Hudson City Bancorp: Concerns Are Overblown

| About: Hudson City (HCBK)

As a new contributor to Seeking Alpha, I hope to provide investment analysis and commentary that is insightful, meaningful and useful to aid in your own investment research and decisions. So here we go.

Hudson City Bancorp (NASDAQ:HCBK) is the holding company for Hudson City Savings Bank. The largest thrift in the country, they operate over 130 branches in New Jersey and the metropolitan area and have over $60 billion in assets. As of Friday, November 25th, the last trade was at $5.13.

Like much of the banking sector in 2011, HCBK’s share price has taken a beating. Concerns over the U.S. recovery, as well as the Eurozone debt crisis, have investors fleeing bank shares. However, luckily for us, it seems that they have thrown out many of the babies with the bath water.

For HCBK, the concerns are way overblown. First, HCBK has one of the strongest loan portfolios of any of the large thrifts in the country. Close to 99% of the loans are one-to four- family residential mortgages and have LTV ratios of, at most, 75% with the majority having LTVs in the 60%-70% range. Large down payments by borrowers usually mean fewer defaults. HCBK’s non-performing loans were 3.16% of the total loan portfolio. Although this is a bit higher than some other institutions, the magnitude of the recession and the lingering economic effects on the borrowers must be taken into account, especially considering how large a percentage of the loans are residential mortgages.

In these extraordinary times, 3.16% doesn’t bother me as much as it maybe should. Also, HCBK has an equity-to-assets ratio of 9.79% as of the end of Q3 2011, which provides a nice cushion if NPLs continue to increase, which I don’t think they will much, if at all.

Although the NPL ratio may not be extraordinary compared to other banks, the efficiency ratio of HCBK certainly is. They have consistently been ranked as the most efficient bank in the country, which means they are the lowest cost provider in the banking sector. Anyone who took business 101 will know that being the low-cost provider in an industry is an important competitive advantage. With an efficiency ratio of 30.25% for the nine months ending Sept 30, 2011 (which is up from 18.94% for the same period the prior year), being a low-cost provider enables HCBK to offer very competitive rates on loans and lower fees that ensures repeat business and customer loyalty.

With distrust of banks extremely high at the moment, an institution that consumers feel isn’t ripping them off is a big plus. There are two points I should mention though. As a result of keeping costs extremely low and passing these savings on to the consumer, HCBK has a below average net interest margin. It generally averages somewhere between 1.70-2.00%, give or take a tenth of a percent. Most other well-run banks are able to average somewhere north of 3.50%. Some investors might want to see wider spreads between borrowing and lending but given the many strengths of HCBK in the area of cost control, it is acceptable. If they cease being a low-cost provider, then the below average spread will become a problem.

That brings me to my second point. As mentioned above, the efficiency ratio was approximately 1100bps higher this year than last. Although this may be startling, it is primarily due to the increased costs of regulation. If the efficiency ratio continues to increase, then there may be cause for concern. However, HCBK management has a history of controlling costs and there is no reason to believe they will stop now. Besides, spending 30 cents to make a $1 still qualifies HCBK as one of, if not the, lowest cost producer in banking.

The big concern that many investors have with HCBK was the balance sheet restructuring that resulted in an after-tax charge of $644 million and a reduction of the quarterly dividend to $0.08 from $0.15 (among other things). There are too many details that can be analyzed with regards to the restructuring so I won’t go over them here. The press release is available on the HCBK website. The main thing to know was that the restructuring was NOT a result of weakness.

Due to the continued low interest rate environment and the resulting refinancing taking place by borrowers, combined with some higher cost borrowings on HCBK balance sheet, management and regulators felt it was prudent to extinguish some of these borrowings. As a result of the restructuring, combined with an unwillingness to expand the balance sheet during the current low interest rate environment, HCBK is better positioned for the future.

With the shares trading well below book value and a 6.2% dividend yield, combined with the reasons stated above, HCBK is a worthy candidate for further research.

Disclosure: I am long HCBK.

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