November 25, 2014 - 9:30am EST by
2014 2015
Price: 5.39 EPS 0 0
Shares Out. (in M): 4 P/E 0 0
Market Cap (in $M): 20 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0

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  • Banks
  • Illiquid
  • Synergies
  • Discount to Tangible Book
  • Demutualization
  • Community Bank




First Federal of Northern Michigan Bancorp is a tiny, $20 million market cap, $300 million-in-assets bank that trades at 70% of TBV. I believe recent selling has been from former shareholders of Alpena Banking Corporation, a private stock bank, that FFNM bought in an all stock deal in August 2014. I believe the deal is accretive and that FFNM could earn $0.55-$0.60/sh and trade at 11-13X earnings multiple.


Background: Let's look at Northern Michigan, starting with the positives:

It was originally part of Anomickee County founded in 1840, which in 1843 was changed to Alpena, a pseudo-Native American word — a neologism coined by Henry Schoolcraft, meaning something like "a good partridge country." This was part of a much larger effort to rename a great many of the Michigan counties at the time.


The region, known as the "Sunrise Side" from its location on the east shoreline of Michigan, was first a site of commercial fishing activity and is still home to extensive commercial fishing activities. Later the region, like much of Michigan, was shaped by the logging era of the 1800s. Today, Alpena is known for its limestone quarry, one of the largest in the world, owned and operated by the Lafarge corporation and is a major cement manufacturer and exporter. While at one time the largest in the world, the cement plant is now just the largest cement plant for Lafarge in North America with an annual capacity of almost 3 million tons of cement. Alpena is also the world headquarters of Besser Company, a manufacturer of concrete block machines. Tourism (fishing, hunting, camping and a variety of water sports) is also important to Alpena's economy.


In February 2007 Bizjournals ranked Alpena as the hottest retirement destination in the Great Lakes area and #44 nationally.


The city has a number of notable buildings, including the Art deco Alpena County Courthouse and Temple Beth El, one of the oldest synagogues in the United States.


Can't forget Kidrock's "All Summer Long" video (even if it was shot in Nashville):


Now, for the cold water from the merger documents:


Alpena County lags both the State of Michigan and the United States with respect to most economic and demographic data. Specifically, according to the U.S. Census Bureau, the population of Alpena County has declined from 31,300 in 2000 to 29,600 in 2013, and is projected to decline to 29,400 by 2018. Further, the median household income for Alpena County in 2013 was $34,500 compared to the Michigan median household income for 2013 of $46,400 and the U.S. median household income of $51,300. Additionally, in 2013 the unemployment rate for Alpena County was 10.4%, compared to 8.0% for the State of Michigan and 6.7% for the United States.


We believe that the unfavorable economic conditions of the past several years will continue to have an unfavorable impact on our operations.



History: The bank was formed in 1957 as a mutual. In 1994, it completed a first step conversion to a mutual holding company. It did a second step in 2005 to fully convert that raised over $16 million in new equity, most of which was subsequently lost from 2007 to 2010. Despite that, the bank was able to avoid having to do TARP preferreds.


Merger: FFNM and Alpena Banking Corporation ("ABC") consummated their merger in August 2014. ABC was formed in 2001 as a commercial bank, led by Craig Kus and eight other community leaders. ABC was a stock bank with one location but never a public one. Looking through the FFEIC records for the bank subsidiary, it had peaked at almost $90 million in assets before the financial crisis. The two banks first considered a merger in 2006 but the ABC board rejected the offer. Talks began again in 2010 but were called off when ABC was hit with an FDIC Consent Order. Talks resumed but were delayed until after FFNM underwent an OCC examination.


Not surprisingly, the combined banks dominate the banking scene in Alpena, with 57% deposit share. The bank does provide breakouts of its other locations (it has a very good IR section on its web site):


The deal was done entirely with FFNM stock, and was dilutive. However, it was softened by FFNM recognizing a $1.8 million bargain purchase. With the large NOL's shielding taxes, it went straight to the bottom line and to equity. If you read the latest 10-Q, you will see that the valuation of the ABC assets, which include $1.4 million of core deposit intangible. M&A accounting results in the balance sheet being reset to fair value, which has some peculiar impacts to banks. The deal had the impact of diluting TBV at the current price from 64% to 70%. I will discuss cost savings in the Earnings section.


Shares: 842,965 shares were issued to ABC shareholder, bringing the total share count to 3,727,014. There are 137,530 stock options outstanding, with a weighted average exercise price of $9.54 and weighted average remaining term of 1.8 years.


Assets: With the economy in a funk in the bank's territory, the loan book is only 52% of assets. ABC was focused on commercial loans although it did do residential mortgages and consumer loans. FFNM's thrift background had been more oriented towards residential, but had started shifting to more commercial at the turn of the century. The combined bank is split almost 50/50 between residential and commercial. The bank has shifted more assets into mortgage-backed securities, government obligations and municipal bonds. Securities represent 37% of assets. Non-performing assets (NPA) to total assets dropped to 1.16% as of 9/30/2014 and non-performing loans to total assets was 0.25% for that time period. Part of the drop was due to the merger and its fair value accounting. Most of the NPA consist of real estate owned. The bank is in much better shape than in 2009 when NPA's were over 6%.


Earnings: Looking backwards, the earnings for both banks in recent years have not exactly been exciting. Let's start by looking at the earnings for the first three quarters of 2014, where the two banks earned $2.2 million. We need to back out $1,816,000 bargain purchase and add in $264,000 of merger related expenses, to get trued up earnings of $650K. Extrapolating for the full year, that is about $800K or $0.21/sh.


FFNM expects synergies of 36% of non-interest expenses. Less than two weeks after the deal closed, FFNM closed one of its two Alpena branches and consolidated it with the former ABC. FFNM also closed an operations center and put both properties up for sale. It seems like the savings are achievable. Using ABC's 2013 figures, that equates to $2.5 million X 36% = $900,000 or $0.24/sh. Normally, that would have to be adjusted for taxes but the bank will not pay taxes for awhile.


In going through the latest 10-Q with the merger details and looking at 6/30/2014 Call Report for Bank of Alpena, the merger numbers were vastly different. The fair value of the merger in the 10-Q shows $102.4 million in assets and $95.8 million in deposits, whereas the call report for the time period 39 days before the merger shows $69.0 million in assets and $61.7 million in deposits. Most of the difference ended up in cash and cash equivalents on the asset side and in non-interest deposits on the liability side. I compared the call reports between the two quarters, and assets increased $23 million. The securities portfolio increased $27.7 million, while loans decreased $5.6 million. It would appear that the bank landed several significant accounts. Assuming $20 million, based on the net new investments made, represents new earning assets, that will increase net income. Assuming a conservative 2.50% spread on $20 million, that adds $500,000 or $0.13/share.


Adding the three components together, estimated EPS is $0.58. With an 11-13X earnings multiple, looking at $6.38 - $7.54 stock price or 18-40% gain. I think the bank could fetch more in a sale but that is not a given. I like that Stilwell (see Institutional Investors) is involved because he has been effective in prodding banks to realize value. The lack of other institutional investors, however, makes it a tougher challenge. That is why I am focusing on earnings.


NOL's: As of the 2013 10-K, there were $10.8 million in NOL carryovers available on Federal taxes for the next 20 years. There is a deferred tax asset on the balance sheet of $1.0 million as of 9/30/2014. I suppose that it could be considered a hidden asset if the DTA is realized but I would rather wait for it to be realized. The bank should not have to pay federal taxes for 4-5 years.


Institutional Investors: There were two 5%+ holders before the merger, DFA and Financial & Investment Management Group. The deal diluted them both under 5% and Financial & Investment sold almost 2/3rds of their shares in the 3rd Quarter. However, two institutional investors took advantage of the selling form the acquired bank shareholders to increase their holdings. Tontine Capital bought 92K shares and recently filed a SC 13G showing 6.27% ownership. Tontine is run by Jeff Gendell and has been a long-time shareholder, having first filed a SC 13D back in 2002. Noted bank investor and activist Joseph Stilwell added 110,900 shares in the 3rd Quarter and now owns about 3.2% of the bank.


Management: The CEO is Michael Mahler, who has a non-traditional background. He was originally an accountant who worked his way up at a steel company and then became corporate controller at a concrete plant. He was hired as the bank's CFO in 2002, became an EVP, then COO before being made CEO. Mahler is only about 51 years old. The CEO of ABC, Craig Kus, became the COO. He has a good background, with over 30 years of banking experience and having served as president of the Michigan Bankers Association. I think Kus will add value from an operational perspective. Looking at the financial history of FFNM (see below), the bank could use some help. Kus did a decent job leading ABC through the financial crisis with an arguably riskier loan book.


Insiders do not own a lot of stock. The board chair, Martin Thomson, owns about 80,000 shares; he was CEO of the bank until 2008. Michael Mahler owns about 45,000 shares. We won't know how much Kus owns until the next proxy.


Financial Overview: Below are the financial highlights for the past 18 years. You will note highlighted data for 2003. The bank bought an insurance agency in 2003 and sold it in 2009. The 2008 annual report recast the past five years to exclude the insurance agency, leaving 2003 as an oddball situation. I could have put the 2003 figures in with the insurance agency but felt it better to approximate the bank's financials.





Locations: Here is a map of the bank's locations:





I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


- Earnings synergies are realized

- Risks: Illiquid, may not achieve earnings that I project

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