ITEM 1. BUSINESS.
Hudson City Bancorp is a Delaware corporation organized in 1999 and is registered as a bank holding company with the Federal Reserve Board ("FRB"). Hudson City Bancorp serves as the holding company of its only subsidiary, Hudson City Savings Bank. A majority of the outstanding shares of Hudson City Bancorp's common stock are owned by Hudson City, MHC. 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.
In 1999, Hudson City Savings converted and reorganized from a New Jersey chartered mutual savings bank into a two-tiered mutual savings bank holding company structure and became a wholly-owned subsidiary of Hudson City Bancorp. Hudson City Bancorp sold 47% of the then outstanding shares of its common stock to the public at $10.00 per share and received net proceeds of $527.6 million. Hudson City Bancorp contributed 50% of the net proceeds from the initial public offering to Hudson City Savings. Hudson City Bancorp issued 53% of the then outstanding shares of its common stock to Hudson City, MHC. At December 31, 2002, as a result of stock repurchases, Hudson City, MHC owned 63.85% of Hudson City Bancorp.
As part of our reorganization in structure, Hudson City Savings organized Hudson City, MHC as a New Jersey chartered mutual savings bank holding company which is registered as a bank holding company with the FRB. Hudson City, MHC's principal assets are the shares of common stock of Hudson City Bancorp it received in the reorganization, the $200,000 it received as its initial capitalization and the cash dividends it receives on the shares of Hudson City Bancorp common stock it owns. Hudson City, MHC does not engage in any business activity other than its investment in a majority of the common stock of Hudson City Bancorp and the management of any cash dividends received from Hudson City Bancorp. Federal and state law and regulations require that as long as Hudson City, MHC is in existence it must own a majority of Hudson City Bancorp's common stock.
Hudson City Savings is a New Jersey chartered stock savings bank, serving the customers of New Jersey since 1868. We are the largest savings bank by asset size headquartered in New Jersey. Our deposits are insured by the Federal Deposit Insurance Corporation ("FDIC.") We are examined and regulated by the Department of Banking and Insurance of the State of New Jersey and the FDIC.
Hudson City Savings is a community and customer-oriented retail savings bank offering traditional deposit products, residential real estate mortgage loans and consumer loans. In addition, Hudson City Savings purchases mortgages, mortgage-backed securities, securities issued by the U.S. government and 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 substantially all of the loans we originate.
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 deposits, borrowings, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of investment securities and funds provided by operations.
AVAILABLE INFORMATION
Hudson City Bancorp, Inc.'s periodic and current reports, and any amendments thereto, are made available free of charge on our website, www.hcbk.com, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. Such reports are also available on the Securities and Exchange Commission's website at www.sec.gov.
MARKET AREA
We conduct our operations out of our executive office in Paramus, Bergen County, New Jersey, and 81 branches located in 14 counties throughout the State of New Jersey: Atlantic, Bergen, Burlington, Camden, Essex, Gloucester, Hudson, Middlesex, Monmouth, Morris, Ocean, Passaic, Union and Warren. We operate in three primary markets: northern New Jersey, the New Jersey shore, and southwestern New Jersey in the suburbs of Philadelphia. Overall, the counties in which we operate reflect approximately 80% of the entire population of New Jersey, providing us with access to a large base of potential customers.
Our market areas provide distinct differences in demographics and economic characteristics. The northern New Jersey market (including Bergen, Essex, Hudson, Middlesex, Morris, Passaic, Union and Warren Counties) represents the greatest concentration of population, deposits and income in the State. 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 (including Atlantic, Monmouth and Ocean counties) 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 (including Burlington, Camden and Gloucester counties) consists of communities adjacent to the Philadelphia metropolitan area and represents the smallest concentration of deposits for Hudson City Savings.
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 the State of New Jersey. The slower economic conditions experienced during 2002, characterized by higher unemployment and a declining equity market, did not impact our recent loan demand or growth opportunities, but have moderately affected our loan delinquencies. We believe that we have developed
lending products and marketing strategies to address the diverse credit-related needs of the residents in our market area.
COMPETITION
We face intense competition both in making loans and attracting deposits. New Jersey has a high concentration of financial institutions, many of which are branches of large money center and regional banks which have resulted from the consolidation of the banking industry in New Jersey and surrounding states. Some of these competitors have greater resources than we do and may offer services that we do not provide such as insurance products, 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 home equity credit lines and fixed-rate second mortgage loans. We have not originated commercial real estate loans or loans secured by multi-family residences since the early 1980's and we do not originate construction loans. We stopped originating commercial/industrial business loans in 1993, 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 $2.6 million at December 31, 2002.
At December 31, 2002, we had total loans of $6.97 billion, of which $6.84 billion, or 98.2%, were first mortgage loans. Of residential mortgage loans outstanding at that date, 86.5% were fixed-rate mortgage loans and 13.5% were variable-rate, or ARM, loans. At December 31, 2002, consumer and other loans, primarily fixed-rate second mortgage loans and home equity credit lines, amounted to $128.2 million, or 1.8%, of total loans. We also offer guaranteed student loans through the Student Loan Marketing Association ("SallieMae") "Loan Referral Program."
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 FRB, legislative tax policies and governmental budgetary matters.
The following table presents the composition of our loan portfolio in dollar amounts and in percentages of the total portfolio at the dates indicated.
Loan Maturity. The following table presents the contractual maturity of our loans at December 31, 2002. The table does not include the effect of prepayments or scheduled principal amortization. Prepayments and scheduled principal amortization on first mortgage loans totaled $2.53 billion for 2002, $1.28 billion for 2001 and $475.9 million for 2000.
The following table presents, as of December 31, 2002, the dollar amount of all loans due after December 31, 2003, and whether these loans have fixed interest rates or adjustable interest rates.
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 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 allow any borrower to have more than two outstanding first mortgage loans with us at any one time. 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.
Late in 2000, we established a wholesale loan purchase program designed principally to supplement our retail loan origination production, which is currently being done solely within the state of New Jersey. The purchase of whole loans enables 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 expect to obtain assets with a relatively low overhead cost, minimize related servicing costs, and supplement loan demand in our local lending areas. We have developed written standard operating guidelines relating to the purchasing of these assets. These guidelines include the evaluation and approval process of the various sellers, primarily large national mortgage loan seller/servicers, from whom we choose to buy whole loans, the types of whole loans, acceptable property locations and maximum interest rate variances. The purchasing agreements, as established with each
servicer/seller, contain parameters as to the loans that can be included in each package. These parameters, such as maximum loan size and maximum loan-to-value ratio, conform to parameters utilized by us to originate mortgage loans. Purchased loan packages are subject to internal due diligence procedures, which may include review of individual loan files. This review subjects the purchased loan file to substantially the same underwriting standards used in our own loan origination process. Loan packages purchased include mortgage loans secured by properties located primarily in the east coast corridor states between Boston and Washington, D.C., and in Michigan and Illinois.
The servicing of purchased loans are 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 taken as required. These operating guidelines should provide a means of evaluating and monitoring the quality of mortgage loan purchases and the servicing abilities of the loan servicers. We purchased first mortgage loans of $1.72 billion in 2002. The average size of our one-to-four family mortgage loans purchased during 2002 was approximately $408,000.
Most of our loan originations are from existing or past customers, members of our local communities or referrals from local real estate agents, attorneys and builders. We believe that our extensive branch network is a significant source of new loan generation. We also employ a small 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. In addition, we use the services of licensed mortgage bankers and brokers for mortgage loan originations.
We currently offer loans that conform to underwriting standards that are based on standards specified by FannieMae ("conforming loans"), non-conforming loans, and loans processed as limited documentation 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 up to 30 years. The non-conforming loans generally follow FannieMae guidelines except for the loan amount. FannieMae guidelines limit loans to $322,700; our non-conforming loans may exceed such limits. The average size of our one- to four-family mortgage loans originated in 2002 was approximately $292,000. The overall average size of our one- to four-family first mortgage loans was approximately $212,000 at December 31, 2002. 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.
Our originations of first mortgage loans amounted to $1.84 billion in 2002, $1.52 billion in 2001 and $895.1 million in 2000. In 2002 and 2001, a significant number of our first mortgage loan originations were the result of refinancing of our existing loans due to the relatively low interest rate levels during those times. In 2000, with relatively higher interest rates, refinancing of existing mortgages were lower. Total refinancing of our existing first mortgage loans were as follows:
In April 2001, we began to allow certain customers to modify their existing 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. In 2002 and 2001, we modified $866.3 and $169.5 million of existing mortgage loans, respectively.
We offer a variety of variable-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 $500,000 are 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. Loan-to-value ratios of 80% or less are also required for one- to four-family loans in excess of $500,000 and less than $750,000. Loans in excess of $750,000 and up to $1,000,000 are subject to a maximum 70% loan-to-value ratio. Loan-to-value ratios of 60% or less are required for one- to four-family loans in excess of $1,000,000 and less than $1,500,000.
We currently offer fixed-rate mortgage loans in amounts generally up to $1.5 million with a maximum term of 30 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 currently offer a variety of ARM loans secured by one- to four-family residential properties that initially adjust after one year, five years or ten years, in amounts generally up to $1.5 million. After the initial adjustment period, ARM loans adjust on an annual basis. The ARM loans that we currently originate have a maximum 30-year amortization period and are subject to the same loan-to-value ratios applicable to fixed-rate mortgage loans 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 ("constant treasury maturity index") 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 steep, the ARM loans we offer have initial interest rates above the fully indexed rate. The loans originated with initial interest rates above the fully indexed rate may reprice down at their initial interest reset date, which could adversely effect our net interest income. As of December 31, 2002, the initial offered rate on these loans was 113 to 175 basis points above the current fully indexed rate. We originated $168.5 million of one- to four-family ARM loans in 2002. At December 31, 2002, 13.5% of our one- to four-family mortgage loans consisted of ARM loans.
The 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 one-year ARM loans based on their ability to repay the loans at the higher of the initial interest rate or the fully indexed rate. All other loan products are evaluated at the offered rate. In an effort to further reduce interest rate risk, we have not in the past, nor do we currently, originate ARM loans which provide for negative amortization of principal.
In addition to our full documentation loan program, we process some loans as limited documentation loans. We have originated these loans for over 10 years. Loans eligible for limited documentation processing are ARM loans and 15-, 20- and 30-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. The maximum loan amount for limited documentation loans is $500,000. 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 which 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.
Limited documentation loans 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 that the limited documentation program has not had a material adverse effect on our asset quality. See "-- Asset Quality." Unseasoned limited documentation loans are not readily salable in the secondary market as whole loans. In addition, these loans may not readily be pooled or securitized. 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."
In addition to our standard mortgage and consumer credit products, since 1992, we have developed 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 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 rates which are 25 to 50 basis points lower than our traditional mortgage loans. In 2002, we provided $86.1 million in mortgage loans to home buyers under these programs.
Consumer Loans. At December 31, 2002, $128.2 million, or 1.8%, of our total loans consisted of consumer and other loans, primarily home equity credit lines and fixed-rate second mortgage loans. Consumer loans generally have shorter terms to maturity, which reduces our exposure to changes in interest rates. Consumer loans also 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 for terms of up to 20 years. At December 31, 2002 these loans totaled $93.7 million, or 1.3% of total loans. Interest rates on fixed-rate second mortgage loans are periodically set by our Consumer Loan Department based on market conditions. 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 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 $33.5 million, or 0.5% of total loans at December 31, 2002, are adjustable-rate loans secured by a second mortgage on owner-occupied one- to four-family residences located in the State of New Jersey. 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 $983,000 at December 31, 2002 and consisted of collateralized passbook loans, overdraft protection loans, automobile loans, unsecured personal loans and commercial loans made to community-based organizations. We no longer originate student loans, but offer guaranteed student loans through the SallieMae "Loan Referral Program."
Loan Approval Procedures and Authority. Our lending policies provide that loans up to $500,000 can be approved by two officers of the Mortgage Origination Department, one of whom must have the title of at least Vice President. Loans in excess of $500,000 require the approval of two officers, one of whom must have the title of at least Vice President, as well as our Senior Vice President-Lending, Chief Executive Officer or Chief Operating Officer. 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.
The following describes our current lending procedures. Upon receipt of a completed loan application from a prospective borrower, we order a credit report and, except for loans originated as limited documentation 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 evidence of previous title insurance. We require borrowers to obtain hazard insurance and we may require borrowers to obtain flood insurance prior to closing. We require 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.
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 relatively favorable real estate market conditions have resulted in relatively low delinquency ratios. These factors have 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 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. We commence foreclosure proceedings if the loan is not brought current between the 90th and 120th day of delinquency unless specific limited circumstances warrant an exception. 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. The collection procedures for Federal Housing Administration (FHA) and Veterans' Administration (VA) one- to four-family mortgage loans follow the collection guidelines outlined by those agencies.
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 Collection Department review loans 60 days or more delinquent 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 by our Collection Department. 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.
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.
At December 31, 2002, 2001 and 2000, loans delinquent 60 days to 89 days and 90 days or more were as follows:
Non-performing assets, which include foreclosed real estate, net, non-accrual loans and accruing loans delinquent 90 days or more, increased $5.6 million, or 35.2%, to $21.5 million at December 31, 2002 from $15.9 million at December 31, 2001 primarily due to the growth of the loan portfolio and the slower economy during 2002, which was characterized by higher unemployment. The increase in accruing loans delinquent 90 days or more was primarily due to the increase in delinquencies in our purchased FHA/VA loan portfolio of $4.5 million. The accrual of income on FHA/VA loans is generally not discontinued as they are guaranteed by a federal agency. Our $20.2 million in loans delinquent 90 days or more at December 31, 2002 were comprised primarily of 139 one- to four-family first mortgage loans (including FHA/VA first mortgage loans). At December 31, 2002, our largest loan delinquent 90 days or more had a balance of $484,000.
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 at December 31, 2002, 2001 and 2000 amounted to $109,000, $154,000 and $179,000, respectively. Additional interest income totaling $319,000, $483,000 and $652,000 on non-accrual loans would have been recognized in 2002, 2001 and 2000, respectively, if interest on all such loans had been recorded based upon original contract terms. We are not committed to lend additional funds to borrowers on non-accrual status.
With the exception of first mortgage loans insured or guaranteed by the FHA or VA 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 may recognize income in the period that we collect it 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.
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
impaired at December 31, 2002 and 2001. In addition, at December 31, 2002 and 2001, we had no loans classified as troubled debt restructurings, as defined in SFAS No. 15.
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.
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 accounting principles generally accepted in the United States of America, 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.
As part of our evaluation of the adequacy of our allowance for loan losses, each month we prepare a worksheet. This worksheet categorizes the entire loan portfolio by certain risk characteristics such as loan type (one- to four-family, multi-family, etc.) 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. We use this worksheet, together with loan portfolio 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, 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, accounting principles generally accepted in the United States of America 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.
Our primary lending emphasis is the origination 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. As a result of our lending emphasis, we had a loan concentration in residential first mortgage loans at December 31, 2002, the majority of which are secured by real property located in New Jersey. Of residential first mortgage loans outstanding at December 31, 2002, 13.5%, or $921.4 million, were adjustable-rate mortgages. The ability of borrowers to make payments on their adjustable-rate mortgages may decrease if interest rates rise.
Based on the composition of our loan portfolio and the growth in our loan portfolio over the past five years, we believe the primary risks inherent in our portfolio are possible increases in interest rates, a further decline in the economy, generally, and a possible decline in real estate market values. Any one or a combination of these events may adversely affect our loan portfolio resulting in increased delinquencies and loan losses. Accordingly, we have maintained our provision for loan losses at the current level to primarily address the actual growth in our loan portfolio. We consider it important to maintain the ratio of our allowance for loan losses to total loans within an acceptable range. At December 31, 2002, the allowance for loan losses as a percentage of total loans was 0.37% compared with 0.48% at December 31, 1998. Because of the primary emphasis of our lending practices and the current market conditions, we consider 0.37% to be within an acceptable range. Furthermore, the increase in the allowance for loan losses each year from 1998 to 2002 reflected the continued growth in the loan portfolio, the relatively low levels of loan charge-offs, the stability in the real estate market during those years and the resulting stability in our overall loan quality.
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 judgement 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, 2002 and 2001-- Provision for Loan Losses."
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, 2002, 2001, 2000, 1999, and 1998.
INVESTMENT ACTIVITIES
Investment Securities. 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. New Jersey chartered savings banks 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 ("FFIEC") considers to be an unsuitable investment practice. In addition, the policy provides that we shall attempt to maintain primary liquidity, which consists of investments in cash, cash in banks, money market investments, securities with remaining maturities of less than five years and GNMA mortgage-backed securities classified as available for sale, in an amount equal to 4% of total deposits and short-term borrowings. At December 31, 2002, our primary liquidity ratio was 18.1%. For information regarding the carrying values, yields and maturities of our investment securities and mortgage-backed securities, see "-- Carrying Values, Yields and Maturities."
We classify 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. Available for sale securities are reported at fair market value. We classify obligations of the U.S. government and federal agencies, corporate bonds and equity securities as available for sale. We classify municipal bonds as held to maturity. We have both the ability and positive intent to hold these investments to maturity. We currently have no securities classified as trading.
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 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, 2002, mortgage-backed securities classified as held to maturity totaled $4.73 billion, or 33.5% of total assets, while $1.39 billion, or 9.8% of total assets, were classified as available for sale. At December 31, 2002, the mortgage-backed securities portfolio had a weighted average rate of 5.72% and a market value of approximately $6.22 billion. Of the mortgage-backed securities we held at December 31, 2002, $3.72 billion, or 60.7% of total mortgage-backed securities, had fixed rates and $2.41 billion, or 39.3% of total mortgage-backed securities, had adjustable-rates. Mortgage-backed securities at
December 31, 2002 included 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"). The volume of our mortgage-backed security purchases increased during 2002, compared to 2001, due to the lower interest rate environment which caused an increase in prepayment activity.
Of the mortgage-backed securities purchased in 2002, $1.44 billion were REMICs. The REMIC purchases in 2002 had fixed interest rates and generally had shorter average lives compared with alternate mortgage-backed security investments available at the time of purchase. Our REMICs have fixed coupon rates ranging from 5.00% to 6.50% and a weighted average rate of 6.16% at December 31, 2002. At December 31, 2002, REMICs totaled $2.27 billion, which constituted 37.1% of the mortgage-backed securities portfolio. Our REMICs had an expected average life of 1.36 years at December 31, 2002. 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 are 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.
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.
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.
- ----------------------------------- (1) Based on carrying value for each investment type.
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, 2002. Mortgage-backed securities are presented by issuer and by coupon type. Equity securities have been excluded from this table.
SOURCES OF FUNDS
General. Deposits, borrowings, scheduled amortization and prepayments of loan principal 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. 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 regular savings deposits, NOW accounts, checking accounts, money market accounts and time deposits. We also offer IRA accounts and qualified retirement plans.
In April 2002, we introduced our interest-bearing High Value Checking account, which we view as an attractive alternative to cash management accounts offered by brokerage firms. This account offers unlimited checking, on-line banking and debit card availability as part of the product, and pays an interest rate generally above competitive market rates. We attracted over $925 million in deposits into this account during the nine months of 2002 that this product was offered.
Deposit flows are influenced significantly by general and local economic conditions, changes in prevailing interest rates, pricing of deposits and competition. 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. We believe the increase in the interest-bearing deposits in 2002 was due primarily to our consistent offering of competitive rates on our deposit products, the introduction of our interest-bearing High Value Checking account and an overall decrease in investor confidence in the equity markets.
When we determine our deposit rates, we consider local competition, U.S. Treasury securities offerings and the rates charged on other sources of funds. Core deposits (defined as regular savings deposits, money market accounts and noninterest-bearing transaction accounts) represented 20.9% of total deposits on December 31, 2002. At December 31, 2002, time deposits with remaining terms to maturity of less than one year amounted to $5.12 billion. 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, 2002, 2001 and 2000.
The following table presents our deposit activity for the periods indicated:
At December 31, 2002, we had $968.0 million in time deposits with balances of $100,000 and over maturing as follows:
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.
The following table presents, by rate category, the amount of our time deposit accounts outstanding at December 31, 2002, 2001 and 2000.
The following table presents, by rate category, the remaining period to maturity of time deposit accounts outstanding as of December 31, 2002.
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 twenty times the amount of FHLB stock owned.
Borrowed funds at December 31 are summarized as follows:
At December 31, 2002, borrowed funds had scheduled maturities and potential call dates as follows:
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, 2002 and 2001 are as follows:
The average balance of our advances from the FHLB during 2002 was $1.12 billion and the maximum FHLB advances outstanding during 2002 was $1.75 billion.
SUBSIDIARIES
Hudson City Savings has one wholly owned and consolidated subsidiary: HudCiti Service Corporation. HudCiti Service Corporation, which qualifies as a New Jersey investment company, has one wholly owned and consolidated subsidiary: Hudson City Preferred Funding Corp. Hudson City Preferred Funding qualifies as a real estate investment trust, pursuant to the Internal Revenue Code of 1986, as amended, and had $5.22 billion of mortgage loans outstanding at December 31, 2002.
PERSONNEL
As of December 31, 2002, we had 966 full-time employees and 90 part-time employees. The employees are not represented by a collective bargaining unit and we consider our relationship with our employees to be good.
REGULATION OF HUDSON CITY SAVINGS BANK AND HUDSON CITY BANCORP
GENERAL
Hudson City Savings is a New Jersey chartered savings bank, and its deposit accounts are insured up to applicable limits by the Federal Deposit Insurance Corporation ("FDIC") under the Bank Insurance Fund ("BIF"). Hudson City Savings is subject to extensive regulation, examination and supervision by the Commissioner of the New Jersey Department of Banking and Insurance (the "Department") as its chartering agency, and by the FDIC as the deposit insurer. Hudson City Savings must file reports with the Commissioner and the FDIC concerning its activities and financial condition, and it must obtain regulatory approval prior to entering into certain transactions, such as mergers with, or acquisitions of, other depository institutions and opening or acquiring branch offices. The Commissioner and the FDIC conduct periodic examinations to assess Hudson City Savings Bank's compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which a 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.
Hudson City, MHC and Hudson City Bancorp, as bank holding companies controlling Hudson City Savings, are subject to the Bank Holding Company Act of 1956, as amended, ("BHCA") and the rules and regulations of the Federal Reserve Board under the BHCA and to the provisions of the New Jersey Banking Act of 1948 (the "New Jersey Banking Act") and the regulations of the Department under the New Jersey Banking Act applicable to bank holding companies. Hudson City, MHC and Hudson City Bancorp are required to file reports with, and otherwise comply with the rules and regulations of the Federal Reserve Board ("FRB") and the Department. Hudson City Bancorp is required to file certain reports with, and otherwise comply with, the rules and regulations of the Securities and Exchange Commission under the federal securities laws.
Any change in such laws and regulations, whether by the Department, the FDIC, the FRB or through legislation, could have a material adverse impact on Hudson City, MHC, Hudson City Bancorp and Hudson City Savings and their operations and stockholders.
NEW JERSEY BANKING REGULATION
Activity Powers. Hudson City Savings derives its lending, investment and other activity powers primarily from the applicable provisions of the New Jersey Banking Act and its related regulations. Under these laws and regulations, savings banks, including Hudson City Savings, generally may invest in:
- real estate mortgages;
- consumer and commercial loans;
- specific types of debt securities, including certain corporate debt securities and obligations of federal, state and local governments and agencies;
- certain types of corporate equity securities; and
- certain other assets.
A savings bank may also invest pursuant to a "leeway" power that permits investments not otherwise permitted by the New Jersey Banking Act. "Leeway" investments must comply with a number of limitations on the individual and aggregate amounts of "leeway" investments. A savings bank may also exercise trust powers upon approval of the Department. New Jersey savings banks may also exercise any power authorized for federally chartered savings banks unless the Department determines otherwise. The exercise of these lending, investment and activity powers are limited by federal law and the related regulations. See "-- Federal Banking Regulation -- Activity Restrictions on State-Chartered Banks" below.
Loans-to-One-Borrower Limitations. With certain specified exceptions, a New Jersey chartered savings bank may not make loans or extend credit to a single borrower and to entities related to the borrower in an aggregate amount that would exceed 15% of the bank's capital funds. A savings bank may lend an additional 10% of the bank's capital funds if secured by collateral meeting the requirements of the New Jersey Banking Act. Hudson City Savings currently complies with applicable loans-to-one-borrower limitations.
Dividends. Under the New Jersey Banking Act, a stock savings bank may declare and pay a dividend on its capital stock only to the extent that the payment of the dividend would not impair the capital stock of the savings bank. In addition, a stock savings bank may not pay a dividend if the surplus of the savings bank would, after the payment of the dividend, be reduced unless after such reduction the surplus was 50% or more of the bank's capital stock. Federal law may also limit the amount of dividends that may be paid by Hudson City Savings. See "-- Federal Banking Regulation -- Prompt Corrective Action" below.
Minimum Capital Requirements. Regulations of the Department impose on New Jersey chartered depository institutions, including Hudson City Savings, minimum capital requirements similar to those imposed by the FDIC on insured state banks. See "-- Federal Banking Regulation -- Capital Requirements" below.
Examination and Enforcement. The Department may examine Hudson City Savings whenever it deems an examination advisable. The Commissioner examines Hudson City Savings at least every two years. The Department may order any savings bank to discontinue any violation of law or unsafe or unsound business practice and may direct any director, officer, attorney or employee of a savings bank engaged in an objectionable activity, after the Department has ordered the activity to be terminated, to show cause at a hearing before the Department why such person should not be removed.
FEDERAL BANKING REGULATION
Capital Requirements. FDIC regulations require BIF-insured banks, such as Hudson City Savings, to maintain minimum levels of capital. The FDIC regulations define two Tiers, or classes, of capital. Tier 1 capital is comprised of the sum of common stockholders' equity (excluding the net unrealized appreciation or depreciation, net of tax, from available for sale securities), non-cumulative perpetual preferred stock (including any related surplus) and minority interests in consolidated subsidiaries, minus all intangible assets (other than qualifying servicing rights), and any net unrealized loss on marketable equity securities. The components of Tier 2 capital currently include cumulative perpetual preferred stock, certain perpetual preferred stock for which the dividend rate may be reset periodically, mandatory convertible securities, subordinated debt, intermediate preferred stock and
allowance for possible loan losses. Allowance for possible loan losses included in Tier 2 capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of Tier 2 capital that may be included in total capital cannot exceed 100% of Tier 1 capital.
The FDIC regulations establish a minimum leverage capital requirement for banks in the strongest financial and managerial condition, with a rating of 1 (the highest examination rating of the FDIC for banks) under the Uniform Financial Institutions Rating System, and that are not experiencing or anticipating significant growth, of a ratio of Tier 1 capital to total average assets of not less than 3%. For all other banks, the minimum leverage capital requirement is 4.0%, unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution. The FDIC regulations also require that savings banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of a ratio of total capital (which is defined as the sum of Tier 1 capital and Tier 2 capital) to risk-weighted assets of at least 8% and a ratio of Tier 1 capital to risk-weighted assets of at least 4%. In determining the amount of risk-weighted assets, all assets, plus certain off-balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item.
The federal banking agencies, including the FDIC, have also adopted regulations to require an assessment of an institution's exposure to declines in the economic value of a bank's capital due to changes in interest rates when assessing the bank's capital adequacy. Under such a risk assessment, examiners will evaluate a bank's capital for interest rate risk on a case-by-case basis, with consideration of both quantitative and qualitative factors. According to the agencies, applicable considerations include the quality of the bank's interest rate risk management process, the overall financial condition of the bank and the level of other risks at the bank for which capital is needed. Institutions with significant interest rate risk may be required to hold additional capital. The agencies also issued a joint policy statement providing guidance on interest rate risk management, including a discussion of the critical factors affecting the agencies' evaluation of interest rate risk in connection with capital adequacy.
The FDIC adopted a regulation, effective April 1, 2002, establishing minimum regulatory capital requirements for equity investments in non-financial companies. The regulation applies a series of marginal capital charges that range from 8% to 25% depending upon the size of the aggregate equity investment portfolio of the banking organization relative to its Tier 1 capital. The capital charge would be applied by making a deduction, which would be based on the adjusted carrying value of the equity investment from the organization's Tier 1 capital. This new capital requirement has not had a material adverse effect upon our operations. However, we will have to take this requirement into consideration should we, at some point in the future, decide to invest in non-financial companies.
The following table shows Hudson City Savings Bank's leverage ratio, its Tier 1 risk-based capital ratio, and its total risk-based capital ratio, at December 31:
As the table shows, Hudson City Savings Bank exceeded the minimum capital adequacy requirements at the date indicated.
Activity Restrictions on State-chartered Banks. Section 24 of the Federal Deposit Insurance Act, as amended (FDIA), which was added by the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), generally limits the activities and investments of state-chartered FDIC insured banks and their subsidiaries to those permissible for federally chartered national banks and their subsidiaries, unless such activities and investments are specifically exempted by Section 24 or consented to by the FDIC.
Section 24 provides an exception for investments by a bank in common and preferred stocks listed on a national securities exchange or the shares of registered investment companies if:
- the bank held such types of investments during the 14-month period from September 30, 1990 through November 26, 1991;
- the state in which the bank is chartered permitted such investments as of September 30, 1991; and
- the bank notifies the FDIC and obtains approval from the FDIC to make or retain such investments. Upon receiving such FDIC approval, an institution's investment in such equity securities will be subject to an aggregate limit up to the amount of its Tier 1 capital.
Hudson City Savings received approval from the FDIC to retain and acquire such equity investments subject to a maximum permissible investment equal to the lesser of 100% of Hudson City Savings' Tier 1 capital or the maximum permissible amount specified by the New Jersey Banking Act. Section 24 also provides an exception for majority-owned subsidiaries of a bank, but Section 24 limits the activities of such subsidiaries to those permissible for a national bank under Section 24 of the FDIA and the FDIC regulations issued pursuant thereto, or as approved by the FDIC.
Before making a new investment or engaging in a new activity not permissible for a national bank or otherwise permissible under Section 24 of the FDIC regulations thereunder, an insured bank must seek approval from the FDIC to make such investment or engage in such activity. The FDIC will not approve the activity unless the bank meets its minimum capital requirements and the FDIC determines that the activity does not present a significant risk to the FDIC insurance funds.
The Gramm-Leach Bliley Act ("Gramm-Leach") permits a state-chartered savings bank to engage, through financial subsidiaries, in any activity in which a national bank may engage through a financial subsidiary and on substantially the same terms and conditions. In general, Gramm-Leach permits a national bank that is well-capitalized and well-managed to conduct, through a financial subsidiary, any activity permitted for a financial holding company other than insurance underwriting, insurance investments, real estate investment or development or merchant banking. The total assets of all such financial subsidiaries may not exceed the lesser of 45% of the bank's total assets or $50 billion. The bank must have policies and procedures to assess the financial subsidiary's risk and protect the bank from such risk and potential liability, must not consolidate the financial subsidiary's assets with the bank's and must exclude from its own assets and equity all equity investments, including retained earnings, in the financial subsidiary. State-chartered savings banks may retain subsidiaries in existence as of March 11, 2000 and may engage in activities that are not authorized under Gramm-Leach; otherwise, Gramm-Leach will preempt all state laws regarding the permissibility of certain activities for state-chartered banks if such state law is in conflict with the provisions of Gramm-Leach (with the exception of certain insurance activities), regardless of whether the state law would authorize broader or more restrictive activities. Although Hudson City Savings meets all conditions necessary to establish and engage in permitted activities through financial subsidiaries, it has not yet determined whether or the extent to which it will seek to engage in such activities.
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 ("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. Hudson City Savings, as a member of the FHLB of New York, is currently required to purchase and hold shares of capital stock in the FHLB of New York in an amount at least equal to the greater of (i) 1% of the aggregate principal amount of its unpaid mortgage loans, home purchase contracts and similar obligations at the beginning of each year; (ii) 0.3% of its assets; or (iii) 5% (or such greater fraction as established by the FHLB) of its advances from the FHLB as of December 31, 2002. Hudson City Savings is in compliance with these requirements. Pursuant to regulations promulgated by the FHFB, as required by Gramm-Leach, the FHLB of New York has adopted a capital plan, which is expected to become effective during the second half of 2003, that will change the foregoing minimum stock ownership requirements for FHLB of New York stock. Under the new capital plan each member of the FHLB of New York must maintain a minimum investment in FHLB of New York stock in an amount equal to the sum of (i) the greater of $1,000 or 0.20% of the member's mortgage-related assets and (ii) 4.50% of the dollar amount of any outstanding advances under such member's Advances, Collateral Pledge and Security Agreement with the FHLB of New York.
Enforcement. The FDIC has extensive enforcement authority over insured savings banks, including Hudson City Savings. This enforcement authority includes, among other things, the ability to
assess civil money penalties, to issue cease and desist orders and to remove directors and officers, to order divestitures and withhold approval of the acquisition of business or the exercise of powers, to terminate deposit insurance coverage and to place a depository institution in receivership. In general, these enforcement actions may be initiated in response to violations of laws and regulations and to unsafe or unsound practices.
The FDIC is required, with certain exceptions, to appoint a receiver or conservator for an insured state bank if that bank is "critically undercapitalized." For this purpose, "critically undercapitalized" means having a ratio of tangible capital to total assets of less than 2%. The FDIC may also appoint a conservator or receiver for a state bank on the basis of the institution's financial condition or upon the occurrence of certain events, including:
- insolvency (whereby the assets of the bank are less than its liabilities to depositors and others);
- substantial dissipation of assets or earnings through violations of law or unsafe or unsound practices;
- existence of an unsafe or unsound condition to transact business;
- likelihood that the bank will be unable to meet the demands of its depositors or to pay its obligations in the normal course of business; and
- insufficient capital, or the incurring or likely incurring of losses that will deplete substantially all of the institution's capital with no reasonable prospect of replenishment of capital without federal assistance.
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 FDIC, 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 FDIC adopted regulations to require a bank that is given notice by the FDIC that it is not satisfying any of such safety and soundness standards to submit a compliance plan to the FDIC. If, after being so notified, a bank fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the FDIC 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 bank fails to comply with such an order, the FDIC 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 FDIC is required to monitor closely the condition of an undercapitalized bank and to restrict the growth of its assets. An undercapitalized bank is required to file a capital restoration plan within 45 days of the date the bank receives notice 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.
Insurance Activities. 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. With respect to the capital ratios, institutions are classified as well-capitalized, adequately capitalized or undercapitalized, using ratios that are substantially similar to the prompt corrective action capital ratios discussed below. 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 (which may include, if applicable, information provided by the institution's state supervisor).
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.
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 2002 for the assessment for deposit insurance and the FICO payments was $1,415,000.
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"), and the regulations of the FRB promulgated thereunder. These provisions, among other things, prohibit or limit a savings banks from extending credit to, or entering into certain transactions with, its affiliates (which for Hudson City Savings would include Hudson City Bancorp and Hudson City, MHC) and principal stockholders, directors and executive officers of Hudson City Savings.
Effective April 1, 2003, the Federal Reserve Board ("FRB"), is rescinding its interpretations of Sections 23A and 23B of the FRA and is replacing these interpretations with Regulation W. Regulation W makes various changes to existing law regarding Sections 23A and 23B, including expanding the definition of what constitutes an affiliate subject to Sections 23A and 23B and exempting certain subsidiaries of state-chartered banks from the restrictions of Sections 23A and 23B.
Under Regulation W, all transactions entered into on or before December 12, 2002, which either became subject to Sections 23A and 23B solely because of Regulation W, and all transactions covered by Sections 23A and 23B, the treatment of which will change solely because of Regulation W, will become subject to Regulation W on July 1, 2003. All other covered affiliate transactions become subject to Regulation W on April 1, 2003. The Federal Reserve Board expects each depository institution that is subject to Sections 23A and 23B to implement policies and procedures to ensure compliance with Regulation W. We do not expect that the changes made by Regulation W will have a material adverse effect on our business.
In addition, provisions of the BHCA prohibit extensions of credit to a bank's insiders and their related interests by any other institution that has a correspondent banking relationship with the bank, unless such extension of credit is on substantially the same terms as those prevailing at the time for comparable transactions with other persons and does not involve more than the normal risk of repayment or present other unfavorable features.
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.
Provisions of the New Jersey Banking Act impose conditions and limitations on the liabilities to a savings bank of its directors and executive officers and of corporations and partnerships controlled by such persons that are comparable in many respects to the conditions and limitations imposed on the loans
and extensions of credit to insiders and their related interests under federal law and regulation, as discussed above. The New Jersey Banking Act also provides that a savings bank that is in compliance with the applicable federal laws and regulations is deemed to be in compliance with such provisions of the New Jersey Banking Act.
Privacy Standards. Hudson City Bancorp and Hudson City Savings are subject to FDIC regulations implementing the privacy protection provisions of Gramm-Leach. These regulations require Hudson City Bancorp and Hudson City Savings to disclose their privacy policy, including identifying with whom they share "non-public personal information," to customers at the time of establishing the customer relationship and annually thereafter.
The regulations also require Hudson City Bancorp and Hudson City Savings to provide their customers with initial and annual notices that accurately reflect its privacy policies and practices. In addition, Hudson City Bancorp and Hudson City Savings are required to provide their customers with the ability to "opt-out" of having Hudson City Bancorp and 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 Bancorp or Hudson City Savings.
Community Reinvestment Act. Under the Community Reinvestment Act ("CRA"), any insured depository institution, 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 FDIC, in connection with its examination of a 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, including applications for branch relocations, additional branches and acquisitions.
Current CRA regulations rate an institution based on its actual performance in meeting community needs. In particular, the evaluation system focuses on three tests:
- a lending test, to evaluate the institution's record of making loans in its service areas;
- an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefitting low or moderate income individuals and businesses; and
- a service test, to evaluate the institution's delivery of services through its branches, ATMs and other offices.
The CRA requires the FDIC to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system and requires public disclosure of an institution's CRA rating. 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.
Internet Banking. Technological developments are dramatically altering the ways in which most companies, including financial institutions, conduct their business. The growth of the Internet is prompting banks to reconsider business strategies and adopt alternative distribution and marketing systems. The federal bank regulatory agencies have conducted seminars and published materials targeted to various aspects of internet banking, and have indicated their intention to reevaluate their regulations to ensure that they encourage banks' efficiency and competitiveness consistent with safe and sound banking practices. We cannot assure you that the federal bank regulatory agencies will adopt new regulations that will not materially affect the Hudson City Savings' internet operations or restrict any such further operations.
FEDERAL RESERVE SYSTEM
Under FRB regulations, Hudson City Savings is required to maintain non-interest earning reserves against its transaction accounts (primarily NOW and regular checking accounts). The FRB regulations generally require that reserves of 3% must be maintained against aggregate transaction accounts of $42.1 million or less (subject to adjustment by the FRB) and an initial reserve of $1.083 million plus 10% (subject to adjustment by the FRB between 8% and 14%) against that portion of total transaction accounts in excess of $42.1 million. The first $6.0 million of otherwise reservable balances (subject to adjustments by the FRB) are exempted from the reserve requirements. Hudson City Savings is in compliance with the foregoing requirements. Because required reserves must be maintained in the form of either vault cash, a non-interest bearing account at a FRB 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.
THE USA PATRIOT ACT
In response to the events of September 11th, President George W. Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the federal government new 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 Act 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.
Among other requirements, Title III of the USA PATRIOT Act imposes the following requirements with respect to financial institutions:
- Pursuant to Section 352, all financial institutions must establish anti-money laundering programs that include, at minimum: (i) internal policies, procedures, and controls, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti-money laundering program. Interim final rules implementing Section 352 were issued by the Treasury Department on April 29, 2002. Such rules state that a financial institution is in compliance with Section 352 if it implements and maintains an anti-money laundering program that complies with the anti-money laundering regulations of its federal functional regulator. Hudson City Savings is in compliance with the FDIC's anti-money laundering regulations.
- Section 326 of the Act authorizes the Secretary of the Department of Treasury, in conjunction with other bank regulators, to issue regulations that provide for minimum standards with respect to customer identification at the time new accounts are opened. On July 23, 2002, the FDIC and the other federal bank regulators jointly issued proposed rules to implement Section 326. The proposed rules require financial institutions to establish a program specifying procedures for obtaining identifying information from customers seeking to open new accounts. This identifying information would be essentially the same information currently obtained by most financial institutions for individual customers generally. A financial institution's program would also have to contain procedures to verify the identity of customers within a reasonable period of time, generally through the use of the same forms of identity verification currently in use, such as through driver's licenses, passports, credit reports and other similar means.
- Section 312 of the Act requires financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) to establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering. Interim rules under Section 312 were issued by the Treasury Department on July 23, 2002. The interim rules state that a due diligence program is reasonable if it comports with existing best practices standards for banks that maintain correspondent accounts for foreign banks and evidences good faith efforts to incorporate due diligence procedures for accounts posing increased risk of money laundering. In addition, an enhanced due diligence program is reasonable if it comports with best practices standards and focuses enhanced due diligence measures on those correspondent accounts posing a particularly high risk of money laundering based on the bank's overall assessment of the risk posed by the foreign correspondent bank. Finally, a private banking due diligence program must be reasonably designed to detect and report money laundering and the existence of proceeds of foreign corruption. Such a program is reasonable if it focuses on those private banking accounts that present a high risk of money laundering.
Financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and will be subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks.
Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications.
Compliance with the regulations adopted under the USA PATRIOT Act is not expected to have a material adverse effect on Hudson City Bancorp or Hudson City Savings.
FEDERAL BANK HOLDING COMPANY REGULATION
General. Hudson City, MHC and Hudson City Bancorp are bank holding companies subject to examination, regulation and periodic reporting under the BHCA, as administered by the FRB.
Activity Restrictions. The BHCA generally limits Hudson City Bancorp's activities to managing or controlling banks, furnishing services to or performing services for its subsidiaries and engaging in other activities that the FRB determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the FRB must consider whether the performance of such an activity reasonably can be expected to produce benefits to the public that outweigh possible adverse effects. Possible benefits include greater convenience, increased competition and gains in efficiency. Possible adverse effects include undue concentration of resources, decreased or unfair competition, conflicts of interest and unsound banking practices. Some of the principal activities that the FRB has determined by regulation to be so closely related to banking as to be a proper incident thereto are:
- making or servicing loans;
- performing certain data processing services;
- providing certain brokerage services;
- acting as fiduciary, investment or financial advisor;
- leasing personal or real property;
- making investments in corporations or projects designed primarily to promote community welfare; and
- acquiring a savings and loan association.
The FRB may require that Hudson City Bancorp terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the FRB believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The FRB also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt.
Gramm-Leach expands the range of permitted activities of certain bank holding companies to include the offering of virtually any type of service that is financial in nature or incidental thereto, including banking, securities underwriting, insurance (both underwriting and agency), merchant banking, acquisitions of and combinations with insurance companies and securities firms and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. In order to engage in these new activities, a bank holding company must qualify and register with the FRB as a financial holding company. To qualify as a financial holding company, a bank holding company must file a certification with the FRB electing to become a financial holding company, must demonstrate that each of its bank subsidiaries is well-capitalized and well-managed and must have received a rating of "satisfactory" or better at its most recent examination under the Community Reinvestment Act of 1977. Certain of the additional activities authorized under Gramm-Leach may also be undertaken by a financial subsidiary of a bank. Under Gramm-Leach, a functional system of regulation will apply to financial holding companies under which banking activities will be regulated by the federal banking regulators, securities activities will be regulated by the federal securities regulators, and insurance activities will be subject to regulation by the appropriate state insurance authorities.
Although Hudson City Bancorp currently meets all standards required for qualification as a financial holding company, it has not yet determined whether it will seek to qualify as, or engage in any of the additional activities authorized for, a financial holding company. At this time, Hudson City Bancorp has no plans to utilize any of the expanded powers permitted by Gramm-Leach.
Acquisition and Sale of Control. Under the federal Change in Bank Control Act ("CBCA"), any person (including a company), or group acting in concert, seeking to acquire 10% or more of the outstanding shares of Hudson City Bancorp's common stock will be required to submit prior notice to the FRB, unless the FRB has found that the acquisition of such shares will not result in a change in control of Hudson City Bancorp. Under the CBCA, the FRB has 60 days within which to act on such notices, taking into consideration certain factors, including the financial and managerial resources of the acquiror, the convenience and needs of the communities served by Hudson City Bancorp and Hudson City Savings, and the antitrust effects of the acquisition. Under the BHCA, any company would be required to obtain prior approval from the FRB before it may obtain "control" of Hudson City Bancorp within the meaning of the BHCA. Control generally is defined under the BHCA to mean the ownership or power to vote 25% or more of any class of voting securities of Hudson City Bancorp or the ability to control in any manner the election of a majority of Hudson City Bancorp's directors.
As bank holding companies, Hudson City, MHC and Hudson City Bancorp will be required to obtain the prior approval of the FRB to acquire all, or substantially all, of the assets of any bank or bank holding company. Prior FRB approval will be required for Hudson City, MHC or Hudson City Bancorp to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after giving effect to such acquisition, it would, directly or indirectly, own or control more than 5% of any class of voting shares of such bank or bank holding company.
Capital; Dividends; Share Repurchases; Source of Strength. The FRB imposes certain capital requirements on Hudson City Bancorp under the BHCA, including a minimum leverage ratio and a minimum ratio of "qualifying" capital to risk-weighted assets. These minimum requirements are substantially the same as the Bank's minimum capital requirements described above under "Federal Banking Regulation -- Capital Requirements". Subject to its capital requirements and certain other restrictions, Hudson City Bancorp is able to borrow money to make a capital contribution to Hudson City Savings, and such loans may be repaid from dividends paid from Hudson City Savings to Hudson City Bancorp. Hudson City Bancorp is also able to raise capital for contribution to Hudson City Savings by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.
The following table shows Hudson City Bancorp's leverage ratio, its Tier 1 risk-based capital ratio, and its total risk-based capital ratio, at December 31:
As the table shows, Hudson City Bancorp exceeded the minimum capital adequacy requirements at the date indicated.
A bank holding company is required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, will be equal to 10% or more of the company's consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, FRB order or directive, or any condition imposed by, or written agreement with, the FRB. Such notice and approval is not required for a bank holding company that would be treated as "well-capitalized" under applicable regulations of the FRB, that has received a composite "1" or "2" rating at its most recent bank holding company examination by the FRB, and that is not the subject of any unresolved supervisory issues.
Regulations of the FRB provide that a bank holding company must serve as a source of strength to any of its subsidiary banks and must not conduct its activities in an unsafe or unsound manner. A bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. Under the prompt corrective action provisions of FDICIA, a bank holding company parent of an undercapitalized subsidiary bank would be directed to guarantee, within limitations, the capital restoration plan that is required of such an undercapitalized bank. See "Federal Banking Regulation -- Prompt Corrective Action" above. If the undercapitalized bank fails to file an acceptable capital restoration plan or fails to implement an accepted plan, the FRB may prohibit the bank holding company parent of the undercapitalized bank from paying any dividend or making any other form of capital distribution without the prior approval of the FRB.
General. Under the FDIA, depository institutions are liable to the FDIC for losses suffered or anticipated by the FDIC in connection with the default of a commonly controlled depository institution or any assistance provided by the FDIC to such an institution in danger of default. This law would have potential applicability if Hudson City, MHC or Hudson City Bancorp ever acquired, as a separate
subsidiary, a depository institution in addition to Hudson City Savings.
Dividend Waivers By Hudson City, MHC. It has been the policy of a number of mutual holding companies to waive the receipt of dividends declared by its savings institution subsidiary. In connection with its approval of the reorganization the FRB required that Hudson City, MHC obtain the prior approval of the FRB before Hudson City, MHC may waive any dividends from Hudson City Bancorp. As of the date hereof, we are not aware that the FRB has given its approval to any waiver of dividends by any mutual holding company that has requested such approval, and we have been informally advised by the staff of the FRB that the FRB will not approve any such request.
In addition, the FDIC required that the amount of any dividends waived by Hudson City, MHC will not be available for payment to its public stockholders of Hudson City Bancorp (i.e., stockholders except for Hudson City, MHC) and that such amount will be excluded from Hudson City Bancorp's capital for purposes of calculating dividends payable to the public stockholders. Moreover, Hudson City Savings is required to maintain the cumulative amount of dividends waived by Hudson City, MHC in a restricted capital account that would be added to the liquidation account established in the reorganization. This amount would not be available for distribution to public stockholders. The restricted capital account and liquidation account amounts are not reflected in our financial statements, but are considered as a notational or memorandum account. These accounts are maintained in accordance with the laws, rules, regulations and policies of the Commissioner and our plan of reorganization.
NEW JERSEY HOLDING COMPANY REGULATION
General. Under the New Jersey Banking Act, a company owning or controlling a savings bank is regulated as a bank holding company. The New Jersey Banking Act defines the terms "company" and "bank holding company" as such terms are defined under the BHCA. Each bank holding company controlling a New Jersey chartered bank or savings bank must file certain reports with the Commissioner and is subject to examination by the Commissioner.
Acquisition of Control. The New Jersey Banking Act requires prior approval of the Commissioner before any person may acquire a New Jersey bank holding company, such as Hudson City Bancorp. For this purpose, the term "person" is defined broadly to mean a natural person or a corporation, company, partnership, or other forms of organized entities. The term "acquire" is defined differently for an existing bank holding company and for other companies or persons. A bank holding company will be treated as "acquiring" a New Jersey bank holding company if the bank holding company acquires more than 5% of any class of the voting shares of the bank holding company. Any other person will be treated as "acquiring" a New Jersey bank holding company if it acquires ownership or control of more than 25% of any class of the voting shares of the bank holding company.
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 (the "Exchange Act"). As such, Hudson City Bancorp is subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Exchange Act.
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.
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, Hudson City, MHC 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. Because Hudson City Savings and Hudson City Bancorp constitute an affiliated group of corporations, they are eligible to report their income on a consolidated basis. However, because Hudson City, MHC owns less than 80% of the common stock of Hudson City Bancorp, it will not be a member of such affiliated group and will report its income on a separate return. 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 is now recapturing (taking 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 has already provided a deferred tax liability equal to the amount of such recapture, the recapture will 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. The Internal Revenue Code of 1986, as amended, imposes a tax ("AMT") on alternative minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net operating loss carryovers of which Hudson City Savings currently has none. AMTI is also adjusted by determining the tax treatment of certain items in a manner that negates the deferral of income resulting from the regular tax treatment of those items. Thus, Hudson City Savings' AMTI is increased by an amount equal to 75% of the amount by which Hudson City Savings' adjusted current earnings exceeds its AMTI (determined without regard to this adjustment and prior to reduction for net operating losses.)
Elimination of Dividends; Dividends Received Deduction. Hudson City Bancorp may exclude from its income 100% of dividends received from Hudson City Savings as a member of the same affiliated group of corporations. Because Hudson City, MHC will not be a member of such affiliated group, it will not qualify for such 100% dividends exclusion, but will be entitled to deduct 80% of the dividends it receives from Hudson City Bancorp so long as it owns more than 20% of the common stock.
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. In July of 2002, the State of New Jersey enacted legislation retroactive to January 1, 2002, which impacts Hudson City Savings. The tax rate has been increased from 3% to 9%. The State also introduced a new tax, the Alternative Minimum Assessment ("AMA"), which for Hudson City Savings is based on New Jersey gross receipts. Hudson City Savings, under the new legislation, 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 3.6%. The new tax legislation increased the income tax rate for qualifying New Jersey investment companies from 2.25% to 3.6%. 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 exempted 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.
ITEM 2.
ITEM 2. PROPERTIES
During 2002, we conducted our business through our executive office, our operations center and 81 branch offices. At December 31, 2002, we owned 29 of our locations and leased the remaining 54. 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 7 of Notes to Consolidated Financial Statements in Item 8 "Financial Statements and Supplementary Data."
ITEM 3.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted during the quarter ended December 31, 2002 to a vote of security holders of Hudson City Bancorp through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
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 100% stock dividend that was effective June 17, 2002.
On January 14, 2003, the Board of Directors of Hudson City Bancorp declared a quarterly cash dividend of eleven cents ($0.11) per common share outstanding that was paid on March 3, 2003 to stockholders of record as of the close of business on February 7, 2003. 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 will provide the principal source of funds for the payment of dividends by Hudson City Bancorp. New Jersey law provides that dividends may be paid by Hudson City Savings only out of net income, earned surplus or undivided profits. However, Hudson City Savings will not be permitted to pay dividends on its capital stock if, among other things, its stockholders' equity would be reduced below the amount required for the liquidation account established in connection with the reorganization.
As of March 7, 2003, there were approximately 17,800 holders of record of Hudson City Bancorp common stock.
ITEM 6.
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 financial statements of Hudson City Bancorp and Hudson City Savings. 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 100% stock dividend that was effective June 17, 2002.
- ----------------------------- (1) The 1999 earnings per share data is from the date of reorganization (July 13, 1999).
- ---------------------------------- (1) Determined by subtracting the weighted average cost of average total interest-bearing liabilities from the weighted average yield on average total interest-earning assets.
(2) Determined by dividing net interest income by average total interest-earning assets.
(3) Determined by dividing total non-interest expense by the sum of net interest income and total non-interest income (adjusted to exclude net gains (losses) on securities transactions of $2,066,000 for 2002, $0 for 2001, $0 for 2000, $(7,000) for 1999, and $24,000 for 1998.)
(4) The 1999 data is from the date of reorganization (July 13, 1999).
ITEM 7.
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.
GENERAL
Our results of operations depend primarily on net interest income. 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 demand deposits and borrowed funds. Our results of operations are also affected by our provision for loan losses, non-interest income, and non-interest expense. Non-interest expense consists primarily of salaries and employee benefits, occupancy expenses and other general and administrative expenses. Non-interest income generally consists of service charges and fees and may include gains on the disposition of 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. Future changes in applicable law, regulations or government policies may materially impact us. Additionally, our lending activity is concentrated in loans secured by real estate primarily located in New Jersey. Accordingly, our results of operations may be affected by regional market and economic conditions.
MUTUAL HOLDING COMPANY STRUCTURE
In 1999, Hudson City Savings converted and reorganized from a New Jersey chartered mutual savings bank into a two-tiered mutual savings bank holding company structure and became a wholly-owned subsidiary of Hudson City Bancorp. Hudson City Bancorp sold 47% of the then outstanding shares of its common stock to the public at $10.00 per share and received net proceeds of $527.6 million. Hudson City Bancorp contributed 50% of the net proceeds from the initial public offering to Hudson City Savings. Hudson City Bancorp issued 53% of the then outstanding shares of its common stock to Hudson City, MHC. At December 31, 2002, as a result of stock repurchases, Hudson City, MHC owned 63.85% of Hudson City Bancorp.
GROWTH INITIATIVES
In accordance with our business plan, we have developed and employed several initiatives, including a program to purchase whole mortgage loans and the introduction of our interest-bearing High Value Checking account, to effectively and prudently utilize our capital through internally generated growth. During 2002, these initiatives helped us to increase our core investments in mortgage-related assets, increase our deposit customer base and grow our assets by 23.8%, or over $2.7 billion. We expect to continue to grow through internal expansion using borrowed funds to supplement our deposit initiatives as a funding source, as well as by adding new branch offices, a strategy that has been successful for us in the past.
MANAGEMENT OF INTEREST RATE RISK
As a financial institution, our primary component of market risk is interest rate volatility. Net interest income is the primary component of our net 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.
A decreasing interest rate environment, such as experienced during 2001 and 2002, can be beneficial to our net interest income as our interest-bearing liabilities generally reprice faster than our interest-earning assets. A steepening yield curve, where the spread between long-term interest rates and short-term interest rates widens, can also be beneficial to our net interest income as our interest-bearing liabilities generally price off short-term market rates while our mortgage loan products, particularly those with initial terms to maturity or repricing greater than one year, generally price off long-term market rates. Conversely, a narrowing or flattening yield curve may have an adverse impact on our net interest income as the interest rate spread between our interest-earning assets and interest-bearing liabilities decreases.
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. The historically low market interest rates experienced during 2001 and 2002 increased prepayment activity on our mortgage-related assets, which may have an adverse impact on our net interest income and interest rate spread in future periods.
General market interest rates declined during 2001 and 2002, reflecting reductions of rates by the Federal Open Market Committee ("FOMC") of the Federal Reserve Bank. The overall market yield curve steepened during 2001 as interest rates on short-term maturities declined faster than the interest rates on long-term maturities. Market interest rates on short-term maturities remained relatively stable through the first nine months of 2002, then declined slightly due to a further FOMC rate reduction in the fourth quarter of 2002. Long-term market interest rates continued to steadily decline in 2002, thus narrowing the overall market yield curve. In the interest rate environment experienced in 2002, our net interest rate spread increased 54 basis points to 2.66% from 2.12% for 2001. It has been because of our ability to grow our business with low cost interest-bearing liabilities that we have been able to increase our net interest income during 2002. However, the current narrower yield curve may have an adverse impact on our future net interest income and net interest rate spread.
The primary objectives of our interest rate risk management strategy are to:
- evaluate the interest rate risk inherent in certain balance sheet accounts;
- determine the appropriate level of interest rate risk given our business plan, the current business environment and our capital and liquidity requirements; and
- manage interest rate risk in a manner consistent with the approved guidelines and policies set by our Board of Directors.
We seek to coordinate asset and liability decisions so that, under changing interest rate scenarios, earnings will remain within an acceptable range.
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 and the Investment Officer. The Asset/Liability Committee presents periodic reports to the Board of Directors at its regular meetings, as well as a comprehensive quarterly report to the Asset Management Committee of the Board of Directors. The quarterly reports address 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.
Historically, our lending activities have emphasized one- to four-family first and second mortgage loans. We believe that the frequent repricing of adjustable-rate mortgage loans and adjustable-rate securities, which reduces the exposure to interest rate fluctuations, would benefit our long-term profitability. However, the prevailing interest rate environment in recent years has resulted in increased demand for fixed-rate first mortgage loans. The result has been an increase in the proportion of fixed-rate loans in our portfolio. This may have an adverse impact on our net interest income, particularly in a rising interest rate environment.
The purchase of real estate mortgage investment conduits ("REMIC") to supplement our purchases of adjustable-rate mortgage-backed securities has given us additional interest rate risk protection. At the date of purchase, these REMIC securities generally had shorter weighted-average lives than traditional mortgage-backed security purchases due to their prepayment schedules. However, since the REMIC purchases have fixed interest rates, the weighted-average life will vary with changes in market interest rates.
Our primary source of funds has been deposits, consisting primarily of time deposits, which have substantially shorter terms to maturity than the loan portfolio. We use securities sold under agreements to repurchase and FHLB advances as additional sources of funds. These borrowings are generally long-term, 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 rising interest rate environment.
Due to the nature of our operations, we are not subject to foreign currency exchange or commodity price risk. Instead, our real estate loan portfolio, primarily located in New Jersey, is subject to risks associated with the local economy. 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 2002 and did not have any such hedging transactions in place at December 31, 2002. In the future, we may, with approval of our Board of Directors, engage in hedging transactions utilizing derivative instruments.
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 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 specific 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 the same 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 liabilities relative to the yields of its 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, 2002, which we anticipate to reprice or mature in each of the future time periods shown. Except as stated below, we determined the amounts of assets and liabilities shown which reprice or mature during a particular period in accordance with the earlier of the term to repricing or the contractual maturity of the asset or liability. The information presented in the gap table is also based on the following assumptions:
- we assumed an annual prepayment rate of 30.0% for mortgage loans repricing or maturing after one year;
- we assumed an annual prepayment rate of 30.0% for mortgage-backed securities repricing or maturing after one year;
- we reported savings accounts that had no stated maturity using decay rates of: 2.5% in less than six months, 2.5% in six months to one year, 25% in one year to two years, 30% in two years to three years, 20% in three years to five years, and 20% in over five years;
- we reported the $943.2 million balance in our High Value Checking account, which is a component of interest-bearing demand accounts, that had no stated maturity using decay rates of : 12.5% in less than six months, 12.5% in six months to one year, 25% in one to two years, 25% in two to three years, and 25% in three years to five years;
- we reported the $97.4 million balance in our traditional NOW accounts, which is a component of interest-bearing demand accounts, that had no stated maturity using decay rates of: 2.5% in less than six months, 2.5% in six months to one year, 25% in one year to two years, 30% in two years to three years, 20% in three years to five years, and 20% in over five years;
- we reported money market accounts using decay rates of: 25% in less than six months, 25% in six months to one year, 25% in one year to two years, and 25% in two years to three years.
In 2001, prepayment assumptions on mortgage loans and mortgage-backed securities were 20.0% and 25.0%, respectively. The change in the prepayment assumptions for 2002 was due to the increase in prepayments experienced during the year on these investments resulting from the lower interest rate environment.
Our determination of deposit decay rates is based on regulatory guidance, as modified by our historical experience. The initial decay rates on our High Value Checking account are based on our initial assessment of the volatility of the product given its current interest rate in relation to the overall market interest rate environment. The initial decay rates will be monitored closely and adjusted as required in future periods. Deposit decay rates, prepayment rates and anticipated bond or borrowing calls can have a significant impact on the estimated interest sensitivity gap. While we believe that our assumptions are reasonable, they may not be indicative of actual future deposit decay activity, mortgage and mortgage-backed securities prepayments, and the actual timing of calls of federal agency bonds or borrowed funds. We have excluded non-accrual loans totaling $6,072,000 from the table.
As indicated in the gap table at December 31, 2002, our interest-bearing liabilities maturing or repricing within one year exceeded our interest-earning assets maturing or repricing within the same period by $15.4 million compared with $1.63 billion at December 31, 2001. This represented a cumulative one-year interest rate sensitivity gap as a percent of total assets of negative 0.1% at December 31, 2002 compared with negative 14.3% at December 31, 2001. However, if current mortgage loan and mortgage-backed security prepayment assumptions were used at December 31, 2001, and all other assumptions remained the same for that analysis, the cumulative interest sensitivity gap as a percentage of total assets would have been approximately negative 8.0%. The ratio of interest-earning assets maturing or repricing within one year to interest-bearing liabilities maturing or repricing within one year was 99.7% at December 31, 2002 compared with 71.9% at December 31, 2001.
The change in these ratios, year-to-year, was primarily due to the accelerated prepayment assumptions for mortgage loans and mortgage-backed securities used during the current lower interest rate environment and the overall growth in our assets during 2002. The change also reflected the growth of borrowed funds in the current year with maturities in excess of one year, the shift of time deposit maturities to over one year due to pricing strategies, and the growth of our High Value Checking account, which we estimate to have a decay rate in excess of one year of 75%.
The methods used in the gap table are inherently imprecise. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Certain assets, such as adjustable-rate loans and mortgage-backed securities, have features that limit changes in interest rates on a short-term basis and over the life of the loan. If interest rates change, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of borrowers to make payments on their adjustable-rate loans may decrease if interest rates increase.
Present Value of Equity. In addition to the gap analysis, we also use a simulation model to monitor interest rate risk. This model reports 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. 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 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.
Our policy sets a maximum percentage change in the present value of equity of 55% from the current, or zero basis point, present value of equity, given an instantaneous and parallel increase or decrease of 200 basis points. Although the percent change in the present value of equity at December 31, 2002 was within the December 31, 2001 maximum percent change limit of 40%, the maximum percent change was increased in 2002 to 55% to allow for more flexibility in managing our asset/liability mix.
The following table presents the estimated present value of equity over a range of interest rate change scenarios at December 31, 2002. The present value ratio shown in the table is the present value of equity as a percent of the present value of total assets in each of the different rate environments. For purposes of this table, we have made assumptions such as prepayment rates and decay rates similar to those used for the gap analysis table.
At December 31, 2001, the percent change in the present value of equity in the 200 basis point increase scenario was negative 35.67% and in the 100 basis point decrease scenario it was positive 3.16% compared with the table above. The decreases in the present value of equity and the percent change in the present value of equity in the increasing rate scenarios in the December 31, 2002 analysis were primarily due to the growth of our fixed-rate mortgage loans and mortgage-backed securities. Generally, these assets will not reprice in a rising rate environment. The overall decrease in the present value of equity and the percent change in the present value of equity in the decreasing rate scenarios in the December 31, 2002 analysis was primarily due to the growth of our fixed-rate borrowed funds in this low interest rate environment. Fixed-rate borrowed funds, even those with call options, generally do not reprice in a decreasing rate environment. We believe the 150 and 200 basis point decrease scenarios presented above may not be meaningful given the prevailing low market interest rate environment.
As in the case of the gap table, the methods we used in the previous table 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 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 present value of equity model 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 present value of equity.
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 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 2002, 2001 and 2000. 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.
- ---------------------------------------------- (1) Amount is net of deferred loan fees and allowance for loan losses and includes non-performing loans.
(2) Determined by subtracting the weighted average cost of average total interest-bearing liabilities from the weighted average yield on average total interest-earning assets.
(3) Determined by dividing net interest income by average total interest-earning assets.
Rate/Volume Analysis. The following table presents the extent to which changes in interest rates and changes in the volume of 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:
- changes attributable to changes in volume (changes in volume multiplied by prior rate);
- changes attributable to changes in rate (changes in rate multiplied by prior volume); and
- the net change.
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 FINANCIAL CONDITION AT DECEMBER 31, 2002 AND DECEMBER 31, 2001
During the year ended December 31, 2002, we continued to grow our operating subsidiary, Hudson City Savings Bank, primarily through our core investments of residential mortgage loans and mortgage-backed securities. Customer deposits and long-term borrowings funded the growth. As a result, our total assets increased $2.72 billion, or 23.8%, to $14.14 billion at December 31, 2002 from $11.42 billion at December 31, 2001.
Loans increased $1.00 billion, or 16.8%, to $6.97 billion at December 31, 2002 from $5.97 billion at December 31, 2001. For the year ended December 31, 2002, we originated first mortgage loans of $1.84 billion and purchased first mortgage loans of $1.72 billion, compared with $1.52 billion and $857.6 million, respectively, for the corresponding 2001 period. These first mortgage loan originations and purchases were exclusively in one-to four-family mortgage loans and were primarily fixed-rate loans. At December 31, 2002, fixed-rate mortgage loans accounted for 86.5% of our first mortgage loan portfolio compared with 72.2% at December 31, 2001. 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 as would adjustable-rate loans. The increase in loan originations and purchases reflected the low long-term market interest rate environment experienced in 2002, which caused increases in loan prepayments and refinancings. The increase in mortgage loan purchases also reflected our internal growth strategy.
The loan purchases were made pursuant to our wholesale loan purchase program established to supplement our retail loan originations. The purchasing agreements, as established with each seller/servicer, contain parameters as to the loans that can be included in each package. These parameters, such as maximum loan size and maximum loan-to-value ratio, conform to parameters utilized by us to originate mortgage loans. Purchased loan packages are subject to internal due diligence procedures that may include review of individual loan files. This review subjects the purchased loan file to substantially the same underwriting standards used in our own loan origination process. Loan packages purchased include mortgage loans secured by properties located primarily in the east coast corridor states between Boston and Washington D.C., and in Michigan and Illinois.
In 2002, due to the low long-term interest rate environment, approximately $496.8 million of our loan originations were the result of refinancing of our existing mortgage loans. These refinancings of existing loans are included in total loan originations. Last year we began to allow certain customers to modify, for a fee, their existing mortgage loans with the intent of maintaining customer relationships in periods of extensive refinancing due to lower 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. Approximately $866.3 million of existing mortgage loans were modified during the year ended December 31, 2002. This total is not included in total loan originations.
Mortgage-backed securities increased $1.12 billion, or 22.4%, to $6.13 billion at December 31, 2002 from $5.01 billion at December 31, 2001. This increase includes a $861.2 million increase in mortgage-backed securities available for sale. In addition to purchases of mortgage-backed securities as part of our internal growth strategy, purchases also increased due to the low market interest rate environment experienced during 2002, which caused increased prepayment activity. Investment securities available for sale increased $393.5 million to $560.9 million at December 31, 2002 from $167.4 million at December 31, 2001. The increase in investment securities primarily reflected the investment of part of the excess cash flows from mortgage-related prepayment activity. These increases in interest-earning assets reflected our continued emphasis on the origination and purchase of one-to four-family
mortgage loans as our primary growth strategy, supplemented by the purchase of mortgage-backed securities and investment securities to help manage interest rate risk.
Cash and due from banks increased $68.9 million to $153.1 million at December 31, 2002 from $84.2 million at December 31, 2001. Of the cash and due from banks balance at December 31, 2002, $54.5 million was held at the Federal Home Loan Bank. This balance receives interest credits equivalent to the current federal funds overnight borrowing rate. Federal funds sold increased $70.1 million to $87.7 million at December 31, 2002 from $17.6 million at December 31, 2001. These increases in cash and cash equivalents were primarily due to the overall growth in assets, increased levels of cash flows due to mortgage-related prepayment activity and excess liquidity received late in the period having been temporarily invested in federal funds sold. FHLB stock increased $56.4 million, or 69.5%, to $137.5 million at December 31, 2002, which was the amount of stock we were required by the FHLB to hold. The growth in accrued interest receivable of $7.4 million to $69.2 million at December 31, 2002 was primarily due to the growth of our interest-earning assets.
At December 31, 2002, total liabilities were $12.83 billion, an increase of 26.5%, or $2.69 billion, compared with $10.14 billion at December 31, 2001. Borrowed funds increased $1.45 billion, or 67.4%, to $3.60 billion at December 31, 2002 from $2.15 billion at December 31, 2001. The additional borrowed funds were primarily used to fund asset growth consistent with our capital management strategy. Funding asset growth with borrowed funds generated additional earnings through a positive interest rate spread. Borrowed funds were comprised of $1.85 billion of securities sold under agreements to repurchase and $1.75 billion of Federal Home Loan Bank advances. Securities pledged as collateral against our securities sold under agreements to repurchase had a market value at December 31, 2002 of approximately $1.96 billion. Advances from the FHLB utilize our mortgage portfolio as collateral. Our increase in borrowed funds consisted primarily of 10-year terms to maturity with call options starting from 3 to 5 years from the borrowing date. The use of long-term borrowed funds has allowed us to better manage our interest rate risk by matching our long-term assets with long-term liabilities. Borrowing long-term in this low interest rate environment should also allow us to better manage interest expense in future periods.
Total deposits increased $1.23 billion, or 15.5%, to $9.14 billion at December 31, 2002 from $7.91 billion at December 31, 2001. Interest-bearing deposits increased $1.21 billion, or 16.0%, to $8.75 billion at December 31, 2002 from $7.54 billion at December 31, 2001. The increase in interest-bearing deposits was primarily due to growth in interest-bearing demand accounts of $938.4 million due to the introduction of our interest-bearing High Value Checking account. The balance in the High Value Checking account at December 31, 2002 was $943.2 million. In April 2002, we introduced our interest-bearing High Value Checking account, which we view as an attractive alternative to cash management accounts offered by brokerage firms. This account offers unlimited checking, on-line banking and debit card availability as part of the product, and pays an interest rate generally above market competitive rates.
The growth in interest-bearing deposits was also due to a $112.3 million, or 21.7% increase in money market deposits to $629.0 million, an $84.0 million, or 1.4%, increase in time deposits to $6.19 billion, and a $78.3 million, or 9.6%, increase in regular savings deposits to $892.7 million at December 31, 2002. Non-interest bearing deposits increased $12.8 million, or 3.4%, to $388.5 million at December 31, 2002 from $375.7 million at December 31, 2001. The increase in total deposits was primarily used to fund our planned asset growth. We believe the increase in interest-bearing deposits was due primarily to our consistent offering of competitive rates on our deposit products, the introduction of our interest-bearing High Value Checking account and an overall decrease in investor confidence in the equity markets.
Accrued expenses and other liabilities increased $14.6 million, or 19.4%, to $89.9 million at December 31, 2002 from $75.3 million at December 31, 2001 primarily due to an increase in accrued interest payable because of the growth in our borrowed funds and an increase in our accrued income tax payable due to timing of tax payments.
Total stockholders' equity increased $27.3 million, or 2.1%, to $1.32 billion at December 31, 2002 from $1.29 billion at December 31, 2001. The increase was primarily the result of net income of $192.0 million, an increase of $19.4 million in accumulated other comprehensive income, net of tax, an increase of $9.9 million due to the exercise of 1,410,330 stock options, and an increase of $12.5 million due to the allocation of stock-related employee benefit plans. The increase in accumulated other comprehensive income was primarily due to the growth in our portfolio of mortgage-backed securities available for sale and increases in the value of our investment securities available for sale. Partially offsetting these increases in stockholders' equity were repurchases of 7,754,472 shares of our common stock at an aggregate cost of $140.2 million and cash dividends declared and paid to common stockholders of $64.5 million. As of December 31, 2002, there remained 1,808,796 shares authorized to be purchased under our current stock repurchase program.
At December 31, 2002, the ratio of total stockholders' equity to total assets was 9.30% compared with 11.28% at December 31, 2001. For the year ended December 31, 2002, the ratio of average stockholders' equity to average assets was 10.12% compared with 13.05% for the year ended December 31, 2001. The decrease in these ratios was primarily due to our capital management strategy of planned internal 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 $7.22 and $6.87 at December 31, 2002 and December 31, 2001, respectively.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 2002 AND 2001
General. Net income was $192.0 million for the year ended December 31, 2002, an increase of $57.5 million, or 42.8%, compared with net income of $134.5 million for the year ended December 31, 2001. Basic and diluted earnings per common share were $1.04 and $1.01, respectively, for the year ended December 31, 2002 compared with basic and diluted earnings per share of $0.69 and $0.68, respectively, for the year ended December 31, 2001. For the year ended December 31, 2002 our return on average stockholders' equity was 14.84% compared with 10.09% for the year ended December 31, 2001. Our return on average assets for the year ended December 31, 2002 was 1.50% compared with 1.32% for the year ended December 31, 2001. These increases reflected our improved profitability due to increased interest rate spreads that we experienced in the low interest rate environment and our ability to grow our business with low cost interest-bearing liabilities.
Interest and Dividend Income. Total interest and dividend income increased $93.7 million, or 13.6%, to $784.2 million for the year ended December 31, 2002 compared with $690.5 million for the year ended December 31, 2001. The increase in total interest income was primarily due to the average balance of total interest-earning assets increasing $2.50 billion, or 25.0%, to $12.52 billion for the year ended December 31, 2002 compared with $10.02 billion for the year ended December 31, 2001. This increase was due in part to a $1.15 billion, or 22.1%, increase in the average balance of first mortgage loans, net to $6.35 billion for the year ended December 31, 2002 compared with $5.20 billion for 2001. The average balance of mortgage-backed securities increased $1.42 billion, or 35.1%, to $5.46 billion for the year ended December 31, 2002 compared with $4.04 billion for 2001. These increases were slightly offset by a decrease in the average balance of investment securities for the year ended December 31, 2002 of $74.3 million, or 19.1%, to $315.2 million from $389.5 million for 2001. The increase in the average
balance of FHLB stock of $22.2 million reflected the increase in the amount of FHLB stock required to be held by us.
The above increases in the average balances of first mortgage loans and mortgage-backed securities reflected internal growth that was consistent with our capital management strategy to originate and purchase first mortgage loans as our primary growth strategy, while purchasing mortgage-backed securities to supplement loan originations and purchases, and assist in the management of interest rate risk. The growth in the average balance of mortgage-backed securities also reflected the investment of excess cash flows, due to the increased prepayment activity on our mortgage-related assets, into mortgage-backed securities. Although the increase in the average balance of loans was somewhat less than the increase in the average balance of mortgage-backed securities, the impact of the loan growth was more significant in terms of interest income because our first mortgage loans are generally higher yielding assets than our mortgage-backed securities.
The impact on interest income due to the growth in the average balance of interest-earning assets, was partially offset by a 63 basis point decrease in the average yield on interest-earning assets to 6.26% for the year ended December 31, 2002 from 6.89% for the year ended December 31, 2001. The average yield on first mortgage loans, net decreased 39 basis points to 6.93% for the year ended December 31, 2002 from 7.32% for 2001. The average yield on mortgage-backed securities decreased 88 basis points to 5.63% for the year ended December 31, 2002 from 6.51% for 2001.
The decrease in the average yield on first mortgage loans reflected the large volume of loan originations, purchases and modifications during the low interest rate environment of 2001 and 2002. The decrease in the average yield on mortgage-backed securities reflected the large volume of purchases and the downward repricing of our adjustable-rate securities during the low interest rate environment of 2001 and 2002. The larger decrease in the average yield on mortgage-backed securities compared with mortgage loans was due to the larger increase in the average balance of mortgage-backed securities in this low rate environment and the greater percentage of adjustable-rate securities in the mortgage-backed security portfolio as compared to our mortgage loan portfolio. If market interest rates remain low, the yield on our mortgage-backed securities may continue to adjust downward due to annual rate change limits that are part of the terms of the security, which have limited the extent our adjustable-rate securities may have adjusted in prior periods.
Interest Expense. Total interest expense, comprised of interest on deposits and interest on borrowed funds, decreased $7.6 million, or 1.9%, to $395.8 million for the year ended December 31, 2002 from $403.4 million for the year ended December 31, 2001, notwithstanding an overall increase in interest-bearing liabilities. Interest expense on borrowed funds increased $43.6 million, or 45.2%, to $140.0 million for the year ended December 31, 2002 from $96.4 million for 2001. Interest expense on deposits decreased $51.2 million, or 16.7%, to $255.8 million for the year ended December 31, 2002 from $307.0 million for 2001. The decrease in total interest expense reflected the impact of a 117 basis point decrease in the average cost of interest-bearing liabilities to 3.60% for the year ended December 31, 2002 from 4.77% for 2001. The decrease in interest expense was offset, in part, by an increase in the average balance of interest-bearing liabilities of $2.55 billion, or 30.2%, to $11.00 billion for the year ended December 31, 2002 from $8.45 billion for the year ended December 31, 2001.
The increase in interest expense on borrowed funds was primarily due to a $1.12 billion, or 64.7%, increase in the average balance of borrowed funds to $2.85 billion for the year ended December 31, 2002 from $1.73 billion for 2001. The impact on interest expense on borrowed funds due to the increase in the average balance of borrowed funds was offset, in part, by a 67 basis point decrease in the average cost of borrowed funds to 4.90% for the year ended December 31, 2002 from 5.57% for 2001.
The growth of borrowed funds has been used to fund internal asset growth consistent with our capital management and growth strategies. The funds borrowed during 2002 had 10-year terms to maturity with call options starting 3 to 5 years from the borrowing date. Although these borrowings generally had higher costs than short-term borrowings, the use of long-term borrowed funds has allowed us to better manage our interest rate risk by matching long-term assets with long-term liabilities. Borrowing long-term in the prevailing interest rate environment should also allow us to better manage interest expense in future periods. The decrease in the average cost of borrowed funds reflected the continued growth of our borrowed funds in the low interest rate environment that existed during 2001 and 2002 and the restructuring of certain of our borrowed funds to obtain lower interest rates.
The $51.2 million decrease in interest expense on deposits was primarily due to a 143 basis point decrease in the average cost of interest-bearing deposits to 3.14% for the year ended December 31, 2002 from 4.57% for 2001. The decrease in the average cost of interest-bearing deposits was primarily due to a 171 basis point decrease in the average cost of our time deposits to 3.44% for 2002 from 5.15% for 2001. The average cost of regular savings accounts decreased 27 basis points to 1.98% for 2002 and the average cost of money market deposits decreased 34 basis points to 1.97% for 2002. Partially offsetting these decreases, the average cost of interest-bearing demand accounts increased 97 basis points to 2.55% for 2002 from 1.58% for 2001 due to the introduction during the second quarter of 2002 of our High Value Checking account. The decrease in the annualized average cost of interest-bearing deposits reflected the low interest rate environment experienced during 2001 and 2002. The impact on the average cost of interest-bearing liabilities due to possible further decreases in market interest rates may not be as favorable in future periods as short-term market rates are currently at historically low levels.
The impact on interest expense on deposits due to the decrease in the average cost of interest-bearing deposits was offset, in part, by a $1.43 billion, or 21.3%, increase in the average balance of interest-bearing deposits to $8.15 billion for the year ended December 31, 2002 from $6.72 billion for 2001. The average balance of time deposits increased $930.0 million, or 17.3%, to $6.31 billion for 2002 from $5.38 billion for 2001. The average balance of interest-bearing demand accounts increased $276.6 million to $370.8 million for 2002 from $94.2 million for 2001 due to the introduction of our High Value Checking account in the second quarter of 2002. The average balance of money market accounts increased $128.0 million to $593.0 million for 2002 from $465.0 million for 2001 and the average balance of regular savings accounts increased $93.4 million to $869.8 million for 2002 from $776.4 million for 2001. We believe the increase in the interest-bearing deposits was due primarily to our consistent offering of competitive rates on our deposit products, the introduction of our interest-bearing High Value Checking account and an overall decrease in investor confidence in the equity markets.
Net Interest Income. Net interest income increased $101.3 million, or 35.3%, to $388.4 million for the year ended December 31, 2002 compared with $287.1 million for the year ended December 31, 2001. This increase primarily reflected our planned balance sheet growth, which resulted in increases in the average balance of both interest-earning assets and interest-bearing liabilities, and the improved net interest rate spread earned on this growth. Our net interest rate spread, the difference between the average yield on total interest-earning assets and the average cost of total interest-bearing liabilities, increased 54 basis points to 2.66% for the year ended December 31, 2002 from 2.12% for 2001. Our net interest margin, represented by net interest income divided by average total interest-earning assets, increased 23 basis points to 3.10% for the year December 31, 2002 from 2.87% for 2001.
These increases reflected our improved profitability due to the declining interest rate environment experienced during 2001 and 2002, the fact that our interest-bearing liabilities repriced faster than our interest-earning assets in the declining interest rate environment and our ability to grow our business with
low cost interest-bearing liabilities during this period. The larger increase in our net interest spread compared with the increase in our net interest margin reflected the use of investable funds to purchase treasury stock. However, during 2002, long-term interest rates generally declined, while short-term interest rates remained relatively stable, thus narrowing the yield curve. The narrower yield curve and the increased prepayment activity on our mortgage-related assets, due to the historically low market interest rates, may have a negative impact on our net interest income, net interest rate spread and net interest margin in future periods.
Provision for Loan Losses. Our provision for loan losses for the year December 31, 2002 was $1.5 million, a decrease of $0.4 million, or 21.1%, compared with $1.9 million for the year ended December 31, 2001. Net charge-offs for the year ended December 31, 2002 were $9,000 compared with net charge-offs of $9,000 for 2001. The decrease in the provision reflected our recent low charge-off history given the relative stability of the housing market. The allowance for loan losses increased $1.5 million, or 6.3%, to $25.5 million at December 31, 2002 from $24.0 million at December 31, 2001. The increase in the allowance for loan losses, through the provision for loan losses, reflected the overall growth of the loan portfolio and the level of delinquent and non-performing loans.
Non-performing loans, defined as non-accruing loans and accruing loans delinquent 90 days or more, increased $4.6 million, or 29.5%, to $20.2 million at December 31, 2002 from $15.6 million at December 31, 2001. The increase in the dollar amount of our non-performing loans, which was primarily due to an increase of our non-performing purchased FHA/VA loan portfolio of $4.5 million, was due to the slow economic conditions during 2002, characterized by higher unemployment. The ratio of non-performing loans to total loans was 0.29% at December 31, 2002 compared with 0.26% at December 31, 2001. The ratio of the allowance for loan losses to non-performing loans was 126.27% at December 31, 2002 compared with 153.44% at December 31, 2001. The ratio of the allowance for loan losses to total loans was 0.37% at December 31, 2002 compared with 0.40% at December 31, 2001.
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, consisting generally of service charges and fees on customer accounts, was $8.0 million and $4.7 million, respectively, for the years ended December 31, 2002 and 2001. The increase in service fees and other income of $1.2 million was primarily due to a $760,000 gain on the sale of a commercial property not deemed to be a strategic part of our business plan.
The $2.1 million gain on securities transactions, net, which occurred in the fourth quarter of 2002, resulted from an opportunity to restructure certain assets and liabilities to allow us to be better positioned for future changes in interest rates. The cash flow of $88.7 million from the sale of the securities was reinvested in higher yielding securities at a slightly longer duration. To match this duration extension, we restructured certain of our borrowed funds to extend their maturity and lower the contract rate.
Non-Interest Expense. Total non-interest expense increased $11.7 million, or 14.3%, to $93.5 million for the year ended December 31, 2002 from $81.8 million for the year ended December 31, 2001. The increase was primarily due to an increase in salaries and employee benefits of $8.4 million, or 16.1%, to $60.7 million for the year ended December 31, 2002 from $52.3 million for 2001. The increase in salaries and employee benefits reflected routine salary increases, senior level promotions, increases in stock-related compensation expense and increases in pension expense. The expense of certain of the
stock-related plans is based on the average market price of our common stock in accordance with the provisions of Statement of Position 93-6, "Employer Accounting for Employee Stock Ownership Plans." The increase in our stock price has resulted in a $3.7 million increase in stock-related compensation expense. Other expenses increased $3.2 million, or 24.4%, to $16.3 million for the year ended December 31, 2002 compared with $13.1 million for 2001. This increase was due, in part, to expenses related to new marketing initiatives and accelerated recognition of stock-related expense due to the passing of one of our directors.
Our efficiency ratio, determined by dividing non-interest expense by the sum of net interest income and non-interest income, excluding net gains on securities transactions, was 23.72% for the year ended December 31, 2002 compared with 28.04% for the year ended December 31, 2001. Our ratio of non-interest expense to average assets for the year ended December 31, 2002 was 0.73% compared with 0.80% for the year ended December 31, 2001.
Income Taxes. Income tax expense increased $35.9 million, or 48.8%, to $109.4 million for the year ended December 31, 2002 from $73.5 million for the year ended December 31, 2001. This increase was primarily due to the $93.3 million, or 44.8% increase in income before income tax expense and changes to the New Jersey corporate business tax code. In July 2002, the New Jersey State Legislature passed the Business Tax Reform Act. This new legislation, which was retroactive to January 1, 2002, has increased our annual effective tax rate to approximately 36.5%. The overall change in income tax expense, due to the new state tax structure, was approximately $2.9 million. Our effective tax rate for 2002 was 36.29% compared with 35.33% for 2001.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2001 AND DECEMBER 31, 2000
Our total assets increased $2.05 billion, or 21.9%, to $11.43 billion at December 31, 2001 from $9.38 billion at December 31, 2000. This increase was generally reflected in increases in mortgage loans and mortgage-backed securities, partially offset by decreases in investment securities.
Loans increased $1.10 billion, or 22.6%, to $5.97 billion at December 31, 2001 from $4.87 billion at December 31, 2000. For the year ended December 31, 2001, we originated and purchased first mortgage loans of approximately $1.52 billion and $857.6 million, respectively, compared with $895.1 million and $110.7 million, respectively, for the corresponding 2000 period. These originations and purchases were concentrated in one- to four-family residential mortgage loans. The increase in loan originations, a part of our growth strategy, was also due to the lower market interest rate environment during 2001 that caused an increase in prepayments and refinancings. To supplement our loan originations we began, late in 2000, to purchase a higher volume of first mortgage loans than were purchased in previous periods. See "Business of Hudson City Savings Bank - Lending Activities - Residential Mortgage Lending" for a discussion of loan purchases. We also originated for the years ended December 31, 2001 and 2000, home equity loans of approximately $62.0 million and $71.4 million, respectively.
Mortgage-backed securities increased $1.75 billion, or 53.6%, to $5.01 billion at December 31, 2001 from $3.26 billion at December 31, 2000. Investment securities available for sale decreased $709.2 million, or 80.9%, to $167.5 million at December 31, 2001 from $876.7 million at December 31, 2000. The increase in mortgage-backed securities, a part of our growth strategy, was also due to the reinvestment of $855.7 million of calls of investment securities into adjustable-rate or higher yielding fixed-rate mortgage-backed securities during 2001. The large amount of calls of investment securities was due to the lower interest rate environment that existed during 2001. These increases in interest-earning assets continue to reflect our emphasis on the origination and purchase of one- to four-family
mortgage loans supplemented by the purchase of mortgage-backed securities as part of our growth strategy. We began classifying certain mortgage-backed security purchases as available for sale during 2001 to maintain internal liquidity requirements.
Federal funds sold decreased $104.1 million, or 85.5%, to $17.6 million at December 31, 2001 from $121.7 million at December 31, 2000. The higher levels of federal funds sold at December 31, 2000 resulted from calls of investment securities, the proceeds from which had not yet been fully invested at year end. FHLB stock increased $7.5 million to $81.1 million at December 31, 2001, which was the amount of stock we were required to hold.
At December 31, 2001, total liabilities were $10.14 billion, an increase of 28.0%, or $2.22 billion, compared with $7.92 billion at December 31, 2000. Borrowed funds increased $900.0 million, or 72.0%, to $2.15 billion at December 31, 2001 from $1.25 billion at December 31, 2000. Borrowed funds at December 31, 2001 were comprised of $1.55 billion of securities sold under agreements to repurchase and $600.0 million of FHLB advances. Advances from the FHLB utilize our mortgage portfolio as collateral. The increase in borrowed funds was primarily used to fund asset growth consistent with our capital management strategy. Funding asset growth with borrowed funds generated additional earnings through a positive interest rate spread.
Total deposits increased $1.31 billion, or 19.8%, to $7.91 billion at December 31, 2001 from $6.60 billion at December 31, 2000. Interest-bearing deposits increased $1.27 billion, or 20.3%, to $7.54 billion at December 31, 2001 from $6.27 billion at December 31, 2000. The increase in interest-bearing deposits was primarily due to a $1.13 billion, or 22.7%, increase in time deposits to $6.10 billion at December 31, 2001 from $4.97 billion at December 31, 2000. Noninterest-bearing deposits increased $43.5 million, or 13.1%, to $375.7 million at December 31, 2001 from $332.2 million at December 31, 2000. The increase in total deposits was primarily used to fund asset growth consistent with our capital management strategy. We believe the increase in interest-bearing deposits was due in part to the volatility in the equity markets, our offering competitive rates on our time deposit products, and deposit movement among financial institutions due to consolidation within our industry.
Accrued expenses and other liabilities increased $13.6 million, or 22.0%, to $75.3 million at December 31, 2001 from $61.7 million at December 31, 2000. This increase was primarily due to an increase in accrued interest payable because of the growth of our borrowed funds and an increase in accrued expenses related to certain employee benefit plans, primarily postretirement benefits.
Total stockholders' equity decreased $175.8 million, or 12.0%, to $1.29 billion at December 31, 2001 from $1.46 billion at December 31, 2000. Hudson City repurchased 25,966,800 dividend-adjusted shares of our common stock during 2001, which decreased stockholders' equity by $278.5 million. As of December 31, 2001, there were 9,563,268 dividend-adjusted shares authorized to be purchased under our current stock repurchase program. Offsetting the effect of repurchases on stockholders' equity was net income of $134.5 million for the year ended December 31, 2001 and an increase in accumulated other comprehensive income, net of tax, of $7.9 million. This increase was due to increases in the market values of our investment securities available for sale due to the lower interest rate environment. Stockholders' equity was also decreased during 2001 by the declarations of cash dividends to common stockholders totaling $46.5 million and the purchase of 374,836 dividend-adjusted shares of common stock for the recognition and retention plans at an aggregate cost of $4.2 million. The exercise of 285,600 dividend-adjusted options during 2001 increased stockholders' equity by $2.0 million.
At December 31, 2001, the ratio of total stockholders' equity to total assets was 11.28% compared with 15.61% at December 31, 2000. For the year ended December 31, 2001, the ratio of average
stockholders' equity to average assets was 13.05% compared with 16.35% for the year ended December 31, 2000. Stockholders' equity per common share was $6.87 at December 31, 2001 compared with $6.89 at December 31, 2000. The decrease in these ratios was primarily due to the decrease in stockholders' equity and the growth in assets as discussed above.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 2001 AND 2000
General. Net income was $134.5 million for the year ended December 31, 2001, an increase of $19.7 million, or 17.2%, from net income of $114.8 million for the year ended December 31, 2000. Basic and diluted earnings per common share were $0.69 and $0.68, respectively, for 2001 compared with basic and diluted earnings per common share of $0.52 for 2000. Our return on average stockholders' equity and return on average assets for 2001 was 10.09% and 1.32%, respectively, compared with 7.87% and 1.29%, respectively, for 2000. The increase in the return on average stockholders' equity reflected the growth in net income and the decrease in stockholders' equity.
Interest and Dividend Income. Total interest and dividend income increased $76.5 million, or 12.5%, to $690.5 million for year ended December 31, 2001 compared with $614.0 million for the corresponding 2000 period. The increase in total interest and dividend income was primarily due to the average balance of total interest-earning assets increasing $1.25 billion, or 14.3%, to $10.02 billion for the year ended December 31, 2001 compared with $8.77 billion for the year ended December 31, 2000. The average balance of first mortgage loans, net increased $748.5 million, or 16.8%, to $5.20 billion for 2001 compared with $4.46 billion for 2000. The average balance of consumer and other loans increased $23.2 million, or 17.7%, to $154.0 million for 2001 compared with $130.8 million for 2000. The average balance of mortgage-backed securities increased $839.2 million, or 26.2%, to $4.04 billion for 2001 compared with $3.20 billion for 2000. These increases were offset in part by a decrease in the average balance of investment securities for 2001 of $492.7 million, or 55.8%, to $389.5 million from $882.2 million for 2000. The average balance of Federal funds sold increased $73.1 million, or 90.9%, to $153.5 million for 2001 compared with $80.4 million for 2000. The average balance of FHLB stock increased $55.4 million to $79.4 million for 2001 from $24.0 million for 2000.
The above increases in the average balances of interest-earning assets reflected internal growth that was consistent with our capital management strategy to originate and purchase first mortgage loans and consumer and other loans, while purchasing mortgage-backed securities to supplement loan originations and manage interest rate risk. The increase in the average balance of first mortgage loans also reflected the program we established late in 2000 to supplement our loan originations by purchasing a higher volume of first mortgage loans than in previous periods. The growth in the average balance of mortgage-backed securities and the decline in the average balance of investment securities reflected the calls of investment securities during 2001 due to the lower interest rate environment. The growth in the average balance of mortgage-backed securities was also due to the investment of other funds in mortage-backed securities as part of our capital management strategy. The increase in the average balance of federal funds sold reflected the initial investment of the proceeds of the calls of investment securities, and the initial investment of the large volume of mortgage loan and mortgage-backed security prepayments. These funds were subsequently invested in adjustable-rate or higher yielding fixed-rate mortgage-backed securities or mortgage loans. The increase in the average balance of FHLB stock reflected the increase in the amount of FHLB stock required to be held by us based on our asset size.
The increase in interest income due to the growth of average total interest-earning assets was partially offset by an 11 basis point decrease in the average yield on interest-earning assets to 6.89% for year ended December 31, 2001 compared with 7.00% for the year ended December 31, 2000. The average yield on first mortgage loans, net, decreased 3 basis points to 7.32% for 2001 compared with
7.35% for 2000. The average yield on mortgage-backed securities decreased 20 basis points to 6.51% for 2001 compared with 6.71% for 2000.
The slight decrease in the average yield on first mortgage loans, net, reflected the relative stability of our offered mortgage interest rates, which are based on long-term market rates, in the lower short-term interest rate environment during 2001. The decrease in the average yield on mortgage-backed securities reflected the repricing of our variable-rate mortgage-backed securities in the lower interest rate environment. The decrease in the average yield on mortgage-backed securities also reflected the large volume of purchases made in the lower rate environment due to the calls of investment securities and the large prepayment volume on our mortgage-backed security portfolio.
Interest Expense. Total interest expense increased $43.4 million, or 12.1%, to $403.4 million for the year ended December 31, 2001 compared with $360.0 million for the year ended December 31, 2000. Interest expense on borrowed funds increased $46.9 million, or 94.7%, to $96.4 million for the year ended December 31, 2001 compared with $49.5 million for the corresponding 2000 period. Interest expense on deposits decreased $3.5 million, or 1.1%, to $307.0 million for the year ended December 31, 2001 compared with $310.5 million for the corresponding 2000 period.
The increase in total interest expense was attributable to an increase in the average balance of total interest-bearing liabilities of $1.38 billion, or 19.5%, to $8.45 billion for the year ended December 31, 2001 compared with $7.07 billion for the year ended December 31, 2000. The increase in the average balance of total interest-bearing liabilities primarily resulted from an increase in the average balance of borrowed funds of $934.0 million, or 117.0%, to $1.73 billion for 2001 compared with $798.0 million for 2000. The use of borrowed funds has accelerated over the past year to fund asset growth. The increase also reflected our decision to assist in managing our interest rate risk by using long-term borrowings to match our long-term assets.
The average balance of interest-bearing deposits increased $443.6 million, or 7.1%, to $6.72 billion for 2001 compared with $6.27 billion for 2000. The increase in the average balance of interest-bearing deposits was attributable to an increase in the average balance of time deposits of $449.4 million, or 9.1%, to $5.38 billion for 2001 compared with $4.93 billion for 2000. We believe the overall increase in total interest-bearing deposits was due in part to the volatility in the equity markets, our offering competitive rates on our time deposit products and deposit movement among financial institutions due to consolidation within our industry.
The increase in interest expense due to the growth of total interest-bearing liabilities was partially offset by a 32 basis point decrease in the average cost of total interest-bearing liabilities to 4.77% for the year ended December 31, 2001 from 5.09% for the year ended December 31, 2000. The average cost of total interest-bearing deposits decreased 38 basis points to 4.57% for 2001 compared with 4.95% for 2000. Within the interest-bearing deposit mix, the average cost of time deposits decreased 48 basis points to 5.15% for 2001 compared with 5.63% for 2000. The decrease in the average cost of interest-bearing deposits reflected the lower market interest rate environment in 2001.
The average cost of borrowed funds decreased 64 basis points to 5.57% for the year ended December 31, 2001 compared with 6.21% for the corresponding 2000 period. The decrease in the average cost of borrowed funds reflected the continued growth in borrowings during the lower interest rate environment of 2001, and the maturing and refunding in 2001 of higher costing short-term borrowings originated in 2000. The decreases in the average costs of the individual components of interest-bearing liabilities reflected the lower interest rate environment experienced during 2001. However, the lower basis point decrease in the overall cost of total average interest-bearing liabilities,
when compared to the individual components, reflected the larger percentage of borrowed funds in our interest-bearing liability mix. These borrowed funds had higher costs than our existing deposit portfolio.
Net Interest Income. Net interest income increased $33.1 million, or 13.0%, to $287.1 million for the year ended December 31, 2001 compared with $254.0 million for the year ended December 31, 2000. This increase primarily reflected 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, the difference between the average yield on average total interest-earning assets and the average cost of average total interest-bearing liabilities, increased 21 basis points to 2.12% for the year ended December 31, 2001 compared with 1.91% for the corresponding 2000 period. The increase in the net interest spread was primarily due to the lower interest rate environment experienced during 2001 and the fact that our interest-bearing liabilities repriced faster than our interest-earning assets.
Our net interest margin, represented by net interest income divided by average total interest-earning assets, decreased 3 basis points to 2.87% for the year ended December 31, 2001 compared with 2.90% for the corresponding 2000 period. The decrease in the net interest margin reflected the fact that the average balance of our interest-bearing liabilities grew at a higher rate than the average balance of our interest-earning assets. This was due, in part, to the use of funds, which could have been otherwise invested, to purchase our common stock. This use of funds caused our net interest income to grow at a lesser rate than did our average interest-earning assets.
Provision for Loan Losses. Our provision for loan losses for the year ended December 31, 2001 was $1.9 million, a decrease of $0.2 million, or 9.5%, compared with $2.1 million for the year ended December 31, 2000. Net loan charge-offs for 2001 were $9,000 compared with net recoveries of $4,000 during 2000. As a result, the allowance for loan losses increased $1.9 million, or 8.6%, to $24.0 million at December 31, 2001 from $22.1 million at December 31, 2000. The increase in the allowance for loan losses to its current level, through the continued provision for loan losses, reflected the overall growth of the loan portfolio, the level of delinquent and non-performing loans and real estate market conditions during 2001.
Non-performing loans, defined as non-accruing loans and accruing loans delinquent 90 days or more, increased $2.6 million, or 20.0%, to $15.6 million at December 31, 2001 from $13.0 million at December 31, 2000, primarily due to the continued growth in the loan portfolio and the slow economic conditions in 2001. Although non-performing loans increased during 2001, the ratio of non-performing loans to total loans decreased to 0.26% at December 31, 2001 compared with 0.27% at December 31, 2000. The ratio of the allowance for loan losses to non-performing loans was 153.4% at December 31, 2001 compared with 170.7% at December 31, 2000. The ratio of the allowance for loan losses to total loans was 0.40% at December 31, 2001 compared with 0.45% at December 31, 2000.
Non-Interest Income. Total non-interest income, consisting primarily of service fees, was $4.7 million for the year ended December 31, 2001 compared with $4.5 million for the year ended December 31, 2000.
Non-Interest Expense. Total non-interest expense increased $2.8 million, or 3.5%, to $81.8 million for the year ended December 31, 2001 compared with $79.0 million for the year ended December 31, 2000. The increase was primarily due to an increase in salaries and employee benefits of $2.4 million, or 4.8%, to $52.3 million for 2001 compared with $49.9 million for 2000. The increase in salaries and employee benefits reflected routine salary increases and included additional expense of our ESOP which is based on the market price of our common stock in accordance with the provisions of Statement of Position 93-6, "Employer Accounting for Employee Stock Ownership Plans."
Our efficiency ratio, determined by dividing non-interest expense by the sum of net interest income and non-interest income, excluding net gains on securities transactions, was 28.0% for 2001 compared with 30.6% for 2000. Our ratio of non-interest expense to average assets for 2001 was 0.80% compared with 0.89% for 2000. The decrease in these ratios reflected our efforts to control non-interest expense while growing assets consistent with our capital management strategy.
Income Taxes. Income tax expense increased $10.9 million, or 17.4%, to $73.5 million for the year ended December 31, 2001 compared with $62.6 million for year ended December 31, 2000. The increase in income tax expense was due to the increase in income before income tax expense. Our effective tax rate for 2001 and 2000 was 35.3%.
LIQUIDITY AND CAPITAL RESOURCES
The term "liquidity" refers to our ability to generate adequate amounts of cash to fund loan originations, loan purchases, deposit withdrawals 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 twenty times the amount of FHLB stock owned.
Scheduled loan repayments and maturing investment securities are a relatively predictable source of funds. However, 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 mortgage rates increase, the opposite effect tends to occur and our loan origination and purchase activity becomes increasingly dependent on the strength of our residential real estate market, home purchase and new construction activity.
Principal repayments on loans were $2.63 billion during 2002 compared with $1.35 billion for 2001. Principal payments received on mortgage-backed securities totaled $2.38 billion during 2002 compared to $1.62 billion during 2001. The increase in payments on loans and mortgage-backed securities reflected the low market interest rate environment during 2001 and 2002, which caused an increase in prepayment activity when compared with the prior period. The increase also reflected the growth in those portfolios, thus a larger base from which to receive payments. Maturities and calls of investment securities totaled $203.4 million during 2002 compared with maturities and calls of $855.7 million during 2001. The higher amount of calls during 2001 was due to the declining interest rate environment that began early in 2001 and the larger balance of callable investment securities held at the beginning of 2001 compared with the amount of callable investment securities held at the beginning of 2002.
For the years ended December 31, 2002 and 2001, we borrowed funds of $1.45 billion and $1.55 billion, respectively. The $1.45 billion of new long-term borrowed funds in 2002 consisted primarily of borrowings with 10-year terms to maturity with call options starting from 3 to 5 years from the borrowing date. There were no principal payments on borrowed funds during 2002, but there were $650.0 million of principal payments during 2001.
The $1.45 billion increase in borrowed funds during 2002 funded planned internal asset growth and generated additional earnings through a positive interest rate spread. The use of long-term borrowed funds has allowed us to better manage our interest rate risk by matching long-term assets with long-term liabilities. Borrowing long-term funds in this low interest rate environment should also allow us to better control interest expense in future periods. At December 31, 2002, there were $50.0 million of borrowed funds scheduled to mature within one year.
Total deposits increased $1.23 billion during 2002 compared with an increase of $1.31 billion during 2001. Deposit flows 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. We believe the increase in interest-bearing deposits was due primarily to our consistent offering of competitive rates on our deposit products, the introduction of our interest-bearing High Value Checking account and an overall decrease in investor confidence in the equity markets. Time deposit accounts scheduled to mature within one year were $5.12 billion at December 31, 2002. Based on our deposit retention experience and current pricing strategy, we anticipate that a significant portion of these time deposits will remain with Hudson City Savings. We are committed to maintaining a strong liquidity position; therefore, we monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments.
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 to a lesser extent, the purchase of investment securities. We originated and purchased total loans of approximately $1.91 billion and $1.72 billion, respectively, during 2002 compared with $1.59 billion and $857.6 million, respectively, during 2001. The increase was primarily due to planned balance sheet growth and the low market interest rate environment during 2001 and 2002, which caused an increase in prepayment and loan refinancing activity. Additionally, to supplement our loan originations, we purchased a higher volume of first mortgage loans than in previous periods.
Purchases of mortgage-backed securities during 2002 were $3.57 billion compared with $3.36 billion during 2001. Of the mortgage-backed securities purchased in 2002, $1.44 billion were real estate mortgage investment conduits ("REMIC") compared with $2.17 billion purchased in 2001. The REMIC purchases in 2002 and 2001 had fixed interest rates and generally had shorter average lives compared with alternate mortgage-backed security investments available at the time of purchase. Generally, these purchases experienced faster prepayment speeds during 2002 than other mortgage-backed securities. The volume of purchases of mortgage-backed securities was related to the increase in prepayment activity due to the low market interest rate environment during 2001 and 2002 and the internal growth strategies employed by us during these periods.
During 2002, we purchased $598.5 million of investment securities compared with purchases of $140.4 million during 2001. These purchases were made with excess cash flows from payments on our mortgage-related assets. As part of the membership requirements of the FHLB, we are required to purchase a certain dollar amount of FHLB common stock. During 2002, we purchased $56.4 million of FHLB common stock compared with purchases of $7.5 million during 2001. The purchases in 2002 bring our total investment in FHLB stock to $137.5 million, the amount we are currently required to hold.
On April 16, 2002, a 100 percent stock dividend was declared, having the effect of a two-for-one stock split. Stockholders of record on May 24, 2002 received one additional share of common stock for every share of common stock held on that date. The stock dividend was paid on June 17, 2002. The effect of the 100% stock dividend has been retroactively reflected in the presentation of this document.
During 2002, our recognition and retention plan purchased 100,580 dividend-adjusted shares of common stock at an aggregate cost of $1.9 million. 167,900 shares were awarded to plan participants during 2002. As of December 31, 2002 we had 65,316 shares purchased and unallocated for the recognition and retention plan.
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. During 2002, we purchased 7,754,472 dividend-adjusted shares of our common stock at an aggregate cost of $140.2 million. During 2001, we purchased 25,966,800 dividend-adjusted shares of our common stock at an aggregate cost of $278.5 million. At December 31, 2002, there were 1,808,796 shares remaining to be repurchased under the existing stock repurchase program.
At December 31, 2002, Hudson City Savings had outstanding loan commitments to borrowers of approximately $213.0 million, commitments to purchase loans of approximately $261.6 million, commitments to purchase mortgage-backed securities of $263.2 million and available home equity and overdraft lines of credit of approximately $83.3 million. We anticipate we will have sufficient funds available to meet our current commitments in the normal course of business.
Cash dividends declared and paid during 2002 were $64.5 million compared with $46.5 million during 2001. The dividend pay-out ratio for the years ended December 31, 2002 and 2001 was 33.17% and 34.06%, respectively. On January 14, 2003, the Board of Directors declared a quarterly cash dividend of eleven cents ($0.11) per common share. The dividend was paid on March 3, 2003 to stockholders of record at the close of business on February 7, 2003.
We opened one new branch during 2002 in Midland Park, NJ. We also purchased, for future use, an office building near our corporate headquarters at a cost of approximately $2.8 million. We do not anticipate any other material capital expenditures nor do we have any balloon or other payments due on any long-term obligations or any significant off-balance sheet items other than the commitments and unused lines of credit noted above.
At December 31, 2002, Hudson City Bancorp and Hudson City Savings exceeded all regulatory capital requirements. Hudson City Bancorp's leverage capital ratio, tier 1 risk-based capital ratio and total risk-based capital ratio were 9.48%, 28.11% and 28.67%, respectively. Hudson City Savings' leverage capital ratio, tier 1 risk-based capital ratio and total risk-based capital ratio were 8.85%, 26.26% and 26.81%, respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This Statement rescinds FASB No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that Statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." This Statement also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers." This Statement amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under change conditions. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. Management does not anticipate that the initial adoption of SFAS No. 145 will have a significant impact on our consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." This Statement is to be applied prospectively to exit or disposal activities initiated after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions - an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No 9." This Statement removes acquisitions of financial institutions from the scope of both SFAS No. 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." The provisions of SFAS No. 147 that relate to the application of the purchase method of accounting apply to all acquisitions of financial institutions, except transactions between two or more mutual enterprises.
SFAS No. 147 clarifies that a branch acquisition that meets the definition of a business should be accounted for as a business combination, otherwise the transaction should be accounted for as an acquisition of net assets that does not result in the recognition of goodwill. The provisions of SFAS No. 147 are effective October 1, 2002. This Statement did not have any impact on our consolidated financial statements.
In December, 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The additional disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. We have adopted the expanded disclosure provisions of this statement effective December 31, 2002.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements of Hudson City Bancorp have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation.
CRITICAL ACCOUNTING POLICIES
Note 1 to our Audited Consolidated Financial Statements for the year ended December 31, 2002, included in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K
for the year ended December 31, 2002, contains a summary of our significant accounting policies. We believe our policies with respect to the methodology for our determination of the allowance for loan losses and asset impairment judgments, including other than temporary declines in the value of our securities, involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors.
Allowance for Loan Losses. The allowance for loan losses has been determined in accordance with accounting principles generally accepted in the United States of America, 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.
As part of our evaluation of the adequacy of our allowance for loan losses, each month we prepare a worksheet. This worksheet categorizes the entire loan portfolio by certain risk characteristics such as loan type (one- to four-family, multi-family, etc.) 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. We use this worksheet, together with loan portfolio 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, 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, accounting principles generally accepted in the United States of America 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.
Our primary lending emphasis is the origination 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. As a result of our lending emphasis, we had a loan concentration in residential first mortgage loans at December 31, 2002, the majority of which are 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 possible increases in interest rates, a further decline in the economy, generally, and a possible 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 have maintained our provision for loan losses at the current level to primarily address the actual growth in our loan portfolio.
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, 2002 and 2001 -- Provision for Loan Losses."
Asset Impairment Judgments. Certain of our assets are carried in our consolidated statements of financial condition at fair value or at the lower of cost or fair value. Valuation allowances are established when necessary to recognize impairment of such assets. We periodically perform analyses to test for impairment of various assets. In addition to our impairment analyses related to loans discussed above, another significant impairment analysis relates to the value of other than temporary declines in the value of our securities.
Our available for sale portfolio is carried at estimated fair value, with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income in stockholders' equity. The securities which we have the positive intent and ability to hold to maturity are classified as held to maturity and are carried at amortized cost. We conduct a periodic review and evaluation of the securities portfolio to determine if the value of any security has declined below its carrying value and whether such decline is other than temporary. If such decline is deemed other than temporary, we would adjust the carrying amount of the security through a valuation allowance. The market values of our securities are significantly affected by changes in interest rates. In general, as interest rates rise, the market value of fixed-rate securities will decrease; as interest rates fall, the market value of fixed-rate securities will increase. Estimated fair values for securities are based on published or securities dealers' market values.
ITEM 7a.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Information regarding quantitative and qualitative disclosures about market risk appear under Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Management of Interest Rate Risk.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEPENDENT AUDITORS' REPORT
To The Board of Directors and Stockholders of Hudson City Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition of Hudson City Bancorp, Inc. and subsidiary as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hudson City Bancorp, Inc. and subsidiary as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
January 14, 2003 Short Hills, New Jersey
Hudson City Bancorp, Inc. and Subsidiary Consolidated Statements of Financial Condition
See accompanying notes to consolidated financial statements.
Hudson City Bancorp, Inc. and Subsidiary Consolidated Statements of Income
See accompanying notes to consolidated financial statements.
Hudson City Bancorp, Inc. and Subsidiary Consolidated Statements of Changes in Stockholders' Equity
See accompanying notes to consolidated financial statements.
Hudson City Bancorp, Inc. and Subsidiary Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements.
Notes to Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) BASIS OF PRESENTATION
The following are the significant accounting and reporting policies applied by Hudson City Bancorp, Inc. ("Hudson City Bancorp") and its wholly-owned subsidiary Hudson City Savings Bank ("Hudson City Savings") in the preparation of the accompanying consolidated financial statements. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. All significant intercompany transactions and balances have been eliminated in consolidation. Certain dollar and share amounts previously reported have been reclassified to conform to the current year's presentation. As used in these consolidated financial statements, "Hudson City" refers to Hudson City Bancorp, Inc. and its consolidated subsidiary, depending on the context.
Hudson City Bancorp is a Delaware corporation organized in March 1999 by Hudson City Savings in connection with the conversion and reorganization of Hudson City Savings from a New Jersey mutual savings bank into a two-tiered mutual savings bank holding company structure, referred to as the Reorganization.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statements of financial condition and income for the period. Actual results could differ from these estimates.
b) COMPREHENSIVE INCOME
Comprehensive income is comprised of net income and other comprehensive income. Other comprehensive income includes items such as unrealized gains and losses on securities available for sale, net of tax. Comprehensive income is presented in the consolidated statements of changes in stockholders' equity.
c) STATEMENTS OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents includes cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.
Transfers of loans to foreclosed real estate of $1,257,000, $747,000 and $1,126,000 for the years ended December 31, 2002, 2001 and 2000, respectively, did not result in cash receipts or cash payments.
d) INVESTMENT SECURITIES
Investment securities are classified as either held to maturity or available for sale. Investment securities classified as held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income, using a method that approximates level yield. Hudson City has both the ability and the positive intent to hold these investment securities to maturity. Securities available for sale are carried at fair value, with unrealized gains and losses, net of tax, reported as a component of other comprehensive income, which is included in stockholders' equity.
Notes to Consolidated Financial Statements
Realized gains and losses are recognized when securities are sold or called using the specific identification method. The estimated fair market value of all investment securities is determined by use of quoted market prices.
e) MORTGAGE-BACKED SECURITIES
Mortgage-backed securities include pass-through certificates, which represent participating interests in pools of long-term first mortgage loans originated and serviced by third-party issuers of the securities, and real estate mortgage investment conduits ("REMICs"), which are debt securities that are secured by mortgage loans or other mortgage-backed securities.
Mortgage-backed securities are classified as either held to maturity or available for sale. Mortgage-backed securities classified as held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income, using a method that approximates level yield. Hudson City has both the ability and the positive intent to hold these investment securities to maturity. Mortgage-backed securities available for sale are carried at fair value, with unrealized gains and losses, net of tax, reported as a component of other comprehensive income, which is included in stockholders' equity. Realized gains and losses are recognized when securities are sold using the specific identification method. The estimated fair market value of these securities is determined by use of quoted market prices.
f) LOANS
Loans are stated at their principal amounts outstanding. Interest income on loans is accrued and credited to income as earned. Net loan origination fees are deferred and amortized to interest income over the life of the loan as an adjustment to the loan's yield, using the level yield method. Purchased loans are stated at their principal amounts outstanding, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income, using a method that approximates level yield.
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 or when the timely collection of such income is doubtful. Loans on which the accrual of income has been discontinued are designated as non-accrual loans and outstanding interest previously credited is reversed. It is recognized subsequently in the period collected only when the ultimate collection of principal is no longer in doubt. A non-accrual loan is returned to accrual status when factors indicating doubtful collection no longer exist.
Hudson City defines the population of impaired loans to be all non-accrual commercial real estate and multi-family loans. Impaired loans are individually assessed to determine that the loan's carrying value is not in excess of the fair value of the collateral or the present value of the loan's expected future 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. There were no loans classified as impaired at December 31, 2002 and 2001.
g) ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is a valuation account established through a provision for loan losses charged to income. Losses on loans are charged against the allowance when management believes the collection of the principal is unlikely. Subsequent recoveries, if any, are generally credited to the
Notes to Consolidated Financial Statements
allowance. The determination of the amount of the allowance, and the related provision for loan losses, is based on such factors as loan loss experience, known and inherent risks in the loan portfolio, the estimated value of underlying collateral, current economic and real estate market trends, loan portfolio growth and other factors which may warrant recognition.
Hudson City's objective is to maintain an allowance at a level sufficient to cover specifically identifiable loan losses, as well as estimated losses inherent in the loan portfolio which are probable but not specifically identifiable. Although management uses the best information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgement and short-term change.
h) FORECLOSED REAL ESTATE
Foreclosed real estate is property acquired through foreclosure and 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. Fair market value is generally based on recent appraisals. Subsequent provisions, which may result from the ongoing periodic valuations of these properties, are charged to income in the period in which they are identified and credited to a valuation allowance account. Foreclosed real estate is reported net of the valuation allowance. Carrying costs, such as maintenance and taxes, are charged to operating expenses as incurred.
i) BANKING PREMISES AND EQUIPMENT
Land is carried at cost. Buildings, leasehold improvements and furniture, fixtures and equipment are carried at cost, less accumulated depreciation and leasehold amortization. Buildings are depreciated over their estimated useful lives using the straight-line method. Furniture, fixtures and equipment are depreciated over their estimated useful lives using the double-declining balance method. Leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the respective leases. The costs for major improvements and renovations are capitalized, while maintenance, repairs and minor improvements are charged to operating expenses as incurred. Gains and losses on dispositions are reflected currently as other non-interest income or expense.
j) INCOME TAXES
We utilize the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
k) EMPLOYEE BENEFIT PLANS
Hudson City maintains certain noncontributory benefit plans which cover all employees who have met the eligibility requirements of the plans. Certain health care and life insurance benefits are provided for retired employees. The expected cost of benefits provided for retired employees is actuarially
Notes to Consolidated Financial Statements
determined and accrued ratably from the date of hire to the date the employee is fully eligible to receive the benefits.
The employee stock ownership plan ("ESOP") is accounted for in accordance with the provisions of Statement of Position 93-6, "Employer Accounting for Employee Stock Ownership Plans." The funds borrowed by the ESOP from Hudson City Bancorp to purchase Hudson City Bancorp common stock are being repaid from Hudson City Savings' contributions and dividends paid on unallocated ESOP shares over a period of up to 30 years. Hudson City common stock not allocated to participants is recorded as a reduction of stockholders' equity at cost. Compensation expense for the ESOP is based on the average price of our stock during each quarter.
The Hudson City stock option plans and the recognition and retention plans ("RRP") are accounted for in accordance with the provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related Interpretations. Accordingly, no compensation expense has been recognized for the stock option plans. The fair value pro forma disclosures required by Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" are included in Note 10 - Employee Benefit Plans. Expense for the RRP in the amount of the fair value of the common stock at the date of grant is recognized ratably over the vesting period. Unvested and unallocated RRP shares are recorded as a reduction of stockholders' equity at cost.
Had expense for Hudson City's stock option plans been determined based on the fair value at the grant date for our stock options consistent with the method of SFAS No. 123, our net income and earnings per share for all expenses related to stock options and stocks granted in our recognition and retention plans would have been reduced to the pro forma amounts that follow:
Notes to Consolidated Financial Statements
l) BORROWED FUNDS
Hudson City enters into sales of securities under agreements to repurchase with selected brokers and the Federal Home Loan Bank ("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 continue 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. Total borrowings with the FHLB are generally limited to twenty times the amount of FHLB stock owned or the fair value of our mortgage portfolio, whichever is greater.
s) EARNINGS PER SHARE
Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock options) were exercised or resulted in the issuance of common stock. These potentially dilutive shares would then be included in the weighted average number of shares outstanding for the period using the treasury stock method. Shares issued and shares reacquired during any period are weighted for the portion of the period that they were outstanding.
In computing both basic and diluted earnings per share, the weighted average number of common shares outstanding includes all 122,576,600 shares issued to Hudson City, MHC. Also included are the ESOP shares previously allocated to participants and shares committed to be released for allocation to participants and the RRP shares which have vested or have been allocated to participants. ESOP and RRP shares that have been purchased but have not been committed to be released have not been considered in computing basic and diluted earnings per share.
2. STOCKHOLDERS' EQUITY
Upon completion of the Reorganization, a "liquidation account" was established in an amount equal to the total equity of Hudson City Savings as of the latest practicable date prior to the Reorganization. The liquidation account was established to provide a limited priority claim to the assets of Hudson City Savings to "eligible account holders" and "supplemental eligible account holders", as defined, who continue to maintain deposits in Hudson City Savings after the Reorganization. In the unlikely event of a complete liquidation of Hudson City Savings, and only in such event, each eligible account holder and supplemental eligible account holder would receive a liquidation distribution, prior to any payment to the holder of the Bank's common stock. This distribution would be based upon each eligible account holder's and supplemental account holder's proportionate share of the then total remaining qualifying deposits.
Notes to Consolidated Financial Statements
3. RESTRICTIONS ON CASH AND DUE FROM BANKS
Cash reserves are required to be maintained on deposit with the Federal Reserve Bank based on deposits. The average amount of the reserves on deposit for the years ended December 31, 2002 and 2001 was approximately $8,456,000 and $2,104,000, respectively.
4. INVESTMENT SECURITIES
The amortized cost and estimated fair market value of investment securities at December 31 are as follows:
Notes to Consolidated Financial Statements
The amortized cost and estimated fair market value of investment securities held to maturity and investment securities available for sale at December 31, 2002, by contractual maturity, are shown below. The expected maturity may differ from the contractual maturity because issuers may have the right to call or prepay obligations. Equity securities have been excluded from this table.
Interest and dividend income for the years ended December 31, 2002, 2001 and 2000 consists of the following:
Gross realized gains on sales of investment securities available for sale during 2002 were $585,000. There were no gains or losses from investment securities transactions during 2001 and 2000.
The carrying value of securities pledged as required security for deposits and for other purposes required by law amounted to $10,966,000 and $16,421,000 at December 31, 2002 and 2001, respectively.
Notes to Consolidated Financial Statements
5. MORTGAGE-BACKED SECURITIES
The amortized cost and estimated fair market value of mortgage-backed securities at December 31 are as follows:
Gross realized gains on sales of mortgage-backed securities available for sale during 2002 were $1,481,000. There were no gains or losses from mortgage-backed securities transactions during 2001 and 2000.
Notes to Consolidated Financial Statements
6. LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans at December 31 are summarized as follows:
Substantially all of Hudson City's loans are secured by first or second liens on real estate property, the majority of which are located in the State of New Jersey. The ultimate ability to collect the loan portfolio and realize the carrying value of real estate is subject to changes in the real estate market and future economic conditions.
The following is a comparative summary of loans on which the accrual of income has been discontinued and loans which are contractually past due 90 days or more but have not been classified non- accrual at December 31:
The total amount of interest income received during the year on non-accrual loans outstanding at December 31, 2002, 2001 and 2000 amounted to $109,000, $154,000 and $179,000, respectively. Additional interest income totaling $319,000, $483,000, and $652,000 on non-accrual loans would have been recognized in 2002, 2001 and 2000, respectively, if interest on all such loans had been recorded based upon original contract terms. Hudson City is not committed to lend additional funds to borrowers on non-accrual status.
Notes to Consolidated Financial Statements
An analysis of the allowance for loan losses at December 31 follows:
7. BANKING PREMISES AND EQUIPMENT, NET
A summary of the net carrying value of banking premises and equipment at December 31 is as follows:
Amounts charged to net occupancy expense for depreciation and amortization of banking premises and equipment amounted to $3,775,000, $3,912,000 and $3,599,000 in 2002, 2001 and 2000, respectively.
Notes to Consolidated Financial Statements
Hudson City has entered into non-cancelable operating lease agreements with respect to banking premises and equipment. It is expected that many agreements will be renewed at expiration in the normal course of business. Future minimum rental commitments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year are as follows:
Net occupancy expense included gross rental expense for certain bank premises of $3,531,000 in 2002, $3,459,000 in 2001 and $3,286,000 in 2000, and rental income of $861,000, $620,000 and $569,000 for the respective years.
8. DEPOSITS
Deposits at December 31 are summarized as follows:
Time deposits $100,000 and over amounted to $967,983,000 and $923,830,000 at December 31, 2002 and 2001, respectively. Interest expense on time deposits $100,000 and over for the years ended December 31, 2002, 2001 and 2000 was $27,399,000, $34,202,000 and $29,671,000, respectively. Included in noninterest-bearing demand accounts are mortgage escrow deposits of $47,730,000 and $48,917,000 at December 31, 2002 and 2001, respectively.
Notes to Consolidated Financial Statements
Scheduled maturities of time deposits are as follows:
9. BORROWED FUNDS
Borrowed funds at December 31 are summarized as follows:
At December 31, 2002, borrowed funds had scheduled maturities and potential call dates as follows:
Notes to Consolidated Financial Statements
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, 2002 and 2001 are as follows:
The average balance of our advances from the FHLB during 2002 was $1.12 billion and the maximum FHLB advances outstanding during 2002 was $1.75 billion.
10. EMPLOYEE BENEFIT PLANS
a) RETIREMENT AND OTHER POSTRETIREMENT BENEFITS
Non-contributory retirement and postretirement plans are maintained to cover all employees, including retired employees, who have met the eligibility requirements of the plans. Benefits under the qualified and non-qualified defined benefit retirement plans are based primarily on years of service and compensation. Funding of the qualified retirement plan is actuarially determined on an annual basis. It is our policy to fund the qualified retirement plan sufficiently to meet the minimum requirements set forth in the Employee Retirement Income Security Act of 1974. The non-qualified retirement plan, for certain executive officers, is unfunded and had a benefit obligation of $3,983,000 at December 31, 2002 and $3,628,000 at December 31, 2001. Certain health care and life insurance benefits are provided to eligible retired employees ("other benefits"). Participants generally become eligible for retiree health care and life insurance benefits after ten years of service.
Notes to Consolidated Financial Statements
The following table shows the change in benefit obligation, the change in plan assets, and the funded status for the retirement plans and other benefits at December 31:
Net periodic benefit (income) cost at December 31 included the following components:
The following are the weighted average assumptions used in accounting for the benefit plans at December 31:
Notes to Consolidated Financial Statements
The assumed health care cost trend rate used to measure the expected cost of other benefits for 2002 was 7.50%. The rate was assumed to decrease gradually to 5.00% for 2007 and remain at that level thereafter.
Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A 1% change in the assumed health care cost trend rate would have the following effects on other benefits:
b) EMPLOYEE STOCK OWNERSHIP PLAN
The ESOP is a tax-qualified plan designed to invest primarily in Hudson City common stock that provides employees with the opportunity to receive a Hudson City-funded retirement benefit based primarily on the value of Hudson City common stock. The ESOP was authorized to purchase, and did purchase, 8,696,000 shares of Hudson City common stock at an average price of $6.74 per share with a loan from Hudson City Bancorp. The outstanding loan principal at December 31, 2002 was $54.1 million. Those shares were pledged as collateral for the loan and are released from the pledge for allocation to participants as loan payments are made.
At December 31, 2002, shares allocated to participants were 1,014,533. For the plan year ending September 30, 2003, there are 289,866 shares that are committed to be released and will be allocated to participants at the end of the plan year. Unallocated ESOP shares held in suspense totaled 7,681,467 at December 31, 2002 and had a fair market value of $143.1 million. ESOP compensation expense for the years ended December 31, 2002, 2001 and 2000 was $5,105,000, $3,238,000 and $2,376,000, respectively.
The ESOP restoration plan is a non-qualified plan that provides supplemental benefits to certain executives who are prevented from receiving the full benefits contemplated by the employee stock ownership plan's benefit formula. The supplemental payments consist of payments representing shares that cannot be allocated to participants under the ESOP due to the legal limitations imposed on tax-qualified plans and, in the case of participants who retire before the repayment in full of the ESOP's loan, payments representing the shares that would have been allocated if employment had continued through the full term of the loan. Compensation expense related to this plan amounted to $2,250,000 in 2002, $1,406,000 in 2001 and $1,959,000 in 2000.
c) RECOGNITION AND RETENTION PLANS
The purpose of the RRP is to promote the growth and profitability of Hudson City Bancorp by providing directors, officers and employees with an equity interest in Hudson City Bancorp as an incentive to achieve corporate goals. The RRP have invested money primarily in shares of Hudson City common stock that were used to make restricted stock awards. The RRP were authorized, in the aggregate, to purchase not more than 4,548,000 shares of common stock, and have purchased 4,407,616 shares on the open market at an average price of $7.87 per share.
Notes to Consolidated Financial Statements
As a general rule, restricted stock grants are held in escrow for the benefit of the award recipient until vested. Awards outstanding generally vest in five annual installments commencing one year from the date of the award. As of December 31, 2002, common stock that had not been awarded totaled 205,700 shares. Expense attributable to the RRP amounted to $7,362,000 for the year 2002, $5,641,000 for 2001 and $4,457,000 for 2000.
A summary of the status of the granted, but unvested shares under the RRP as of December 31, and changes during those years, is presented below:
d) STOCK OPTION PLANS
Each stock option granted entitles the holder to purchase one share of Hudson City's common stock at an exercise price not less than the fair market value of a share of common stock at the date of grant. Options granted generally vest over a five year period from the date of grant and will expire no later than 10 years following the grant date. Under the Hudson City stock option plans, 11,190,000 shares of Hudson City Bancorp, Inc. common stock have been reserved for issuance. Directors and employees have been granted 10,026,000 stock options.
Notes to Consolidated Financial Statements
A summary of the status of the granted, but unexercised stock options as of December 31, and changes during those years, is presented below:
The following table summarizes information about our stock options outstanding at December 31, 2002:
Notes to Consolidated Financial Statements
Hudson City Bancorp applies APB 25 and related Interpretations in accounting for the stock option plans. Accordingly, no compensation expense has been recognized in 2002, 2001 or 2000. Had compensation expense for Hudson City's stock option plans been determined based on the fair value at the grant date for our stock options consistent with the method of SFAS No. 123, our net income and earnings per share would have been reduced to the pro forma amounts indicated below:
The fair value of the option grants was estimated on the date of grant using the Black-Sholes option-pricing model with the following weighted average assumptions:
e) INCENTIVE PLANS
A tax-deferred profit incentive bonus savings plan is maintained based on Hudson City's profitability. All employees are eligible after one year of employment and the attainment of age 21. The expense was $1,230,000, $1,145,000 and $1,095,000 in 2002, 2001 and 2000, respectively.
Certain incentive plans are maintained to recognize key executives who are able to make substantial contributions to the long-term success and financial strength of Hudson City. At the end of each performance period, the value of the award is determined in accordance with established criteria. Participants can elect cash payment or elect to defer the award until retirement. The expense related to these plans was $2,462,000 in 2002, $2,489,000 in 2001 and $2,407,000 in 2000.
Notes to Consolidated Financial Statements
11. INCOME TAXES
Income tax expense (benefit) for each of the years in the three-year period ended December 31, 2002 is summarized as follows:
Not included in the above table is deferred income tax expense of $11,918,000, $4,868,000 and $15,240,000 for 2002 , 2001 and 2000, respectively, which represents the deferred income tax expense on the net unrealized gains of securities available for sale.
The amounts reported as income tax expense vary from the amounts that would be reported by applying the statutory federal income tax rate to income before income taxes due to the following:
Notes to Consolidated Financial Statements
The net deferred tax asset at December 31 consists of the following:
The net deferred tax asset represents the anticipated federal and state tax benefits expected to be realized in future years upon the utilization of the underlying tax attributes comprising this balance. In management's opinion, in view of Hudson City's previous, current and projected future earnings trends, such net deferred tax asset will more likely than not be fully realized. Accordingly, no valuation allowance was deemed to be required at December 31, 2002 and 2001.
At December 31, 2002 and 2001, the bad debt reserve for federal income tax reporting purposes was approximately $54,500,000 and $62,000,000, respectively. Retained earnings at December 31, 2002 and 2001 included approximately $49,000,000 for which no deferred income taxes have been provided. This amount represents the base year allocation of income to bad debt deduction for tax purposes. Under SFAS No. 109, this amount is treated as a permanent difference and deferred taxes are not recognized unless it appears that it will be reduced and result in taxable income in the foreseeable future. Events that would result in taxation of these reserves include failure to qualify as a bank for tax purposes or distributions in complete or partial liquidation.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of financial instruments represents the estimated amounts at which the asset or liability could be exchanged in a current transaction between willing parties, other than in a forced liquidation sale. These estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Further, certain tax implications related to the realization of the unrealized gains and losses could have a substantial impact on these fair value estimates and have not been incorporated into any of the estimates.
Notes to Consolidated Financial Statements
Carrying amounts of cash, due from banks and federal funds sold are considered to approximate fair value. The fair value of one- to four-family mortgages and home equity loans are generally estimated using the present value of expected future cash flows. For time deposits and borrowed funds, the fair value is estimated by discounting estimated future cash flows using currently offered rates. For deposit liabilities payable on demand, the fair value is estimated by discounting estimated future cash flows using a regulatory borrowing rate most closely associated with maturity date ranges that were established using Hudson City's history and regulatory guidelines. There is no material difference between the fair value and the committed amounts of our off-balance commitments.
Other important elements which are not deemed to be financial assets or liabilities and therefore, not considered in these estimates include the value of Hudson City's retail branch delivery system, its existing core deposit base and banking premises and equipment.
The estimated fair value of Hudson City's financial instruments at December 31 are summarized as follows:
13. REGULATORY CAPITAL
Deposits at Hudson City Savings are insured up to standard limits of coverage provided by the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC"). Hudson City Savings is a New Jersey state-chartered savings bank and is subject to comprehensive regulation, supervision and periodic examinations by the FDIC and by the New Jersey State Department of Banking.
FDIC regulations require banks to maintain minimum levels of regulatory capital. Under the regulations in effect at December 31, 2002, Hudson City Savings was required to maintain (a) a minimum leverage ratio of Tier 1 capital to total adjusted average assets of 4.0%, and (b) minimum ratios of Tier 1 and total capital to risk-weighted assets of 4.0% and 8.0 %, respectively.
Under its prompt corrective action regulations, the FDIC is required to take certain supervisory actions (and may take additional discretionary actions) with respect to an undercapitalized institution. Such actions could have a direct material effect on the institution's financial statements. The regulations establish a framework for the classification of savings institutions into five categories: well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.
Notes to Consolidated Financial Statements
Generally, an institution is considered well-capitalized if it has a leverage (Tier 1) capital ratio of at least 5.0%; a Tier 1 risk-based capital ratio of at least 6.0%; and a total risk-based capital ratio of at least 10.0%.
The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the FDIC about capital components, risk-weightings and other factors.
Management believes that, as of December 31, 2002, Hudson City Savings meets all capital adequacy requirements to which it is subject. Further, the most recent FDIC notification categorized Hudson City Savings as a well-capitalized institution under the prompt corrective action regulations. There have been no conditions or events since that notification that management believes have changed Hudson City Savings' capital classification.
The following is a summary of Hudson City Savings' actual capital amounts and ratios as of December 31, 2002 and 2001, compared to the FDIC minimum capital adequacy requirements and the FDIC requirements for classification as a well-capitalized institution:
The Federal Reserve Bank imposes certain capital requirements on Hudson City Bancorp under the Bank Holding Company Act of 1956, including a minimum leverage ratio and a minimum ratio of "qualifying" capital to risk-weighted assets. These minimum requirements are substantially the same as Hudson City Savings' minimum capital requirements described above. Subject to its capital requirements and certain other restrictions, Hudson City Bancorp is able to borrow money to make a capital contribution to Hudson City Savings, and such loans may be repaid from dividends paid from Hudson City Savings to Hudson City Bancorp. Hudson City Bancorp is also able to raise capital for contribution to Hudson City Savings by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.
Notes to Consolidated Financial Statements
The following table shows Hudson City Bancorp's leverage capital ratio, its Tier 1 risk-based capital ratio, and its total risk-based capital ratio, at December 31, 2002 and 2001:
14. OFF-BALANCE SHEET RISK AND CONTINGENCIES
Hudson City Savings is a party to commitments to extend credit in the normal course of business to meet the financial needs of its customers. Commitments to extend credit are agreements to lend money to a customer as long as there is no violation of any condition established in the contract. Commitments to fund first mortgage loans generally have fixed expiration dates or other termination clauses, whereas home equity lines of credit have no expiration date. Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Hudson City Savings evaluates each customer's credit-worthiness on a case-by-case basis.
At December 31, 2002, Hudson City Savings had fixed- and variable-rate first mortgage loan commitments to extend credit of approximately $174,103,000 and $38,917,000, respectively, commitments to purchase loans of $261,554,000, commitments to purchase mortgage-backed securities of $263,200,000 and unused home equity and overdraft lines of credit of approximately $83,291,000. No commitments are included in the accompanying financial statements. There is no exposure to credit loss in the event the other party to commitments to extend credit does not exercise its rights to borrow under the commitment.
In the normal course of business, there are various outstanding legal proceedings. In the opinion of management, the consolidated financial statements of Hudson City will not be materially affected as a result of such legal proceedings.
Notes to Consolidated Financial Statements
15. PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following condensed financial statements for Hudson City Bancorp, Inc. (parent company only) reflect Hudson City Bancorp's investment in its wholly-owned subsidiary, Hudson City Savings Bank, using the equity method of accounting.
STATEMENTS OF FINANCIAL CONDITION
Notes to Consolidated Financial Statements
STATEMENTS OF INCOME
Notes to Consolidated Financial Statements
STATEMENTS OF CASH FLOWS
Notes to Consolidated Financial Statements
16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables are a summary of certain quarterly financial data for the years ended December 31, 2002 and 2001.
Notes to Consolidated Financial Statements
17. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations.
18. RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This Statement rescinds FASB No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that Statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." This Statement also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers." This Statement amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under change conditions. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. Management does not anticipate that the initial adoption of SFAS No. 145 will have a significant impact on our consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." This Statement is to be applied prospectively to exit or disposal activities initiated after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions - an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No 9." This Statement removes acquisitions of financial institutions from the scope of both SFAS No. 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." The provisions of SFAS
Notes to Consolidated Financial Statements
No. 147 that relate to the application of the purchase method of accounting apply to all acquisitions of financial institutions, except transactions between two or more mutual enterprises.
SFAS No. 147 clarifies that a branch acquisition that meets the definition of a business should be accounted for as a business combination, otherwise the transaction should be accounted for as an acquisition of net assets that does not result in the recognition of goodwill. The provisions of SFAS No. 147 are effective October 1, 2002. This Statement did not have any impact on our consolidated financial statements.
In December, 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The additional disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. We have adopted the expanded disclosure provisions of this statement effective December 31, 2002.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
Information regarding directors and executive officers of the Company is presented under the headings "Proposal 1 - Election of Directors-General," "-Who Our Directors Are," "-Our Directors Backgrounds," "-Nominees for Election as Directors," "-Continuing Directors," "-Meetings of the Board of Directors and Its Committees," "-Executive Officers," "-Director Compensation," "-Executive Officer Compensation," and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement for the 2003 Annual Meeting of Stockholders to be held on May 2, 2003, which will be filed with the SEC on or about April 2, 2003, and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Information regarding executive compensation is presented under the headings "Election of Directors-Director Compensation," " -Executive Officer Compensation," "-Summary Compensation Table," "Employment Agreements," "Change of Control Agreements," and "Benefit Plans" in the Company's definitive Proxy Statement for the 2003 Annual Meeting of Stockholders to be held May 2, 2003, which will be filed with the SEC on or about April 2, 2003, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information regarding security ownership of certain beneficial owners and management is presented under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement for the 2003 Annual Meeting of Stockholders to be held May 2, 2003, which will be filed with the SEC on or about April 2, 2003, and is incorporated herein by reference.
The following table presents the equity compensation plan information as of December 31, 2002.
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(1) Of such 1,369,700 shares, 205,700 remain available for future restricted stock awards under Hudson City Bancorp's 2000 Recognition and Retention Plan. Hudson City's practice is to purchase outstanding common stock to satisfy its obligations for restricted stock awards.
The Hudson City Bancorp, Inc. Denis J. Salamone Restricted Stock Award Plan and the Hudson City Bancorp, Inc. Denis J. Salamone Stock Option Plan were adopted in fiscal year 2001. Pursuant to the Denis J. Salamone Restricted Stock Award Plan, Mr. Salamone was granted a restrictive stock award of 200,000 shares, which vest at the rate of 40,000 shares per year beginning April 20, 2002, with accelerated vesting in cases of death, disability, retirement or change of control in Hudson City Bancorp. Pursuant to the Denis J. Salamone Stock Option Plan, Mr. Salamone was granted an option to purchase 320,000 shares, which become exercisable at the rate of 64,000 shares per year beginning January 13, 2002. These awards were granted as a recruitment incentive to induce Mr. Salamone to leave his prior position and join Hudson City. In 2001, Hudson City purchased outstanding common stock to meet its obligations under Mr. Salamone's restricted stock award.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding certain relationships and related transactions is presented under the heading "Certain Transactions with Members of our Board of Directors and Executive Officers" in the Company's definitive Proxy Statement for the 2003 Annual Meeting of Stockholders to be held on May 2, 2003, which will be filed with the SEC on or about April 2, 2003, and is incorporated herein by reference.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
Ronald E. Hermance, Jr., our President and Chief Executive Officer, and Denis J. Salamone, our Senior Executive Vice President and Chief Operating Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended) as of January 14, 2003. Based upon their evaluation, they each found that our disclosure controls and procedures were adequate to ensure that information required to be disclosed in the reports that we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required.
There were no significant changes in our disclosure controls and procedures or internal controls for financial reporting or other factors that could significantly affect those controls subsequent to January 14, 2003, and we identified no significant deficiencies or material weaknesses requiring corrective action with respect to those controls.
ITEM 15.
ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding principal accountant fees and services is presented under the heading "Proposal 2 - Ratification of Appointment of Independent Auditors" in Hudson City Bancorp's definitive Proxy Statement for the 2003 Annual Meeting of Stockholders to be held on May 2, 2003, which will be filed with the SEC on or about April 2, 2003 and is incorporated herein by reference.
PART IV
ITEM 16. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) List of Documents Filed as Part of this Annual Report on Form 10-K
(1) The following consolidated financial statements are in Item 8 of this annual report:
Consolidated Financial Statements as of December 31, 2002, 2001 and
- Independent Auditors' Report
- Consolidated Statements of Financial Condition as of December 31, 2002 and 2001
- Consolidated Statements of Income for the years ended December 31, 2002, 2001 and 2000
- Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2002, 2001 and 2000
- Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000
- Notes to Consolidated Financial Statements
(2) Financial Statement Schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto in Item 8 of this annual report.
(b) Reports on Form 8-K. During the last quarter of 2002, no reports on Form 8-K were required to be filed and as such, none were filed.
(c) Exhibits Required by Item 601 of Regulation S-K
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(1) Incorporated herein by reference to the Exhibits to the Registrant's Registration Statement No. 333-74383 on Form S-1, filed with the Securities and Exchange Commission on March 15, 1999, as amended.
(2) Incorporated herein by reference to the Exhibits to the Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on January 27, 2003.
(3) Incorporated herein by reference to the Exhibits to the Registrant's Registration Statement No. 333-95193 on Form S-8, filed with the Securities and Exchange Commission on January 21, 2000.
(4) Incorporated herein by reference to the Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1999 filed with the Securities and Exchange Commission on March 29, 2000.
(5) Incorporated herein by reference to the Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2001 filed with the Securities and Exchange Commission on March 28, 2002.
(6) Submitted only with filing in electronic format.
CERTIFICATION OF DISCLOSURE
I, Ronald E. Hermance, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of Hudson City Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in the Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 20, 2003 By: /s/ Ronald E. Hermance, Jr. ------------------------------------- Ronald E. Hermance, Jr. President and Chief Executive Officer
CERTIFICATION OF DISCLOSURE
I, Denis J. Salamone, certify that:
1. I have reviewed this annual report on Form 10-K of Hudson City Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in the Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 20, 2003 By: /s/ Denis J. Salamone ------------------------------------- Denis J. Salamone Senior Executive Vice President and Chief Operating Officer
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant had duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Paramus, New Jersey, on March 20, 2003.
Hudson City Bancorp, Inc.
By: /s/ Ronald E. Hermance, Jr. ------------------------------------- Ronald E. Hermance, Jr. President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.