Monday, May 25, 2009

Volume 3, Issue #42

Also in Today's Issue...

The company in question is Hudson City Bancorp (Nasdaq: HCBK), a tight-knit thrift that manages 140 branches spread throughout affluent regions of New York, New Jersey and Connecticut. The firm has been around since the Civil War, but few know of it outside its home turf.

So what makes this particular bank unique?

Well, for starters it has been ranked one of the nation's three strictest mortgage underwriters. Management never fell prey to the subprime mortgage mania, balked at exotic option adjustable-rate loans, and refused to even dabble in auto or credit card lending.

Instead, the company deals primarily with wealthy customers sporting top FICO scores who can make hefty down-payments and easily afford their monthly notes. In fact, the firm's branches are concentrated within 10 of the nation's top-50 counties in terms of median household income.

This conservative approach has kept Hudson City at arms length from the problems plaguing other banks -- it said "thanks, but no thanks" to government TARP money. And because the firm doesn't package and sell its loans to investors (or invest in private mortgage-backed debt) it hasn't run into liquidity issues or been forced to take write-downs because of problems in the secondary market.

Amid the greatest crisis for the banking industry since the Great Depression, Hudson City reported bad debt charge-offs of just $4.4 million last year -- a trivial 1/100 of 1% of its $29.4 billion loan portfolio.

But cautious lending is just one reason why the firm has thrived during this downturn. Much of its success can be traced back to an industry-leading efficiency ratio below 20%. That means this lean organization needs just $0.20 in overhead to bring in $1.00 in revenue -- by comparison, the average large bank has a bloated ratio three times that size, or about 62%.

That efficiency enables Hudson City to offer better rates to prospective customers -- higher yields for depositors and lower interest rates for mortgage borrowers.

Despite all the turmoil, the firm originated more than $5 billion in new loans last year. Meanwhile, customers flooded the bank with $3.3 billion in new deposits. Remarkably, the average Hudson City branch now holds roughly $145 million in deposits -- double the national average of around $70 million.

Customers certainly recognize Hudson City's sterling reputation. In fact, the bank gained share in 20 of its 22 markets last year. Unfortunately, investors have painted the stock with the same brush that has tarnished the rest of the banking industry. Despite posting record first quarter profits that were up +44% over last year, the shares have still wilted below $13 -- down from a peak above $20.

But there's a good reason why HCBK has vaulted +935% since its IPO in 1999, versus a -20% drop in the Dow.

it speaks volumes that when most other banks have slashed or eliminated their dividends, Hudson City has raised its distributions six times since this mess started. Looking ahead, a steeper yield curve should translate into fatter profits -- net interest margins have already widened considerably.

Plus, let's not forget that industry consolidation has thinned the herd and left even more business on the table. There aren't too many other lenders hunting in Hudson's "jumbo" mortgage stomping grounds.

My discounted cash flow models suggest a fair value in the low $20s. So in addition to a generous yield near 5%, investors could see upside potential of +80% or more.

Who would have though that under all that hay, the needle would turn out to be a bank?
 
-- Nathan Slaughter
Editor
Half-Priced Stocks

Nathan Slaughter
Editor
Half-Priced Stocks

About Half-Priced Stocks

Written by value investing expert Nathan Slaughter, Half-Priced Stocks is a monthly newsletter designed to help readers identify securities that are trading at the steepest discount to their intrinsic net worth. In some cases this discount can reach up to 50% or more, giving savvy value investors the chance to purchase quality stocks for just pennies on the dollar. (Learn More)

About Nathan Slaughter

Nathan Slaughter has developed a long and successful track record over the years by investing in both exchange-traded funds (ETFs) and deeply discounted value securities. When it comes to ETFs, Nathan has created a proprietary ranking system that helps him zero in on today's most promising funds. And on the value front, Nathan uses advanced discounted cash flow techniques, along with a host of fundamental research, to uncover quality stocks that are trading well below their actual intrinsic value.

Nathan's previous experience includes a long tenure at AXA/Equitable Advisors, where he provided comprehensive investment advisory services to small businesses and high net-worth clients. He also honed his research skills at Morgan Keegan, where he performed asset allocation, retirement planning, and consultative portfolio management services.

Several years ago Nathan switched gears and decided to devote his time exclusively to financial analysis and writing. He has since published hundreds of articles for a variety of prominent online and print publications. 

Nathan's educational background includes NASD Series 6, 7, 63, & 65 certifications, as well as a degree in Finance/Investment Management. He currently resides in Shreveport, LA with wife Julie and sons Aidan and Riley.

To learn more about Nathan's value investing newsletter -- Half-Priced Stocks -- please visit this link.

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