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I'm not sure where the term "harder to find than a needle in a haystack" first originated, or why anyone would look there in the first place. But that's what it must feel like for frustrated investors in search of that rare company unscathed by this vicious economic downturn. From retailers to commodity producers, just about every industry has suffered some degree of slowdown -- it's just a matter of how slow. Look all you want, but there just aren't too many businesses that are still humming along and churning out record profits these days. So imagine my surprise when I recently uncovered a tenacious little company whose earnings climbed for the 10th straight year in 2008 -- a whopping +50% increase at that. And this was no creative accounting gimmickry. In fact, the firm had the financial stamina to increase its dividend payments all four quarters last year. So what is this recession-proof business? A regulated utility unfazed by the sluggish economy, or maybe a counter-cyclical discounter like Family Dollar (NYSE: FDO) that is feasting on these conditions. Not exactly. What if I told you it was actually a savings and loan that specializes in mortgage lending. Sometimes truth is indeed stranger than fiction. 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?
P.S. I just added Hudson City Bancorp to the "Yield Doublers" portfolio of my Half-Priced Stocks newsletter on May 6th. It's my eighth addition to this unique portfolio since its inception three months ago. To see how the other seven "Yield Doublers" have fared, check out the table below.
If you want access to these seven "Yield Doublers" -- each
of which have plenty of double- and triple-digit upside
potential left in them before reaching my estimated fair
value price --
simply visit this link.
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