 2014 from $21.47 billion at December 31, 2013. The decrease in total deposits reflected a $527.9 million decrease in our money market accounts and a $420.5 million decrease in our time deposits accounts. The decrease in our money market and time deposit accounts was due to our decision to maintain lower deposit rates that allow us to manage deposit levels at a time when there are limited investment opportunities with attractive yields to reinvest the funds received from payment activity on mortgage-related assets. We had 135 banking offices at both June 30, 2014 and December 31, 2013.

Borrowings amounted to $12.18 billion at both June 30, 2014 and December 31, 2013. At June 30, 2014, we had $3.88 billion of borrowed funds with put dates within one year, including $3.33 billion that can be put back to the Company quarterly. If interest rates were to decrease, or remain consistent with current rates, we believe these borrowings would likely not be put back and our average cost of existing borrowings would not decrease even as market interest rates decrease. Conversely, if interest rates increase above the market interest rate for similar borrowings, we believe these borrowings would likely be put back at their next put date and our cost to replace these borrowings would increase. However, we believe, given current market conditions, that the likelihood that a significant portion of these borrowings would be put back will not increase substantially unless interest rates were to increase by at least 250 basis points.

Total shareholders' equity increased $70.3 million to $4.81 billion at June 30, 2014 from $4.74 billion at December 31, 2013. The increase was primarily due to net income of $81.7 million and a $19.2 million change in accumulated other comprehensive income, partially offset by cash dividends paid to common shareholders of $40.1 million.

Accumulated other comprehensive income amounted to $25.6 million at June 30, 2014 as compared to accumulated other comprehensive income of $6.3 million at December 31, 2013. The $19.2 million change in accumulated other comprehensive income primarily reflects an increase in the net unrealized gain on securities available for sale at June 30, 2014 as compared to December 31, 2013.

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As of June 30, 2014, there remained 50,123,550 shares that may be purchased under our existing stock repurchase programs. We did not repurchase any shares of our common stock during the second quarter of 2014 pursuant to our repurchase programs. Pursuant to the Company MOU, any future share repurchases must be approved by the FRB. In addition, pursuant to the terms of the Merger Agreement, we may not repurchase shares of Hudson City Bancorp common stock without the consent of M&T. At June 30, 2014, our capital ratios were in excess of the applicable regulatory requirements to be considered well-capitalized. See "Liquidity and Capital Resources."

At June 30, 2014, our shareholders' equity to asset ratio was 12.77% compared with 12.28% at December 31, 2013. Our book value per share, using the period-end number of outstanding shares, less purchased but unallocated employee stock ownership plan shares and less purchased but unvested recognition and retention plan shares, was $9.65 at June 30, 2014 and $9.52 at December 31, 2013. Our tangible book value per share, calculated by deducting goodwill and the core deposit intangible from shareholders' equity, was $9.34 as of June 30, 2014 and $9.21 at December 31, 2013.

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Comparison of Operating Results for the Three-Month Periods Ended June 30, 2014 and 2013

Average Balance Sheet. The following table presents the average balance sheets, average yields and costs and certain other information for the three months ended June 30, 2014 and 2013. The table presents the annualized average yield on interest-earning assets and the annualized average cost of interest-bearing liabilities. We derived the yields and costs by dividing annualized income or expense by the average balance of interest-earning assets and interest-bearing liabilities, respectively, for the periods shown. We derived average balances from daily balances over the periods indicated. Interest income includes fees that we considered to be adjustments to yields. Yields on tax-exempt obligations were not computed on a tax equivalent basis. Nonaccrual loans were included in the computation of average balances and therefore have a zero yield. The yields set forth below include the effect of deferred loan origination fees and costs, and purchase discounts and premiums that are amortized or accreted to interest income.

                                                                 For the Three Months Ended June 30,
                                                         2014                                          2013
                                                                       Average                                       Average
. . .
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