HCBK (MM)

We are downgrading our recommendation on Hudson City Bancorp Inc. (HCBK) to Underperform from Neutral considering its fundamentals, dividend cut, restructuring initiatives and the current low interest rate environment.

Hudson City reported a loss of $555.7 million or $1.13 per share on a GAAP basis in the first quarter of 2011 due to the completion of balance sheet restructuring during the quarter.

Yet, operating earnings of 19 cents per share were significantly better than the Zacks Consensus Estimate of a massive loss aided by lower interest expense and reduced provision for loan losses. But, lower interest and dividend income, and increased non-interest expense were the downside.

Concurrent with the earnings release, Hudson City declared a quarterly dividend of 8 cents per share. This represented a 47% decrease from the prior quarter’s dividend of 15 cents per share. The dividend was paid on May 27 to shareholders of record on May 5.

The restructuring initiatives would boost its interest margin in the upcoming quarters. However, we believe that with interest rates on mortgage-related assets remaining at near-historic lows, increased competition for mortgage loans due to the unprecedented involvement of government-sponsored enterprises (GSEs) and absence of any indication from the Fed regarding an increase in interest rates in the near future would result in a compression of the net interest margin from its new higher level resulting from the restructuring transaction.

Moreover, the reduction in the size of balance sheet from restructuring, would lead to a reduction in net interest income at Hudson City.

While the company’s strong business model and solid capital position would aid results, the dividend cut somewhat dampens investors’ appetite for the stock. An increase in FDIC insurance costs also remains an overhang.

Hudson City currently retains its Zacks #5 Rank, which translates into a short-term ‘Strong Sell rating. However, Hudson City’s closest competitor, People's United Financial Inc. (PBCT) retains a Zacks #3 Rank (a short-term Hold rating).

 
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