News that Hudson City Bancorp Inc. expects an informal warning from regulators to rein in its interest rate risk sent the Paramus, N.J. thrift's shares tumbling, while validating some mounting concerns about one of the darlings of the post-recession banking industry.
On Monday the $61 billion-asset company's shares closed down 9%, or 98 cents, at $9.92, after it said it may have to do a costly overhaul of how it borrows money to pay for the big, New York-area mortgages that have been the key to its success through the downturn. (Tuesday morning it retraced some of those losses, with shares up 2%.)
Hudson City's latest jumbo mortgages — safe from a credit-quality standpoint — pose a different kind of risk because their rates are relatively low — and often fixed. With the bank relying on relatively high-rate, long-term wholesale funding sources for about half its funding needs, a rise in its costs to borrow could squeeze profits.
The bank's $60 billion in earning assets are about evenly split between between those long-maturing mortgages and shorter-duration investment securities like government-backed mortgage bonds.
Hudson City, unlike large commercial banks, holds onto mortgages rather than selling to the government agencies.
Some analysts have voiced these concerns for months, and the worries are now also apparently shared by Hudson City's primary regulator, the Office of Thrift Supervision.
Hudson City said on Wednesday that it expects "to become subject to an informal regulatory enforcement action" from the OTS that could force it to shrink assets, cut its quarterly dividend or raise capital, among other things.
It said will probably have to enter a memorandum of understanding, one of the OTS's least severe regulatory actions.
Despite the stock-price drop suggesting otherwise, market watchers weren't caught entirely off-guard by the move.
"Based on anecdotal evidence, the OTS has been an aggressive regulator, and therefore the [announcement] is not a complete shock," Rick Weiss, an analyst at Janney Montgomery Scott LLC, wrote in a research note. "We have long-regarded interest rate exposure as Hudson City's chief risk due to its operating model."
Analysts at Guggenheim Securities LLC said an overhaul of Hudson City's funding strucure could be costly.
"While one possibility is to de-lever $30 billion of borrowings and securities … the capital cost would be too great," they wrote. "A likely outcome will include both de-levering and restructuring borrowings."
Hudson City didn't respond to requests for comment.