December 20, 2011 - 1:02pm EST by
2011 2012
Price: 13.58 EPS $0.00 $0.00
Shares Out. (in M): 3 P/E 0.0x 0.0x
Market Cap (in $M): 41 P/FCF 0.0x 0.0x
Net Debt (in $M): 41 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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  • Community Bank
  • Demutualization
  • Discount to Tangible Book
  • two posts in one day


Two Little Piggies: If you remember the story of three little pigs, this is not it. Instead, this is the story of two little piggies, a.k.a., thrifts or savings & loans.

Ramblings: Before I proceed further, I will provide some background that led me to this pair of piggies. (If not interested, skip to the “Shale” section.) Most of my investments are in financials but I have become less bullish on the sector over the past six months. To be honest, I am not into macro economics or investing but the current low interest rate environment is starting to have a negative impact and there is no relief in sight. Uncle Ben is saying rates stay low through 2013 and my guess is that it will continue well beyond that time. The Fed is worried more about deflation, particularly in the capital markets, than inflation due to having over stimulated the economy for three decades with leverage. The reversion to the mean can be very mean on demand.

Not here to pitch a tent for Occupy Wall Street but I am trying to put the last thirty years into context. Saying things will return to normal is a relative question, as you need to have a basis for what normal is. In summing up the Greenspan/Bernanke era, all I can think of is the dialogue in “Young Frankenstein” as to whose brain Igor got: Abby Someone. Abby Who? Abby Normal. Since 1980, the US Federal debt has grown at an annual percentage rate of 9.28%. This graph captures it:


Corporate America is not banking on growth and is thus returning capital back to shareholders via buybacks and dividends. Yet, it continues to maintain lean expenses. Real wages appear stagnant and unemployment remains elevated. The result is an American stand-off – companies are reluctant to hire and consumers are reluctant to spend. That does not even factor in what happens to government demand, where the most optimistic view at this time is it stays flat.

I have some company in this train of thought; please see the GMO Quarterly Letter for December 2011 by Jeremy Grantham (note the paragraph “No Market for Young Men”):


In banking, the spreads are likely to contract slowly over time. While the low interest rates have helped the banks by providing cheap funding on the liability side of the balance sheet, the challenge is on the asset side. Directly and indirectly, banks have had to deleverage, whether for Basel III or by regulators. As loans and securities have matured, the banks have had to accept lower yields on reinvestment opportunities. Loan rates are so low that banks are unable or unwilling, depending on one’s perspective, to redeploy capital into loans. Many banks are seeing their loan portfolios shrink, particularly those who are busy writing off real estate related loans. According to BankRegData.com, net loans to total assets over the past 36 months has shrunk from a period high of 55.79% to the current low of 51.70% in 3rd Qtr 2011. Lack of growth leaves two attractions for bank investors – dividend yield and discount to TBV.

Now let me introduce my friend, Bob, who lives up in Wyoming County in Pennsylvania. For the past two years, Bob has seen the Marcellus shale gas boom up close in his small town. For him, it has been the degradation in the quality of life issues. The local Wal-Mart store is being replaced by a Super Wal-Mart. Two new motels have been built that cater to temporary workers. The bars are crowded, as are the newly widened state roads that carry water trucks, tree trimmers (who make more money from the shalers than working for CL&P) and heavy equipment. School enrollment is up, too. Light bulb goes off! Yes, Virginia, there is growth out there; you just have to find out where it is.

Shale: The task became to identify all the small banks with most of their business in the shale regions of Pennsylvania. I started with a map of the Marcellus shale:


Some friends of mine mentioned another bank just over the border in Ohio that might benefit from the Utica shale field. I looked through the Ohio banks but there are not many with a focus in the eastern part of the state. It is interesting to look at the Utica formation (map is about 60% down the page):


When you look at where the Marcellus and the Utica overlap and the respective thickness, one can see where long-term gas will be developed. You can get a quick sense just from reading the news headlines in the green box here:


Or look at p.14 of this 2010 presentation that highlights the benefit of being in the middle of the Marcellus shale field:


You can also see the impact from the Bureau of Labor Statistics state map for Pennsylvania:


 (Note: You will have to select “Pennsylvania” and click on “Draw Map” button.)

With that as my basis, I identified 9 banks in PA and one in OH. I then collected some basic information on the 10 banks and used that for the start of my research. It is in this spreadsheet:


From that, I narrowed the focus to those trading below tangible book value. Since some of the banks had significant All Other Comprehensive Income (AOCI) amounts, I excluded it from TBV to be more conservative. I then narrowed it further by focusing on the two with the highest capital levels, i.e., tangible equity to tangible assets (TE/TA). What can I say, I am a value investor.

Of course, if I had subscribed to Grant’s Interest Rate Observer, I would have read all about this in its October 29, 2010 edition, as further highlighted by Jim McTague in the November 6, 2010 edition of Barron’s. Oh, well, the mental exercise was good and coming to the same conclusion seemingly validates my analysis.

FFCO Summary: FedFirst is a tiny, $41 million market cap bank tucked in the southwest corner of Pennsylvania. It trades at 70% of tangible book value (TBV), non-performing loans (NPL) are very manageable at 1.01% with 126% allowance for loan loss (ALL) coverage. The bank has $346 million in assets and 9 branches.

History: The bank was founded in 1922 as the Monessen Home Building and Loan Association. In 1940, it converted to a federal savings & loan charter. It changed its name to First Federal Savings Bank and converted to a non-stock mutual holding company (MHC) in 1999. This allowed them to purchase an 80% stake in an insurance agency, Exchange Underwriters, in 2002. In 2005, the MHC sold 3.0 million shares to the public, resulting in net proceeds of $28.7 million. This represented 45% of the outstanding stock, while the MHC retained 55%. The decision to 2nd step in 2010 was accelerated by the demise of their regulator, the Office of Thrift Supervision (OTS). Unfortunately, the initial attempt did not fly, so a second, and lower, appraisal was made that was completed. 2nd step gross proceeds were $17.2 million, net $15.4 million.

Loans: FFCO still has significant amount of residential mortgages on the books, representing 54% of the loan portfolio. One knock is that 12% of the residential mortgages were purchased and that is where most of their problems loans have been. Good news/bad news, is that about half of non-accrual loans by value stem from one relationship. The bank no longer purchases loans, which had been done under previous management prior to 2005. Other that, construction loans are small and HELOC’s well managed.

Other Assets: FedFirst has a high percentage of assets in loans, so investment portfolio is mainly mortgage backed securities (MBS) and real estate mortgage investment conduits (REMIC’s). FFCO is showing a $2.6 million unrealized loss on two pools of insurance company preferred trust obligations. Many small banks bought these in the past decade and FedFirst was fortunate not to have over indulged, The CEO has indicated that given where the yield curve is today, buying securities for short-term benefit is not prudent if interest rates were to rise. While total assets have been flat, the bank has been growing the loan portfolio while shrinking the investment securities.

Management: The Chairman of the Board, John LaCarte, is relatively young at 45 years old and has an interesting background. He worked at PNC for 3 years before leaving to run the family dry cleaning business. He expanded the business to include work uniform sales and sits on the board of a mutual insurer for dry cleaners. Not surprisingly, he wants to expand, which may explain recent turnover in CEO’s and the decision to tap former PNC executives. Given the small market cap size, management is responsive to investor inquiries.

SC 13 Filers: Stilwell owns 9.7% and filed a 13D, while two noted 13G filings came from Third Avenue (7.0%) and Wellington (5.2%). Stilwell has filed a number of 13D’s on thrifts that have gone through mutual conversions (standards, MHC’s, 2nd steps). I do not know anything about Stilwell but you can see how his firm uses the liquidity provided by a conversion to acquire sizable stakes in what become illiquid stocks. Not likely that such a position can be easily sold without causing the stock to plummet.

Earnings: This is obviously the biggest knock against FFCO. If the bank can grow assets to $550 million and earn a return on assets (ROA) of 0.9%, net income would be $5.0 million or $1.67/sh. With a 12 P/E multiple, that equates to a $20 stock price. And maybe there is a Santa Claus. The story here is more about pulling capital levers, being a merger possibility and trading at a 30% discount to TBV. In September 2011, the bank announced a 5% buyback of stock, almost exactly a year after completing its 2nd step. Converted banks cannot do a buyback within a year of conversion without regulator approval.


- The bank has only recently started earning money consistently, albeit anemically

- Management starts empire building

- Economic benefits of shale gas drilling do not trickle down to the local area

- Loan book deteriorates

- Fracking becomes an environmental nightmare


Tangible Equity to Tangible Assets is very healthy at 17.1% as the result of the 2nd step. There are two ways to view that: 1) FFCO is over-capitalized or 2) FFCO’s balance sheet is underutilized. The solution to #1 is stock buybacks, which is likely what Stilwell is expressing to management. Personally, it is an odd situation if you look at from a capital allocation perspective. In the worst light, it is a self-funded Ponzi scheme where shareholders buy stock with an expectation of the company buying it back at a higher price. However, it generally works; case in point is ORIT.
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