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Hudson City Bancorp 10-K 2006 Documents found in this filing:
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
For the fiscal year ended: December 31, 2005
For the transition period from to
Commission File Number: 0-26001
Hudson City Bancorp, Inc.
(Exact name of registrant as specified in its charter)
(201) 967-1900
(Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act.
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15d of the Act.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge,
in definitive proxy or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer”
in Rule 12b-2 of the Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act).
As of February 28, 2006, the registrant had 741,466,555 shares of common stock, $0.01 par
value, issued and 585,051,228 shares outstanding. The aggregate market value of voting stock held
by non-affiliates of the registrant as of June 30, 2005 was $6,365,334,000. This figure was based
on the closing price by the NASDAQ National Market for a share of the registrant’s common stock,
which was $11.41 as reported in the Wall Street Journal on July 1, 2005.
Documents Incorporated by Reference: Portions of the definitive Proxy Statement to be used in
connection with the Annual Meeting of Stockholders to be held on May 30, 2006 and any adjournment
thereof and which is expected to be filed with the Securities and Exchange Commission no later than
April 30, 2006, are incorporated by reference into Part III.
Hudson City Bancorp, Inc.
2005 Annual Report on Form 10-K Table of Contents Page 2
Table of Contents
PRIVATE SECURITIES LITIGATION REFORM ACT SAFE HARBOR STATEMENT
This Annual Report on Form 10-K contains certain “forward looking statements” within the meaning of
the Private Securities Litigation Reform Act of 1995 which may be identified by the use of such
words as “may,” “believe,” “expect,” “anticipate,” “should,” “plan,” “estimate,” “predict,”
“continue,” and “potential” or the negative of these terms or other comparable terminology.
Examples of forward-looking statements include, but are not limited to: (i) estimates with respect
to our financial condition, results of operations and business that are subject to various factors
which could cause actual results to differ materially from these estimates, (ii) statements about
the benefits of the merger between us and Sound Federal Bancorp, including future financial and
operating results, cost savings and accretion to reported earnings that may be realized from the
merger, (iii) statements about our and Sound Federal’s plans, objectives, expectations and
intentions, and (iv) other statements in this Form 10-K that are not historical facts. The
following factors, among others, could cause actual results to differ materially from the
anticipated results or other expectations expressed in the forward-looking statements:
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Any or all of our forward-looking statements in this Form 10-K and in any other public statements
we make may turn out to be wrong. They can be affected by inaccurate assumptions we might make or
by known or unknown risks and uncertainties. Consequently, no forward-looking statement can be
guaranteed. We do not intend to update any of the forward-looking statements after the date of
this Form 10-K or to conform these statements to actual events.
As used in this Form 10-K, unless we specify otherwise, “Hudson City Bancorp,” “our company,” “we,”
“us,” and “our” refer to Hudson City Bancorp, Inc., a Delaware corporation. “Hudson City Savings”
refers to Hudson City Savings Bank, a federal stock savings bank and the wholly-owned subsidiary of
Hudson City Bancorp. “Hudson City, MHC” refers to Hudson City, MHC, a New Jersey mutual holding
company and former majority-owner of Hudson City Bancorp.
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PART I
Item 1. Business.
Hudson City Bancorp is a Delaware corporation organized in 1999 and serves as the holding company
of its only subsidiary, Hudson City Savings Bank. Hudson City Bancorp’s executive offices are
located at West 80 Century Road, Paramus, New Jersey 07652 and our telephone number is (201)
967-1900.
On June 7, 2005, Hudson City Bancorp reorganized from a two-tier mutual holding company structure
to a stock holding company structure and completed a stock offering in accordance with a Plan of
Conversion and Reorganization (the “Plan”). Under the terms of the Plan, Hudson City, MHC, which
owned 65.77% of the outstanding common stock of Hudson City Bancorp immediately prior to the
conversion, merged into Hudson City Bancorp and the shares of Hudson City Bancorp common stock
owned by Hudson City, MHC were cancelled. Hudson City Bancorp sold 392,980,580 shares of common
stock at a price of $10.00 per share raising approximately $3.93 billion. After related expenses of
$125.0 million, net proceeds from the stock offering amounted to $3.80 billion. In accordance with
the Plan, we also affected a stock split pursuant to which each share of common stock outstanding
or held as treasury stock before completion of the offering was split into 3.206 shares. Hudson
City Bancorp contributed $3.00 billion of the net proceeds from the offering to Hudson City Savings
Bank. These transactions are referred to collectively as the second-step conversion.
Hudson City Savings is a federally chartered stock savings bank subject to supervision and
examination by the Office of Thrift Supervision (“OTS”). Hudson City Bancorp, as a savings and
loan holding company, is also subject to supervision and examination by the OTS. Our deposits are
insured by the Federal Deposit Insurance Corporation (“FDIC”). Hudson City Savings Bank has served
the customers of New Jersey since 1868 and now, through de novo branching, serves the customers of
Suffolk County and Richmond County (Staten Island), New York.
We are a community- and customer-oriented retail savings bank offering traditional deposit
products, residential real estate mortgage loans and consumer loans. In addition, we purchase
mortgages, mortgage-backed securities, securities issued by the U.S. government and
government-sponsored agencies and other investments permitted by applicable laws and regulations.
Except for community-related investments, we have not recently originated or invested in commercial
real estate loans, loans secured by multi-family residences or commercial/industrial business
loans, although we have the legal authority to make such loans. We retain in our portfolio
substantially all of the loans we originate.
Our business model and product offerings allow us to serve a broad range of customers with varying
demographic characteristics. Our traditional thrift products such as conforming one- to
four-family residential mortgages, certificates of deposit, and passbook savings accounts appeal to
a broad customer base. Our jumbo mortgage lending proficiency and our High Value Checking product
allow us to target higher-income customers successfully.
Our revenues are derived principally from interest on our mortgage loans and mortgage-backed
securities and interest and dividends on our investment securities. Our primary sources of funds
are customer deposits, borrowings, scheduled amortization and prepayments of mortgage loans and
mortgage-backed securities, maturities and calls of investment securities and funds provided by
operations. We are the largest savings bank by asset size headquartered in New Jersey.
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Available Information
Our periodic and current reports, proxy and information statements, and other information that
Hudson City Bancorp files with the Securities and Exchange Commission, or SEC, are made available
free of charge through our website, www.hcbk.com, as soon as reasonably practicable after such
reports are electronically filed with, or furnished to, the SEC. Except for these reports, the
information on our website is not part of this annual report. Such reports are also available on
the SEC’s website at www.sec.gov, or at the SEC’s Public Reference Room at 450 Fifth Street, NW,
Washington, DC, 20549. Information may be obtained on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330.
Proposed Acquisition of Sound Federal Bancorp, Inc.
In February 2006, we signed a definitive agreement to acquire Sound Federal Bancorp Inc. (“Sound
Federal”), for $265.0 million in cash. Sound Federal has approximately $1.15 billion in assets and
$969.6 million in deposits as of December 31, 2005. Sound Federal operates 14 branches in
Westchester, Putnam and Rockland Counties, New York and Fairfield County, Connecticut. The addition
of these branch offices will complement our organic branch expansion strategy and will give the
combined institution operations in seven of the top 50 counties in the United States ranked by
median household income. The transaction is subject to approval by shareholders of Sound Federal as
well as customary regulatory approvals and is expected to close in the early summer of 2006.
Market Area
We conduct our operations out of our corporate offices in Paramus, Bergen County, New Jersey, 84
branches located in 15 counties throughout the State of New Jersey, four branch offices located in
Suffolk County, New York and two branch offices in Richmond County (Staten Island), New York. We
operate in four primary markets: northern New Jersey (Bergen, Essex, Hudson, Mercer, Middlesex,
Morris, Passaic, Union and Warren Counties, and Richmond County, New York), the New Jersey shore
(Atlantic, Monmouth and Ocean Counties), southwestern New Jersey (Burlington, Camden and Gloucester
Counties) in the suburbs of Philadelphia and Suffolk County, New York. Branch offices in these
areas give us operations in three of the top 50 counties in the United States ranked by median
household income. Operating in high median household income counties fits well with our jumbo
mortgage loan and time deposit business model. We plan to open approximately 10 offices in 2006 in
these market areas, while continually evaluating new locations in areas that present the greatest
opportunity to promote our deposit and mortgage products.
Our current market areas provide distinct differences in demographics and economic characteristics.
The northern New Jersey market represents the greatest concentration of population, deposits and
income in New Jersey. The combination of these counties represents more than half of the entire New
Jersey population and more than half of New Jersey households. The northern New Jersey market also
represents the greatest concentration of Hudson City Savings retail operations – both lending and
deposit gathering – and based on its high level of economic activity, we believe that the northern
New Jersey market provides significant opportunities for future growth.
The New Jersey shore market represents a strong concentration of population and income, and is an
increasingly popular resort and retirement economy – providing healthy opportunities for deposit
growth and residential lending. The southwestern New Jersey market consists of communities
adjacent to the Philadelphia metropolitan area and represents the smallest concentration of
deposits for Hudson City Savings. The Suffolk County market area has similar demographic and
economic characteristics to the northern New Jersey market area. We believe the market area
currently served by Sound Federal is an extension of our Northern New Jersey market area,
reflecting similar demographic and economic characteristics.
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In 2005, we opened two of several planned branch locations in Richmond County (Staten Island), New
York and continued our expansion efforts in Suffolk County, New York by opening three branch
offices. This expansion has provided us with further resources for our retail operations and
allowed for additional geographic diversification. Areas being considered for further expansion
have similar demographic and economic characteristics as those in which we already have proven our
ability to garner significant market share.
Our future growth opportunities will be influenced by the growth and stability of the statewide and
regional economies, other demographic population trends and the competitive environment within and
around the State of New Jersey and the New York metropolitan area. We expect to continue to grow
through internal expansion primarily through the origination and purchase of mortgage loans, while
purchasing mortgage-backed securities and investment securities as a supplement to our mortgage
loans. We believe that we have developed lending products and marketing strategies to address the
diverse credit-related needs of the residents in our market areas. We intend the primary funding
for our growth to be customer deposits, using borrowed funds to complement our deposit initiatives
given the market rate environment existing during the year. We intend to grow customer deposits by
continuing to offer desirable products at competitive rates and by opening new branch offices.
Competition
We face intense competition both in making loans and attracting deposits in the market areas we
serve. New Jersey and the New York metropolitan area have a high concentration of financial
institutions, many of which are branches of large money center and regional banks. Some of these
competitors have greater resources than we do and may offer services that we do not provide such as
trust services or investment services. Customers who seek “one stop shopping” may be drawn to
these institutions.
Our competition for loans comes principally from commercial banks, savings institutions, mortgage
banking firms, credit unions, finance companies, mutual funds, insurance companies and brokerage
and investment banking firms. Our most direct competition for deposits has historically come from
commercial banks, savings banks, savings and loan associations and credit unions. We face
additional competition for deposits from short-term money market funds and other corporate and
government securities funds and from brokerage firms and insurance companies.
Lending Activities
Loan Portfolio Composition. Our loan portfolio primarily consists of one- to four-family
residential first mortgage loans. To a lesser degree, the loan portfolio includes consumer and
other loans, which primarily consist of fixed-rate second mortgage loans and home equity credit
lines. We do not originate commercial real estate loans, loans secured by multi-family residences,
construction loans or commercial/industrial business loans although we have the legal authority to
make such loans. From time to time we purchase participation interests in multi-family and
commercial first mortgage loans and commercial loans through community-based organizations. These
loans amounted to $2.3 million at December 31, 2005.
At December 31, 2005, we had total loans of $15.06 billion, of which $14.83 billion, or 98.4%, were
first mortgage loans. Of the first mortgage loans outstanding at that date, 82.7% were fixed-rate
mortgage loans and 17.3% were adjustable-rate, or ARM loans. At December 31, 2005, consumer and
other loans, primarily fixed-rate second mortgage loans and home equity credit lines, amounted to
$235.6 million, or 1.6%, of total loans. We also offer guaranteed student loans through the Student
Loan Marketing Association, commonly known as SallieMae, “Loan Referral Program.”
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Our loans are subject to federal and state laws and regulations. The interest rates we charge on
loans are affected principally by the demand for loans, the supply of money available for lending
purposes and the interest rates offered by our competitors. These factors are, in turn, affected by
general and local economic conditions, monetary policies of the federal government, including the
Federal Reserve Board (“FRB”), legislative tax policies and governmental budgetary matters.
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The following table presents the composition of our loan portfolio in dollar amounts and in
percentages of the total portfolio at the dates indicated.
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Loan Maturity. The following table presents the contractual maturity of our loans at
December 31, 2005. The table does not include the effect of prepayments or scheduled principal
amortization. Prepayments and scheduled principal amortization on first mortgage loans totaled
$2.10 billion for 2005, $1.96 billion for 2004 and $3.53 billion for 2003.
The following table presents, as of December 31, 2005, the dollar amount of all loans due
after December 31, 2006, and whether these loans have fixed interest rates or adjustable interest
rates.
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The following table presents our loan originations, purchases, sales and principal payments
for the periods indicated.
Residential Mortgage Lending. Our primary lending emphasis is the origination and purchase
of first mortgage loans secured by one- to four-family properties that serve as the primary or
secondary residence of the owner. We do not offer loans secured by cooperative apartment units or
interests therein. Since the early 1980’s, we have originated and purchased substantially all of
our one- to four-family first mortgage loans for retention in our portfolio. We have developed a
core competency in residential mortgage loans with principal balances in excess of the Fannie Mae
single-family limit of $417,000 (“non-conforming” or “jumbo” loans). We are one of the largest
jumbo residential mortgage lenders in New Jersey and one of the largest buyers of jumbo mortgages
nationally. We believe that our retention and servicing of the residential mortgage loans that we
originate allows us to maintain higher levels of customer service and satisfaction than originators
who sell loans to third parties.
Our wholesale loan purchase program is an important component of our strategy to grow our
residential loan portfolio, and complements our retail loan origination production by enabling us
to diversify assets outside our local market area, thus providing a safeguard against economic
trends that might affect one particular area of the nation. Through this program, we have obtained
assets with a relatively low overhead cost and minimized related servicing costs. At December 31,
2005, $8.05 billion, or 54.3%, of
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our first mortgage loans were purchased loans. At December 31, 2005, approximately 63% of the
mortgage loan portfolio was secured by real estate located in the states of New Jersey, New York
and Connecticut. Additionally, the states of Virginia, Illinois, Massachusetts and Maryland each
accounted for approximately 4% to 7% of our total mortgage loan portfolio. The remainder of the
loan portfolio is secured by real estate in 31 other states.
We have developed written standard operating guidelines relating to the purchase of these assets.
These guidelines include the evaluation and approval process of the various sellers from whom we
choose to buy whole loans, which are primarily large national mortgage loan seller/servicers, and
the types of whole loans, acceptable property locations and maximum interest rate variances. The
purchase agreements, as established with each seller/servicer, contain parameters of the loan
characteristics that can be included in each package. These parameters, such as maximum loan size
and maximum loan-to-value ratio, generally conform to parameters utilized by us to originate
mortgage loans. All loans are reviewed for compliance with the agreed upon parameters. All
purchased loan packages are subject to internal due diligence procedures including review of a
sampling of individual loan files. It is our policy to perform full credit reviews of between 10%
to 50% of all loans purchased. Our loan review includes review of the legal documents, including
the note, the mortgage and the title policy, review of the credit file, evaluating debt service
ratios, review of the appraisal and verifying loan-to-value ratios and evaluating the completeness
of the loan package. This review subjects the loan file to substantially the same underwriting
standards used in our own loan origination process.
The loan purchase agreements recognize that the time frame to complete our due diligence reviews
may not be sufficient prior to the completion of the purchase and afford us a limited period of
time after closing to complete our review and return, or request substitution of, any loan for any
legitimate underwriting concern. After the review period, we are still provided recourse to the
seller for any breach of a representation or warranty with respect to the loans purchased. Among
these representations and warranties are attestations of the legality and enforceability of the
legal documentation, adequacy of insurance on the collateral real estate, compliance with
regulations and certifications that all loans are current as to principal and interest at the time
of purchase.
In general, the seller of a purchased loan continues to service the loan following our purchase of
it. The servicing of purchased loans is governed by the servicing agreement entered into with each
servicer. Oversight of the servicer is maintained by us through review of all reports, remittances
and non-performing loan ratios with appropriate further action, such as contacting the servicers by
phone or in writing to clarify or correct our concerns, taken as required. We also require that
all servicers provide end-of-year financial statements to confirm company soundness. These
servicers must also deliver industry certifications substantiating that they have in place all
appropriate controls to ensure their mode of administration is in accordance with standards set by
the Mortgage Bankers Association of America. These operating guidelines provide a means of
evaluating and monitoring the quality of mortgage loan purchases and the servicing abilities of the
loan servicers. We typically purchase loans from eight to ten of the largest nationwide mortgage
producers. We purchased first mortgage loans of $3.68 billion in 2005, $3.12 billion in 2004 and
$3.21 billion in 2003. The average size of our one-to-four family mortgage loans purchased during
2005 was approximately $463,000.
Most of our retail loan originations are from existing or past customers, members of our local
communities or referrals from local real estate agents, licensed mortgage bankers and brokers,
attorneys and builders. We believe that our extensive branch network is a significant source of new
loan generation. We also employ a staff of representatives who call on real estate professionals to
disseminate information regarding our loan programs and take applications directly from their
clients. These representatives are paid for each origination.
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We currently offer loans that conform to underwriting standards that are based on standards
specified by FannieMae (“conforming loans”), non-conforming loans, loans processed as limited
documentation loans and, to a limited extent, no income or asset verification loans, as described
below. These loans may be fixed-rate one- to four-family mortgage loans or adjustable-rate one- to
four-family mortgage loans with maturities of up to 40 years. The non-conforming loans generally
follow FannieMae guidelines, except for the loan amount. FannieMae guidelines limit the principal
amount of single-family loans to $417,000; our non-conforming loans generally exceed such limits.
The average size of our one- to four-family mortgage loans originated in 2005 was approximately
$367,000. The overall average size of our one- to four-family first mortgage loans was
approximately $326,000 at December 31, 2005. We are an approved seller/servicer for FannieMae and
an approved servicer for FreddieMac. We generally hold loans for our portfolio but have, from time
to time, sold loans in the secondary market. During 2005, we sold approximately $10.3 million of
first mortgage loans to other financial institutions.
Our originations of first mortgage loans amounted to $2.07 billion in 2005, $1.38 billion in 2004
and $2.17 billion in 2003. During 2003, a significant number of our first mortgage loan
originations were the result of refinancing of existing loans due to declining interest rates.
Total refinancing of our existing first mortgage loans were as follows:
We allow existing customers to modify their mortgage loans with the intent of maintaining
customer relationships in periods of extensive refinancing due to a low interest rate environment.
The modification allows adjustment of the existing interest rate to the currently offered fixed
interest rate product with a similar or reduced term, for a fee, after past payment performance is
reviewed. In general, all other terms and conditions of the existing mortgage remain the same.
Modifications of existing mortgage loans were as follows:
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We offer a variety of adjustable-rate and fixed-rate one- to four-family mortgage loans with
maximum loan-to-value ratios that depend on the type of property and the size of loan involved. The
loan-to-value ratio is the loan amount divided by the appraised value of the property. The
loan-to-value ratio is a measure commonly used by financial institutions to determine exposure to
risk. Except for loans to low- and moderate-income home mortgage applicants, described below, loans
on owner-occupied one- to four-family homes of up to $750,000 are generally subject to a maximum
loan-to-value ratio of 80%. However, we make loans in amounts up to $400,000 with a 95%
loan-to-value ratio and loans in excess of $400,000 and less than $500,000 with a 90% loan-to-value
ratio if the borrower obtains private mortgage insurance. Under certain circumstances, where we
deem appropriate, we will originate a first and second mortgage, up to a combined loan amount of
$500,000, where the combined loan-to-value ratio is 90%. Under these circumstances, we will waive
the private mortgage insurance requirements and receive a higher interest rate on the second
mortgage loan than we would receive on a regular second mortgage loan. Loans in excess of $750,000
and up to $1.0 million are generally subject to a maximum 70% loan-to-value ratio. Loan-to-value
ratios of 65% or less are generally required for one- to four-family loans in excess of $1.0
million and less than $1.5 million. Loans in excess of $1.5 million and less than $2.0 million are
generally subject to a maximum loan-to-value ratio of 60%. Loans in excess of $2.0 million and up
to $2.5 million are generally subject to a maximum loan-to-value ratio of 55%. Loans in excess of
$2.5 million and up to $3.0 million are generally subject to a maximum loan-to-value ratio of 50%.
At December 31, 2005, we had outstanding 433 originated mortgage loans with principal balances in
excess of $750,000 with an aggregate balance of $408.5 million.
We currently offer fixed-rate mortgage loans in amounts generally up to $3.0 million with a maximum
term of 40 years secured by one- to four-family residences. We price our interest rates on
fixed-rate loans to be competitive in light of market conditions.
We also offer a variety of ARM loans secured by one- to four-family residential properties that
initially adjust after three years, five years or ten years, in amounts generally up to $3.0
million. After the initial adjustment period, ARM loans adjust on an annual basis. The ARM loans
that we currently originate have a maximum 40-year amortization period and are generally subject to
the loan-to-value ratios described above. The interest rates on ARM loans fluctuate based upon a
fixed spread above the monthly average yield on United States treasury securities, adjusted to a
constant maturity of one year and generally are subject to a maximum increase of 2% per adjustment
period and a limitation on the aggregate adjustment of 5% over the life of the loan. In the
current rate environment, where the yield curve is relatively flat, the ARM loans we offer have
initial interest rates below the fully indexed rate. As of December 31, 2005, the initial offered
rate on these loans was 137.5 to 187.5 basis points below the current fully indexed rate. We
originated $1.04 billion of one- to four-family ARM loans in 2005. At December 31, 2005, 17.3% of
our one- to four-family mortgage loans consisted of ARM loans.
The origination and retention of ARM loans helps reduce exposure to increases in interest rates.
However, ARM loans can pose credit risks different from the risks inherent in fixed-rate loans,
primarily because as interest rates rise, the underlying payments of the borrower may rise, which
increases the potential for default. The marketability of the underlying property also may be
adversely affected. In order to minimize risks, we evaluate borrowers of ARM loans based on their
ability to repay the loans at the higher of the initial interest rate or the fully indexed rate. In
an effort to further reduce interest rate risk, we have not in the past, nor do we currently,
originate ARM loans that provide for negative amortization of principal. Currently, we do not offer
option ARM loans, where the borrower is given various payment options that could change payment
flows to the Bank.
Early in 2005,we began to offer a limited menu of “interest-only” products. These loans are
designed to appeal to our mortgage clients who wish to use their mortgage for tax deductibility
purposes as well as a
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financial leveraging tool. These loans are originated as 5/1 or 10/1 ARM loans, with the interest
only portion of the payment based upon the initial loan term, or offered on a 30-year fixed-rate
loan, with interest-only payments for the first 10 years of the obligation. At the end of the
initial 5- or 10-year interest-only period of these loans, the payment will adjust to include both
principal and interest and will amortize over the remaining term so the loan will be repaid at the
end of its original life. These loans are underwritten using more restrictive standards and
generally are made with lower loan to value limitations imposed to help minimize any potential
credit risk. These loans may involve higher risks compared to standard loan products since there is
the potential for higher payments once the interest rate resets and the principle begins to
amortize and they rely on a stable or rising housing market to maintain an acceptable loan-to-value
ratio. However, we do not believe these programs will have a material adverse impact on our asset
quality. As of December 31, 2005, we had $236.2 million of interest-only loans outstanding.
In addition to our full documentation loan program, we process some loans as limited documentation
loans. We have originated these types of loans for over 15 years. Loans eligible for limited
documentation processing are ARM loans and 10-, 15-, 20-, 30- and 40-year fixed-rate loans to
owner-occupied primary and second home applicants. These loans are available in amounts up to 75%
of the lower of the appraised value or purchase price of the property. Generally the maximum loan
amount for limited documentation loans is $600,000. We do not charge borrowers additional fees for
limited documentation loans. We require applicants for limited documentation loans to complete a
FreddieMac/FannieMae loan application and request income, assets and credit history information
from the borrower. Additionally, we obtain credit reports from outside vendors on all borrowers. We
also look at other information to ascertain the credit history of the borrower. Applicants with
delinquent credit histories usually do not qualify for the limited documentation processing,
although relatively minor delinquencies that are adequately explained will not prohibit processing
as a limited documentation loan. We reserve the right to verify income, asset information and other
information where we believe circumstances warrant. We also allow certain borrowers to obtain
mortgage loans without verification of income or assets. These loans are subject to somewhat
higher interest rates than our regular products, and are limited to a maximum loan-to-value ratio
of 65% on purchases and 60% on refinancing transactions.
Limited documentation and no verification loans may involve higher risks compared to loans with
full documentation, as there is a greater opportunity for borrowers to falsify their income and
ability to service their debt. We believe these programs have not had a material adverse effect on
our asset quality. Unseasoned limited documentation and no verification loans are not as readily
salable in the secondary market as are conforming whole loans. We do not believe that an inability
to sell such loans will have a material adverse impact on our liquidity needs, because internally
generated sources of liquidity are expected to be sufficient to meet our liquidity needs. See
“Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity
and Capital Resources” and “— Sources of Funds.”
Since 1992, we have offered mortgage programs designed to address the credit needs of low- and
moderate-income home mortgage applicants, first-time home buyers and low- and moderate-income home
improvement loan applicants. We define low- and moderate-income applicants as borrowers residing in
low- and moderate-income census tracts or households with income not greater than 80% of the median
income of the Metropolitan Statistical Area in the county where the subject property is located.
Our low- and moderate-income home improvement loans are discussed under “— Consumer Loans.” Among
the features of the low- and moderate-income home mortgage and first-time home buyer’s programs are
reduced rates, lower down payments, reduced fees and closing costs, and generally less restrictive
requirements for qualification compared with our traditional one- to four-family mortgage loans.
For instance, certain of these programs currently provide for loans with up to 95% loan-to-value
ratios and
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rates which are 25 to 50 basis points lower than our traditional mortgage loans. In 2005, we
originated $24.4 million in mortgage loans to home buyers under these programs.
Consumer Loans. At December 31, 2005, $235.6 million, or 1.6%, of our total loans consisted of
consumer and other loans, primarily fixed-rate second mortgage loans and home equity credit lines.
Consumer loans generally have shorter terms to maturity, which reduces our exposure to changes in
interest rates. Consumer loans generally carry higher rates of interest than do one- to
four-family residential mortgage loans. In addition, we believe that offering consumer loan
products helps to expand and create stronger ties to our existing customer base by increasing the
number of customer relationships and providing cross-marketing opportunities.
We offer fixed-rate second mortgage loans in amounts up to $200,000 secured by owner-occupied one-
to four-family residences located in the State of New Jersey, and the portions of New York State
served by our first mortgage loan products, for terms of up to 20 years. At December 31, 2005 these
loans totaled $205.8 million, or 1.4% of total loans. The underwriting standards applicable to
these loans generally are the same as one- to four-family first mortgage loans, except that the
combined loan-to-value ratio, including the balance of the first mortgage, cannot exceed 80% of the
appraised value of the property.
We also offer discounted fixed-rate second mortgage loans to low- and moderate-income borrowers in
amounts up to $20,000. The borrower must use a portion of the loan proceeds for home improvements
or the satisfaction of an existing obligation. The underwriting standards under this program are
similar to those for standard second mortgage loans, except that the combined maximum loan-to-value
ratio is 90%.
Our home equity credit line loans, which totaled $29.2 million, or 0.2% of total loans at December
31, 2005, are adjustable-rate loans secured by a second mortgage on owner-occupied one- to
four-family residences located in the State of New Jersey and the portions of New York State served
by our first mortgage loan products. Current interest rates on home equity credit lines are based
on the “prime rate” as published in the “Money Rates” section of The Wall Street Journal (the
“Index”) subject to certain interest rate limitations. Interest rates on home equity credit lines
are adjusted monthly based upon changes in the Index. Minimum monthly principal payments on
currently offered home equity lines of credit are based on 1/240th of the outstanding principal
balance or $100 whichever is greater. The maximum credit line available is $200,000. The
underwriting terms and procedures applicable to these loans are substantially the same as for our
fixed-rate second mortgage loans.
Other loans totaled $662,000 at December 31, 2005 and consisted of collateralized passbook loans,
overdraft protection loans, automobile loans, and unsecured personal loans. We no longer originate
student loans, but offer guaranteed student loans through the SallieMae “Loan Referral Program.” As
of December 31, 2005, we have suspended origination of unsecured personal loans and automobile
loans.
Loan Approval Procedures and Authority. All first mortgage loans up to $600,000 must be approved
by two officers in the Mortgage Origination Department. Loans in excess of $600,000 require one of
the two officers approving the loan bear the title of either First Vice President-Mortgage Officer,
Senior Vice President-Lending, Chief Operating Officer or Chief Executive Officer prior to the
issuance of a commitment letter. The aggregate of all loans existing and/or committed by any one
borrower shall not exceed $3,000,000 without the prior approval of the Board of Directors. Home
equity credit lines and fixed-rate second mortgage loans in principal amounts of $25,000 or less
are approved by one of our designated loan underwriters. Home equity loans in excess of $25,000, up
to the $200,000 maximum, are approved by an underwriter and either our Consumer Loan Officer,
Senior Vice President-Lending, Chief Executive Officer or Chief Operating Officer.
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Upon receipt of a completed loan application from a prospective borrower, we order a credit report
and, except for loans originated as limited documentation or no income/no asset verification loans,
we verify certain other information. If necessary, we obtain additional financial or credit-related
information. We require an appraisal for all mortgage loans, except for some loans made to
refinance existing mortgage loans. Appraisals may be performed by our in-house Appraisal Department
or by licensed or certified third-party appraisal firms. Currently most appraisals are performed by
third-party appraisers and are reviewed by our in-house Appraisal Department.
We require title insurance on all mortgage loans, except for home equity credit lines and
fixed-rate second mortgage loans. For these loans, we require a property search detailing the
current chain of title. We require borrowers to obtain hazard insurance and we may require
borrowers to obtain flood insurance prior to closing. We require most borrowers to advance funds on
a monthly basis together with each payment of principal and interest to a mortgage escrow account
from which we make disbursements for items such as real estate taxes, flood insurance and private
mortgage insurance premiums, if required. In a limited number of instances, at our discretion, we
will waive the real estate tax escrow for the borrower, subject to an interest rate somewhat higher
than our regular offered rate. Presently, we do not escrow for real estate taxes on properties
located in the State of New York.
Asset Quality
One of our key operating objectives has been, and continues to be, to maintain a high level of
asset quality. Through a variety of strategies, including, but not limited to, borrower workout
arrangements and aggressive marketing of owned properties, we have been proactive in addressing
problem and non-performing assets. These strategies, as well as our concentration on one- to
four-family mortgage lending, our maintenance of sound credit standards for new loan originations
and favorable real estate market conditions have resulted in relatively low delinquency ratios.
This, in turn, has helped strengthen our financial condition.
Delinquent Loans and Foreclosed Assets. When a borrower fails to make required payments on a
loan, we take a number of steps to induce the borrower to cure the delinquency and restore the loan
to a current status. In the case of originated mortgage loans, our mortgage servicing department is
responsible for collection procedures from the 15th day up to the 90th day of delinquency. Specific
procedures include a late charge notice being sent at the time a payment is over 15 days past due.
Telephone contact is attempted on approximately the 20th day of the month to avoid a 30-day
delinquency. A second written notice is sent at the time the payment becomes 30 days past due.
We send additional letters if no contact is established by approximately the 45th day of
delinquency. On the 60th day of delinquency, we send another letter followed by continued telephone
contact. Between the 30th and the 60th day of delinquency, if telephone contact has not been
established, an independent contractor makes a physical inspection of the property. When contact is
made with the borrower at any time prior to foreclosure, we attempt to obtain full payment or work
out a repayment schedule with the borrower in order to avoid foreclosure. It has been our
experience that most loan delinquencies are cured within 90 days and no legal action is taken.
We send foreclosure notices when a loan is 90 days delinquent and we transfer the loan to the
foreclosure/bankruptcy section for referral to legal counsel. The accrual of income on loans that
do not carry private mortgage insurance or are not guaranteed by a federal agency is generally
discontinued when interest or principal payments are 90 days in arrears. We commence foreclosure
proceedings if the loan is not brought current between the 90th and 120th day of delinquency unless
specific limited
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circumstances warrant an exception. The collection procedures for mortgage loans guaranteed by
government agencies follow the collection guidelines outlined by those agencies.
We monitor delinquencies on our serviced loan portfolio, in aggregate, from reports sent to us by
the servicers. Once all past due reports are received, we examine the delinquencies and contact
appropriate servicer personnel to determine the collectability of the loans. We also use these
reports to prepare our own monthly reports for management review. These summaries breakdown, by
servicer, total principal and interest due, length of delinquency, as well as accounts in
foreclosure and bankruptcy. We control, on a case-by-case basis, all accounts in foreclosure to
confirm that the servicer has taken all proper steps to foreclose promptly if there is no other
recourse. We also monitor whether mortgagors who filed bankruptcy are meeting their obligation to
pay the mortgage debt in accordance with the terms of the bankruptcy petition.
The collection procedures for consumer and other loans include our sending periodic late notices to
a borrower once a loan is past due. We attempt to make direct contact with a borrower once a loan
becomes 30 days past due. Supervisory personnel in our Consumer Loan department review the
delinquent loans and collection efforts on a regular basis. If collection activity is unsuccessful
after 90 days, we may refer the matter to our legal counsel for further collection effort or
charge-off the loan. Loans we deem to be uncollectible are proposed for charge-off. Charge-offs of
consumer loans require the approval of our Consumer Loan Officer and either the Senior Vice
President-Lending, our Chief Executive Officer or Chief Operating Officer.
We hold property foreclosed upon as foreclosed real estate. We carry foreclosed real estate at the
lower of fair market value less estimated selling costs, or at cost. If a foreclosure action is
commenced and the loan is not brought current, paid in full or refinanced before the foreclosure
sale, we either sell the real property securing the loan by a foreclosure sale, or sell the
property as soon thereafter as practicable.
Our policies require that management continuously monitor the status of the loan portfolio and
report to the Board of Directors on a monthly basis. These reports include information on
delinquent loans and foreclosed real estate.
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At December 31, 2005, 2004 and 2003, loans delinquent 60 days to 89 days and 90 days or more were
as follows:
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Non-performing assets, which include foreclosed real estate, net, non-accrual loans and
accruing loans delinquent 90 days or more, were $20.4 million at December 31, 2005 compared with
$22.5 million at December 31, 2004. Our $19.3 million in loans delinquent 90 days or more at
December 31, 2005 were comprised primarily of 91 one- to four-family first mortgage loans
(including VA first mortgage loans). At December 31, 2005, our largest loan delinquent 90 days or
more had a balance of $658,000.
With the exception of first mortgage loans guaranteed by a federal agency or for which the borrower
has obtained private mortgage insurance, we stop accruing income on loans when interest or
principal payments are 90 days in arrears or earlier when the timely collectibility of such
interest or principal is doubtful. We designate loans on which we stop accruing income as
non-accrual loans and we reverse outstanding interest that we previously credited to income. We
recognize income in the period that we collect it or when the ultimate collectibility of principal
is no longer in doubt. We return a non-accrual loan to accrual status when factors indicating
doubtful collection no longer exist. The accrual of income on VA loans is generally not
discontinued as they are guaranteed by a federal agency.
Foreclosed real estate consists of property we acquired through foreclosure or deed in lieu of
foreclosure. After foreclosure, foreclosed properties held for sale are carried at the lower of
fair value minus estimated cost to sell, or at cost. A valuation allowance account is established
through provisions charged to income, which results from the ongoing periodic valuations of
foreclosed real estate properties. Fair market value is generally based on recent appraisals.
The following table presents information regarding non-accrual mortgage and consumer and other
loans, accruing loans delinquent 90 days or more, and foreclosed real estate as of the dates
indicated.
The total amount of interest income received during the year on non-accrual loans outstanding
and additional interest income on non-accrual loans that would have been recognized if interest
on all such loans had been recorded based upon original contract terms is immaterial. We are not
committed to lend additional funds to borrowers on non-accrual status.
We define the population of impaired loans to be all non-accrual commercial real estate and
multi-family loans. Impaired loans are individually assessed to determine whether a loan’s carrying
value is not in excess of the fair value of the collateral or the present value of the loan’s cash
flows. Smaller balance homogeneous loans that are collectively evaluated for impairment, such as
residential mortgage loans and consumer loans, are specifically excluded from the impaired loan
portfolio. We had no loans classified as
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impaired at December 31, 2005 and 2004. In addition, at December 31, 2005 and 2004, we had no loans
classified as troubled debt restructurings, as defined in SFAS No. 15.
Allowance for Loan Losses. The following table presents the activity in our allowance for loan
losses at or for the periods indicated.
The allowance for loan losses has been determined in accordance with U.S. generally accepted
accounting principles, under which we are required to maintain adequate allowances for loan losses.
We are responsible for the timely and periodic determination of the amount of the allowance
required. We believe that our allowance for loan losses is adequate to cover specifically
identifiable loan losses, as well as estimated losses inherent in our portfolio for which certain
losses are probable but not specifically identifiable.
Our primary lending emphasis is the origination and purchase of one- to four-family first mortgage
loans on residential properties and, to a lesser extent, second mortgage loans on one- to
four-family residential properties resulting in a loan concentration in residential first mortgage
loans at December 31, 2005. As a result of our lending practices, we also have a concentration of
loans secured by real property located in New Jersey. Based on the composition of our loan
portfolio and the growth in our loan portfolio, we believe the primary risks inherent in our
portfolio are increases in interest rates, a decline in the economy, generally, and a decline in
real estate market values. Any one or a combination of these events may adversely affect our loan
portfolio resulting in increased delinquencies, loan losses and future levels of provisions. We
consider it important to maintain the ratio of our allowance for loan losses to total loans at an
acceptable level given current economic conditions, interest rates and the composition of our
portfolio.
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Due to the nature of our loan portfolio, our evaluation of the adequacy of our allowance for loan
losses is performed on a “pooled” basis. Each month we prepare a worksheet which categorizes the
entire loan portfolio by certain risk characteristics such as loan type (one- to four-family,
multi-family, etc.), loan source (originated or purchased) and payment status (i.e., current or
number of days delinquent). Loans with known potential losses are categorized separately. We assign
potential loss factors to the payment status categories on the basis of our assessment of the
potential risk inherent in each loan type. These factors are periodically reviewed for
appropriateness giving consideration to charge-off history and delinquency trends. We use this
worksheet, as a tool, together with principal balances and delinquency reports, to evaluate the
adequacy of the allowance for loan losses. Other key factors we consider in this process are
current real estate market conditions in geographic areas where our loans are located, changes in
the trend of non-performing loans, the current state of the local and national economy and loan
portfolio growth.
We maintain the allowance for loan losses through provisions for loan losses that we charge to
income. We charge losses on loans against the allowance for loan losses when we believe the
collection of loan principal is unlikely. We establish the provision for loan losses after
considering the results of our review of delinquency and charge-off trends, the allowance for loan
loss worksheet, the amount of the allowance for loan losses in relation to the total loan balance,
loan portfolio growth, U.S. generally accepted accounting principles and regulatory guidance. We
have applied this process consistently and we have made minimal changes in the estimation methods
and assumptions that we have used.
During 2005, we lowered the loss factors used in our worksheet on our first mortgage loans and our
loan commitments to reflect the seasoning of the portfolio, and the charge-off and delinquency
experience. We provided a minimal amount for loan losses during the first quarter of 2005, and did
not provide for loan losses for the second through fourth quarter of 2005 reflecting recent low
levels of charge-offs, the stability of the real estate market and the resulting stability of our
overall loan quality. At December 31, 2005, the allowance for loan losses as a percentage of total
loans was 0.18%, which, given the primary emphasis of our lending practices and the current market
conditions, we consider to be at an acceptable level. The slight increase in the allowance for loan
losses during 2005 was due to the minimal provision and a net recovery during 2005.
Although we believe that we have established and maintained the allowance for loan losses at
adequate levels, additions may be necessary if future economic and other conditions differ
substantially from the current operating environment. Although management uses the best
information available, the level of the allowance for loan losses remains an estimate that is
subject to significant judgment and short-term change. See “Management’s Discussion and Analysis of
Financial Condition and Results of Operations — Comparison of Operating Results for the Years
Ended December 31, 2005 and 2004— Provision for Loan Losses.”
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The following table presents our allocation of the allowance for loan losses by loan category and
the percentage of loans in each category to total loans at December 31, 2005, 2004, 2003, 2002, and
2001.
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Investment Activities
The Board of Directors reviews and approves our investment policy on an annual basis. The Chief
Executive Officer, Chief Operating Officer and Investment Officer, as authorized by the Board of
Directors, implement this policy. The Board of Directors reviews our investment activity on a
monthly basis.
Our investment policy is designed primarily to manage the interest rate sensitivity of our assets
and liabilities, to generate a favorable return without incurring undue interest rate and credit
risk, to complement our lending activities and to provide and maintain liquidity within established
guidelines. In establishing our investment strategies, we consider our interest rate sensitivity
position, the types of securities to be held, liquidity and other factors. We have authority to
invest in various types of assets, including U.S. Treasury obligations, securities of various
federal agencies, mortgage-backed securities, certain time deposits of insured banks and savings
institutions, certain bankers’ acceptances, repurchase agreements, loans of federal funds, and,
subject to certain limits, corporate debt and equity securities, commercial paper and mutual funds.
Our investment policy currently does not authorize participation in hedging programs, options or
futures transactions or interest rate swaps, and also prohibits the purchase of non-investment
grade bonds. In the future we may amend our policy to allow us to engage in hedging transactions.
Our investment policy also provides that we will not engage in any practice that the Federal
Financial Institutions Examination Council considers being an unsuitable investment practice. In
addition, the policy provides that we shall maintain a primary liquidity ratio, which consists of
investments in cash, cash in banks, Federal funds sold, securities with remaining maturities of
less than five years and adjustable-rate mortgage-backed securities repricing within one year, in
an amount equal to at least 4% of total deposits and short-term borrowings. At December 31, 2005,
our primary liquidity ratio was 38.0%. For information regarding the carrying values, yields and
maturities of our investment securities and mortgage-backed securities, see “— Carrying Values,
Rates and Maturities.”
Investment Securities. We classify investment securities as held to maturity or available for
sale at the date of purchase. Held to maturity securities are reported at cost, adjusted for
amortization of premium and accretion of discount. We have both the ability and positive intent to
hold these securities to maturity. Available for sale securities are reported at fair market
value. We currently have no securities classified as trading.
During 2005, we purchased $4.31 billion of investment securities compared with $2.11 billion during
2004, reflecting the investment of a portion of the net proceeds from our second-step conversion.
Of the agency securities held as of December 31, 2005, $1.72 billion have step-up features where
the interest rate is increased on scheduled future dates. These securities have call options that
are generally effective prior to the initial rate increase but after an initial non-call period of
three months to one year. The rate increases are at least one percent per adjustment and are fixed
over the life of the security. Approximately $1.10 billion of these step-up notes will reset or
mature within two years. Also included in investment securities as of December 31, 2005 were $1.42
billion of agency securities with initial periods to maturity of less than two years. The aggregate
$2.52 billion of step-up notes and short-term securities maturing within two years assists in our
management of interest rate risk.
Mortgage-backed Securities. All of our mortgage-backed securities are directly or indirectly
insured or guaranteed by GNMA, FannieMae or FreddieMac. We classify mortgage-backed securities as
held to maturity or available for sale at the date of purchase based on our assessment of our
internal liquidity requirements. Held to maturity mortgage-backed securities are reported at cost,
adjusted for amortization
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of premium and accretion of discount. We have both the ability and positive intent to hold these
investments to maturity. Available for sale mortgage-backed securities are reported at fair market
value. We currently have no mortgage-backed securities classified as trading.
At December 31, 2005, mortgage-backed securities classified as held to maturity totaled $4.39
billion, or 15.6% of total assets, while $2.52 billion, or 9.0% of total assets, were classified as
available for sale. At December 31, 2005, the mortgage-backed securities portfolio had a
weighted-average rate of 4.57% and a market value of approximately $6.81 billion. Of the
mortgage-backed securities we held at December 31, 2005, $3.21 billion, or 46.4% of total
mortgage-backed securities, had fixed rates and $3.70 billion, or 53.6% of total mortgage-backed
securities, had adjustable rates. Our mortgage-backed securities portfolio includes real estate
mortgage investment conduits (“REMICs”), which are securities derived by reallocating cash flows
from mortgage pass-through securities or from pools of mortgage loans held by a trust. REMICs are a
form of, and are often referred to as, collateralized mortgage obligations (“CMOs”). At December
31, 2005, we held $452.6 million of fixed-rate REMICs, which constituted 6.6% of our
mortgage-backed securities portfolio. Mortgage-backed security purchases totaled $3.28 billion
during 2005 compared with $2.20 billion during 2004. 93.1% of the mortgage-backed securities
purchased during 2005 were variable-rate or hybrid instruments in order to manage our interest rate
risk. Purchases of mortgage-backed securities may decline in the future to offset any significant
increase in demand for one- to four-family mortgage loans.
Mortgage-backed securities generally yield less than the loans that underlie such securities
because of the cost of payment guarantees or credit enhancements that reduce credit risk. However,
mortgage-backed securities are more liquid than individual mortgage loans and may be used to
collateralize certain borrowings. In general, mortgage-backed securities issued or guaranteed by
GNMA, FannieMae and FreddieMac are weighted at no more than 20% for risk-based capital purposes,
compared to the 50% risk-weighting assigned to most non-securitized residential mortgage loans.
While mortgage-backed securities carry a reduced credit risk as compared to whole loans, they
remain subject to the risk of a fluctuating interest rate environment. Along with other factors,
such as the geographic distribution of the underlying mortgage loans, changes in interest rates may
alter the prepayment rate of those mortgage loans and affect both the prepayment rates and value of
mortgage-backed securities. At December 31, 2005, we did not own any principal-only, REMIC
residuals or other higher risk securities.
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The following table presents our investment securities activity for the periods indicated.
The following table presents our mortgage-backed securities activity for the periods
indicated.
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The following table presents the composition of our money market investments, investment securities
and mortgage-backed securities portfolios in dollar amount and in percentage of each investment
type at the dates indicated. It also presents the coupon type for the mortgage-backed securities
portfolio.
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Carrying Values, Rates and Maturities. The table below presents information regarding the
carrying values, weighted average rates and contractual maturities of our money market investments,
investment securities and mortgage-backed securities at December 31, 2005. Mortgage-backed
securities are presented by issuer and by coupon type. Equity securities have been excluded from
this table.
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Sources of Funds
General. Customer deposits, borrowed funds, scheduled amortization and prepayments of mortgage
loans and mortgage-backed securities, maturities and calls of investment securities and funds
provided by operations are our primary sources of funds for use in lending, investing and for other
general purposes. Retail deposits generated through our branch network and longer-term wholesale
borrowings are our primary means of funding our growth initiatives. See “Management’s Discussion
and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”
Deposits. We offer a variety of deposit accounts having a range of interest rates and terms. We
currently offer passbook and statement savings accounts, interest-bearing transaction accounts
including our High Value Checking product and traditional NOW accounts, checking accounts, money
market accounts and time deposits. We also offer IRA accounts and qualified retirement plans.
Deposit flows are influenced significantly by general and local economic conditions, changes in
prevailing market interest rates, pricing of deposits and competition. In determining our deposit
rates, we consider local competition, U.S. Treasury securities offerings and the rates charged on
other sources of funds. Our deposits are primarily obtained from market areas surrounding our
offices. We rely primarily on paying competitive rates, providing strong customer service and
maintaining long-standing relationships with customers to attract and retain these deposits. We do
not use brokers to obtain deposits and currently do not accept new deposits via the internet.
During the second-half of 2005, we experienced significant competitive pressure and extreme pricing
of short-term deposits in the New York metropolitan area. We believed the price of borrowed funds
was more economical and reflective of current rates than the price of deposits and, therefore,
priced our deposits at a competitive, but prudent rate.
Total deposits decreased $94.0 million during 2005 reflecting the consolidation of the $145.8
million deposit of Hudson City, MHC, which was added to our capital as part of the second-step
conversion, and the use of approximately $229.9 million of customer deposits to purchase stock in
our second-step conversion. Total deposit funding provided by core deposits (defined as non-time
deposit accounts) represented approximately 45.8% of total deposits as of December 31, 2005
compared with 54.1% as of December 31, 2004. The balance of core deposits decreased $995.1 million
during 2005 as customers shifted deposits to higher costing short-term time deposits. The aggregate
balance in our time deposit accounts was $6.17 billion as of December 31, 2005 compared with $5.27
billion as of December 31, 2004. Time deposits with remaining maturities of less than one year
amounted to $4.98 billion at December 31, 2005 compared with $3.71 billion at December 31, 2004,
reflecting the shift of customer deposits to short-term time deposits.
The balance in our High Value Checking account product, introduced in April 2002, was $3.52
billion, representing 67.5% of core deposits at December 31, 2005. We view our interest-bearing
High Value Checking account as an attractive alternative to cash management accounts offered by
brokerage firms. This account offers unlimited check writing, no charge on-line banking, no-charge
bill payment and debit card availability as part of the product, and pays an interest rate
generally above competitive market rates. We also offer a Business Money Market Account that has
similar features and benefits to our High Value Checking account. This product, in conjunction with
our regular business checking account, provides small business customers in our market area
competitive returns and operating flexibility. Early in 2006 we introduced a high yielding money
market checking account product, which we view as a complementary alternative investment to our
High Value Checking account. This new product will pay a slightly higher rate than our High Value
Checking account with fewer features.
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See “Management’s Discussion and Analysis of Financial Condition and Results of Operations —
Analysis of Net Interest Income” for information relating to the average balances and costs of our
deposit accounts for the years ended December 31, 2005, 2004 and 2003.
The following table presents our deposit activity for the periods indicated:
At December 31, 2005, we had $1.38 billion in time deposits with balances of $100,000 and over
maturing as follows:
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The following table presents the distribution of our deposit accounts at the dates indicated
by dollar amount and percent of portfolio, and the weighted average nominal interest rate on each
category of deposits.
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The following table presents, by rate category, the amount of our time deposit accounts
outstanding at December 31, 2005, 2004 and 2003.
The following table presents, by rate category, the remaining period to maturity of time
deposit accounts outstanding as of December 31, 2005.
Borrowings. Hudson City enters into sales of securities under agreements to repurchase
with selected brokers and the Federal Home Loan Bank of New York (“FHLB”). These agreements are
recorded as financing transactions as Hudson City maintains effective control over the transferred
securities. The dollar amount of the securities underlying the agreements continues to be carried
in Hudson City’s securities portfolio. The obligations to repurchase the securities are reported
as a liability in the consolidated statements of financial condition. The securities underlying the
agreements are delivered to the party with whom each transaction is executed. They agree to resell
to Hudson City the same securities at the maturity or call of the agreement. Hudson City retains
the right of substitution of the underlying securities throughout the terms of the agreements.
Hudson City has also obtained advances from the FHLB, which are generally secured by a blanket lien
against our mortgage portfolio. Borrowings with the FHLB are generally limited to approximately
twenty times the amount of FHLB stock owned.
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Borrowed funds at December 31 are summarized as follows:
At December 31, 2005, borrowed funds had scheduled maturities and potential call dates as
indicated below. Substantially all of our borrowed funds are callable at the discretion of the
issuer. These call features are generally quarterly, after an initial non-call period of three
months to five years from the date of borrowing.
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The amortized cost and fair value of the underlying securities used as collateral for
securities sold under agreements to repurchase, the average balances and the maximum outstanding at
any month-end at or for the years ended December 31, 2005 and 2004 are as follows:
The average balances of our advances from the FHLB during 2005 and 2004 were $2.47 billion and
$1.92 billion, respectively, and the maximum FHLB advances outstanding during 2005 and 2004 were
$3.45 billion and $1.95 billion, respectively.
Subsidiaries
Hudson City Savings has two wholly owned and consolidated subsidiaries: HudCiti Service Corporation
and HC Value Broker Services, Inc. HudCiti Service Corporation, which qualifies as a New Jersey
investment company, has one wholly owned and consolidated subsidiary: Hudson City Preferred
Funding Corporation. Hudson City Preferred Funding qualifies as a real estate investment trust,
pursuant to the Internal Revenue Code of 1986, as amended, and had $6.22 billion of residential
mortgage loans outstanding at December 31, 2005.
HC Value Broker Services, Inc., whose primary operating activity is the referral of insurance
applications, formed a strategic alliance that jointly markets insurance products with Savings Bank
Life Insurance of Massachusetts. HC Value Broker Services offers customers access to a variety of
life insurance products.
Personnel
As of December 31, 2005, we had 1,019 full-time employees and 131 part-time employees. Employees
are not represented by a collective bargaining unit and we consider our relationship with our
employees to be good.
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REGULATION OF HUDSON CITY SAVINGS BANK AND HUDSON CITY BANCORP
General
Hudson City Savings has been a federally chartered savings bank since January 1, 2004 when it
converted from a New Jersey chartered savings bank. Its deposit accounts are insured up to
applicable limits by the Federal Deposit Insurance Corporation (“FDIC”) under the Bank Insurance
Fund (“BIF”). Under its charter, Hudson City Savings is subject to extensive regulation,
examination and supervision by the Office of Thrift Supervision as its chartering agency, and by
the FDIC as the deposit insurer. Hudson City Bancorp is a unitary savings and loan holding company
regulated, examined and supervised by the Office of Thrift Supervision. Each of Hudson City Bancorp
and Hudson City Savings must file reports with the Office of Thrift Supervision concerning its
activities and financial condition, and must obtain regulatory approval from the Office of Thrift
Supervision prior to entering into certain transactions, such as mergers with, or acquisitions of,
other depository institutions. The Office of Thrift Supervision will conduct periodic examinations
to assess Hudson City Bancorp and Hudson City Savings Bank’s compliance with various regulatory
requirements. The Office of Thrift Supervision has primary enforcement responsibility over
federally chartered savings banks and has substantial discretion to impose enforcement action on an
institution that fails to comply with applicable regulatory requirements, particularly with respect
to its capital requirements. In addition, the FDIC has the authority to recommend to the Director
of the Office of Thrift Supervision that enforcement action be taken with respect to a particular
federally chartered savings bank and, if action is not taken by the Director, the FDIC has
authority to take such action under certain circumstances.
This regulation and supervision establishes a comprehensive framework of activities in which a
federal savings bank can engage and is intended primarily for the protection of the deposit
insurance fund and depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of assets and the
establishment of adequate loan loss reserves for regulatory purposes. Any change in such laws and
regulations, whether by the Office of Thrift Supervision, the FDIC or through legislation, could
have a material adverse impact on Hudson City Bancorp and Hudson City Savings and their operations
and stockholders.
Federally Chartered Savings Bank Regulation
Activity Powers. Hudson City Savings derives its lending, investment and other activity powers
primarily from the Home Owners’ Loan Act, as amended, commonly referred to as HOLA, and the
regulations of the Office of Thrift Supervision thereunder. Under these laws and regulations,
federal savings banks, including Hudson City Savings, generally may invest in:
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Hudson City Savings may also establish service corporations that may engage in activities not
otherwise permissible for Hudson City Savings, including certain real estate equity investments and
securities and insurance brokerage activities. These investment powers are subject to various
limitations, including (1) a prohibition against the acquisition of any corporate debt security
that is not rated in one of the four highest rating categories, (2) a limit of 400% of an
association’s capital on the aggregate amount of loans secured by non-residential real estate
property, (3) a limit of 20% of an association’s assets on commercial loans, with the amount of
commercial loans in excess of 10% of assets being limited to small business loans, (4) a limit of
35% of an association’s assets on the aggregate amount of consumer loans and acquisitions of
certain debt securities, (5) a limit of 5% of assets on non-conforming loans (loans in excess of
the specific limitations of HOLA), and (6) a limit of the greater of 5% of assets or an
association’s capital on certain construction loans made for the purpose of financing what is or is
expected to become residential property.
Capital Requirements. The Office of Thrift Supervision capital regulations require federally
chartered savings banks to meet three minimum capital ratios: a 1.5% tangible capital ratio, a 4%
(3% if the savings bank received the highest rating on its most recent examination) leverage (core
capital) ratio and an 8% total risk-based capital ratio. In assessing an institution’s capital
adequacy, the Office of Thrift Supervision takes into consideration not only these numeric factors
but also qualitative factors as well, and has the authority to establish higher capital
requirements for individual institutions where necessary. Hudson City Savings, as a matter of
prudent management, targets as its goal the maintenance of capital ratios which exceed these
minimum requirements and that are consistent with Hudson City Savings’ risk profile. At December
31, 2005, Hudson City Savings exceeded each of its capital requirements as shown in the following
table:
The Federal Deposit Insurance Corporation Improvement Act, or FDICIA, requires that the Office
of Thrift Supervision and other federal banking agencies revise their risk-based capital standards,
with appropriate transition rules, to ensure that they take into account interest rate risk, or
IRR, concentration of risk and the risks of non-traditional activities. The Office of Thrift
Supervision adopted regulations, effective January 1, 1994, that set forth the methodology for
calculating an IRR component to be incorporated into the Office of Thrift Supervision risk-based
capital regulations. On May 10, 2002, the Office of Thrift Supervision adopted an amendment to its
capital regulations which eliminated the IRR component of the risk-based capital requirement.
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Pursuant to the amendment, the Office of Thrift Supervision will continue to monitor the IRR of
individual institutions through the Office of Thrift Supervision requirements for IRR management,
the ability of the Office of Thrift Supervision to impose individual minimum capital requirements on
institutions that exhibit a high degree of IRR, and the requirements of Thrift Bulletin 13a, which
provides guidance on the management of IRR and the responsibility of boards of directors in that
area.
The Office of Thrift Supervision continues to monitor the IRR of individual institutions through
analysis of the change in net portfolio value, or NPV. NPV is defined as the net present value of
the expected future cash flows of an entity’s assets and liabilities and, therefore, hypothetically
represents the value of an institution’s net worth. The Office of Thrift Supervision has also used
this NPV analysis as part of its evaluation of certain applications or notices submitted by thrift
institutions. The Office of Thrift Supervision, through its general oversight of the safety and
soundness of savings associations, retains the right to impose minimum capital requirements on
individual institutions to the extent the institution is not in compliance with certain written
guidelines established by the Office of Thrift Supervision regarding NPV analysis. The Office of
Thrift Supervision has not imposed any such requirements on Hudson City Savings.
Safety and Soundness Standards. Pursuant to the requirements of FDICIA, as amended by the
Riegle Community Development and Regulatory Improvement Act of 1994, each federal banking agency,
including the Office of Thrift Supervision, has adopted guidelines establishing general standards
relating to internal controls, information and internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees
and benefits. In general, the guidelines require, among other things, appropriate systems and
practices to identify and manage the risks and exposures specified in the guidelines. The
guidelines prohibit excessive compensation as an unsafe and unsound practice and describe
compensation as excessive when the amounts paid are unreasonable or disproportionate to the
services performed by an executive officer, employee, director, or principal stockholder.
In addition, the Office of Thrift Supervision adopted regulations to require a savings bank that is
given notice by the Office of Thrift Supervision that it is not satisfying any of such safety and
soundness standards to submit a compliance plan to the Office of Thrift Supervision. If, after
being so notified, a savings bank fails to submit an acceptable compliance plan or fails in any
material respect to implement an accepted compliance plan, the Office of Thrift Supervision may
issue an order directing corrective and other actions of the types to which a significantly
undercapitalized institution is subject under the “prompt corrective action” provisions of FDICIA.
If a savings bank fails to comply with such an order, the Office of Thrift Supervision may seek to
enforce such an order in judicial proceedings and to impose civil monetary penalties.
Prompt Corrective Action. FDICIA also established a system of prompt corrective action to
resolve the problems of undercapitalized institutions. Under this system, the bank regulators are
required to take certain, and authorized to take other, supervisory actions against
undercapitalized institutions, based upon five categories of capitalization which FDICIA created:
“well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized”
and “critically capitalized.” The severity of the action authorized or required to be taken under
the prompt corrective action regulations increases as a bank’s capital decreases within the three
undercapitalized categories. All banks are prohibited from paying dividends or other capital
distributions or paying management fees to any controlling person if, following such distribution,
the bank would be undercapitalized. The Office of Thrift Supervision is required to monitor
closely the condition of an undercapitalized bank and to restrict the growth of its assets.
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An undercapitalized bank is required to file a capital restoration plan within 45 days of the date
the bank receives notices that it is within any of the three undercapitalized categories, and the
plan must be guaranteed by any parent holding company. The aggregate liability of a parent holding
company is limited to the lesser of:
(1) an amount equal to five percent of the bank’s total assets at the time it became
“undercapitalized; and
(2) the amount that is necessary (or would have been necessary) to bring the bank into
compliance with all capital standards applicable with respect to such bank as of the time it
fails to comply with the plan.
If a bank fails to submit an acceptable plan, it is treated as if it were “significantly
undercapitalized.” Banks that are significantly or critically undercapitalized are subject to a
wider range of regulatory requirements and restrictions. Under the Office of Thrift Supervision
regulations, generally, a federally chartered savings bank is treated as well capitalized if its
total risk-based capital ratio is 10% or greater, its Tier 1 risk-based capital ratio is 6% or
greater, and its leverage ratio is 5% or greater, and it is not subject to any order or directive
by the Office of Thrift Supervision to meet a specific capital level. As of December 31, 2005,
Hudson City Savings was considered “well capitalized” by the Office of Thrift Supervision.
Insurance Activities. Hudson City Savings is generally permitted to engage in certain activities
through its subsidiaries. However, the federal banking agencies have adopted regulations
prohibiting depository institutions from conditioning the extension of credit to individuals upon
either the purchase of an insurance product or annuity or an agreement by the consumer not to
purchase an insurance product or annuity from an entity that is not affiliated with the depository
institution. The regulations also require prior disclosure of this prohibition to potential
insurance product or annuity customers.
Deposit Insurance. Pursuant to FDICIA, the FDIC established a system for setting deposit
insurance premiums based upon the risks a particular bank or savings association posed to its
deposit insurance funds. Under the risk-based deposit insurance assessment system, the FDIC
assigns an institution to one of three capital categories based on the institution’s financial
information as of its most recent quarterly financial report filed with the applicable bank
regulatory agency prior to the commencement of the assessment period. The three capital categories
are (1) well-capitalized, (2) adequately capitalized and (3) undercapitalized. The FDIC also
assigns an institution to one of three supervisory subcategories within each capital group. The
FDIC also assigns an institution to a supervisory subgroup based on a supervisory evaluation
provided to the FDIC by the institution’s primary federal regulator and information that the FDIC
determines to be relevant to the institution’s financial condition and the risk posed to the
deposit insurance funds.
An institution’s assessment rate depends on the capital category and supervisory category to which
it is assigned. Under the final risk-based assessment system, there are nine assessment risk
classifications (i.e., combinations of capital groups and supervisory subgroups) to which different
assessment rates are applied. Assessment rates for deposit insurance currently range from 0 basis
points to 27 basis points. The capital and supervisory subgroup to which an institution is
assigned by the FDIC is confidential and may not be disclosed. The assessment rates for our BIF
assessable deposits are zero basis points. If the FDIC determines that assessment rates should be
increased, institutions in all risk categories could be affected. The FDIC has exercised this
authority several times in the past and could raise insurance assessment rates in the future.
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Under the Deposit Insurance Funds Act of 1996 (“Funds Act”), the assessment base for the payments
on the bonds (“FICO bonds”) issued in the late 1980’s by the Financing Corporation to recapitalize
the now defunct Federal Savings and Loan Insurance Corporation was expanded to include, beginning
January 1, 1997, the deposits of BIF-insured institutions, such as Hudson City Savings. Our total
expense in 2005 for the assessment for deposit insurance and the FICO payments was $1.7 million.
Under the FDIA, the FDIC may terminate the insurance of an institution’s deposits upon a finding
that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC. The management of Hudson City Savings does not know of any
practice, condition or violation that might lead to termination of deposit insurance.
Transactions with Affiliates of Hudson City Savings. Hudson City Savings is subject to the
affiliate and insider transaction rules set forth in Sections 23A, 23B, 22(g) and 22(h) of the
Federal Reserve Act (“FRA”), Regulation W issued by the Federal Reserve Board (“FRB”), as well as
additional limitations as adopted by the Director of the Office of Thrift Supervision. Office of
Thrift Supervision regulations regarding transactions with affiliates conform to Regulation W.
These provisions, among other things, prohibit or limit a savings bank from extending credit to, or
entering into certain transactions with, its affiliates (which for Hudson City Savings would
include Hudson City Bancorp) and principal stockholders, directors and executive officers of Hudson
City Savings.
In addition, the Office of Thrift Supervision regulations include additional restrictions on
savings banks under Section 11 of HOLA, including provisions prohibiting a savings bank from making
a loan to an affiliate that is engaged in non-bank holding company activities and provisions
prohibiting a savings association from purchasing or investing in securities issued by an affiliate
that is not a subsidiary. Office of Thrift Supervision regulations also include certain specific
exemptions from these prohibitions. The FRB and the Office of Thrift Supervision require each
depository institution that is subject to Sections 23A and 23B to implement policies and procedures
to ensure compliance with Regulation W and the Office of Thrift Supervision regulations regarding
transactions with affiliates.
Section 402 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) prohibits the extension of
personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley). The
prohibition, however, does not apply to mortgages advanced by an insured depository institution,
such as Hudson City Savings, that are subject to the insider lending restrictions of Section 22(h)
of the FRA.
Privacy Standards. Hudson City Savings is subject to Office of Thrift Supervision regulations
implementing the privacy protection provisions of the Gramm-Leach-Bliley Act. These regulations
require Hudson City Savings to disclose its privacy policy, including identifying with whom it
shares “non-public personal information,” to customers at the time of establishing the customer
relationship and annually thereafter.
The regulations also require Hudson City Savings to provide its customers with initial and annual
notices that accurately reflect its privacy policies and practices. In addition, Hudson City
Savings is required to provide its customers with the ability to “opt-out” of having Hudson City
Savings share their non-public personal information with unaffiliated third parties before they can
disclose such information, subject to certain exceptions. The implementation of these regulations
did not have a material adverse effect on Hudson City Savings.
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Hudson City Savings is subject to regulatory guidelines establishing standards for safeguarding
customer information. These regulations implement certain provisions of Gramm-Leach. The
guidelines describe the agencies’ expectations for the creation, implementation and maintenance of
an information security program, which would include administrative, technical and physical
safeguards appropriate to the size and complexity of the institution and the nature and scope of
its activities. The standards set forth in the guidelines are intended to ensure the security and
confidentiality of customer records and information, protect against any anticipated threats or
hazards to the security or integrity of such records and protect against unauthorized access to or
use of such records or information that could result in substantial harm or inconvenience to any
customer.
Community Reinvestment Act. Under the Community Reinvestment Act (“CRA”), as implemented by the
Office of Thrift Supervision regulations, any federally chartered savings bank, including Hudson
City Savings, has a continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or programs for financial
institutions nor does it limit an institution’s discretion to develop the types of products and
services that it believes are best suited to its particular community. The CRA requires the Office
of Thrift Supervision, in connection with its examination of a federally chartered savings bank, to
assess the depository institution’s record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications by such institution.
Current CRA regulations rate an institution based on its actual performance in meeting community
needs. In particular, the evaluation system focuses on three tests:
The CRA also requires all institutions to make public disclosure of their CRA ratings. Hudson City
Savings has received a “satisfactory” rating in its most recent CRA examination. The federal
banking agencies adopted regulations implementing the requirements under Gramm-Leach that insured
depository institutions publicly disclose certain agreements that are in fulfillment of the CRA.
Hudson City Savings has no such agreements in place at this time.
Loans to One Borrower. Under the HOLA, savings banks are generally subject to the national bank
limits on loans to one borrower. Generally, savings banks may not make a loan or extend credit to
a single or related group of borrowers in excess of 15% of the institution’s unimpaired capital and
unimpaired surplus. Additional amounts may be loaned, not in excess of 10% of unimpaired capital
and unimpaired surplus, if such loans or extensions of credit are secured by readily-marketable
collateral. Hudson City Savings is in compliance with applicable loans to one borrower
limitations. At December 31, 2005, Hudson City Savings’ largest aggregate amount of loans to one
borrower totaled $2.9 million. All of the loans for the largest borrower were performing in
accordance with their terms and the borrower had no affiliation with Hudson City Savings.
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Qualified Thrift Lender (“QTL”) Test. The HOLA requires federal savings banks to meet a QTL
test. Under the QTL test, a savings bank is required to maintain at least 65% of its “portfolio
assets” (total assets less (1) specified liquid assets up to 20% of total assets, (2) intangibles,
including goodwill, and (3) the value of property used to conduct business) in certain “qualified
thrift investments” (primarily residential mortgages and related investments, including certain
mortgage-backed securities, credit card loans, student loans, and small business loans) on a
monthly basis during at least 9 out of every 12 months. As of December 31, 2005, Hudson City
Savings held 79.5% of its portfolio assets in qualified thrift investments and had more than 75% of
its portfolio assets in qualified thrift investments for each of the 12 months ending December 31,
2005. Therefore, Hudson City Savings qualified under the QTL test.
A savings bank that fails the QTL test and does not convert to a bank charter generally will be
prohibited from: (1) engaging in any new activity not permissible for a national bank, (2) paying
dividends not permissible under national bank regulations, and (3) establishing any new branch
office in a location not permissible for a national bank in the institution’s home state. In
addition, if the institution does not requalify under the QTL test within three years after failing
the test, the institution would be prohibited from engaging in any activity not permissible for a
national bank and would have to repay any outstanding advances from the FHLB as promptly as
possible.
Limitation on Capital Distributions. The Office of Thrift Supervision regulations impose
limitations upon certain capital distributions by federal savings banks, such as certain cash
dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of
another institution in a cash out merger and other distributions charged against capital.
The Office of Thrift Supervision regulates all capital distributions by Hudson City Savings
directly or indirectly to Hudson City Bancorp, including dividend payments. As the subsidiary of a
savings and loan holding company, Hudson City Savings currently must file a notice with the Office
of Thrift Supervision at least 30 days prior to each capital distribution. However, if the total
amount of all capital distributions (including each proposed capital distribution) for the
applicable calendar year exceeds net income for that year to date plus the retained net income for
the preceding two years, then Hudson City Savings must file an application to receive the approval
of the Office of Thrift Supervision for a proposed capital distribution.
Hudson City Savings may not pay dividends to Hudson City Bancorp if, after paying those dividends,
it would fail to meet the required minimum levels under risk-based capital guidelines and the
minimum leverage and tangible capital ratio requirements or the Office of Thrift Supervision
notified Hudson City Savings Bank that it was in need of more than normal supervision. Under the
Federal Deposit Insurance Act, or FDIA, an insured depository institution such as Hudson City
Savings is prohibited from making capital distributions, including the payment of dividends, if,
after making such distribution, the institution would become “undercapitalized” (as such term is
used in the FDIA). Payment of dividends by Hudson City Savings also may be restricted at any time
at the discretion of the appropriate regulator if it deems the payment to constitute an unsafe and
unsound banking practice.
In addition, Hudson City Savings may not declare or pay cash dividends on or repurchase any of its
shares of common stock if the effect thereof would cause stockholders’ equity to be reduced below
the amounts required for the liquidation account which was established as a result of Hudson City
Savings’ conversion to stock holding company structure.
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Liquidity. Hudson City Savings maintains sufficient liquidity to ensure its safe and sound
operation, in accordance with Office of Thrift Supervision regulations.
Assessments. The Office of Thrift Supervision charges assessments to recover the cost of
examining federal savings banks and their affiliates. These assessments are based on three
components: the size of the institution on which the basic assessment is based; the institution’s
supervisory condition, which results in an additional assessment based on a percentage of the basic
assessment for any savings institution with a composite rating of 3, 4 or 5 in its most recent
safety and soundness examination; and the complexity of the institution’s operations, which results
in an additional assessment based on a percentage of the basic assessment for any savings
institution that managed over $1.00 billion in trust assets, serviced for others loans aggregating
more than $1.00 billion, or had certain off-balance sheet assets aggregating more than $1.00
billion. Effective July 1, 2004, the Office of Thrift Supervision adopted a final rule replacing
examination fees for savings and loan holding companies with semi-annual assessments. The Office
of Thrift Supervision phased in the assessments at a rate of 25% of the first semiannual assessment
on July 1, 2004, 50% of the second semiannual assessment on January 1, 2005 and 100% of the third
semiannual assessment on July 1, 2005. Hudson City Savings paid an assessment of $2.6 million in
2005.
Branching. The Office of Thrift Supervision regulations authorize federally chartered savings
banks to branch nationwide to the extent allowed by federal statute. This permits federal savings
and loan associations with interstate networks to more easily diversify their loan portfolios and
lines of business geographically. Office of Thrift Supervision authority preempts any state law
purporting to regulate branching by federal savings associations.
Anti-Money Laundering and Customer Identification
Hudson City Savings is subject to Office of Thrift Supervision regulations implementing the Uniting
and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism Act of 2001, or the USA PATRIOT Act. The USA PATRIOT Act gives the federal government
powers to address terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing, and broadened anti-money laundering
requirements. By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT takes
measures intended to encourage information sharing among bank regulatory agencies and law
enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a
broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions,
money transfer agents and parties registered under the Commodity Exchange Act.
Title III of the USA PATRIOT Act and the related Office of Thrift Supervision regulations impose
the following requirements with respect to financial institutions:
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Federal Home Loan Bank System
Hudson City Savings is a member of the FHLB system, which consists of twelve regional FHLBs, each
subject to supervision and regulation by the Federal Housing Finance Board, or FHFB. The FHLB
provides a central credit facility primarily for member thrift institutions as well as other
entities involved in home mortgage lending. It is funded primarily from proceeds derived from the
sale of consolidated obligations of the FHLBs. It makes loans to members (i.e., advances) in
accordance with policies and procedures, including collateral requirements, established by the
respective boards of directors of the FHLBs. These policies and procedures are subject to the
regulation and oversight of the FHFB. All long-term advances are required to provide funds for
residential home financing. The FHFB has also established standards of community or investment
service that members must meet to maintain access to such long-term advances.
Effective December 1, 2005, the FHLB-NY implemented a new capital plan. The new capital plan
resulted in an automatic exchange of shares of FHLB-NY stock held by members for shares of FHLB-NY
Class B stock and changed the member’s minimum stock investment requirements. The Class B stock
has a par value of $100 per share and is redeemable upon five years notice, subject to certain
conditions. The Class B stock has two subclasses, one for membership stock purchase requirements
and the other for activity-based stock purchase requirements. The minimum stock investment
requirement in the FHLB-NY Class B stock is the sum of the membership stock purchase requirement,
determined on an annual basis at the end of each calendar year, and the activity-based stock
purchase requirement, determined on a daily basis. For Hudson City Savings, the membership stock
purchase requirement is 0.2% of the Mortgage-Related Assets, as defined by the FHLB-NY, which
consists principally of residential mortgage loans and mortgage-backed securities, including CMOs
and REMICs, held by Hudson City Savings. The activity-based stock purchase requirement for Hudson
City Savings is equal to the sum of: (1) 4.5% of outstanding borrowing from the FHLB-NY; (2) 4.5%
of the outstanding principal balance of Acquired Member Assets, as defined by the FHLB-NY, and
delivery commitments for Acquired Member Assets; (3) a specified dollar amount related to certain
off-balance sheet items, which for Hudson City Savings is zero; and (4) a specified percentage
ranging from 0 to 5% of the carrying value on the FHLB-NY’s balance sheet of derivative contracts
between the FHLB-NY and its members, which for Hudson City Savings is also zero. The FHLB-NY can
adjust the specified percentages and dollar amount from time to time within the ranges established
by the FHLB-NY capital plan. Prior to December 1, 2005, Hudson City Savings was required to
acquire and hold shares of capital stock in the FHLB-NY in an amount at least equal to 1% of the
aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the
beginning of each year or 5% of its outstanding borrowings from the FHLB-NY, whichever was greater.
At December 31, 2005, the amount of FHLB stock held by us satisfies
the requirements of this new plan.
Federal Reserve System
FRB regulations require federally chartered savings banks to maintain non-interest-earning cash
reserves against their transaction accounts (primarily NOW and demand deposit accounts). A reserve
of 3% is to be maintained against aggregate transaction accounts between $7 million and $47.6
million (subject to adjustment by the FRB) plus a reserve of 10% (subject to adjustment by the FRB
between 8% and 14%) against that portion of total transaction accounts in excess of $47.6 million.
The first $7 million of otherwise reservable balances (subject to adjustment by the FRB) is exempt
from the reserve requirements. Hudson City Savings is in compliance with the foregoing
requirements. Because required
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reserves must be maintained in the form of either vault cash, a non-interest-bearing account at a
Federal Reserve Bank or a pass-through account as defined by the FRB, the effect of this reserve
requirement is to reduce Hudson City Savings’ interest-earning assets. FHLB system members are
also authorized to borrow from the Federal Reserve “discount window,” but FRB regulations require
institutions to exhaust all FHLB sources before borrowing from a Federal Reserve Bank.
Federal Holding Company Regulation
Hudson City Bancorp is a unitary savings and loan holding company within the meaning of the HOLA.
As such, Hudson City Bancorp is registered with the Office of Thrift Supervision and is subject to
the Office of Thrift Supervision regulation, examination, supervision and reporting requirements.
In addition, the Office of Thrift Supervision has enforcement authority over Hudson City Bancorp
and its savings bank subsidiary. Among other things, this authority permits the Office of Thrift
Supervision to restrict or prohibit activities that are determined to be a serious risk to the
subsidiary savings bank.
Restrictions Applicable to New Savings and Loan Holding Companies. Gramm-Leach also restricts the
powers of new unitary savings and loan holding companies. Under Gramm-Leach, all unitary savings
and loan holding companies formed after May 4, 1999, such as Hudson City Bancorp, are limited to
financially related activities permissible for bank holding companies, as defined under
Gramm-Leach. Accordingly, Hudson City Bancorp’s activities are restricted to:
Permissible activities which are deemed to be financial in nature or incidental thereto under
section 4(k) of the BHC Act include:
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In addition, Hudson City Bancorp cannot be acquired or acquire a company unless the acquirer or
target, as applicable, is engaged solely in financial activities.
Restrictions Applicable to All Savings and Loan Holding Companies. Federal law prohibits a savings
and loan holding company, including Hudson City Bancorp, directly or indirectly, from acquiring:
A savings and loan holding company may not acquire as a separate subsidiary an insured institution
that has a principal office outside of the state where the principal office of its subsidiary
institution is located, except:
If the savings institution subsidiary of a federal mutual holding company fails to meet the QTL
test set forth in Section 10(m) of the HOLA and regulations of the Office of Thrift Supervision,
the holding company must register with the FRB as a bank holding company under the BHC Act within
one year of the savings institution’s failure to so qualify.
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The HOLA prohibits a savings and loan holding company (directly or indirectly, or through one or
more subsidiaries) from acquiring another savings association or holding company thereof without
prior written approval of the Office of Thrift Supervision; acquiring or retaining, with certain
exceptions, more than 5% of a non-subsidiary savings association, a non-subsidiary holding company,
or a non-subsidiary company engaged in activities other than those permitted by the HOLA; or
acquiring or retaining control of a depository institution that is not federally insured. In
evaluating applications by holding companies to acquire savings associations, the Office of Thrift
Supervision must consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to the insurance funds,
the convenience and needs of the community and competitive factors.
Federal Securities Law
Hudson City Bancorp’s securities are registered with the Securities and Exchange Commission under
the Securities Exchange Act of 1934, as amended. As such, Hudson City Bancorp is subject to the
information, proxy solicitation, insider trading, and other requirements and restrictions of the
Securities Exchange Act of 1934.
Delaware Corporation Law
Hudson City Bancorp is incorporated under the laws of the State of Delaware, and is therefore
subject to regulation by the State of Delaware. In addition, the rights of Hudson City Bancorp’s
shareholders are governed by the Delaware General Corporation Law.
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TAXATION
Federal
General. The following discussion is intended only as a summary and does not purport to be a
comprehensive description of the tax rules applicable to Hudson City Savings or Hudson City
Bancorp. For federal income tax purposes, Hudson City Savings reports its income on the basis of a
taxable year ending December 31, using the accrual method of accounting, and is generally subject
to federal income taxation in the same manner as other corporations. Hudson City Savings and
Hudson City Bancorp constitute an affiliated group of corporations and are therefore eligible to
report their income on a consolidated basis. Hudson City Savings is not currently under audit by
the Internal Revenue Service and has not been audited by the IRS during the past five years.
Bad Debt Reserves. Pursuant to the Small Business Job Protection Act of 1996, Hudson City
Savings is no longer permitted to use the reserve method of accounting for bad debts, and has
recaptured (taken into income) over a multi-year period a portion of the balance of its tax bad
debt reserve as of December 31, 1995. Since Hudson City Savings had already provided a deferred
tax liability equal to the amount of such recapture, the recapture did not adversely impact Hudson
City Savings’ financial condition or results of operations.
Distributions. To the extent that Hudson City Savings makes “non-dividend distributions” to
stockholders, such distributions will be considered to result in distributions from Hudson City
Savings’ unrecaptured tax bad debt reserve “base year reserve,” i.e., its reserve as of December
31, 1987, to the extent thereof and then from its supplemental reserve for losses on loans, and an
amount based on the amount distributed will be included in Hudson City Savings’ taxable income.
Non-dividend distributions include distributions in excess of Hudson City Savings’ current and
accumulated earnings and profits, distributions in redemption of stock and distributions in partial
or complete liquidation. However, dividends paid out of Hudson City Savings’ current or
accumulated earnings and profits, as calculated for federal income tax purposes, will not
constitute non-dividend distributions and, therefore, will not be included in Hudson City Savings’
income.
The amount of additional taxable income created from a non-dividend distribution is equal to the
lesser of Hudson City Savings’ base year reserve and supplemental reserve for losses on loans or an
amount that, when reduced by the tax attributable to the income, is equal to the amount of the
distribution. Thus, in certain situations, approximately one and one-half times the non-dividend
distribution would be included in gross income for federal income tax purposes, assuming a 35%
federal corporate income tax rate. Hudson City Savings does not intend to pay dividends that would
result in the recapture of any portion of its bad debt reserve.
Corporate Alternative Minimum Tax. In addition to the regular corporate income tax,
corporations generally are subject to an alternative minimum tax, or AMT, in an amount equal to 20%
of alternative minimum taxable income, to the extent the AMT exceeds the corporation’s regular
income tax. The AMT is available as a credit against future regular income tax. We do not expect to
be subject to the AMT.
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Elimination of Dividends; Dividends Received Deduction. Hudson City Bancorp may exclude from
its income 100% of dividends received from Hudson City Savings because Hudson City Savings is a
member of the affiliated group of corporations of which Hudson City Bancorp is the parent.
State
New Jersey State Taxation. Hudson City Savings files New Jersey Corporate Business income tax
returns. Generally, the income of savings institutions in New Jersey, which is calculated based on
federal taxable income, subject to certain adjustments, is subject to New Jersey tax at a rate of
9.00%. Savings institutions must also calculate, as part of their corporate tax return, an
Alternative Minimum Assessment (“AMA”), which for Hudson City Savings is based on New Jersey gross
receipts. Hudson City Savings must calculate its corporate business tax and the AMA, then pay the
higher amount. In future years, if the corporate business tax is greater than the AMA paid in
prior years, Hudson City Savings may apply the prepaid AMA against its corporate business taxes (up
to 50% of the corporate business tax, subject to certain limitations). Hudson City Savings is not
currently under audit with respect to its New Jersey income tax returns and Hudson City Savings’
state tax returns have not been audited for the past five years.
Hudson City Bancorp is required to file a New Jersey income tax return and will generally be
subject to a state income tax at a 9% rate. However, if Hudson City Bancorp meets certain
requirements, it may be eligible to elect to be taxed as a New Jersey Investment Company, which
would allow it to be taxed at a rate of 3.60%. Further, investment
companies are not subject to the AMA. If Hudson City Bancorp does not qualify as an investment
company, it would be subject to taxation at the higher of the 9% corporate business rate on taxable
income or the AMA.
Delaware State Taxation. As a Delaware holding company not earning income in Delaware, Hudson
City Bancorp is exempt from Delaware corporate income tax but is required to file annual returns
and pay annual fees and a franchise tax to the State of Delaware.
New York State Taxation. New York State imposes an annual franchise tax on banking corporations,
based on net income allocable to New York State, at a rate of 7.5%. If, however, the application
of an alternative minimum tax (based on taxable assets allocated to New York, “alternative” net
income, or a flat minimum fee) results in a greater tax, an alternative minimum tax will be
imposed. In addition, New York State imposes a tax surcharge of 17.0% of the New York State
Franchise Tax, calculated using an annual franchise tax rate of 9.0% (which represents the 2000
annual franchise tax rate), allocable to business activities carried on in the Metropolitan
Commuter Transportation District. These taxes apply to Hudson City Savings.
New York City Taxation. Hudson City Savings is also subject to the New York City Financial
Corporation Tax calculated, subject to a New York City income and expense allocation, on a similar
basis as the New York State Franchise Tax. A significant portion of Hudson City Savings’ entire
net income for New York City purposes is allocated outside the jurisdiction which has the effect of
significantly reducing the New York City taxable income of Hudson City Savings.
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Item 1A. Risk Factors.
Changes In Interest Rates Could Adversely Affect Our Results of Operations And Financial Condition.
Our earnings may be adversely impacted by an increase in interest rates because the majority of
our interest-earning assets are long-term, fixed rate mortgage-related assets that will not reprice
as long-term interest rates increase while a majority of our interest bearing liabilities are
expected to reprice as interest rates increase. At December 31, 2005, 82.8% of our loans with
contractual maturities of greater than one year had fixed rates of interest, and 99.5% of our total
loans had contractual maturities of five or more years. Overall, at December 31, 2005, 85.5% of
our total interest-earning assets had contractual maturities of more than five years. Conversely,
our interest-bearing liabilities generally have much shorter contractual maturities. A significant
portion of our deposits, including the $3.62 billion in our interest-bearing transaction accounts
as of December 31, 2005, have no contractual maturities and are likely to reprice quickly as
short-term interest rates increase. In addition, 80.7% of our certificates of deposit will mature
within one year and 36.8% of our borrowed funds may be called by the lenders within one year.
Therefore, in an increasing rate environment, our cost of funds is expected to increase more
rapidly than the yields earned on our loan portfolio and securities portfolio. An increasing rate
environment is expected to cause a narrowing of our net interest rate spread and a decrease in our
earnings.
We anticipate that short-term interest rates will continue to increase in 2006, as it is
anticipated the Federal Open Market Committee will continue to increase the Fed funds rate at its current measured pace in
the near term. We also anticipate long-term interest rates will increase at a similar rate, thus
maintaining the flat market yield curve. The result of this potential market interest rate
scenario, where the market yield curve remains flat, would have a negative impact on our results of
operations and our net interest margin as the yields on our interest-earning assets and the costs
of our interest-bearing liabilities will increase at a similar rate, thus maintaining the current
narrow spread. In addition, our interest-bearing liabilities will reset to the current market
interest rates faster than our interest-earning assets as our interest-bearing liabilities
generally have shorter periods to reset than our interest-earning assets and our originated and
purchased interest-earning assets generally have commitment periods of up to 90 days.
The impact of changes in interest rates on our interest income is generally felt in later periods
than the impact on our interest expense due to the timing of the recording on the balance sheet of
our interest-earning assets and interest-bearing liabilities. The recording of interest-earning
assets on the balance sheet generally lags the current market due to normal delays of up to three
months between the time we commit to originate or purchase a mortgage loan and the time we fund the
loan, while the recording of interest-bearing liabilities on the balance sheet generally reflects
the current market rates. This timing difference is expected to have an adverse impact on our net
interest income in a rising interest rate environment. Additionally, if both short- and long-term
interest rates increase by the same amount, the resulting environment is also likely to have a
negative impact on our results of operations, as our interest-bearing liabilities will reset to the
current market interest rate faster than our interest-earning assets.
Also impacting our net interest income and net interest rate spread is the level of prepayment
activity on our mortgage-related assets. Mortgage prepayment rates will vary due to a number of
factors, including the regional economy where the mortgage loan or the underlying mortgages of the
mortgage-backed security were originated, seasonal factors and demographic variables. However, the
major factors affecting prepayment rates are the prevailing market interest rates, related mortgage
refinancing opportunities and competition. Generally, the level of prepayment activity directly
affects the yield earned on those assets, as the payments received on the interest-earning assets
will be reinvested at the prevailing market interest rate. In a rising interest rate environment,
prepayment rates tend to decrease and,
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therefore, the yield earned on our existing mortgage-related assets will remain constant instead of
increasing. This would adversely affect our net interest margin and, therefore, our net interest
income.
Office of Thrift Supervision Thrift Bulletin 13a provides guidance on the management of interest
rate risk and the responsibility of boards of directors in that area. Under Thrift Bulletin 13a,
the Office of Thrift Supervision monitors the interest rate risk of institutions through analysis
of the change in net portfolio value, or NPV. NPV is defined as the net present value of the
expected future cash flows of an entity’s assets and liabilities and, therefore, hypothetically
represents the value of an institution’s net worth. The Office of Thrift Supervision, through its
general oversight of the safety and soundness of savings associations, retains the right to impose
minimum capital requirements on individual institutions to the extent the institution is not in
compliance with certain written guidelines established by the Office of Thrift Supervision
regarding NPV analysis. In March 2005, the Board of Directors of Hudson City Savings revised its
internal interest rate risk policy to narrow the permissible range for the change in NPV under
certain interest rate shock scenarios. Although $3.00 billion of the proceeds from the second-step
conversion were contributed to Hudson City Savings, improving its interest rate risk position as
measured by Thrift Bulletin 13a, we expect the Office of Thrift Supervision will continue to
closely monitor the interest rate risk of Hudson City Savings.
Our Plans To Increase The Level Of Our Adjustable-Rate Assets May Be Difficult To Implement And May
Decrease Our Profitability. One component of our plans for reducing our interest rate risk is to
grow our variable-rate and short-term investments at an equivalent rate as our fixed-rate
investments. While we believe that in the anticipated rising interest rate environment market
demand for variable-rate assets will increase and pricing terms will therefore become more
favorable to us, there is no assurance that this will be the case. If we are unable to originate
or purchase variable-rate assets at favorable rates, we will either not be able to execute
successfully this component of our interest rate risk reduction strategy or our profitability may
decrease, or both.
Because We Compete Primarily On The Basis Of The Interest Rates We Offer Depositors And The Terms
Of Loans We Offer Borrowers, Our Margins Could Decrease If We Were Required To Increase Deposit
Rates Or Lower Interest Rates On Loans In Response To Competitive Pressures. We face intense
competition both in making loans and attracting deposits. The New Jersey and metropolitan New York
market areas have a high concentration of financial institutions, many of which are branches of
large money center and regional banks. Some of these competitors have significantly greater
resources than we do and may offer services that we do not provide such as trust and investment
services. Customers who seek “one stop shopping” may be drawn to these institutions.
We compete primarily on the basis of the rates we pay on deposits and the rates and other terms we
charge on the mortgage loans we originate or purchase, as well as the quality of our customer
service. Our competition for loans comes principally from mortgage banking firms, commercial
banks, savings institutions, credit unions, finance companies, mutual funds, insurance companies
and brokerage and investment banking firms operating locally and elsewhere. Some of the largest
mortgage originators in the country have significant operations in New Jersey. In addition, we
purchase a significant volume of mortgage loans in the wholesale markets, and our competition in
these markets also includes many other types of institutional investors located throughout the
country. Price competition for loans might result in us originating fewer loans or earning less on
our loans.
Our most direct competition for deposits comes from commercial banks, savings banks, savings and
loan associations and credit unions. There are large money-center and regional financial
institutions operating throughout our market area, and we also face strong competition from other
community-based financial institutions. As interest rates continue to rise, we would expect to face
additional significant competition
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for deposits from short-term money market funds and other corporate and government securities funds
and from brokerage firms and insurance companies, in addition to the money center and regional
financial institutions. To the extent the equity markets continue to improve, we would also expect
significant competition from brokerage firms and mutual funds. Price competition for deposits
might result in us attracting or retaining fewer deposits or paying more on our deposits.
We May Fail to Realize the Anticipated Benefits of the Merger with Sound Federal and May Not
Receive Required Regulatory Approvals or Such Approvals, if Received, May Be Subject to Adverse
Regulatory Conditions. The success of the merger with Sound Federal will depend on, among other
things, our ability to realize anticipated cost savings and to combine our business and Sound
Federal’s business in a manner that does not materially disrupt our existing customer relationships
or those of Sound Federal or result in decreased revenues from any loss of customers. If we are
not able to successfully achieve these objectives, the anticipated benefits of the merger may not
be realized fully or at all or may take longer to realize than expected.
Hudson City and Sound Federal have operated and, until completion of the merger, will continue to
operate, independently. It is possible that the integration process could result in the loss of
key employees, the disruption of our or Sound Federal’s ongoing businesses or inconsistencies in
standards, controls, procedures and policies that adversely affect our ability to maintain
relationships with customers and employees or to achieve the anticipated benefits of the merger.
Before the merger may be completed, the approval of the Office of Thrift Supervision must be
obtained. We cannot guarantee that we will receive the approval of the Office of Thrift
Supervision. In addition, the Office of Thrift Supervision may impose conditions on the completion
of the merger or require changes in the terms of the merger. These conditions or changes could
have the effect of delaying the merger or imposing additional costs or limiting the possible
revenues of the combined company.
We May Not Be Able To Successfully Implement Our Plans For Growth. Since our conversion to the
mutual holding company form of organization in 1999, we have experienced rapid and significant
growth. Our assets have grown from $8.52 billion at December 31, 1999 to $28.08 billion at
December 31, 2005. We acquired a significant amount of capital from the second-step conversion,
which we plan to use to continue implementing our growth strategy, primarily by building our core
banking business through internal growth and increased de novo branching. In addition, we will
consider expansion opportunities through the acquisition of branches and other financial
institutions. There can be no assurance, however, that we will continue to experience such rapid
growth, or any growth, in the future. Significant changes in interest rates or the competition we
face may make it difficult to attract the level of customer deposits needed to fund our internal
growth at projected levels. In addition, we may have difficulty finding suitable sites for de novo
branches. Our expansion plans may result in us opening branches in geographic markets in which we
have no previous experience, and, therefore, our ability to grow effectively in those markets will
be dependent on our ability to identify and retain management personnel familiar with the new
markets. Furthermore, any future acquisitions of branches or of other financial institutions would
present many challenges associated with integrating merged institutions and expanding operations.
We cannot assure you that we will be able to adequately and profitably implement our possible
future growth or that we will not have to incur additional expenditures beyond current projections
to support such growth.
The Geographic Concentration Of Our Loan Portfolio And Lending Activities Makes Us Vulnerable To A
Downturn In The Local Economy. Originating loans secured by residential real estate is our
primary business. Our financial results may be adversely affected by changes in prevailing
economic conditions, either nationally or in our local New Jersey and metropolitan New York market
areas,
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including decreases in real estate values, adverse employment conditions, the monetary and fiscal
policies of the federal and state government and other significant external events. As of December
31, 2005, approximately 63% of our loan portfolio was secured by properties located in New Jersey,
New York and Connecticut. Decreases in real estate values could adversely affect the value of
property used as collateral for our loans. Adverse changes in the economy may also have a negative
effect on the ability of our borrowers to make timely repayments of their loans, which would have
an adverse impact on our earnings. In addition, if poor economic conditions result in decreased
demand for real estate loans, our profits may decrease because our alternative investments may earn
less income for us than real estate loans.
Changes In The Regulation Of Financial Services Companies Could Adversely Affect Our Business.
Proposals for further regulation of the financial services industry are continually being
introduced in Congress and various state legislatures. The agencies regulating the financial
services industry also periodically adopt changes to their regulations. It is possible that one or
more legislative proposals may be adopted or regulatory changes may be made that would have an
adverse effect on our business.
Our Stock Benefit Plans Will Increase Our Costs, Which Will Reduce Our Profitability And
Stockholders’ Equity. During the third quarter of 2005, our employee stock ownership plan
purchased approximately 15.7 million shares of common stock at an aggregate cost of $189.3 million,
adding to the previous 22.3 million shares purchased following our initial conversion in 1999.
Under current accounting standards, we will record annual employee stock ownership plan expenses in
an amount equal to the fair market value of shares committed to be released to employees for that
year. These shares will be released to participants over a forty-year period. If our common stock
appreciates in value over time, compensation expense relating to the employee stock ownership plan
will increase.
In the second quarter of 2006, we plan to implement a stock incentive plan pursuant to which our
officers and directors, at no cost to them, could be awarded shares of common stock in an aggregate
amount up to 8% of the shares of common stock outstanding. Under current accounting standards, as
the shares are awarded and vest, we will recognize compensation expense equal to the fair market
value of such shares at grant. In the event that a portion of the shares used to fund the plan are
newly issued shares purchased from us, the issuance of additional shares will decrease our net
income per share and stockholders’ equity per share and will dilute existing stockholders’
ownership and voting interests.
Our Return On Average Equity Is Low Compared To Other Companies. This Could Negatively Impact The
Price Of Our Common Stock. The net proceeds from the second-step conversion, completed in June
2005, substantially increased our equity capital. It will take a significant period of time to
prudently invest this capital. Our ability to leverage our new capital and grow our balance sheet
profitably will be significantly affected by industry competition for loans and deposits, as well
as our need to manage interest rate risk. As a result, our return on equity, which is the ratio of
our earnings divided by our average stockholders’ equity, will be lower than that of our peer
group. To the extent that the stock market values a company based in part on its return on equity,
our low return on equity relative to our peer group could negatively affect the trading price of
our stock.
Item 1B. Unresolved Staff Comments.
None.
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Item 2. Properties.
During 2005, we conducted our business through our two executive office buildings located in
Paramus, NJ, our operations center located in Glen Rock, NJ, and 90 branch offices. At December
31, 2005, we owned 33 of our locations and leased the remaining 60. Our lease arrangements are
typically long-term arrangements with third parties that generally contain several options to renew
at the expiration date of the lease.
For additional information regarding our lease obligations, see Note 8 of Notes to Consolidated
Financial Statements in Item 8 “Financial Statements and Supplementary Data.”
Item 3. Legal Proceedings.
We are not involved in any pending legal proceedings other than routine legal proceedings occurring
in the ordinary course of business. We believe that these routine legal proceedings, in the
aggregate, are immaterial to our financial condition and results of operation.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted during the quarter ended December 31, 2005 to a vote of security holders of
Hudson City Bancorp through the solicitation of proxies or otherwise.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities.
On July 13, 1999, Hudson City Bancorp, Inc. common stock commenced trading on the Nasdaq National
Market under the symbol “HCBK.” The table below shows the reported high and low sales prices of
the common stock during the periods indicated. Certain share, per share and dividend information
reflects the 3.206 to 1 stock split effected as part of our second-step conversion and stock
offering completed in June 2005.
On January 17, 2006, the Board of Directors of Hudson City Bancorp declared a quarterly cash
dividend of $0.075 per common share outstanding that was paid on March 1, 2006 to stockholders of
record as of the close of business on February 3, 2006. The Board of Directors intends to review
the payment of dividends quarterly and plans to continue to maintain a regular quarterly dividend
in the future, dependent upon our earnings, financial condition and other relevant factors.
Hudson City Bancorp is subject to the requirements of Delaware law that generally limits dividends
to an amount equal to the difference between the amount by which total assets exceed total
liabilities and the amount equal to the aggregate par value of the outstanding shares of capital
stock. If there is no difference between these amounts, dividends are limited to net income for
the current and/or immediately preceding year.
As the principal asset of Hudson City Bancorp, Hudson City Savings provides the principal source of
funds for the payment of dividends by Hudson City Bancorp. Hudson City Savings is subject to
certain restrictions that may limit its ability to pay dividends. Hudson City Savings may not pay
dividends to Hudson City Bancorp if paying such dividends would cause it to fail to meet capital
requirements or cause its stockholders’ equity to be reduced below the amounts required for its
liquidation account. See Note 3 of Notes to Consolidated Financial Statements in Item 8 of this
report for a further discussion of the liquidation account. For more information regarding the
limitations on dividends paid by Hudson City Savings, see “Regulation of Hudson City Savings Bank
and Hudson City Bancorp – Federally Chartered Savings Bank Regulation – Limitation on Capital
Distributions.”
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As of February 3, 2006, there were approximately 34,252 holders of record of Hudson City Bancorp
common stock.
The following table reports information regarding repurchases of our common stock during the fourth
quarter of 2005 and the stock repurchase plans approved by our Board of Directors.
Information regarding equity plan compensation is presented under the headings “Equity
Compensation Plan Information” in the Company’s definitive Proxy Statement for the 2006 Annual
Meeting of Stockholders to be held on May 30, 2006, which will be filed with the SEC no later than
April 30, 2006, and is incorporated herein by reference.
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Item 6. Selected Financial Data
The summary information presented below under “Selected Financial Condition Data,” “Selected
Operating Data” and “Selected Financial Ratios and Other Data” at or for each of the years
presented is derived in part from the audited consolidated financial statements of Hudson City
Bancorp. The following information is only a summary and you should read it in conjunction with
our audited consolidated financial statements in Item 8 of this document. Certain share, per share
and dividend information reflects the 3.206 to 1 stock split effected in conjunction with our
second-step conversion and stock offering completed June 7, 2005.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis should be read in conjunction with Hudson City Bancorp’s Consolidated
Financial Statements and accompanying Notes to Consolidated Financial Statements in Item 8, and the
other statistical data provided elsewhere in this document.
Executive Summary
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 deposits 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, and the
prepayment rate on our mortgage-related assets. 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, government policies and actions of regulatory
authorities. Our results are also affected by the market price of our stock, as the expense of
certain of our employee stock compensation plans is related to the current price of our common
stock.
We completed the second-step conversion and stock offering in June 2005, selling a total of
392,980,580 shares of common stock at a purchase price of $10.00 per share and raising
approximately $3.93 billion. The net $3.80 billion increase to stockholders’ equity due to the
conversion reflected the receipt of the $3.93 billion gross offering proceeds less the payment of
$125.0 million in conversion related expenses. Equity was further increased by $145.8 million due
to the consolidation of Hudson City, MHC into Hudson City Bancorp, Inc. We also effected a stock
split pursuant to which each share of common stock outstanding or held as treasury stock before
completion of the offering was split into 3.206 shares. All prior share and per share data has been
adjusted to reflect the 3.206 to 1 stock split effected as part of the second-step conversion and
stock offering. Hudson City Bancorp contributed $3.00 billion of the net proceeds to Hudson City
Savings Bank, resulting in a significant increase in the Bank’s capital.
The amount of funds available for investment from the net offering proceeds was approximately $3.57
billion, reflecting a further $229.9 million reduction from the net offering proceeds due to the
use of customer deposits to purchase stock. Of this amount available for investment, approximately
$2.80 billion was invested in securities with maturities or initial rate reset dates of less than
two years. The remainder of the proceeds available for investment was primarily used to purchase
adjustable-rate mortgage-backed securities and, to a lesser extent, purchase and originate first
mortgage loans.
During 2005 we grew our balance sheet $7.93 billion, reflecting the use of the net offering
proceeds and internally generated growth. The internally generated growth, consistent with our
traditional thrift business model, primarily reflected a $3.70 billion increase in total loans,
funded by a $4.20 billion increase in borrowed funds. The growth in our core investment of
residential first mortgage loans was due to our continued strong levels of loan purchases, which
allowed us to grow and geographically diversify our mortgage loan portfolio at a relatively low
overhead cost. The new borrowed funds had ten-year maturities and initial non-call periods of one
to five years.
Our net income for 2005 increased 15.4% to $276.1 million for the year 2005, generally due to the
growth in our interest-earning assets. Basic and diluted earnings per share for 2005 were $0.49 and
$0.48, respectively, compared with $0.41 and $0.40, respectively, for 2004. Our return on average
assets was
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1.14% for 2005. Total stockholders’ equity increased $3.80 billion during 2005, primarily due to
the completion of our second-step conversion and stock offering. Our return on average
stockholders’ equity was 7.52% for 2005.
Short-term market interest rates increased during 2005 following increases during the entirety of
2004. The Federal Open Market Committee of the Federal Reserve Bank (“FOMC”) increased the
overnight lending rate 25 basis points at each of the regularly scheduled meetings beginning in
June 2004 to the current rate of 4.50%. Intermediate-term market interest rates, those with
maturities of two to five years, and long-term market interest rates, in particular the 10-year
bond, also increased during the year 2005, but at a slower pace than short-term interest rates. The
result of these market interest rate changes was a continued flattening of the market yield curve
during 2005. This interest rate environment, where short-term rates increased to the same level as
intermediate- and long-term rates, had a negative impact on our results of operations and net
interest margin as our interest-bearing liabilities generally price off short-term market interest
rates while our interest-earning assets generally price off long-term interest rates.
In this rate environment, our net interest margin decreased 31 basis points and our net interest
rate spread decreased 59 basis points when comparing the year 2005 to 2004. The decrease in these
ratios reflected the flattening market yield curve as our interest income, in general, reflects
movements in long-term rates while our interest expense, in general, reflects movements in
short-term rates. The smaller decrease in our net interest margin, when compared to our net
interest rate spread, reflected the infusion of capital due to the completion of our second-step
conversion.
The increase in our interest income for the year ended December 31, 2005 was primarily derived from
the overall growth in our interest-earning assets, while the increase in our interest expense
reflected both the growth in our interest-bearing liabilities and increases in prevailing interest
rates. Net interest income increased $77.1 million for the year 2005, when compared to the
corresponding period in 2004, reflecting the larger growth of our interest-earning assets when
compared to the growth of our interest-bearing liabilities. Interest-earning assets increased
approximately 31.3% for the year 2005, as compared to prior year period, while our interest-bearing
liabilities increased 20.1% for the year 2005. This difference in growth rates offset the negative
impact of the flattening market yield curve, where the yield on our interest-earning assets
decreased 9 basis points during the year 2005, as compared to the prior year, while the cost of
our interest-bearing liabilities increased 50 basis points, over that same period.
We anticipate that short-term interest rates will continue to increase in 2006, as it is
anticipated the FOMC will continue to increase the Fed funds rate at its current measured pace in
the near term. We also anticipate long-term interest rates will increase at a similar rate, thus
maintaining the flat market yield curve. The result of this potential market interest rate
scenario, where the market yield curve remains flat, would have a negative impact on our results of
operations and our net interest margin as the yields on our interest-earning assets and the costs
of our interest-bearing liabilities will increase at a similar rate, thus maintaining the current
narrow spread. In addition, our interest-bearing liabilities will reset to the current market
interest rates faster than our interest-earning assets as our interest-bearing liabilities
generally have shorter periods to reset than our interest-earning assets. Our originated and
purchased interest-earning assets generally have commitment periods of up to 90 days. However, we
expect the planned growth in our balance sheet resulting from the infusion of capital due to the
completion of the second-step conversion will continue to offset the impact of movements in
interest rates on our net interest income.
We plan to grow our assets in 2006 primarily through the origination and purchase of mortgage
loans, while purchasing investment and mortgage-backed securities as a supplement to our
investments in mortgage loans. We also plan that approximately half of the growth in
interest-earning assets will be short-term or variable-rate in nature, in order to assist in the
management of our interest rate risk. We
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consider a loan or security to be variable rate if there exists a contractual rate adjustment
during the life of the instrument, including those variable-rate mortgage-related assets with
three-, five- or ten-year initial fixed-rate periods.
The primary funding for our asset growth is expected to come from customer deposits and borrowed
funds, using the funding source that is most reasonably priced given the overall market interest
rate conditions. In the second half of 2005, we experienced extreme competitive pricing of
short-term deposits in the New York metropolitan market. During this period, wholesale borrowing
costs were more economical and reflective of current rates. We expect this condition to continue in
the first six months of 2006. We plan that the funds borrowed will primarily have initial non-call
periods of one to five years and final maturities of ten years in order to extend the maturity of
our liabilities and assist in the management of our interest rate risk. We intend to grow customer
deposits by continuing to offer desirable products at competitive, but prudent rates and by opening
new branch offices. We opened three branch offices in Suffolk County, NY and two branch offices in
Richmond County (Staten Island), NY during 2005. We will continue to explore branch expansion
opportunities in market areas that present significant opportunities for our traditional thrift
business model and intend to expand our branch network by ten to fifteen branches annually.
On February 9, 2006, Hudson City announced a definitive agreement to acquire Sound Federal Bancorp,
Inc. (“Sound Federal”) for $20.75 per share in cash, representing an aggregate transaction value of
approximately $265.0 million. Sound Federal has 14 branch offices in Westchester, Rockland and
Putnam Counties, New York and Fairfield County, Connecticut. This network will complement our
current branch network as well as our organic branch expansion plans. Sound Federal has $1.15
billion in assets and $969.6 million in deposits as of December 31, 2005. The transaction is
subject to approval by shareholders of Sound Federal as well as customary regulatory approvals, and
is expected to close in the early summer of 2006.
Comparison of Financial Condition at December 31, 2005 and December 31, 2004
During 2005, our total assets increased $7.93 billion, or 39.4%, to $28.08 billion at December 31,
2005 from $20.15 billion at December 31, 2004, reflecting the investment of the proceeds from the
second-step conversion and stock offering, which was completed in June 2005, and internally
generated growth. We raised approximately $3.93 billion from the second-step conversion, which was
reduced by $125.0 million in related expenses and $229.9 million due to the use of customer
deposits to purchase stock to $3.57 billion, reflecting the net cash available for investment. Of
the proceeds, approximately $1.50 billion was directly invested into government-sponsored agency
discount notes yielding approximately 3.24%, $900.0 million was invested into callable
government-sponsored agency securities with an average yield of 3.94%, and $400.0 million was
invested into government-sponsored agency step-up notes with an initial average yield of 4.00%. All
the discount notes purchased immediately after the second-step conversion matured during the third
and fourth quarters of 2005 and were subsequently reinvested primarily into callable
government-sponsored agency securities with maturities not exceeding two years or callable
government sponsored agency step-up notes. These purchases and maturities were reflected in the
$2.57 billion increase in total investment securities during 2005. The remainder of the proceeds
from the second-step conversion was primarily used to purchase adjustable-rate mortgage-backed
securities and, to a lesser extent, purchase and originate one- to four-family first mortgage
loans.
Loans increased $3.70 billion, or 32.6%, to $15.06 billion at December 31, 2005 from $11.36 billion
at December 31, 2004. The increase in loans reflected our continued loan purchase activity as well
as our focus on the origination of one- to four-family first mortgage loans, primarily in New
Jersey and the New York metropolitan area. For the year 2005, we purchased first mortgage loans of
$3.68 billion and
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originated first mortgage loans of $2.07 billion, compared with purchases of $3.12 billion and
originations of $1.38 billion for 2004. The larger volume of purchased mortgage loans in 2005,
when compared to the volume of loan originations, allowed us to continue to grow and geographically
diversify our mortgage loan portfolio at a relatively low overhead cost while maintaining our
traditional thrift business model. The increase in origination and purchase activity, when compared
to the prior year, reflected the investment of part of the proceeds from our second-step conversion
and stock offering. We will continue to purchase mortgage loans to grow and diversify our
portfolio, as opportunities and funding are available.
Our first mortgage loan originations and purchases were exclusively in one-to four-family mortgage
loans. Approximately 25.4% of the mortgage loan purchases and 52.9% of the mortgage loan
originations were variable-rate loans, which we consider to be any loan with a contractual annual
rate adjustment, including those loans with an initial fixed-rate period of one to ten years. At
December 31, 2005, fixed-rate mortgage loans accounted for 82.7% of our first mortgage loan
portfolio compared with 92.5% at December 31, 2004. Notwithstanding the decrease in the percent of
fixed-rate loans to total loans, this percentage of fixed-rate loans to total loans may have an
adverse impact on our earnings in a rising rate environment as the interest rate on these loans
would not reprice to current market interest rates, while our interest-bearing deposits and
callable borrowed funds would reprice, from time to time, to the higher market interest rates. At
December 31, 2005, we were committed to purchase and originate $715.4 million and $260.8 million,
respectively, of first mortgage loans, which are expected to settle during the first quarter of
2006.
Total mortgage-backed securities increased $1.53 billion to $6.91 billion at December 31, 2005 from
$5.38 billion at December 31, 2004 reflecting the investment of part of the proceeds from our
second-step conversion and our growth initiatives. This increase in total mortgage-backed
securities resulted from $3.28 billion in purchases of securities, all of which are directly or
indirectly insured or guaranteed by a government agency or government-sponsored enterprise. Of
these purchases, approximately 93.1% were variable-rate or hybrid instruments, with initial
fixed-rate periods ranging from one to seven years. At December 31, 2005, variable-rate
mortgage-backed securities accounted for 53.6% of our portfolio compared with 23.4% at December 31,
2004. We intend to continue to purchase variable-rate securities, as well as originate and purchase
variable-rate mortgage loans, growing our fixed-rate and variable-rate portfolios by equal amounts,
as part of our strategy to assist in the management of our interest rate risk. At December 31,
2005, we were committed to purchase $452.5 million of when-issued government agency or
government-sponsored agency variable-rate mortgage-backed securities, which are expected to settle
during the first quarter of 2006.
Accrued interest receivable increased $43.2 million, primarily due to increased balances in loans
and investments. The $12.7 million increase in banking premises and equipment, net, reflected
additional growth related to our branch expansion strategy. The $41.4 million increase in other
assets primarily reflected the increase in the deferred tax asset related to the increase in the
unrealized loss on our available for sale investment and mortgage-backed securities.
Total liabilities increased $4.13 billion, or 22.0%, to $22.87 billion at December 31, 2005
compared with $18.74 billion at December 31, 2004. Borrowed funds increased $4.20 billion, or
58.7%, to $11.35 billion at December 31, 2005 from $7.15 billion at December 31, 2004. The
additional borrowed funds were primarily used to fund our asset growth. Borrowed funds were
comprised of $7.90 billion of securities sold under agreements to repurchase and $3.45 billion of
Federal Home Loan Bank advances. The fair market value of securities pledged as collateral for our
reverse repurchase agreements was approximately $8.23 billion. Advances from the Federal Home Loan
Bank utilize our mortgage loan portfolio as
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collateral. The $5.13 billion in new borrowings have initial non-call periods ranging from one to
five years, final maturities of ten years, and a weighted-average rate of 3.82%.
Total deposits decreased $94.0 million during 2005, reflecting the consolidation of the $145.8
million deposit of Hudson City, MHC, which was added to our capital, and the use of approximately
$229.9 million of customer deposits to purchase stock during our second-step stock offering. We
experienced increased competitive pressure and extreme pricing of short-term deposits during the
second-half of 2005 in the New York metropolitan area. We believed the price of borrowed funds was
more economical and reflective of current rates than the price of deposits and therefore priced our
deposits at a competitive, but prudent rate, resulting in the use of borrowed funds at a greater
rate to fund our asset growth. During 2005, a portion of our customers shifted deposits to the
higher costing time deposit accounts from the High Value Checking account product. At December 31,
2005, the aggregate balance in our time deposits was $6.17 billion and the aggregate balance in the
High Value Checking account was $3.52 billion compared with $5.27 billion and $4.19 billion,
respectively, at December 31, 2004.
Total stockholders’ equity increased $3.80 billion to $5.20 billion at December 31, 2005 from $1.40
billion at December 31, 2004. The increase in stockholders’ equity was primarily due to the net
offering proceeds of $3.80 billion, a $145.8 million increase due to the consolidation of the
deposit of Hudson City, MHC into Hudson City Bancorp as part of the second-step conversion, and net
income of $276.1 million for 2005. Also increasing stockholders’ equity was a $2.8 million increase
due to the exercise of stock options, a $9.4 million permanent tax benefit due to the exercise of
stock options and the vesting of employee stock benefit plans, and an $11.9 million increase due to
the commitment of shares for our employee stock benefit plans. These increases to stockholders’
equity were partially offset by cash dividends declared and paid to common stockholders of $102.1
million, purchases of 15,719,223 shares for our employee stock ownership plan at an aggregate cost
of $189.3 million, and purchases of 9,119,768 shares of treasury stock at an aggregate cost of
$107.5 million. Further decreasing stockholders’ equity were purchases of 115,839 shares of common
stock for our recognition and retention plan at an aggregate cost of $1.3 million and a $54.4
million further increase in our accumulated other comprehensive loss primarily due to higher market
interest rates decreasing the market value of our available for sale portfolio.
In October 2005, a sixth stock repurchase plan was approved to repurchase up to 29,880,000 shares,
or approximately five percent of the then outstanding common stock. The fifth repurchase plan was
terminated upon approval of the sixth plan. As of December 31, 2005, 21,017,000 shares are
available for repurchase under this program. At December 31, 2005, the ratio of total stockholders’
equity to total assets was 18.53% compared with 6.96% at December 31, 2004. For 2005, the ratio of
average stockholders’ equity to average assets was 15.10% compared with 7.29% for the year ended
December 31, 2004. The increase in these ratios was primarily due to our completion of the
second-step conversion and stock offering. Stockholders’ equity per common share, calculated using
the period-end share count of outstanding shares, less purchased but unallocated employee stock
ownership plan shares and less purchased but unvested management plan shares, was $9.44 at December
31, 2005 compared with $7.85 at December 31, 2004, reflecting the funds received from our
second-step conversion.
Analysis of Net Interest Income
Net interest income represents the difference between the interest income we earn on our
interest-earning assets, such as mortgage loans, mortgage-backed securities and investment
securities, and the expense we pay on interest-bearing liabilities, such as time deposits and
borrowed funds. Net interest income depends
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on our volume of interest-earning assets and interest-bearing liabilities and the interest rates we
earned or paid on them.
Average Balance Sheet. The following table presents certain information regarding our financial
condition and net interest income for 2005, 2004, and 2003. The table presents the average yield on
interest-earning assets and the average cost of interest-bearing liabilities for the periods
indicated. We derived the yields and costs by dividing income or expense by the average balance of
interest-earning assets or 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 adjustments to yields. Yields on tax-exempt obligations were not computed
on a tax equivalent basis.
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Rate/Volume Analysis. The following table presents the extent to which the changes in
interest rates and the changes in volume of our interest-earning assets and interest-bearing
liabilities have affected our interest income and interest expense during the periods indicated.
Information is provided in each category with respect to:
The changes attributable to the combined impact of volume and rate have been allocated
proportionately to the changes due to volume and the changes due to rate.
Comparison of Operating Results for the Years Ended December 31, 2005 and 2004
General. Net income was $276.1 million for the year 2005, reflecting an increase of $36.8
million, or 15.4%, compared with net income of $239.3 million for the year 2004. Basic and diluted
earnings per common share were $0.49 and $0.48, respectively, for 2005 compared with basic and
diluted earnings per share of $0.41 and $0.40, respectively, for 2004. For the year 2005 our return
on average stockholders’ equity was 7.52% compared with 17.66% for the year 2004. Our return on
average assets for 2005 was 1.14% compared with 1.29% for 2004. The decreases in these ratios were
primarily due to the receipt of the net proceeds from our second-step conversion and stock offering
completed in June 2005, which significantly increased average stockholders’ equity and average
assets. The decrease in the return on average assets also reflected our balance sheet growth during
a period of narrowing net interest rate spreads and a flattening market yield curve.
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Interest and Dividend Income. Total interest and dividend income increased $263.9 million,
or 28.8%, to $1.18 billion for 2005 compared with $915.1 million for 2004. The increase in total
interest and dividend income was primarily due to a $5.72 billion, or 31.3%, increase in the
average balance of total interest-earning assets to $23.97 billion for 2005 compared with $18.25
billion for 2004. The growth in the average balance of total interest-earning assets was consistent
with the growth initiatives employed by us during recent periods and also reflected the receipt of
the net offering proceeds from our second-step conversion. The increase in interest and dividend
income due to the increase in the average balance was partially offset by a decrease of nine basis
points in the weighted-average yield on total interest-earning assets to 4.92% for the year 2005
from 5.01% for the year 2004. This decrease in the weighted-average yield reflected a shift in our
interest-earning asset mix to shorter-term investment securities to help manage our interest rate
risk. Investments of this type included the purchase of agency discount notes from the second-step
conversion net offering proceeds, and the origination and purchase of a larger percentage of
variable-rate mortgage loans and mortgage-backed securities.
The $149.4 million increase in interest and fee income on first mortgage loans was primarily due to
a $2.88 billion increase in the average balance of first mortgage loans, which reflected our
continued emphasis on balance sheet growth in our core investment in first mortgage loans. The
increase in mortgage loan income due to the increase in the average balance was partially offset by
a seven basis point decrease in the weighted-average yield, which reflected the larger volume of
originations and purchases of variable-rate loans during 2005, which generally have initial yields
that are less than fixed-rate loans.
The $71.9 million increase in interest and dividends on total investment securities was primarily
due to an increase in the average balance of total investment securities of $1.83 billion, which
reflected the investment of part of the net proceeds from the second-step conversion and stock
offering, and the investment of certain of the cash flows from the prepayment activity on our
mortgage-related assets in 2004 into investment securities. The increase in interest and dividends
on total investment securities due to the increase in the average balance was partially offset by a
22 basis point decrease in the weighted-average yield reflecting purchases of securities with
maturity or initial rate reset dates of less than two years, in order to assist in our management
of interest rate risk.
The $30.8 million increase in interest income on total mortgage-backed securities was due to an
$838.9 million increase in the average balance of total mortgage-backed securities, which primarily
reflected the purchase of variable-rate securities during 2005 from the investment of part of the
net proceeds from the second-step offering to assist in our management of interest rate risk. The
increase in income due to the increase in the average balance was partially offset by a 11 basis
point decrease in the weighted-average yield, reflecting the larger volume of purchases of
variable-rate and hybrid instruments, which generally have initial yields that are less than
fixed-rate securities.
Interest Expense. Total interest expense, comprised of interest on deposits and interest on
borrowed funds, increased $186.7 million, or 43.4%, to $616.8 million for the year 2005 from $430.1
million for the year 2004. This increase was primarily due to a $3.35 billion, or 20.1%, increase
in the average balance of total interest-bearing liabilities to $20.04 billion for 2005 compared
with $16.69 billion for 2004. This increase in interest-bearing liabilities was primarily used to
fund asset growth. The increase in total interest expense was also due to a 50 basis point increase
in the weighted-average cost of total interest-bearing liabilities to 3.08% for the year 2005
compared with 2.58% for the year 2004, which reflected the growth of our interest-bearing
liabilities during the rising short-term interest rate environment experienced during 2004 and
2005.
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Interest expense on borrowed funds increased $107.7 million primarily due to a $2.82 billion
increase in the average balance of borrowed funds and, to a lesser extent, a nine basis point
increase in the weighted-average cost of borrowed funds. The increase in the average balance of
borrowed funds was used to fund asset growth. The $5.13 billion of new borrowings incurred during
2005 all had maturity periods of ten years and initial non-call periods of one to five years,
extending the overall maturity of our liabilities in order to assist in the management of interest
rate risk. The new borrowings had a weighted-average rate of 3.82%. The increase in the average
cost of borrowed funds reflected the continued growth of our borrowed funds in the increasing
intermediate- and long-term interest rate environment that existed during 2004 and 2005.
The $78.9 million increase in interest expense on interest-bearing deposits for the year 2005 was
due to a $526.8 million increase in the average balance of interest-bearing deposits and a 61 basis
point increase in the weighted-average cost of interest-bearing deposits. The growth in the average
balance of interest-bearing deposits was primarily used to fund our growth initiatives and was
primarily due to increases in our interest-bearing transaction account. The increase in the
weighted-average cost of interest-bearing deposits, experienced principally in
interest-bearing transaction accounts and time deposits, reflected the rising short-term market
interest rate environment experienced during 2004 and 2005 and the need to increase rates on these
deposit products in the highly competitive deposit market of the New York metropolitan area.
The $38.7 million increase in interest expense on our interest-bearing transaction accounts
reflected an increase in the average balance of interest-bearing transaction accounts of $548.9
million, primarily due to the growth of our High Value Checking account product, and a 64 basis
point increase in the weighted-average cost due to the rising short-term market interest rate
environment. The $40.3 million increase in interest expense on our time deposit accounts reflected
a 70 basis point increase in the weighted-average cost, due to the rising short-term market
interest rate environment, and a $63.8 million increase in the average balance of time deposit
accounts. We intend to continue to fund future asset growth using customer deposits as our primary
source of funds, by continuing to pay competitive, but prudent rates and by opening new branch
offices. We will continue to supplement deposit growth using borrowed funds.
Net Interest Income. Net interest income increased $77.1 million, or 15.9%, to $562.1 million
for the year 2005 compared with $485.0 million for the year 2004. This increase primarily reflected
the investment of the net offering proceeds from our second-step conversion and our internally
generated growth initiatives, the combination of which resulted in a larger increase in the average
balance of total interest-earning assets when compared to the increase in the average balance of
total interest-bearing liabilities. The increase due to our growth was partially offset by an
increase in the costs of our interest-bearing deposits and borrowed funds. Our net interest rate
spread decreased 59 basis points to 1.84% for 2005 from 2.43% for 2004 and our net interest margin
decreased 31 basis points to 2.35% for 2005 from 2.66% for 2004.
The decrease in these ratios was primarily due to an increase in the weighted-average cost of
interest-bearing liabilities and a decrease in the weighted-average yield on interest-earning
assets. The increase in the cost of our interest-bearing liabilities reflected the rising
short-term interest rate environment and the borrowing of funds with longer terms to initial
reprice or maturity than in previous periods. The decrease in the yield on our interest-earning
assets reflected the shift in our investment portfolio to shorter-term interest-earning assets,
accomplished by purchasing and originating a larger percentage of variable-rate instruments and
purchasing agency discount notes with part of the proceeds from our second-step conversion and
stock offering. The smaller decrease in our net interest margin, when compared to the decrease in
our net interest rate spread, reflected the infusion of capital due to the completion of our
second-step conversion.
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Provision for Loan Losses. Our provision for loan losses during 2005 was $65,000 compared with
$790,000 during 2004. The decrease in the provision reflected recent favorable charge-off trends
and strong payment performance by our borrowers during 2005 resulting in a positive delinquency
experience. Net recoveries for the year 2005 were $9,000 compared with net charge-offs of $18,000
for the year 2004. The allowance for loan losses increased $74,000 to $27.4 million at December 31,
2005 from $27.3 million at December 31, 2004. The ratio of the allowance for loan losses to total
loans was 0.18% at December 31, 2005 compared with 0.24% at December 31, 2004.
Non-performing loans, defined as non-accruing loans and accruing loans delinquent 90 days or more,
decreased $2.3 million to $19.3 million at December 31, 2005 from $21.6 million at December 31,
2004, reflecting decreases in delinquencies primarily in our serviced loan portfolio. The ratio of
non-performing loans to total loans was 0.13% at December 31, 2005 compared with 0.19% at December
31, 2004. The ratio of the allowance for loan losses to non-performing loans was 141.84% at
December 31, 2005 compared with 126.44% at December 31, 2004.
During 2005, we lowered the loss factors used in our analysis of the loan loss allowance for our
first mortgage loans to reflect the seasoning of the purchased loan
portfolio and the recent favorable charge-off experience and delinquency trends. As a result of
these trends, we recorded no provision during the second, third and fourth quarters of 2005 and a
minimal provision for loan losses in the year 2005 to reflect probable losses resulting from the
actual growth in our loan portfolio. We consider the ratio of allowance for loan losses to total
loans at December 31, 2005, given our primary lending emphasis and current market conditions, to be
adequate.
Although we believe that we have established and maintained the allowance for loan losses at
adequate levels, additions may be necessary if future economic and other conditions differ
substantially from the current operating environment. Although we use the best information
available, the level of the allowance for loan losses remains an estimate that is subject to
significant judgment and short-term change. See “Critical Accounting Policies.”
Non-Interest Income. Total non-interest income decreased $8.6 million to $8.0 million for 2005
from $16.6 million for 2004. The decrease in non-interest income primarily reflected the decrease
in gains on securities transactions, net, as no sales of securities occurred during the second,
third or fourth quarters of 2005, and minimal sales occurred in the first quarter of 2005.
Non-Interest Expense. Total non-interest expense increased $9.4 million, or 7.9%, to $127.7
million for 2005 from $118.3 million for 2004. The increase primarily reflected normal salary
adjustments, and increases in net occupancy expense, employee compensation and advertising expense
due to our branch expansion program. Our efficiency ratio was 22.40% for the year 2005 compared
with 23.60% for the year 2004. Our ratio of non-interest expense to average total assets for 2005
was 0.53% compared with 0.64% for 2004. The decrease in these ratios reflected our ability to
leverage our existing infrastructure to support continuing asset growth while controlling operating
expenses, as our average assets grew in excess of 30.0% during 2005.
Income Taxes. Income tax expense increased $23.2 million, or 16.2%, to $166.3 million for 2005
from $143.1 million for 2004, reflecting the 15.7% increase in income before income tax expense.
Our effective tax rate for the year 2005 was 37.60% compared with 37.43% for 2004. Our effective
tax rate may increase approximately 2% in future years related to a change in New Jersey tax
regulations regarding the deductibility of dividends received from a real estate investment trust
subsidiary.
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Comparison of Financial Condition at December 31, 2004 and December 31, 2003
During 2004, our total assets increased $3.12 billion, or 18.3%, to $20.15 billion at December 31,
2004 from $17.03 billion at December 31, 2003. Loans increased $2.56 billion, or 29.1%, to $11.36
billion at December 31, 2004 from $8.80 billion at December 31, 2003. The increase in loans
reflected our loan purchase activity, our continued focus on the origination of one- to four-family
first mortgage loans, primarily in New Jersey and the New York metropolitan area, and a significant
decline in loan prepayment activity during the period. For 2004, we purchased first mortgage loans
of $3.12 billion and originated first mortgage loans of $1.38 billion, compared with purchases of
$3.21 billion and originations of $2.17 billion for 2003. The larger volume of purchased mortgage
loans, when compared to the amount of mortgage loans originated, allowed us to grow and
geographically diversify our mortgage loan portfolio at a relatively low overhead cost while
maintaining our traditional thrift business model.
We will continue to purchase mortgage loans to grow and diversify our portfolio, as opportunities
and funding are available. The lower volume of origination activity was primarily due to a decline
in refinancing activity.
Our first mortgage loan originations and purchases were exclusively in one-to four-family mortgage
loans and were primarily fixed-rate loans. At December 31, 2004, fixed-rate mortgage loans
accounted for 92.5% of our first mortgage loan portfolio compared with 90.9% at December 31, 2003.
This percentage of fixed-rate loans to total loans may have an adverse impact on our earnings in a
rising rate environment as the interest rate on these loans would not reprice, while our
interest-bearing deposits and callable borrowed funds would reprice, from time to time, to the
higher market interest rates.
During 2004, $144.0 million of our loan originations were the result of refinancing of our existing
mortgage loans compared with $530.4 million during 2003. The dollar amount of refinancing of
existing mortgage loans was included in total loan originations. We allow customers with Hudson
City originated loans to modify, for a fee, their existing mortgage loans with the intent of
maintaining customer relationships in periods of extensive refinancing due to low long-term
interest rates. In general, all terms and conditions of the existing mortgage loan remain the same
except the adjustment of the interest rate to the currently offered fixed-rate product with a
similar term to maturity or to a reduced term at the request of the borrower. Modifications of our
existing mortgage loans during 2004 were approximately $220.1 million compared with $1.46 billion
during 2003. These loan modifications were not reflected in loan origination totals. We feel loan
refinancing and modification activity are inversely related to the level of interest rates. The
decrease in the refinancing and modification activity, when comparing the 2004 activity to the 2003
activity, was due to the general stability of long-term interest rates during 2004 compared to the
steeply declining interest rate environment during the first half of 2003 and prior periods. If
long-term rates increase or remain relatively stable, we expect the amount of loan refinancings and
modifications to remain at the 2004 levels or decrease.
Investment securities held to maturity increased to $1.33 billion at December 31, 2004 from $1.4
million at December 31, 2003. During 2004, we began to classify certain of our government-sponsored
agency security purchases as held to maturity. This increase in investment securities held to
maturity reflected, in part, the subsequent reinvestment of part of the resulting cash flows from
the $649.2 million decrease of investment securities available for sale due to calls of such
securities during 2004. The increase in investment securities held to maturity also represented a
strategy to shorten the overall final maturity of our
interest-earning assets, while continuing to grow our balance sheet, by investing a portion of the cash flows from our mortgage-related assets
into investment securities. Of the agency securities purchased and classified as held to maturity,
$621.6 million have step-up features, where the interest rate is increased on scheduled future
dates. These securities have call options that are generally effective prior to the initial
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rate increase but after an initial non-call period of three months to one year. The initial rate
for the securities purchased was higher than interest rates on similar agency securities offered at
the time of purchase without the step-up feature. The rate increases are at least one percent per
adjustment and are fixed over the life of the security.
Overall, the aggregate balance of the mortgage-backed securities portfolio remained relatively
stable at $5.38 billion at December 31, 2004 compared with $5.42 billion at December 31, 2003.
Payments received on mortgage-backed securities were primarily reinvested into fixed-rate
mortgage-backed securities at the prevailing market interest rates. Accrued interest receivable
increased $17.3 million, primarily due to increased balances in loans and investments. Fixed
assets increased $5.0 million primarily due to our branch expansion.
Total liabilities increased $3.04 billion, or 19.4%, to $18.74 billion at December 31, 2004
compared with $15.70 billion at December 31, 2003. Total deposits increased $1.03 billion, or 9.8%,
to $11.48 billion at December 31, 2004 from $10.45 billion at December 31, 2003. The increase in
total deposits was primarily used to fund our growth initiatives. Interest-bearing deposits
increased $1.00 billion primarily due to an increase of $1.48 billion in our interest-bearing High
Value Checking account product, partially offset by a $405.8 million decrease in time deposits. We
believe the increase in interest-bearing deposits was due primarily to our consistent offering of
competitive rates on our interest-bearing High Value Checking account product. The balance in the
High Value Checking account at December 31, 2004 was $4.19 billion compared with $2.71 billion at
December 31, 2003. We believe the decrease in time deposits was due, in part, to transfers to our
High Value Checking account and significant competition for deposits in the New York metropolitan
area.
Borrowed funds increased $2.00 billion, or 38.8%, to $7.15 billion at December 31, 2004 from $5.15
billion at December 31, 2003. The additional borrowed funds were primarily used to fund our asset
growth. Borrowed funds were comprised of $5.30 billion of securities sold under agreements to
repurchase and $1.85 billion of FHLB advances. Securities pledged as collateral against our
securities sold under agreements to repurchase had a market value at December 31, 2004 of
approximately $5.63 billion. Advances from the FHLB utilize our mortgage portfolio as collateral.
The $3.75 billion in new borrowings, which had initial call dates of predominately two to four
years from the date of borrowing, were partially offset by calls and maturities of borrowed funds
in an aggregate amount of $1.75 billion.
Total stockholders’ equity increased $73.5 million, or 5.5%, to $1.40 billion at December 31, 2004
from $1.33 billion at December 31, 2003. The increase in stockholders’ equity was primarily due to
net income of $239.3 million for 2004, a $6.5 million increase due to the exercise of 2,886,042
stock options, a $20.9 million permanent tax benefit due to the exercise of stock options and the
vesting of employee stock benefit plans, and a $19.5 million increase due to the commitment of
shares for our employee stock benefit plans.
These increases to stockholders’ equity were partially offset by repurchases of 14,716,187 shares
of our common stock at an aggregate cost of $161.7 million, purchases of 641,200 shares of common
stock for our recognition and retention plan at an aggregate cost of $7.3 million, cash dividends
declared and paid to common stockholders of $40.5 million and a $3.1 million increase in
accumulated other comprehensive loss primarily due to a decrease in the fair value of our available
for sale investment portfolio. As of December 31, 2004 there remained 9,862,365 shares authorized
to be purchased under our then current stock repurchase program. The decrease from prior years in the
amount of the cash dividend paid to common stockholders reflects the waiver of receipt of the
dividend by Hudson City, MHC, the majority stockholder of Hudson City Bancorp in accordance with
the regulations and policies of the OTS. Prior to 2004, Hudson City, MHC was subject to the
policies of the FDIC, which did not permit dividend waivers.
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At December 31, 2004, the ratio of total stockholders’ equity to total assets was 6.96% compared
with 7.80% at December 31, 2003. For the year ended December 31, 2004, the ratio of average
stockholders’ equity to average assets was 7.29% compared with 8.73% for the year ended December
31, 2003.
The decrease in these ratios was primarily due to our capital management strategy of planned asset
growth, and a slower percentage growth in stockholders’ equity as compared to the percentage growth
in assets, due to payment of cash dividends and stock repurchases. Stockholders’ equity per common
share was $7.85 at December 31, 2004 compared with $7.33 at December 31, 2003.
Comparison of Operating Results for the Years Ended December 31, 2004 and 2003
General. Net income was $239.3 million for the year ended December 31, 2004, an increase of
$31.9 million, or 15.4%, compared with net income of $207.4 million for the year ended December 31,
2003. Basic and diluted earnings per common share were $0.41 and $0.40, respectively, for 2004
compared with basic and diluted earnings per share of $0.35 and $0.34, respectively, for 2003. For
the year ended December 31, 2004 our return on average stockholders’ equity was 17.66% compared
with 15.38% for 2003. The increase in the return on average stockholders’ equity was primarily due
to the growth of our net income and a slower percentage growth of stockholders’ equity due to
payment of cash dividends and stock repurchases. Our return on average assets for 2004 was 1.29%
compared with 1.34% for 2003. The decrease in the return on average assets was primarily due to our
overall balance sheet growth in the prevailing interest rate environments of 2003 and 2004.
Interest and Dividend Income. Total interest and dividend income increased $137.8 million, or
17.7%, to $915.1 million for the year ended December 31, 2004 compared with $777.3 million for the
year ended December 31, 2003. The increase in total interest and dividend income was primarily due
to a $3.12 billion, or 20.6%, increase in the average balance of total interest-earning assets to
$18.25 billion for the year ended December 31, 2004 compared with $15.13 billion for the year ended
December 31, 2003. The growth in the average balance of total interest-earning assets was
consistent with the growth initiatives employed by us during recent periods. The impact on interest
and dividend income from the increase in the average balance of our total interest-earning assets
was partially off-set by a 13 basis point decrease in the average yield on total interest-earning
assets to 5.01% for 2004 from 5.14% for 2003, primarily reflecting the growth of our
interest-earning assets during the prevailing interest rate environments of 2003 and 2004.
The $125.6 million increase in interest and fee income on first mortgage loans was primarily due to
a $2.79 billion increase in the average balance of first mortgage loans, which reflected our
continued emphasis on balance sheet growth in our core business of first mortgage loans. The
increase in mortgage loan income due to the increase in the average balance was partially offset by
a 41 basis point decrease in the average yield, which reflected the large volume of loan
origination and purchase activity during the prevailing long-term interest rate environments of
2003 and 2004.
The $39.2 million increase in interest and dividends on total investment securities was primarily
due to an increase in the average balance of investment securities of $938.0 million, which
reflected the subsequent reinvestment of certain of the cash flows from the prepayment activity on
our mortgage-related assets in 2003 and 2004 into investment securities, and was consistent with
the decision to shorten the overall weighted-average life of our interest-earning assets by
investing in callable securities with initial call dates of three months to one year and final
maturity dates of five to seven years. The increase in income on total investment securities due to
the increase in the average balance was partially offset by a 15 basis
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point decrease in the average yield on our investment securities, which reflected the large volume
of purchases made during the prevailing interest rate environments of 2003 and 2004.
The $25.9 million decrease in interest income on total mortgage-backed securities was primarily due
to a $568.9 million decrease in the average balance of total mortgage-backed securities, which
reflected the high volume of prepayment activity, the sales of mortgage-backed securities available
for sale, and the subsequent reinvestment of certain of the resulting cash flows into investment
securities or purchased mortgage loans. The decrease in interest income on total mortgage-backed
securities also reflected a 1 basis point decrease in the average yield on mortgage-backed
securities.
The impact on mortgage-backed securities interest income of the decline in the average balance and
weighted average yield was partially offset by the slowing of the net premium amortization due to
the decline in prepayment activity during the second half of 2003 and 2004.
Interest Expense. Total interest expense, comprised of interest on deposits and interest on
borrowed funds, increased $53.7 million, or 14.3%, to $430.1 million for the year ended December
31, 2004 from $376.4 million for the year ended December 31, 2003. This increase was primarily due
to a $3.11 billion, or 22.9%, increase in the average balance of total interest-bearing liabilities
to $16.69 billion for the year ended December 31, 2004 compared with $13.58 billion for the year
ended December 31, 2003. The impact of the increase in the average balance of total
interest-bearing liabilities was offset, in part, by a 19 basis point decrease in the average cost
of total interest-bearing liabilities to 2.58% for 2004 from 2.77% for 2003.
Interest expense on borrowed funds increased $48.3 million primarily due to a $2.01 billion
increase in the average balance of borrowed funds to $6.10 billion for 2004, the impact of which
was partially offset by a 55 basis point decrease in the average cost of borrowed funds to 3.53%
for 2004. The increase in the average balance of borrowed funds was used to fund asset growth. The
decrease in the average cost of borrowed funds reflected the continued growth of our borrowed funds
in the prevailing interest rate environments that existed during 2003 and 2004. We intend to
continue to use borrowed funds as a funding source for our asset growth initiatives, with new
borrowings primarily having periods to initial repricing of three to five years.
Interest expense on interest-bearing deposits increased $5.5 million primarily due to a $1.10
billion increase in the average balance of interest-bearing deposits to $10.59 billion for 2004,
the impact of which was partially offset by an 18 basis point decrease in the average cost to
2.03%. The increase in the average balance of interest-bearing deposits, primarily used to fund
asset growth, reflected a $1.61 billion increase in the average balance of interest-bearing
transaction accounts due to the growth in our High Value Checking account product. We believe the
increase in the average balance of interest-bearing deposits was primarily due to our consistent
offering of competitive rates on our High Value Checking account product. We believe the $487.9
million decrease in the average balance of time deposits was due in part to transfers to our High
Value Checking account and significant competition for deposits in the New York metropolitan area.
We intend to continue to fund future asset growth using customer deposits as our primary source of
funds, by continuing to pay competitive rates and by opening new branch offices, while
supplementing the deposit growth with borrowed funds.
The 18 basis point decrease in the average cost of interest-bearing deposits primarily reflected a
29 basis point decrease in the average cost of our time deposits, a 16 basis point decrease in the
average cost of savings accounts and a 14 basis point decrease in the average cost of money market
accounts. These decreases were partially offset by a 2 basis point increase in the average cost of
interest-bearing transaction deposits reflecting the increasing short-term interest rate
environment of 2004. This decrease
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in the average cost of interest-bearing deposits reflected the prevailing interest rate
environments experienced during 2003 and 2004.
Net Interest Income. Net interest income increased $84.0 million, or 20.9%, to $485.0 million
for the year ended December 31, 2004 compared with $401.0 million for the year ended December 31,
2003. This increase primarily reflected our growth initiatives, which resulted in increases in the
average balance of both interest-earning assets and interest-bearing liabilities, and the net
interest rate spread earned on this growth. Our net interest rate spread, determined by subtracting
the weighted-average cost of total interest-bearing liabilities from the weighted-average yield on
total interest-earning assets, increased 6 basis points to 2.43% for 2004 from 2.37% for 2003. Our
net interest margin, determined by dividing net interest income by total average interest-earning
assets, increased 1 basis point to 2.66% for 2004 from 2.65% for 2003.
The increases in these ratios reflected the larger decrease in the cost of total interest-bearing
liabilities compared with the decrease in the yield of total interest-earning assets primarily due
to the decreased prepayment activity on our mortgage-related assets, and the resulting decrease in
the amortization of the net premium on these assets. The increase in these ratios also reflected
the overall shift in our asset mix towards first mortgage loans, which have a higher yield than our
other interest-earning assets, the impact of which was partially offset by an overall shift in our
liability mix toward borrowed funds, which have a higher average rate than our other
interest-bearing liabilities.
Provision for Loan Losses. Our provision for loan losses for the year ended December 31, 2004
was $790,000 compared with $900,000 for the year ended December 31, 2003. Net charge-offs for the
year ended December 31, 2004 were $18,000 compared with net recoveries of $146,000 for the year
ended December 31, 2003. The allowance for loan losses increased $772,000 to $27.3 million at
December 31, 2004 from $26.5 million at December 31, 2003. The increase in the allowance for loan
losses, through the provision for loan losses, reflected the overall growth of the loan portfolio,
increases in non-performing loans and low levels of charge-offs.
Non-performing loans, defined as non-accruing loans and accruing loans delinquent 90 days or more,
increased $1.3 million to $21.6 million at December 31, 2004 from $20.3 million at December 31,
2003, primarily reflecting increases in non-accrual loans. The ratio of non-performing loans to
total loans was 0.19% at December 31, 2004 compared with 0.23% at December 31, 2003. The ratio of
the allowance for loan losses to non-performing loans was 126.44% at December 31, 2004 compared
with 131.09% at December 31, 2003. The ratio of the allowance for loan losses to total loans was
0.24% at December 31, 2004 compared with 0.30% at December 31, 2003.
During 2004, we lowered the loss factors used in our worksheet on our purchased mortgage loans to
reflect the seasoning of the portfolio, and the charge-off and delinquency experience.
Notwithstanding such decrease, we have maintained a minimal provision for loan losses during 2004
to reflect expected losses resulting from the actual growth in our loan portfolio. We consider the
ratio of allowance for loan losses to total loans at December 31, 2004, given our primary lending
emphasis and current market conditions, to be at an acceptable level. Furthermore, the increase in
the allowance for loan losses during 2004 reflected the growth in the loan portfolio, the low
levels of loan charge-offs, the stability in the real estate market and the resulting stability in
our overall loan quality.
Non-Interest Income. Total non-interest income decreased $13.1 million to $16.6 million for the
year ended December 31, 2004 from $29.7 million for the year ended December 31, 2003. The decrease
in non-interest income primarily reflected a $12.9 million decrease in gains on securities
transactions, net to $11.4 million for 2004 from $24.3 million for 2003, primarily due to decreases
in sales of mortgage-
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backed securities. The $11.4 million gain on securities transactions during 2004 resulted from an
opportunity to realize gains from the sale of certain available for sale mortgage-backed securities
prior to interest rate changes, such as seen in the second quarter of 2004, which would have had an
adverse impact on their fair market value. The historically low interest rate environment enabled
us to realize these gains on the sales of securities, as the lower rates increased the fair value
of the fixed-rate securities sold. The gains in 2003 resulted from the enhanced opportunities to
realize gains due to the declining interest rate environment. The total cash flow from the sales of
these securities during 2004 was $510.5 million, which was subsequently reinvested into mortgage
loans and investment securities.
Non-Interest Expense. Total non-interest expense increased $15.8 million, or 15.4%, to $118.3
million for the year ended December 31, 2004 from $102.5 million for the year ended December 31,
2003. The increase was primarily due to increases in compensation and employee benefit expense
related to our employee stock benefit plans, compensation expense related to staff increases due to
our branch expansion program, occupancy expenses due to our branch expansion program and expenses
related to internal control evaluation and testing in order to comply with the new certification
requirements imposed by the Sarbanes-Oxley Act and other regulatory costs. Our efficiency ratio was
23.60% for 2004 compared with 23.81% for 2003. Our ratio of non-interest expense to average total
assets for 2004 was 0.64% compared with 0.66% for 2003. The relative stability of these ratios
reflected our efforts to control costs, notwithstanding the actual increase in non-interest
expense, as our average assets grew in excess of 20.0% when comparing 2004 to 2003.
Income Taxes. Income tax expense increased $23.3 million, or 19.4%, to $143.1 million for the
year ended December 31, 2004 from $119.8 million for the year ended December 31, 2003, primarily
due to the 16.9% increase in income before income tax expense. Our effective tax rate increased
for 2004 to 37.43% from 36.61% for 2003, primarily due to the expense of the employee stock
ownership plan, which is not fully deductible for income tax purposes.
Liquidity and Capital Resources
The term “liquidity” refers to our ability to generate adequate amounts of cash to fund loan
originations, loan and security purchases, deposit withdrawals, repayment of borrowings and
operating expenses. Our primary sources of funds are scheduled amortization and prepayments of loan
principal and mortgage-backed securities, deposits, borrowed funds, maturities and calls of
investment securities and funds provided by our operations. Our membership in the FHLB provides us
access to additional sources of borrowed funds, which is generally limited to approximately twenty
times the amount of FHLB stock owned. We also have the ability to access the capital markets from
time to time, depending on market conditions.
Our investment policy provides that we shall maintain a primary liquidity ratio, which consists of
investments in cash, cash in banks, Federal funds sold, securities with remaining maturities of
less than five years and adjustable-rate mortgage-backed securities repricing within one year, in
an amount equal to at least 4% of total deposits and short-term borrowings. At December 31, 2005,
our primary liquidity ratio was 38.0%.
Deposit flows, calls of investment securities and borrowed funds, and prepayments of loans and
mortgage-backed securities are strongly influenced by interest rates, general and local economic
conditions and competition in the marketplace. These factors reduce the predictability of the
timing of these sources of funds. As mortgage interest rates decline, customer prepayment activity
tends to accelerate causing an increase in cash flow from both our mortgage loan and
mortgage-backed security portfolios. If our pricing is competitive, the demand for mortgage
originations also accelerates. When
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mortgage rates increase, the opposite effect on prepayment activity tends to occur and our loan
origination and purchase activity becomes increasingly dependent on the strength of our residential
real estate market and the volume of home purchases and new construction activity in the markets we
serve.
The second-step conversion provided a significant amount of net available proceeds for investment.
We raised approximately $3.93 billion in our second-step conversion, which was completed in June
2005. The net $3.80 billion in cash proceeds from the second-step conversion reflected the receipt
of the $3.93 billion in offering proceeds less the payment of $125.0 million in conversion related
expenses. The amount of funds available for investment was $3.57 billion, reflecting a further
$229.9 million reduction from the net offering proceeds due to the use of customer deposits to
purchase stock.
Principal repayments on loans were $2.15 billion during the year 2005 compared with $2.02 billion
for the year 2004. The increase in payments on loans reflected the growth of our loan portfolio
during this period of relatively stable long-term interest rates and prepayment activity. Principal
payments received on mortgage-backed securities totaled $1.46 billion during 2005 compared with
$1.73 billion during 2004. The decrease in payments on mortgage-backed securities reflected the
decline in the aggregate balance of mortgage-backed securities during 2004, and a decline in the
prepayment rate. Maturities and calls of investment securities totaled $1.70 billion during 2005,
which included the $1.50 billion of maturing agency discount notes purchased with a portion of the
net offering proceeds, compared with maturities and calls of $1.42 billion during the corresponding
period in 2004. The decrease in maturities and calls, when not including the maturing discount
notes, reflected the relatively stable long-term interest rate environment during 2005 resulting in
a decrease in call activity.
Total deposits decreased $94.0 million during the year 2005 compared with an increase of $1.02
billion during the year 2004. Deposit flows, in general, are affected by the level of market
interest rates, the interest rates and products offered by competitors, the volatility of equity
markets, and other factors. The decrease in deposits during 2005 was due primarily to the
consolidation of the $145.8 million deposit of Hudson City, MHC, as part of the second-step
conversion, which was added to our capital, and the use of approximately $229.9 million of customer
deposits to purchase stock during our offering. Time deposit accounts scheduled to mature within
one year were $4.98 billion at December 31, 2005. We anticipate that we will have sufficient
resources to meet this current funding commitment. Based on our deposit retention experience and
current pricing strategy, we anticipate that a significant portion of these time deposits will
remain with us as renewed time deposits or transfers to other deposit products. We are committed to
maintaining a strong liquidity position; therefore we monitor our liquidity position on a daily
basis.
For the year 2005, we borrowed an additional $5.13 billion compared with new borrowings of $3.75
billion for the year 2004. We made $925.0 million in principal payments on borrowed funds during
2005 compared with $1.75 billion for 2004. The funds borrowed during 2005 all have initial non-call
periods ranging from one to five years and final maturities of ten years, and were primarily used
to fund our asset growth. At December 31, 2005, there were no borrowed funds scheduled to mature
within one year. However, we had $4.18 billion in borrowed funds, with a weighted-average rate of
3.77%, that have the potential to be called within one year. We anticipate we will have sufficient
resources to meet this funding commitment by borrowing new funds at the prevailing market interest
rate, or by paying-off the borrowed funds as they are called.
Our primary investing activities are the origination and purchase of one-to four-family real estate
loans and consumer and other loans, the purchase of mortgage-backed securities, and the purchase of
investment securities. Of the $3.57 billion in net proceeds from the second-step conversion
available for investment, approximately $1.50 billion was directly invested into
government-sponsored agency
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discount notes yielding approximately 3.24%, all of which matured during the second-half of 2005.
These funds were subsequently reinvested primarily into callable government-sponsored agency
securities with maturities not exceeding two years, government-sponsored agency step-up securities.
We also directly invested approximately $900.0 million of the offering proceeds into callable
government-sponsored agency securities with an average yield of 3.94% and approximately $400.0
million into government-sponsored agency step-up notes with an average yield of 4.00%. The
remainder of the proceeds was primarily used to purchase adjustable-rate mortgage-backed securities
and, to a lesser extent, purchase and originate first mortgage loans.
We originated total loans of $2.19 billion during the year 2005 compared with $1.46 billion during
the year 2004. Of the first mortgage loan originations during 2005, 52.9% were variable-rate loans.
During the year 2005 we purchased total loans of $3.68 billion compared with $3.12 billion during
the year 2004. Of the first mortgage loan purchases during 2005, 25.4% were variable-rate loans.
The continued larger volume of purchased mortgage loans in 2005, when compared to originated loans,
allowed us to grow and geographically diversify our mortgage loan portfolio at a relatively low
overhead cost while maintaining our traditional thrift business model. The increase in loan
purchases also reflected the asset growth strategies we have employed during recent periods, using
borrowed funds as our primary funding source. We will continue to purchase mortgage loans to grow
and diversify our portfolio, as opportunities and funding are available.
Purchases of mortgage-backed securities during the year 2005 were $3.28 billion compared with $2.20
billion during the year 2004. The increase in purchases of mortgage-backed securities reflected the
shift of security purchases to variable-rate mortgage-backed securities to assist in our management
of interest rate risk and the investment of part of the net proceeds from our second-step
conversion. Of the mortgage-backed securities purchased during 2005, 93.1% were variable-rate
securities. During the year 2005, we purchased $4.31 billion of investment securities, of which
$2.80 billion was invested directly from the net offering proceeds, compared with purchases of
$2.11 billion during the year 2004. This decrease in purchases of investment securities, outside
the investment of the net offering proceeds, reflected the lower amount of cash flows available for
investment in 2005 due to the lower amount of calls of investment securities and the shift of
security purchases to variable-rate mortgage-backed securities.
As part of the membership requirements of the FHLB, we are required to hold a certain dollar amount
of FHLB common stock based on our asset size or our borrowings from the FHLB. During the year
2005, we increased our amount of FHLB common stock held by $87.0 million due to purchases of $104.2
million exceeding redemptions of $17.2 million, necessitated by increases in our amount of
outstanding borrowings with the FHLB and the implementation of a new capital plan by the FHLB.
During the year 2004, we redeemed $24.9 million of FHLB stock, decreasing our FHLB common stock
held by that amount, due to our declining balance of borrowed funds at the FHLB. The net purchases
made during 2005 brought our total investment in FHLB stock to $227.0 million, the amount we are
currently required to hold.
Cash dividends declared and paid during 2005 were $102.1 million compared with $40.5 million during
2004. In both 2004 and 2005, Hudson City, MHC applied for and was granted approval from the OTS to
waive receipt of dividends declared by Hudson City Bancorp. These waivers of dividend payments were
effective for the entirety of 2004 and the first six months of 2005. Beginning in the third quarter
of 2005, due to the consolidation of Hudson City, MHC into Hudson City Bancorp as part of the
second-step conversion, dividends were paid on all outstanding shares of Hudson City Bancorp common
stock. The dividend pay-out ratio using amount per share information, which does not reflect the
dividend waiver by Hudson City, MHC in periods prior to the third quarter of 2005, was 54.69% for
the year 2005 compared with 53.17% for the year 2004. On January 17, 2006, the Board of Directors
declared a quarterly cash
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dividend of $0.075 per common share. The dividend was paid on March 1, 2006 to stockholders of
record at the close of business on February 3, 2006.
During 2005, the independent trustee of our Employee Stock Ownership Plan purchased 15,719,223
shares of outstanding common stock at an aggregate cost of $189.3 million. Also during 2005, the
trustee of our recognition and retention plan purchased 115,839 shares of common stock for our
recognition and retention plan at an aggregate cost of $1.3 million due to awards to employees made
during the period.
Under our stock repurchase programs, shares of Hudson City Bancorp common stock may be purchased in
the open market and through other privately negotiated transactions, from time-to-time, depending
on market conditions. The repurchased shares are held as treasury stock for general corporate use.
In October 2005, a sixth stock repurchase plan was approved by the Board of Directors and the OTS
to repurchase up to 29,880,000 shares, or approximately five percent of the then outstanding common
stock. The fifth stock repurchase program, which had been suspended in late 2004 due to our
second-step conversion and stock offering, was canceled due to the approval of this sixth plan.
During 2005 we purchased 9,119,768 of our common stock at an aggregate cost of $107.5 million,
including the purchase of 256,768 shares in April 2005 directly from vesting shares in our
recognition and retention plan for payment of income taxes. At December 31, 2005, there remained
21,017,000 shares to be purchased in the sixth plan. During 2004, we purchased 14,716,187 shares at
an aggregate cost of $161.7 million under our stock repurchase program.
At December 31, 2005, Hudson City Savings exceeded all regulatory capital requirements. Hudson City
Savings’ tangible capital ratio, leverage (core) capital ratio and total risk-based capital ratio
were 14.68%, 14.68% and 41.31%, respectively. These ratios reflect the $3.00 billion contribution
of net offering proceeds from Hudson City Bancorp.
The primary source of liquidity for Hudson City Bancorp, the holding company of Hudson City
Savings, is capital distributions from the banking subsidiary. During the year 2005, Hudson City
Bancorp received $259.3 million in dividend payments from Hudson City Savings, which amounted to
approximately 96.4% of Hudson City Savings’ net income for that period. The primary use of these
funds is the payment of dividends to our shareholders, the repurchase of our common stock and the
lending of funds to the independent trustee of our ESOP for the purchase of shares. Hudson City
Bancorp’s ability to continue these activities is solely dependent upon capital distributions from
Hudson City Savings. Applicable federal law may limit the amount of capital distributions Hudson
City Savings may make. (See “Item 1 — Business — Regulation of Hudson City Savings Bank and Hudson City Bancorp —
Federally Chartered Savings Bank Regulations — Limitation on Capital Distributions”)
Management of Interest Rate Risk
As a financial institution, our primary component of market risk is interest rate volatility. Our
net income is primarily based on net interest income, and fluctuations in interest rates will
ultimately impact the level of both income and expense recorded on a large portion of our assets
and liabilities. Fluctuations in interest rates will also affect the market value of all
interest-earning assets, other than those that possess a short term to maturity. During 2005,
short-term interest rates increased to the same levels as intermediate- and long-term interest
rates, resulting in a flat, and occasionally inverted, market yield curve. This interest rate
environment had an adverse impact on our net interest income as our interest-bearing liabilities
generally price off short-term interest rates, while our interest-earning assets, a majority of
which have initial terms to maturity or repricing greater than one year, generally price off
long-term rates.
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The timing of the placement of interest-earning assets and interest-bearing liabilities on our
balance sheet, particularly during this rising short-term interest rate environment, also had an
adverse impact on our net interest income. The impact of interest rate changes on our interest
income is generally felt in later periods than the impact on our interest expense due to the timing
of the recording on the balance sheet of our interest-earning assets and interest-bearing
liabilities. The recording of interest-earning assets on the balance sheet generally lags the
current market due to normal commitment period of up to three months for the purchase or
origination of mortgage loans and mortgage-backed securities, while the recording of
interest-bearing liabilities on the balance sheet is generally concurrent with the current market.
Also impacting our net interest income and net interest rate spread is the level of prepayment
activity on our mortgage-related assets. The actual amount of time before mortgage loans and
mortgage-backed securities are repaid can be significantly impacted by changes in market interest
rates and mortgage prepayment rates. Mortgage prepayment rates will vary due to a number of
factors, including the regional economy in the area where the underlying mortgages were originated,
seasonal factors, demographic variables and the assumability of the underlying mortgages. However,
the major factors affecting prepayment rates are prevailing interest rates, related mortgage
refinancing opportunities and competition. Generally, the level of prepayment activity directly
affects the yield earned on those assets, as the payments received on the interest-earning assets
will be reinvested at the prevailing market interest rate. Prepayment rates are generally inversely
related to the prevailing market interest rate, thus, as market interest rates increase, prepayment
rates tend to decrease.
Prepayment activity was relatively stable during 2005 and 2004, when compared to the significant
prepayment activity experienced during 2003, as long-term market interest rate have been relatively
stable during 2005 and 2004, with a slight increase in rates during 2005. The mortgage-related
assets resulting from this prepayment activity during 2005 and 2004 will tend to not prepay as
fast, as their contractual interest rates are relatively low. The slowing of the prepayment
activity in turn decreased the amount of related premium amortized on these assets during 2005 and
2004, when compared to the net amortization during 2003.
The primary objectives of our interest rate risk management strategy are to:
We seek to manage our asset/liability mix to help minimize the impact that interest rate
fluctuations may have on our earnings. To achieve the objectives of managing interest rate risk,
our Asset/Liability Committee meets weekly to discuss and monitor the market interest rate
environment compared to interest rates that are offered on our products. This committee consists of
the Chief Executive Officer, the Chief Operating Officer, the Investment Officer and other senior
officers of the institution as required. The Asset/Liability Committee presents periodic reports to
the Board of Directors at its regular meetings and, on a quarterly basis, presents a comprehensive
report addressing the results of activities and strategies and the effect that changes in interest
rates will have on our results of operations and the present value of our equity.
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Historically, our lending activities have emphasized one- to four-family fixed-rate first and
second mortgage loans. Our growth in variable-rate mortgage loans has helped reduce our exposure
to interest rate fluctuations and is expected to benefit our long-term profitability, as the rate
earned on the mortgage loan will increase as prevailing market rates increase. However, the
prevailing interest rate environment, and the desires of our customers, has resulted in a demand
for long-term hybrid and fixed-rate first mortgage loans. This may have an adverse impact on our
net interest income, particularly in a rising interest rate environment.
During 2005 our investment and mortgage-backed security purchases were generally short-term in
nature in order to give us additional interest rate risk protection and offset the increases in
fixed-rate first mortgage loan originations and purchases. Our mortgage-backed security purchases
were primarily variable-rate or hybrid instruments, and our investment security purchases were U.S.
government-sponsored agency securities with final maturities of two years or less or with step-up
features. At December 31, 2005, approximately 53.6% of our mortgage-backed security portfolio was
variable-rate, which we define as having a contractual rate adjustment during the life of the
security, including those securities with a set initial fixed-rate period. Approximately $1.72
billion of the government-sponsored agency securities held at December 31, 2005 have step-up
features, where the interest rate is increased on scheduled future dates. These securities have
call options that are generally effective prior to the initial rate increase but after an initial
non-call period of three months to one year. The rate increases are one-half of one percent to two
percent per adjustment and are fixed over the life of the security.
Our primary source of funds has been deposits, consisting primarily of time deposits and the
interest-bearing High Value Checking account product, which have substantially shorter terms to
maturity than our mortgage loan portfolio. We use securities sold under agreements to repurchase
and FHLB advances as additional sources of funds. These borrowings are generally long-term to
maturity, in an effort to offset our short-term deposit liabilities and assist in managing our
interest rate risk. Certain of these borrowings have call options that could shorten their
maturities in a changing interest rate environment. We intend to continue to grow our borrowed
funds, as part of our interest rate risk management strategy with new borrowings having maturities
of ten years and initial non-call periods of one to five years. During 2005 our borrowed funds
increased significantly when compared to our deposits due to the use of deposits by our customers
to purchase stock in our second-step conversion and the significant competition for deposits in the
New York metropolitan area.
Due to the nature of our operations, we are not subject to foreign currency exchange or commodity
price risk. Instead, our mortgage loan portfolio, the majority of
which is located in New Jersey, New York and Connecticut,
is subject to risks associated with the local economy. The purchases of first mortgage loans have
allowed us to geographically diversify our mortgage loan portfolio in order to attempt to mitigate
this concentration risk. We do not own any trading assets. We did not engage in any hedging
transactions that use derivative instruments (such as interest rate swaps and caps) during 2005 and
did not have any such hedging transactions in place at December 31, 2005. In the future, we may,
with approval of our Board of Directors, engage in hedging transactions utilizing derivative
instruments, but we have no current plans to do so.
Simulation Model. We use a simulation model as our primary means to calculate and monitor the
interest rate risk inherent in our portfolio. This model reports net interest income and the
present value of equity in different interest rate environments, assuming an instantaneous and
permanent interest rate shock to all interest rate-sensitive assets and liabilities. We assume
maturing or called instruments are reinvested into the same type of product, with the rate earned
or paid reset to our currently offered rate for loans and deposits, or the current market rate for
securities and borrowed funds.
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Our interest-earning assets and interest-bearing liabilities are generally reported at the earlier
of their maturity date or next rate reset date, subject to prepayment rates, non-maturity deposit
decay rates, and the call of certain of our investment securities and borrowed funds. In the
preparation of the simulation model, we are required to make certain assumptions regarding
reporting changes, which are highly subjective to the current interest rate environment. The
information presented in the following table is based on the following assumptions:
The prepayment rate on our first mortgage loans and mortgage-backed securities will fluctuate given
the current market interest rate environment. We use 125% of the FHLMC index for our first mortgage
loans as we hold a high percentage of jumbo loans in our portfolio, which tend to prepay faster
than conforming product, and a high percentage of our loans are in the active New York metropolitan
market area. Generally, prepayment rates have decreased during 2005 due to the relative stability
of intermediate- and long-term market interest rates over that period. Our determination of deposit
decay rates is based on historical experience with the varying non-maturity deposit types and an
analysis of our current deposit base. The change in the deposit decay rates for regular savings
deposits and interest-bearing transaction accounts from the decay rate used at December 31, 2004
was due to the decline in those balances during 2005 due to a shift in deposits to time deposits.
The deposit decay rate assumptions are examined by a third party for reasonableness.
Prepayment rates, deposit decay rates and anticipated calls of investment securities or borrowed
funds can have a significant impact on the results of the simulation model. While we believe that
our assumptions are reasonable, actual future deposit decay activity, mortgage and mortgage-backed
securities prepayments, and the timing of calls of federal agency bonds and borrowings may vary
materially from our estimates and assumptions. Significant increases in market interest rates may
tend to reduce
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prepayment speeds on our mortgage-related assets, as fewer borrowers refinance their loans. At the
same time, deposit decay rates may tend to increase in the shorter-term periods, as depositors seek
higher yielding investments elsewhere. If these trends occur, we could experience larger negative
percent changes in our model results in the varying rate shock scenarios.
As a primary means of managing interest rate risk, we monitor the impact of interest rate changes
on our net interest income over the next twelve-month period. This model does not purport to
provide estimates of net interest income over the next twelve-month period, but attempts to assess
the impact of a simultaneous and parallel interest rate change on our net interest income. The
following table reports the changes to our net interest income over various interest rate change
scenarios. Our internal policy sets a maximum change of 40.0% given a positive or negative 200
basis point interest rate shock.
As indicated in the table, the percent change in our net interest income in the positive 200
basis point shock scenario is negative 8.50% compared with negative 6.80% at December 31, 2004. The
percent change in net interest in the negative 100 basis point shock scenario was negative 3.13% at
December 31, 2005 compared with negative 5.81% in the negative basis 100 basis point scenario at
December 31, 2004. We did not report the change in the negative 200 basis point scenario at
December 31, 2004 as the results would not have been meaningful given market interest rates at that
time. The negative change to net interest income in the positive change scenarios was primarily due
to the expected call, and subsequent reset to higher market interest rates, of our borrowed funds.
The negative change to net interest income in the negative change scenarios was primarily due to
the expected call of our government-sponsored agency securities and the acceleration of the
prepayment speeds on our mortgage-related assets, and the subsequent reset to lower market interest
rates of the reinvested assets.
We also monitor our interest rate risk by monitoring changes in the present value of equity in the
different rate environments. The present value of equity is the difference between the estimated
fair value of interest rate-sensitive assets and liabilities. The changes in market value of assets
and liabilities due to changes in interest rates reflect the interest sensitivity of those assets
and liabilities as their values are derived from the characteristics of the asset or liability
(i.e., fixed-rate, adjustable-rate, caps, floors) relative to the current interest rate
environment. For example, in a rising interest rate environment the fair market value of a
fixed-rate asset will decline, whereas the fair market value of an adjustable-rate asset, depending
on its repricing characteristics, may not decline. Increases in the market value of assets will
increase the present value of equity whereas decreases in the market value of assets will decrease
the present value of equity. Conversely, increases in the market value of liabilities will decrease
the present value of equity whereas decreases in the market value of liabilities will increase the
present value of equity.
The following table presents the estimated present value of equity over a range of interest rate
change scenarios at December 31, 2005. The present value ratio shown in the table is the present
value of equity
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as a percent of the present value of total assets in each of the different rate environments.
Our current policy sets a minimum ratio of the present value of equity to the fair value of assets
in the current interest rate environment (no rate shock) of 8.00%, a minimum present value ratio of
6.50% in the plus 200 basis point interest rate shock scenario and a minimum present value ratio of
6.00% in the minus 200 basis point scenario.
As indicated in the table, our present value ratio in the positive 200 basis point scenario
was 18.71% compared with 9.44% at December 31, 2004. The increase in the present value ratio was
primarily due to the infusion of capital due to the completion of our second-step conversion and
stock offering. The change in the present value ratio in the positive 200 basis point scenario was
negative 309 basis points at December 31, 2005 compared with negative 307 basis points at December
31, 2004. The decreases in the present value of equity and the present value ratio in the
increasing rate scenarios in the December 31, 2005 analysis were primarily due to the high
percentage of fixed-rate mortgage loans, mortgage-backed securities and investment securities in
our portfolio. At December 31, 2005, fixed-rate interest earning-assets were 70.3% of total
interest-earning assets. This percentage of fixed-rate interest-earning assets to total
interest-earning assets may have an adverse impact on our earnings in a rising rate environment, as
these assets will not reprice in a rising rate environment.
The present value ratio in the negative 100 basis point change was 20.95% at December 31, 2005
compared with 11.02% in the negative 100 basis point change at December 31, 2004. The increase in
the present value ratio was primarily due to the infusion of capital due to the completion of our
second-step conversion and stock offering. The change in the present value ratio in the negative
100 basis point scenario was negative 85 basis points at December 31, 2005 compared with negative
149 basis points in the negative 100 basis point scenario at December 31, 2004. We did not report
the change in the negative 200 basis point scenario at December 31, 2004 as the results would not
have been meaningful given market interest rates at that time. The decreases in the present value
of equity and the present value ratio in the increasing rate scenarios in the December 31, 2005
analysis were primarily due to the growth of our fixed-rate borrowed funds with long terms to
maturity, which generally do not reprice in a decreasing rate environment.
The methods we used in simulation modeling are also inherently imprecise. This type of modeling
requires that we make assumptions that may not reflect the manner in which actual yields and costs
respond to changes in market interest rates. For example, we assume the composition of the interest
rate-sensitive assets and liabilities will remain constant over the period being measured and that
all interest rate shocks will be uniformly reflected across the yield curve, regardless of the
duration to maturity or
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repricing. The table assumes that we will take no action in response to the changes in interest
rates. In addition, prepayment estimates and other assumptions within the model are subjective in
nature, involve uncertainties, and, therefore, cannot be determined with precision. Accordingly,
although the previous two tables may provide an estimate of our interest rate risk at a particular
point in time, such measurements are not intended to and do not provide a precise forecast of the
effect of changes in interest rates on our net interest income or present value of equity.
Gap Analysis. The matching of the repricing characteristics of assets and liabilities may be
analyzed by examining the extent to which such assets and liabilities are “interest rate-sensitive”
and by monitoring a financial institution’s interest rate sensitivity “gap.” An asset or liability
is said to be “interest rate-sensitive” within a specific time period if it will mature or reprice
within that time period. The interest rate sensitivity gap is defined as the difference between the
amount of interest-earning assets maturing or repricing within a specific time period and the
amount of interest-bearing liabilities maturing or repricing within that same time period.
A gap is considered negative when the amount of interest-bearing liabilities maturing or repricing
within a specific time period exceeds the amount of interest-earning assets maturing or repricing
within that same period. A gap is considered positive when the amount of interest-earning assets
maturing or repricing within a specific time period exceeds the amount of interest-bearing
liabilities maturing or repricing within that same time period. During a period of rising interest
rates, a financial institution with a negative gap position would be expected, absent the effects
of other factors, to experience a greater increase in the costs of its interest-bearing liabilities
relative to the yields of its interest-earning assets and thus a decrease in the institution’s net
interest income. An institution with a positive gap position would be expected, absent the effect
of other factors, to experience the opposite result. Conversely, during a period of falling
interest rates, a negative gap would tend to result in an increase in net interest income while a
positive gap would tend to reduce net interest income.
The following table, referred to as the gap table, presents the amounts of our interest-earning
assets and interest-bearing liabilities outstanding at December 31, 2005, which we anticipate to
reprice or mature in each of the future time periods shown. Except for prepayment activity and
non-maturity deposit decay rates, we determined the amounts of assets and liabilities that reprice
or mature during a particular period in accordance with the earlier of the term to rate reset or
the contractual maturity of the asset or liability. For purposes of this table, assumptions used in
decay rates and prepayment activity are similar to those used in the preparation of our simulation
model. Borrowed funds are reported at the anticipated call date, for those that are callable within
one year, or at their contractual maturity date. We have excluded originated non-accrual mortgage
loans of $4,312,000 and non-accrual other loans of $2,000 from the table.
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