Lenders Rebalance Portfolios in Late 2005

Balance sheet restructuring is the name of the game in the new year as two bank holding companies and one mortgage real estate investment trust will conduct or have conducted a series of transactions to accomplish that goal.

Portland, Maine-based TD Banknorth Inc., which is majority owned by TD Bank Financial Group, Toronto, is implementing a restructuring in order to facilitate its pending acquisition of Hudson United Bancorp, Mahwah, N.J.

The company will sell $2.6 million of mortgage-backed securities with the proceeds to be reinvested in shorter duration assets. It said the sale would reduce earnings volatility because of prepayments and call features of MBS.

However, TD Banknorth will take a pretax loss of $45 million because of the sale. It will mark the securities as impaired as of Dec. 31, and the loss will be recorded into TD Banknorth's fourth-quarter results.

It anticipates selling $2.7 million in investment securities currently owned by Hudson United once the deal is completed. The proceeds of this sale are expected to be used to repay borrowings.

Separately, First Community Bancshares Inc., Bluefield, Va., prepaid $77 million of Federal Home Loan Bank advances on Dec. 23.

The borrowings had a weighted average interest rate of 5.96% and a 4.3 year weighted average maturity.

In connection with the early termination, First Community had a prepayment penalty of $3.7 million.

On the other hand, on Jan. 6, First Community drew additional FHLB advances totaling $75 million. These new advances have a floating interest rate tied to the three-month LIBOR and mature in 15 years. After five years, FHLB has the option to convert the advances to a fixed rate of 4%.

As a hedge, First Community entered into an interest rate swap agreement, which effectively fixes the interest rate at 4.335% on $50 million of the advances for five years. In return, it will receive floating interest rate payments of three-month LIBOR minus 45 basis points. It expects to save $813,000 in annual interest expense as a result of the swap.

First Community noted that the initial interest rate on the floating portion of the advances (the remaining $25 million) is 1.86% less than the weighted average rate of the prepaid advances.

Finally, Annaly Mortgage Management, New York, also announced a portfolio rebalancing that took place in the fourth quarter of last year.

The REIT's chairman, chief executive and president, Michael A.J. Farrell, said, "As the federal funds rate has risen from 1% to 4.25% since June 30, 2004, legacy portfolios have suffered. Certain assets that were purchased in the much lower interest rate environment of 2003 and 2004 are unlikely to recover to their amortized cost basis. However, the returns for new capital invested in short duration assets have improved significantly.

"As a result, we are taking advantage of current market conditions by either selling or reducing the cost basis of these assets, and by repositioning the portfolio into higher yielding investments. We believe the actions we are taking accelerate the positive fundamentals occurring in our AAA mortgage portfolio and will have a direct impact on our performance by strengthening net interest margin and, ultimately, increasing our dividend."

As of Dec. 31, Annaly reclassified $2.9 billion of MBS as other-than-temporarily impaired on its balance sheet. This had a loss of $83 million, or $0.67 per share.

In addition, during the fourth quarter, the REIT sold $2.3 billion of securities at a realized loss $65 million, or $0.53 per share.

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