Hudson City: Banking on a TARP-Free Stock

May.12.09 | About: Hudson City (HCBK)

Hudson City Bancorp (NDQ:HCBK) May 11, 2009: $12.75 10:50 AM EST
52-week range: $7.46 (Mar. 9, 2009) - $20.97 (Sep. 19, 2008)
Dividend = $0.15 quarterly = 4.71% current yield

Hudson City was considered a shining star of the banking industry as recently as last summer due to its conservative lending practices during the housing market insanity. HCBK requires a 20% minimum down payment on its mortgage originations. The shares actually hit an all-time closing high of $20.97 /share as recently as last September.

Unlike most banks and thrifts, Hudson City’s EPS continued to grow in both the December and March quarters. Zacks now looks for 2009 – 2010 earnings of $1.05 and $1.15 versus the $0.90 posted in 2008.

HCBK took nothing from the TARP funds as it didn’t need external capital. Their net interest spreads have widened with the cost of depositor funds near an all-time low.

Here are the per share numbers as reported by Value Line

[2009 figures include estimates for Q2 - Q4]:

Hudson City converted from a chartered mutual savings bank into a partly owned mutual holding company in 1999. They effected a second-step conversion that eliminated the mutual holding status completely on June 7, 2005. That’s why the book value figure jumped significantly in that year.

It is now entirely publicly held.

Dividends were initiated in 2000 and have been raised in each subsequent year. The latest quarter saw the rate go up by 7.14% taking the quarterly payout from $0.14 to $0.15. At today’s quote of $12.75 that’s a current yield of 4.71%. Shareholders are getting paid much better than the buyers of their 1, 3 and 5 year CDs.

Value Line gives HCBK a ‘B+’ financial strength rating and notes their high percentile ranking for ‘stock price stability’, ‘price growth persistence’ and ‘earnings predictability’ at 90th, 80th and 90th respectively (with 100th being best). Morningstar gives Hudson City a ‘4-Star’ overall ranking and calls its ‘fair value’ to be $16.00/share.

I don’t see a lot of risk in these shares due to their reasonable valuation, good quality and their almost 5% current yield.

Here’s a way to play Hudson City out to October 16th even if the shares just hold their current price:

If HCBK shares remain > $12.50 on October 16, 2009:

The $12.50 calls will be exercised.
You will sell your shares for $12,500.
The $12.50 puts will expire worthless – a good thing for you as a seller.
You will collect a $150 dividend payment in August.
You will have no further option obligations.

You will hold no shares and $12,650 cash for your original outlay of $9,500 = $3,150 net profit.

That’s a 33% total return achieved in less than six months on shares
which did not need to move up at all from your trade inception.

What’s the risk?

If Hudson City closes below $12.50 on Oct. 16, 2009:

The $12.50 calls will expire worthless.
The $12.50 puts will be exercised.
You will be forced to buy an additional 1000 shares and to
pay out another $12,500 cash.
You will have collected $150 in dividends.
You will have no further option obligations.
You’ll end up owning 2000 shares of HCBK.

What’s the break-even on the whole trade?

On the first 1000 shares it’s their $12.75 cost less the $1.70 /share call premium = $11.05 /share.

On the ‘put’ shares it’s their $12.50 strike price less the $1.55 /share put premium = $10.95 /share.

Thus your net break-even price would be $11 /share (excluding dividends).

HCBK shares could drop by up to $1.75 /share or (-13.7%) without causing a loss.

Disclosure: Author is long HCBK shares and short HCBK options.