Hudson City Bancorp (Nasdaq:HCBK) is tempting some investors as various issues impacting the bank have driven the stock to a multi-year low. Is this stock the classic value trap that investors are often warned about?
TUTORIAL: Stock Basics

The Hudson City Profile
Hudson City Bancorp is a bank holding company that operates Hudson City Savings Bank. The bank specializes in residential mortgage lending in the New York metropolitan area, and had a portfolio of $31 billion in mortgage loans outstanding at the end of 2010. These loans were almost entirely first mortgages, with approximately two thirds of the loan portfolio composed of fixed rate mortgages and the balance adjustable mortgages.

Hudson City Bancorp did well through the financial crisis and suffered less than its peers. However, the company has been hurt in 2011, with two sharp drops in price during the first quarter. These declines were caused in part by regulatory issues involving the company's balance sheet.

Regulatory Issues
Hudson City Bancorp is a federally chartered savings bank that is regulated by the Office of Thrift Supervision (OTS). The bank disclosed in March 2011 that it would receive a memorandum of understanding from the OTS regarding the bank's "level of interest rate risk and funding concentration."

The OTS may require Hudson City Bancorp to raise capital or restrict its dividend payments to comply with the memorandum of understanding. While this new capital will make the bank stronger in the long term, the initial market reaction to raising capital is sometimes negative.

New Regulator
In July 2011, the OTS is being merged into the Office of the Comptroller of the Currency (OCC), which is assuming regulatory authority over federally chartered savings banks. The OCC may be even stricter than the OTS on its regulatory oversight of banks, which may accelerate actions needed by Hudson City Bancorp.

Other federally chartered savings banks that will come under the OCC include Home Bancorp (Nasdaq:HBCP), which has total assets of $700 million as of the end of 2010.

Structured Borrowings
One issue that the OTS is concerned about is the composition of Hudson City Bancorp's balance sheet, as the bank partially funded itself with structured putable borrowings. These types of borrowings allow the holder of the debt to put the issue back to Hudson City Bancorp after a set initial time period.

The OTS and many investors felt that the presence of these borrowings added to the interest rate risk profile of the bank because if interest rates rise over the next year, as many expect, the issuers will have an incentive to put the paper back to Hudson City Bancorp. The bank might see its funding costs rise, or in the most bearish case, find itself unable to fund its operations.

Hudson City Bancorp reported $29.675 billion of these types of liabilities at the end of 2010, with 78% of the total either maturing or putable in 2011.

Steps Taken
Hudson City Bancorp restructured its balance sheet in late March 2011, and repaid $12.5 billion of these borrowings. The bank incurred a $644 million or $1.30 per share restructuring charge due to this action.

While this may ease some concerns that investors have regarding Hudson City Bancorp, the bank still has approximately $16.5 billion of these putable liabilities remaining on its balance sheet. The bank also replaced $5 billion of the repaid borrowings with short term funding. While these new borrowings are a cheaper source of funding, it will reprice fairly quickly when interest rates rise.

Other banks may also suffer if interest rates move higher. These include Provident Financial Services (NYSE:PFS) and Flushing Financial Corp (Nasdaq:FFIC), according to the Sterne Agee Fixed Income Strategies Group.

Bottom Line
Hudson City Bancorp still faces issues regarding its balance sheet in 2011, and may see a negative impact from the expected rise in interest rates. (For additional reading, also see Analyzing A Bank's Financial Statements.)

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Tickers in this Article: HCBK, HBCP, FFIC, PFS

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