Hudson City Bankcorp Avoids Subprime Mess Through Jumbo Loans
StockTradingToGo reader Josh wrote in this past week asking about a fantastic article on Hudson City Bankcorp which was one of very few banks that refused to participate in risky subprime mortgages. Part of the bank’s success is through writing Jumbo Loans, but why are these loans so successful?
The one line from the article that puzzled Josh was the following, “In addition to taking deposits, the bank specializes in writing jumbo prime home mortgages — its average borrower puts down 42 percent of a home’s value to get a loan.”
Brandon here. The best way to look at this is in two parts: the loan type and the down payment.
The loan type is a “Jumbo prime home mortgage” which essentially tells us two things. First, it’s a jumbo class loan, meaning the loan value is exceeding the “conforming” loan threshold set by Fannie & Freddie. Depending on the applicant’s family type, there are different maximum loan amounts, or thresholds, that F&F will (..or in present day terms we could say “would”) buy from banks/loan originator and then sell on the secondary market. Jumbo loans are thus considered “non-conforming” because of the loan value; they typically are exceeding $1M. If you read the article, Hudson City Bancorp’s primary customer base is affluent and high-class. That target market, due to their financial ability, is who would be purchasing a mansion or large estate which you would need a jumbo loan for.
The second part of the “Jumbo prime home mortgage” is the fact that it is a “prime” class loan. This means that the borrower is considered to have a prime credit rating based on the three credit reporting agencies metrics. This is also where “sub-prime” is derived from since sub-prime lenders have below average and lower credit ratings. Since we already established that the typical Hudson City customer is wealthy, they most likely also have excellent credit ratings. What’s interesting to note here is that over the past few years, the jumbo prime mortgages have had higher than average interest rates.
Typically you would conclude that an excellent credit rating correlates to a lower interest rate since it should be less risk for the bank. An exception to that rule can be found with the jumbo prime loan. This is due to the fact that they are for hefty amounts and since they are non-conforming loans are more difficult for the bank to sell since F&F won’t buy them in addition to the fact that there is not a huge demand for non-conforming loan types on the secondary market. Thus the bank ups the interest rate to cover their costs and presto the wealthy applicant with a solid credit score get nailed with a slightly higher interest rate.
Knowing that, the down payment now comes into play. An old school bank like Hudson City probably has an old school minimum down payment requirement on these jumbo class loans of 15-20% even with excellent credit. On top of that, the wealthy applicant most likely has some serious cash and doesn’t want an enormous mortgage payment or huge debt position, so they put more down on the loan. A win for the bank since their risk exposure is reduced and they are still making solid interest on the debt.
If you put all of that together, it’s clear as day why Hudson City is performing so well. They stuck to their simple, yet fundamentally sound business model. Their client base is of higher class, which means their deposits will be substantial thus providing Hudson with more capital to issue these jumbo loans at high interest rates and purchase other similar banks to absorb more market share. They didn’t go after the sub-prime market and stuck to their game plan. That and they had a 3.9B IPO to work with.
Brandon Reinkensmeyer is the Marketing Director for Campus Village Realty and a commercial finance guru. He runs a Cigar review site in his spare time, solidcigars.com.
