Hudson City Bancorp, Inc.

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1 March 20, 2015 Hudson City Bancorp, Inc. Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Outperform Date of Last Change 03/20/2015 Current Price (03/19/15) $10.31 Target Price $ Week High $ Week Low $8.85 One-Year Return (%) 6.76 Beta 1.12 Average Daily Volume (sh) 3,235,892 Shares Outstanding (mil) 529 Market Capitalization ($mil) $5,454 Short Interest Ratio (days) 1.56 Institutional Ownership (%) 68 Insider Ownership (%) 11 Annual Cash Dividend $0.16 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) Earnings Per Share (%) Dividend (%) using TTM EPS 32.2 using 2015 Estimate 73.6 using 2016 Estimate 41.2 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page SUMMARY Risk Level * (HCBK-NASDAQ) Hudson City s fourth-quarter 2014 earnings per share outpaced the Zacks Consensus Estimate. Results were aided by increased non-interest income and lower expenses along with no provision for loan losses in the quarter. However, these were partly offset by lower net interest income. The extension date of closure of the merger deal with M&T Bank Corp. creates further possibilities of completion of the long proposed deal. Also, we remain optimistic about the company s strategic plan, which is aimed to boost the overall performance of the company. However, a continuous decline in loan production, top-line pressure and stringent regulations are likely to dampen the company s financials in the near term. Below Avg., Type of Stock Large-Value Industry Fin-Svgs & Loan Zacks Industry Rank * 36 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 169 A 153 A 149 A 651 A A 139 A 129 A 135 A 553 A E 89 E 88 E 87 E 354 E E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.09 A $0.10 A $0.09 A $0.09 A $0.37 A 2014 $0.09 A $0.08 A $0.07 A $0.08 A $0.32 A 2015 $0.04 E $0.04 E $0.03 E $0.03 E $0.14 E 2016 $0.25 E Projected EPS Growth - Next 5 Years % N/A 2015 Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Founded in 1999, Hudson City Bancorp Inc. (HCBK) is a Delaware corporation that serves as the holding company of its only subsidiary, Hudson City Savings Bank. The principal asset of the company is its investment in Hudson City Savings Bank. Hudson City Savings Bank, a well-established community financial institution serving its customers since 1868, is ranked among the top twenty-five U.S. financial institutions by asset size and is the largest thrift institution. In 1999, Hudson City converted into a two-tiered mutual holding company structure and offered the shares of the mid-tier holding company to the public. In Jun 2005, Hudson City reorganized its two-tiered mutual holding structure to a 100% public ownership through a second-step conversion. This conversion raised a tremendous amount of capital for the company, nearly quadrupling its capital base. In our view, management s continuous challenge is to utilize these funds effectively. Hudson City now operates 135 branch offices in the New York metropolitan area. The company functions on a traditional thrift model; it is a community and customer-oriented retail savings bank offering traditional deposit products, residential real estate mortgage loans, and consumer loans. Additionally, the bank purchases mortgages, mortgage-backed securities and other securities issued by U.S. governmentsponsored enterprises (GSEs) as well as other investments. Its lending activities consist of one- to fourfamily residential first mortgage loans, consumer loans, and other loans. As of Dec 31, 2014, Hudson City had total assets of $36.6 billion, net loans of $22.4 billion and deposits of $19.4 billion. REASONS TO BUY M&T Bank Corp. and Hudson City merger deal closure date has been extended to Apr 30, 2015 in anticipation of regulatory approvals till then. The deal, which was inked in Aug 2012, would integrate Hudson City s retail network with M&T Bank s full-service commercial banking suite and help in expanding the premier community banking franchise in eastern U.S. Though the deal ran into regulatory difficulties regarding M&T Bank s anti-money laundering program and consequently got delayed for the third time, we remain optimistic. Given M&T Bank s efforts in gradually addressing the issues raised by the Federal Reserve, and expected consequent materialization of the deal, the shareholders are likely to benefit from projected synergies of the combined entity. Hudson City, adopted a Strategic Plan laying down objectives for the company s overall risk profile, earnings performance, growth and balance sheet mix and to enhance enterprise risk management program. Several initiatives of the plan include secondary mortgage market operations, commercial real estate (CRE) lending and introduction of small business banking products. Though such initiatives will require significant time for full implementation, we believe such initiatives to be beneficial for the company in the long run. During 2014, the company purchased CRE and multifamily loans and interests in such loans and expects to broaden its CRE lending business in the second half of Also the company plans to commence origination of residential mortgage loans confirming GSE guidelines for sale to the GSEs by the end of the firstquarter In the fourth quarter of 2011, Hudson City completed its balance sheet restructuring, which substantially reduced higher-cost structured borrowings. Notably the interest expenses recorded a negative compound annual growth rate (CAGR) of 3% over the last 3-years ( ). Also, the company may undertake further restructuring in 2015, which is likely to improve net interest Equity Research HCBK Page 2

3 REASONS TO SELL margin and future earnings prospects. The company s expense management was further reflected as total non-interest expense recorded a negative CAGR of 9.3% over the last 3-years ( ). Despite the macro pressure, Hudson City s credit quality continues to normalize as evident from the past couple of years. We are impressed with the overall improving trend in the company s credit metrics including total non-performing assets, allowance for loan losses and net chargeoffs. Notably, provision for loan losses recorded a negative CAGR of 34.2% over the last four years ( ) while the company recorded net credit provision for loan losses in We believe the company is poised to strengthen its balance sheet, given such favorable trends in credit quality. Hudson City chose not to participate in the Treasury's Capital Purchase Program, as its own capital levels were adequate for its operations. Even without the bailout, capital ratios remain solid. As of Dec 31, 2014, Hudson City and its subsidiary bank had substantially more capital than the minimum amount required to be well capitalized. Further, Hudson City s capital is common capital and the company has never issued trust preferred securities, which will generally no longer be included in regulatory capital for institutions of this size. Such a healthy capital position would boost shareholders confidence. RECENT NEWS Net loans declined 10.5% year over year in 2014, mainly as a result of lower loan production (originations and purchases). Given the low interest rate environment, decline in loan production indicates the company s low appetite for adding long-term fixed-rate mortgage loans to the portfolio. Also, the recent CFPB s (Consumer Financial Protection Bureau) qualified mortgage rules further fueled the situation. Notably, first mortgage loan portfolio (comprised 99.1% of total loans for 2014) recorded a negative 6-year compound annual growth rate (CAGR) of 8.6% in Though the company has started initiatives to reverse the situation, no substantial growth is expected in such a loan portfolio owing to the still higher mortgage lending rates. This may consequently impact the overall top line in the near term. Though we view the proposed merger of Hudson City with M&T Bank Corp. as a strategic fit, we remain cautious owing to any possibilities of termination of the long delayed deal. If the agreement fails to materialize, it would pose a threat to Hudson City s financials and send negative sentiment in the market. Stringent capital, liquidity and leverage ratio requirements under the financial reform law are expected to limit Hudson City s ability to pursue business opportunities and impose additional costs. Though such measures are aimed at improving the overall condition of the banking system, we expect such stringent capital norms to somewhat limit the company s flexibility with respect to its lending volumes and investments in growth initiatives in the mid term. Hudson City Tops Q4 Earnings on High Fee Income Jan 28, 2015 Hudson City reported the fifth consecutive quarter of positive earnings surprise with fourth-quarter 2014 earnings coming in at $0.08 per share. The bottom line outpaced the Zacks Consensus Estimate of $0.05, but came $0.01 below the prior-year quarter figure. Equity Research HCBK Page 3

4 For 2014, earnings of $0.32 per share surpassed the Zacks Consensus Estimate of $0.28 per share. However, this compared unfavorably with the prior-year quarter figure of $0.37. Better-than-expected results were driven by a significant rise in non-interest income as well as a fall in operating expenses. However, these were partially offset by a continued decline in net interest income. Further, strong capital ratios and improving asset quality were the other highlights. Hudson City s net income for the quarter came in at $39.1 million, down 14.6% from the prior-year quarter. For 2014, net income was $158.0 million, a decrease of 14.7% year over year. Details Total revenue (net of interest expense) of $134.7 million surpassed the Zacks Consensus Estimate of $105.0 million. However, the figure was down 9.8% year over year. For 2014, total revenue (net of interest expense) of $552.5 million outpaced the Zacks Consensus Estimate of $503.0 million. However, the reported figure was down 15.2% year over year. Net interest income fell 35.8% year over year to $87.2 million. The decline was mainly due to an overall decrease in the average balance of interest-earning assets and interest-bearing liabilities, a continued rise in the average balance of short-term liquid assets and the persistent low interest rate environment. Also, net interest margin came in at 1.01%, down 46 basis points from the year-ago quarter. Non-interest income totaled $47.5 million, up substantially from $13.5 million in the prior-year quarter. The reported quarter included $45.9 million of gain from the sale of mortgage-backed securities compared with $11.1 million in the year-ago quarter. Total non-interest expense decreased 4.5% from the prior-year quarter to $70.2 million. The decline was primarily the result of lower compensation and employee benefits costs, and other expenses. The efficiency ratio increased to 51.60% from 48.77% in the year-ago quarter. An increase in efficiency ratio indicates a decline in profitability. As of Dec 31, 2014, net loans were $21.4 billion, down 10.5% year over year. Total deposits were $19.4 billion, a fall of 34.9% from the Dec 31, 2013 level. Credit Quality Credit metrics continued to improve with allowance for loan losses declining 14.8% year over year to $235.3 million. Non-performing loans were $852.0 million as of Dec 31, 2014, down 18.8% year over year. Further, the reported quarter witnessed nil provision for loan losses, similar to the year-ago quarter. Nonperforming assets decreased 16.8% year over year to $932.0 million. Moreover, net charge-offs came in at $6.9 million, down 53.8% from the prior-year quarter. Capital Ratios Hudson City s capital ratios continued to improve. As of Dec 31, 2014, the bank s Tier 1 leverage capital ratio advanced to 11.74% from 10.82% as of Dec 31, Equity Research HCBK Page 4

5 Equity to total assets was 13.08%, up from 12.28% as of Dec 31, Total risk-based capital ratio was 28.75%, up from 25.31% in the year-ago quarter. Dividend Update On Jan 28, 2015, Hudson City declared a quarterly cash dividend of $0.04 per share. The dividend was paid on Mar 2, 2015 to shareholders of record on Feb 13, M&T Bank, Hudson City Merger Delayed for 3rd Time Dec 9, 2014 The long awaited merger deal between M&T Bank Corporation and Hudson City has been thwarted yet again. The closing date of the proposed merger has been further extended to Apr 30, 2015 from the previous deadline of Dec 31, This is the third time that these two banking entities have agreed to extend the deadline for merger completion. Either of the two companies may terminate the merger agreement if it is still not complete. The companies are hoping that more time will allow them to receive the regulatory approvals for completion of the merger. However, there is no certainty regarding the timing and actual grant of the regulatory approvals. The consideration and exchange ratio as per the merger agreement has been kept unaltered. Background In Aug 2012, M&T Bank agreed to take over Hudson City in a cash and stock deal worth $3.7 billion. The deal was projected to fetch M&T Bank around $25 billion in deposits and $28 billion in loans, subject to acquisition accounting adjustments. However, in Apr 2013, the Federal Reserve detected loopholes in M&T Bank's efforts to fight money laundering and put the acquisition on hold. The U.S. regulatory body had pointed out several discrepancies in M&T Bank s risk-management agenda that violated federal anti-money-laundering regulations. The Fed also raised questions about M&T Bank's procedures, systems and processes relating to M&T's Bank Secrecy Act and anti-money-laundering compliance program. The bank was successful in reaching an agreement with the Fed to improve compliance with relation to risky activities. However, in Dec 2013, M&T Bank and Hudson City planned to extend the deal s closure date from Jan 31, 2014 to Dec 31, 2014, citing the same reasons as it cited now. In connection to the latest extension date, the Chairman and Chief Executive Officer (CEO) of Hudson City, Mr. Denis J. Salamone said, "While we are disappointed that the transaction is delayed further, we understand that M&T has continued to make significant progress towards addressing the Federal Reserve's concerns. As a result, we believe that it is reasonable to agree to an extension to allow M&T to further progress the remediation initiative. Robert G. Wilmers, Chairman and CEO of M&T Bank stated that the company remains committed to completion of the deal. Equity Research HCBK Page 5

6 VALUATION Hudson City s shares on a price-to-earnings () basis currently trade at 73.6x the Zacks Consensus Estimate for 2015, which reflects a significant premium to the industry average of 20.9x. The valuation on price-to-book (P/B) basis looks attractive as shares trade at 1.1x, reflecting 8.3% discount to the industry average of 1.2x. The company has a trailing 12-month ROE of 3.3%. Our 6-month target price of $11.00 equates to 78.6x the Zacks Consensus Estimate for Combined with an annual dividend of $0.16 per share, this target price implies an expected return of 7.5% over that period. This is consistent with our long-term Neutral recommendation on the shares. Currently, Hudson City carries a Zacks Rank #3 (Hold). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Hudson City Bancorp, Inc. (HCBK) NA Industry Average S&P People's United Financial Inc. (PBCT) NA First Niagara Financial Group Inc. (FNFG) EverBank Financial Corp. (EVER) Investors Bancorp Inc. (ISBC) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Hudson City Bancorp, Inc. (HCBK) Industry Average S&P NA 2.0 NA Equity Research HCBK Page 6

7 Earnings Surprise and Estimate Revision History Equity Research HCBK Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of HCBK. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1133 companies covered: Outperform %, Neutral %, Underperform 9.0%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. 11B Kalyan Nandy Priti Dhanuka Anindita Chaudhury Ishani Mukherjee Priti Dhanuka Equity Research HCBK Page 8