A run-in with the government has rattled Hudson City Bancorp — and Ronald Hermance's outlook on its bread-and-butter product: 30-year-fixed rate mortgages.
The Paramus, N.J., thrift announced a costly overhaul of its balance sheet this week in response to pressure from regulators to lower interest rate risk. Hermance, the chief executive, said in an interview Tuesday that the situation "calls into question several things" about how the government should help people buy homes, and oversee the banks that want make loans to them, he said.
The way Washington has been doing both lately has put Hudson City in an enormous bind: It's had a tough time making loans because it is losing business to Fannie Mae and Freddie Mac. Those two companies are owned by the government, the same entity that deemed its basic business model too risky.
"We're getting killed," Hermance said. "How do you finance a 30-year-mortgage? Does the government need to guarantee" them?
Hudson City's method for financing them — with relatively low-cost wholesale borrowings that mature after ten years — is one of the chief reasons it will book a $644 million charge restructuring its balance sheet this quarter.
The restructuring has altered the unusual mix of assets and liabilities it had built up to make money on its mortgages. Hudson City's loans rarely go bad because the people that take them out have good credit and they're used to buy homes that tend to hold their value. Its typical mortgage is $525,000 on properties in New Jersey, New York and Connecticut.
Hudson City had planned to grow aggressively by making as many of loans as possible as soon as the economy had rebounded, but those ambitions were tempered by the threat of an order from the Office of Thrift Supervision to reduce its interest rate risk. Hudson City disclosed earlier this month that it expected to receive a memorandum of understanding from the OTS.
Its response — reducing its leverage — will affect the basic way Hudson City does business, Hermance said.
Among them: It may rely on more deposits for funding, which means raising rates to drum up business at its more than 135 branches. Up until now its funding depended on securities guarantees and advances from the Federal Home Loan Bank of New York; it could consider making mortgages that it can sell, rather than hold on its balance sheet. It may get rated by the credit agencies so it can start selling bonds,
Like all thrifts, Hermance said, it will also have to figure out how to safely and profitably finance 30-year-loans as the government begins the long process of scaling back its involvement in the housing market.
He said that could mean demanding that borrowers make higher down payments, or making doing away with fixed-rates and replacing them with balloon rates that can be adjusted after five years. "Part of the problem may be we have to adjust our feeling" about home ownership," he said. "Maybe not everybody can own a house. That's why we have apartment living."
Analysts project that Hudson City may have to cut its quarterly dividend from a current 15 cents to 10 cents to conserve capital. Its board is expected to rule on the dividend in April: "There is nothing that we can really say other than that we intend to pay a dividend," Hermance said.
Hudson City is smaller now after shedding about 13% of its assets in the restructuring; Analysts now expect it to grow less aggressively than it did during the downturn because of the way its funding profile has changed.
The trade-off, Hermance said, is that reducing its wholesale borrowing should improve its net interest margin. "We can make more money on smaller growth than we have done," he said.
The overhaul involved paying down $12.5 billion in long-term borrowings with the proceeds of $8.66 million in securities sales and $5 billion in new, cheaper, short-term borrowings. It now has $16.5 billion in wholesale funds.
Will regulators be satisfied? "That we don't know," Hermance said. "We thoroughly expect that we'll hear about it shortly."
