Friday, January 12, 2018
MANAGING DIRECTOR: Scott Carrithers   PORTFOLIO SALES AND SERVICE: Steve Panknin • George Morris • Jeff Goble • Chris Thompson • Sean Doherty Robert Brickson • Kevin Doyle • Lonnie Harris •  Mark Tranckino • Robert Schuyler  Tom Toburen • Josh Kiefer • Nicole Burczyk • Kelley Frye • Natalie Regan • Aaron Stoffer • Chuck Honeywell

US Treasury Market
Date	1 mo	3 mo	6 mo	1 yr	2 yr	3 yr	5 yr	7 yr	10 yr	20 yr	30 yr
1/5/18	1.27	1.39	1.58	1.80	1.96	2.06	2.29	2.40	2.47	2.64	2.81
1/8/18	1.30	1.45	1.60	1.79	1.96	2.07	2.29	2.41	2.49	2.65	2.81
1/9/18	1.27	1.44	1.60	1.78	1.98	2.09	2.33	2.46	2.55	2.72	2.88
1/10/18	1.31	1.42	1.59	1.78	1.98	2.08	2.32	2.47	2.55	2.73	2.88
1/11/18	1.32	1.43	1.58	1.77	1.98	2.09	2.32	2.46	2.54	2.72	2.91

                                                                                       Source: U.S. Department of the Treasury, as of 1/11/18  

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Case Study: The Rise and Fall of Hudson City Savings Bank

“Only when the tide goes out do you discover who’s been swimming naked.” – Warren Buffet.

In 2008 as the “credit tide” receded, most money center and regional banks were left struggling with a combination of problems:  nonperforming loans, rising funding costs, and negative earnings.  Yet during 2008, Hudson City Savings Bank increased its earnings by over 50%!  They avoided chasing subprime mortgage loan production and maintained high underwriting standards.  As a result, they experienced significantly lower loan losses compared to its peers.

The tides did however turn against Hudson City in 2011 as incorrect interest rate bets and mortgage loans refinanced.  Pre-crisis, the bank took out a substantial amount of long-term FHLB advances and other borrowings at 4% or more as core deposit growth struggled.  At the time the market was booming and loan demand remained robust.  A significant portion of the market believed rates were only going to go higher, however the opposite proved to be true as the Federal Reserve dramatically grew its balance sheet and rates cratered (June 2007 the 10yr UST was 5.30% falling to less than 2% by the end of 2011).  To add fuel to the fire, jumbo mortgages that were not eligible to easily refinance became much more competitive as Fannie Mae and Freddie Mac significantly increased loan size limits.  Hudson City Savings Bank prior to this change was able to charge above average interest rates with less competition.  The bank was subsequently hit with a wave of refinancing and saw its margins significantly decline.  With high cost of long-term borrowings on the balance sheet they were forced to retire ~$15 billion of long-term borrowing with a ~$2 billion prepayment penalty (resulting in a loss of ~$750mm in 2011).    Hudson City was eventually sold for ~$3.7 billion which represented a ~12% discount to tangible book value of ~$4.2 billion to M&T bank.

Key Takeaways

• Long-term borrowings – We continue to favor attractive long-term financing with limited prepayment penalties (callable brokered CDs vs FHLB advances).The cheapness of the call (5-10bps with only 6 month lockout) allows you to significantly decrease interest rate sensitivity compared to a bullets (FHLB or CDs) helping to avoid making a large interest rate call like Hudson Savings.

• FHLB long-term borrowings - If you are using long-term FHLB advances to offset new loan growth make sure your loan contains a prepayment penalty to offset the charge.

• Funding mix – Maintain a diverse set of funding sources including core deposits, FHLB advances, and brokered CDs to avoid funding concentration risks.

Sources: Bloomberg, Crains New York, 10-Q

This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

•Not FDIC Insured •No Bank Guarantee •May Lose Value