We recently purchased Hudson City Bancorp, Inc. (HCBK), a top 25 bank and the country’s largest thrift. They joined the S&P 500 in 2007 and are recognized for their conservative mortgage underwriting standards. They operate over 130 branches located in 10 of the top 50 U.S. counties rated by medium household income. As the nation’s low-cost provider of banking services, they have been often recognized as “The Most Efficient Bank in America”.
The classic caution that past performance is not indicative of future results aptly applies to price movement. However, when examining past operating results of a business, the past can provide valuable insights. Historical operating excellence speaks volumes about the skills of a management team and the competitive qualities of the company and its products or services. Hudson City’s management team has been recognized as among the best in banking by numerous sources.
Our philosophy is to screen for companies that have consistently generated above-average profit growth. Among banks, Hudson City Bancorp, Inc. (HCBK) stands heads and shoulders above the rest. While most banks faltered during the recession and had to seek government assistance, Hudson City excelled. In fact, 2008 was their most successful year since they converted from a New Jersey chartered mutual savings bank into Hudson City Bancorp, Inc. in 1999.
Strong History
In 2005 a second public offering raised $3.9 billion in capital as they converted to full public ownership. Since the 2005 public offering, Hudson City has grown its assets from $22 billion to over $57 billion as of June 30, 2009. Their deposits per branch are more than double the average of FDIC insured institutions.
Figure 1 below shows how strong and consistent Hudson City Bancorp, Inc.’s (HCBK) profit growth has been. Especially note the acceleration of growth in 2008 (red circles).
Figure 1 HCBK 12yr EPS Growth
In Figure 2 below, we overlay monthly closings stock price (black line) and show dividends paid out of earnings (light blue shaded area).
Figure 2 HCBK 12yr EPS Growth Correlated to Price
What is most striking to see in Figure 2 is how Hudson City Bancorp, Inc.’s stock price fell in late 2008 in spite of its stellar earnings. We believe this unwarranted drop was based on prejudice against all banks. Even though Hudson City Bancorp, Inc. achieved a remarkable operating efficiency ratio at 20.8%, increased their dividend and gained market share and has no debt on their balance sheet they were nevertheless unfairly punished by the market.
We concur that past performance is no guarantee of future results. However, we do find it useful to know how well a company has rewarded its shareholders. In Figure 3 we calculate Hudson City Bancorp, Inc.’s track record since going public on July 30, 1999. The important point is that Hudson City’s returns to shareholders correlates to their earnings growth and not to the general stock market.
Figure 3 HCBK Dividend and Stock Price Performance
Even at today’s depressed valuation, Hudson City Bancorp, Inc. has outperformed the stock market (S&P 500) on a capital appreciation basis. In addition, Hudson City Bancorp, Inc.’s dividend record has been exceptional as well. They have paid a dividend every quarter since going public and have increased it 31 times.
Low Value & High Yield
Go back to Figure 2 and note that Hudson City Bancorp, Inc. with a PE ratio of 12.9 is trading at its lowest valuation since becoming a public company. Also, their 4.3% current yield is more than can be earned on a 10-year Treasury bond and dividends are expected to continue to grow.
Thesis for Growth
Figure 4 calculates the five-year earnings and dividend growth expectations for Hudson City Bancorp, Inc. based on the consensus of 17 leading analysts reporting to FirstCall.
Figure 4 HCBK Earnings Forecast
Note that the forecast growth rate of 17.5% is less than their 19.8% historical average. We believe that a negative bias towards banks in general is built into these forecasts. We are more optimistic based on the following rationale of how Hudson City Bancorp, Inc. differentiates themselves from other banks.
Perhaps most noteworthy is to look at what Hudson City Bancorp, Inc. hasn’t done before we examine what they have accomplished. They did not participate in subprime mortgages, option ARM loans or brokered CDs. Most importantly they did not participate in TARP (Troubled Asset Relief Program). With most competitors under the Government’s thumb, Hudson City has maintained their independence.
What they have done is build financial strength through conservative banking practices. They loan money to people who can afford to pay it back and require a minimum of a 20% down payment on all mortgages. This winning formula for efficiency and conservative credit underwriting has led to competitive pricing and healthy profit generation. It’s no wonder that Forbes has named them the “Best Managed Bank in America” for both 2007 and 2008. No other bank has received this accolade two years running before.
Hudson City Bancorp, Inc.’s expense discipline allows them to pay higher interest rates to customers on deposits and offer competitive rates on loans. Both their annualized ratio of non-interest expense to average assets of 0.43% and an efficiency ratio of approximately 20% are industry leading. This efficient operation means they only need to pay $0.20 (20 cents) to generate a dollar’s worth of earnings. In short, the problems facing competitor banks is benefiting the more efficient Hudson City Bancorp, Inc.
On January 7, 2009, Hudson City Bancorp, Inc. filed an automatic shelf registration statement on Form S-3 with the Securities & Exchange Commission. This will allow them to sell an indeterminate amount of common stock, preferred stock, debt securities, etc. Along with management, we believe this will enable them to easily access the capital markets should the need or opportunity present itself. This level of capitalization when other banks are struggling with capital issues should be a great long-term advantage for Hudson City.
Conclusion
Consistent with the principle of a diversified portfolio, we maintained our exposure to financials by selling Charles Schwab (SCHW) in order to make room for Hudson City Bancorp, Inc. This was initiated based on valuation. Both Charles Schwab and Hudson City Bancorp, Inc. are expected to grow at approximately the same rate. However, Charles Schwab sports a PE Ratio of 27.6 versus Hudson City’s PE Ratio at only 12.9, and Charles Schwab offers a dividend yield of only1.3% versus 4.3% for Hudson City.
Although we still like Charles Schwab’s long-term prospects for growth we feel it’s overvalued today, however, not dangerously so. On the other hand, we feel Hudson City Bancorp, Inc. represents a compelling value with a very attractive dividend yield and strong prospects for growth. Therefore, we felt obligated to take advantage of what we believe to be a rare investment opportunity based on unjustifiably low valuation.
In Part II we will contrast Hudson City Bancorp, Inc. against various competitors across the broad banking and thrift industry. Using our Fundamentals-at-a-Glance research tool we will illuminate the state of banking from a fundamental viewpoint.
Click here for Part II
Disclosure: Author holds a long position in HCBK at the time of writing
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