FIRST FINANCIAL NORTHWEST FFNW
May 17, 2010 - 12:01pm EST by
ronmexico
2010 2011
Price: 5.25 EPS $0.00 $0.00
Shares Out. (in M): 19 P/E 0.0x 0.0x
Market Cap (in $M): 98 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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Description

 

First Financial Northwest (FFNW) $5.25

Mkt Cap               $98MM

P/B                         0.46x

 

Recommendation

We believe FFNW is a highly attractive "orphan equity" that is grossly undervalued for a variety of identifiable reasons.  The company is a capital rich bank trading below 50% of tangible book value.  On first glance the company appears to be another bank loaded with NPLs, but on further inspection FFNW has more than sufficient capital to absorb the expected losses on these NPLs even under scorched earth assumptions.  With the stock trading at ~50% of tangible book, the market has already discounted expected losses from these NPLs and is essentially pricing the company as if it going to fail. In reality, the housing market in Seattle is bottoming (prices are leveling and volumes are picking up significantly) which should allow the company to make significant progress on reducing NPL levels over the next 6-12 months.  In addition, the company is a conservative underwriter and therefore ultimate loss severities on non-performing loans are likely to be much lower than market expectations. We anticipate a worst case tangible book around $8/share vs. current tangible book of $10.88/share. We expect the stock to trade towards tangible book as the company's NPL levels decline over the course of the year.  In addition, the Company was forced to curtail its dividend (more below) which we believe will be reinstated next quarter along with a special dividend for the recently curtailed dividend.  Since demutualizing in 2007, the company has a history of shareholder friendly behavior such as large share repurchases.  We would expect to see management step up share repurchases once the OTS recognizes the strength of their balance sheet.  We're not the only ones who think the bank is cheap as management and the board have been purchasing shares recently on the open market at higher than current prices.

 

Overview of the Company

FFNW is a single branch community bank based in Renton, WA. First Savings Bank Northwest was founded in 1923 in Renton, WA as a Washington state chartered savings and loan. FFNW converted to a federal mutual savings and loan in 1935 and to a Washington state charted mutual savings bank in 1992. In October 2007, the company did an IPO in conjunction with its conversion from a mutual holding company to a stock holding company at a price of $10/share with KBW as the lead underwriter. FFNW is the 19th largest bank in the state of Washington with 0.83% deposit market share. In King County, WA (Seattle) FFNW is the 8th largest bank with 1.81% deposit market share.

 

The Balance Sheet

FFNW's bank capital ratios are very strong with Tier 1 leverage of 11.33%, Tier 1 risk-based at 16.43% and Total risk-based capital at 17.73%. In addition, FFNW's holding company has $49.1MM of additional capital. FFNW did not take any TARP capital.

 

FFNW Balance Sheet              
               
Assets Mar-10 Dec-09 Sep-09 Jun-09 Mar-09 Dec-08 Sep-08
Cash 8,373 8,937 4,238 3,105 2,532 3,366 4,045
Interest Bearing Deposits 107,326 96,033 36,681 49,975 31,776 600 2,736
Fed Funds Sold 0 0 2,295 2,295 3,105 1,790 3,965
Investments available for sale 109,593 97,383 172,207 172,586 140,644 149,323 162,877
Loans Receivable, net of allowance 1,016,896 1,039,300 1,055,906 1,025,324 1,031,186 1,035,181 1,002,562
Premises and Equipment 20,453 19,585 16,609 13,713 13,182 13,026 12,992
Federal Home Loan Bank Stock 7,413 7,413 7,413 7,413 7,413 7,413 6,425
Accrued Interest Receivable 4,716 4,880 5,265 5,387 5,794 5,532 5,457
Federal Income Tax Receivable 12,160 9,499 1,266 0 0 0 0
Deferred Tax Assets 5,415 12,139 14,128 15,039 8,577 9,266 8,627
Goodwill 0 0 0 0 14,206 14,206 14,206
Other Real Estate Owned 20,500 11,835 0 0 0 0 0
Prepaid Expenses 8,384 8,330 3,414 3,279 3,367 4,737 3,489
               
Total Assets 1,321,229 1,315,334 1,319,422 1,298,116 1,261,782 1,244,440 1,227,381
               
Liabilities              
Deposits 962,590 939,423 908,213 884,155 821,186 791,483 777,569
Advances from the Federal Home Loan Bank 139,900 139,900 149,900 149,900 148,150 156,150 135,000
Advance payments from borrowers for taxes and insurance 4,509 2,377 4,375 2,510 4,758 2,745 4,161
accrued interest payable 402 457 522 514 494 478 117
Federal income tax payable 0 0 0 2,001 94 336 865
Other laibilities 3,789 4,660 5,550 5,222 3,736 3,140 3,653
Total Liabilities 1,111,190 1,086,817 1,068,560 1,044,302 978,418 954,332 921,365
               
Stockholders Equity 210,039 228,517 250,862 253,814 283,364 290,108 306,016
               
Total Shares Outstanding 18,805,168 18,823,068 20,038,320 20,337,220 20,363,120 21,293,368 22,852,800
% QoQ -0.10% -6.06% -1.47% -0.13% -4.37% -6.82%  
               
BVPS 11.17 12.14 12.52 12.48 13.92 13.62 13.39
% QoQ -8.00% -3.03% 0.31% -10.31% 2.14% 1.74%  
               
Tangible Common Equity 204624 216378 236734 238775 260581 266636 283183
               
Tangible BVPS 10.88 11.50 11.81 11.74 12.80 12.52 12.39
% QoQ -5.34% -2.70% 0.62% -8.25% 2.19% 1.05%  
               
               
TCE Leverage 6.4 6.0 5.5 5.4 4.8 4.6 4.3
TCE Ratio 15.6% 16.6% 18.1% 18.6% 21.0% 21.8% 23.5%

 

The $109MM investment book is almost entirely invested in government guaranteed loans.

 

The loan book is heavily weighted towards residential real estate. The commercial real estate book is predominately warehouses and office buildings with minimal retail and no strip malls.

 

Loans Receivables Mar-10 Dec-09 Sep-09 Jun-09 Mar-09 Dec-08 Sep-08
One-to-Four Family 488,210 496,731 511,279 502,930 504,663 512,446 499,214
Multifamily Residential 152,179 146,508 132,084 109,691 103,886 100,940 80,639
Commercial Real Estate 287,810 288,996 285,168 273,607 259,925 260,727 238,581
Construction/land development 138,971 163,953 206,510 220,816 240,813 250,512 268,646
Business 347 353 351 251 0 0 0
Consumer 19,006 18,678 17,873 16,557 13,073 12,927 12,668
               
Total Gross Loans 1,086,523 1,115,219 1,153,265 1,123,852 1,122,360 1,137,552 1,099,748
               
Loans in Process 30,252 39,942 63,348 63,346 74,175 82,541 82,574
Deferred loan fees 2,946 2,938 2,877 2,732 2,705 2,848 2,775
Allowance for loan losses 36,479 33,039 31,134 32,450 14,294 16,982 11,837
               
Total Net Loans 1,016,846 1,039,300 1,055,906 1,025,324 1,031,186 1,035,181 1,002,562

 

 

Non Performing Assets

FFNW has seen a doubling in its non-performing assets over the past year with the increase almost entirely due to residential construction land/development loans. Note: $37.1MM of the $48.0MM non performing one-to-four family loans are non-owner occupied units held by the bank's construction/land development customers.  FFNW did not finance any high-rise developments. According to management, ~95% of non-performing loans relate to 15 borrowers.

 

Loans Accounted for on a nonaccrual Basis

Mar-10

Dec-09

Sep-09

Jun-09

Mar-09

Dec-08

One-to-Four Family

48,035

36,874

40,899

26,912

12,013

9,630

Commercial RE

14,108

11,535

18,052

9,025

5,171

2,865

Construction/land Development

83,016

71,780

88,757

86,361

50,371

44,043

Consumer

759

514

375

0

0

0

Total Nonaccrual Loans

145,159

120,189

147,708

122,298

67,555

56,538

             

Accruing Loans Past Due

           

One-to-Four Family

0

0

382

891

4,620

1,207

Multifamily

0

0

0

809

0

0

Commercial RE

0

0

475

5,380

4,212

897

Construction/land Development

0

0

0

0

3,775

0

Consumer

0

0

50

50

50

0

Total accruing loans past due

0

0

907

7,130

12,657

2,104

             

Total REO

20,500

11,835

0

0

0

0

             

Total NPAs

165,659

132,024

148,615

129,428

80,212

58,642

             

Source: Company Reports

           

 

FFNW's NPLs are unlikely to grow materially going forward if for no other reason than 68.8% of the company's construction land/development loans are already non performing and 17.1% of the non owner occupied residential loans are non-performing. FFNW significantly curtailed its construction/land development lending in Q4 2007 and the company is not currently writing any new construction/land development loans. As a result the construction land/development book has fallen by 34% YoY. Note: $43.1MM of non-performing loans in Q1 2010 relate to 2 merchant builders who are actually current on their loans.

 

Construction/land development Loans by County

       
               
 

Q1 2010

Q4 2009

Q3 2009

Q2 2009

Q1 2009

Q4 2008

Q3 2008

King

50,433

59,905

68,842

73,935

78,040

82,900

89,749

Pierce

20,155

23,722

36,420

39,431

43,965

42,100

46,184

Kitsap

15,815

16,960

17,040

18,039

19,265

19,200

19,193

Snohomish

11,491

11,525

12,409

12,926

12,940

13,600

13,600

Whatcom

6,767

11,491

11,648

11,648

11,648

11,648

11,648

All other counties

15,974

17,195

16,510

16,613

17,384

17,352

16,789

Total

120,635

140,798

162,869

172,592

183,242

186,800

197,163

               

Source: Company Reports

           

 

FFNW has historically been a conservative underwriter - before Q4 2009 the bank hadn't had any REO in over 20 years. The average LTV at origination for the company's owner occupied residential loans is 60%. Construction loans were underwritten with maximum loan to values of 75% of the appraised value. Non-owner occupied residential loans have maximum LTVs of 80%.

 

FFNW has been building loss reserves over the last 4 quarters.  According to management, realized loan loss severity has ranged from 0-25%. Realized losses on OREO sales were 11.1% in Q1 2010.

 

 

Mar-10

Dec-09

Sep-09

Jun-09

Mar-09

Dec-08

Sep-08

Allowance Begin of Period

33,039

31,134

32,450

14,294

16,982

11,837

8,416

Provision

13,000

23,705

7,795

18,256

1,544

5,500

3,498

Charge Offs

-9,682

-21,816

-9,154

-100

-4,232

-355

-77

Recoveries

122

16

43

0

0

0

0

Allowance for Loan Losses

36,479

33,039

31,134

32,450

14,294

16,982

11,837

               

Source: Company Reports

             

 

The Seattle Housing Market is Recovering

Residential real estate sales activity in the Seattle area increased significantly in Q1 2010 with King County (Seattle, 41.8% of FFNW's book) seeing sales volumes up 54% YoY and Pierce County (Tacoma, 16.7% of FFNW's book) seeing sales volumes up 24% YoY.

 

Meanwhile, home price declines in the Seattle metro area appear to be moderating.

 

 

 

 

 

Since FFNW's problem loans are almost entirely tied to residential housing in Seattle the increased sales volumes and moderating price declines should allow the bank to achieve its goal of cutting NPAs by over $60MM by the end of 2010.

 

Valuation is cheap

FFNW trades at 49% of tangible book value.

 

As a stress test, we assume the bank encounters a 50% loss severity on its REO, a 40% loss severity on its non performing construction/land development loans, 25% loss severity on its other non performing loans and an additional 3% loss on all of its current performing loans. In total the bank would have $87.4MM of charge offs. This compares to its current $36.4MM allowance implying a worst case need for $51MM in additional provisions. This would cut tangible book to $153MM or $8.17/share. In other words at the current share price, the stock is trading at 65% this worst case tangible book value.  Even with $51MM in additional provisions the company would still have tangible common equity north of 11.6% and therefore the company would not need any additional capital.

 

Shareholder Friendly Management and Board

The company decided against taking TARP capital because it did not want to accept the restrictions on its ability to pay a full dividend and to buy back its shares. The company proceeded to increase its dividend to 8.5 cents/quarter from 8 cents/quarter in October 2008 and the company continued to buyback its stock.

 

CEO bought 5,000 shares on May 7th at $5.03/share and CFO bought 4,000 shares on May 7th at $5.03/share. Director Gary Faull bought 1,000 shares on May 12th at $5.34/share. CEO bought 4,302 shares on March 9th at $7.54. Director Gary Kohlwes bought 2,400 shares at $7.25 on March 9th. Insiders have only bought stock since the company de-mutualized in 2007.

 

Company has had a voracious appetite for its own stock. Since going public, the company has bought back 4.9MM shares at an average price of $8.23/share using just over $40.6MM on repurchases. In Q4 2009, the company bought back 1.2MM shares at an average price of $6.50.

 

Income Statement

FFNW has consistently generated ~ $3MM in pre tax pre provision earnings per quarter with PTPP earnings declining over 2009 to reflect the forgone interest from non performing loans.  As the bank stabilizes its balance sheet, management believes it can raise pre-tax pre provision earnings back to $5MM/quarter implying earnings power approaching $0.75/share.

 

  Mar-10 Dec-09 Sep-09 Jun-09 Mar-09 Dec-08 Sep-08 Jun-08 Mar-08
Interest Income                  
  Loans 14,594 14,817 14,376 14,016 15,123 15,101 15,220 14,928 15,069
    Avg. Interest Rate 0 0 0 0 0 0 0    
  Investments 1,007 1,422 1,813 1,691 1,625 1,489 1,883 1,774 1,653
    Avg. Interest Rate 0 0 0 0 0 0 0    
  Tax Exempt Investments 0 48 0 0 0 351 132 144 0
  Fed Funds Sold 61 48 32 20 2 11 43 220 536
  Dividends from FHLB Stock 0 0 0 0 0 -17 17 36 11
                   
Total Interest Income 15,662 16,335 16,221 15,727 16,750 16,935 17,295 17,102 17,269
                   
Interest Expense                  
  Deposits 6,571 6,787 7,262 7,428 7,329 7,710 7,827 8,016 8,079
     Deposit rate 0 0 0 0 0 0 0    
  Federal Home Loan Bank Advances 1,023 1,239 1,310 1,312 1,246 1,159 1,137 1,021 1,029
    FHLB Borrow Rate 0 0 0 0 0 0 0    
                   
Total Interest Expense 7,594 8,026 8,572 8,740 8,575 8,869 8,964 9,037 9,108
                   
Net Interest 8,068 8,309 7,649 6,987 8,175 8,066 8,331 8,065 8,161
                   
Noninterest Income                  
  Net Gain on Sale of Investments 0 1,880 -2 0 76 -51 274 10 1,373
  Other 0 0 74 55 54 55 69 120 -10
                   
Total noninterest Income 46 0 74 55 54 55 69 120 -10
                   
Noninterest expense                  
  salaries and employee benefits 3,189 2,577 3,077 3,037 3,039 2,796 2,459 2,192 1,761
  occupancy and equipment 425 320 343 1,293 350 301 303 290 294
  professional fees 459 384 332 389 307 366 264 552 295
  data processing 170 162 178 150 144 135 125 113 113
  fdic/ots assessments 580 351 352 896 682 0 0 127 30
  other g&a 634 533 607 736 622 639 627 512 393
                   
Total noninterest expense 5,457 4,327 4,889 6,501 5,144 4,237 3,778 3,786 2,886
                   
Pre-Provision Operating income 2,657 3,982 2,834 541 3,085 3,884 4,622 4,399 5,265

 

 

Catalysts

While FFNW suspended its dividend in conjunction with its Q1 2010 earnings release, management believes it will be able to reinstate a dividend possibly by the end of Q2 or in Q3 2010. The OTS indicated it was willing to allow the company to pay a $0.01/share dividend this quarter but management and the board are confident the OTS will allow them to pay the full $0.085/share dividend next quarter. When the OTS approves the company's ability to issue dividends, management and the board are looking at possibly doing a special dividend to reflect past dividends that weren't paid.

 

Significant reductions in non-performing assets. Management expects to be able to cut its non-performing loans in half by the end of the year. If it is successful in doing so, then the bank will look to gain regulator approval to resume share repurchase activity.

 

Risks

FFNW poked its nose at its regulators in Q4 2009 by buying back 1.2MM shares when the regulators had asked banks in the Seattle area to conserve capital. In response, FFNW has been subject to a more stringent examination resulting in more of its current loans being forced into the non performing category.  In April, FFNW entered into an informal supervisory agreement with the OTS which requires the company to obtain OTS approval prior to declaring a dividend or buying back stock. The company is also required by the FDIC to obtain written non-objection before growing assets more than 5%, changing funding mix or declaring or paying dividends. The company expects to enter a formal written enforcement order with the FDIC to develop and implement plans to reduce construction/land development loans, improve credit quality and improve profitability within a specified time frame.

 

It bodes repeating that we think management is very high quality, especially for a company of this size.  We recommend interested investor reach out to CEO Victor Karpiak and head of Strategic Development Scott Gaspard, both of whom are happy to walk through the story.

 

Victor Karpiak: 425.255.4400

Scott Gaspard: 425.254.2002

 

 

Catalyst

    sort by    

    Description

     

    First Financial Northwest (FFNW) $5.25

    Mkt Cap               $98MM

    P/B                         0.46x

     

    Recommendation

    We believe FFNW is a highly attractive "orphan equity" that is grossly undervalued for a variety of identifiable reasons.  The company is a capital rich bank trading below 50% of tangible book value.  On first glance the company appears to be another bank loaded with NPLs, but on further inspection FFNW has more than sufficient capital to absorb the expected losses on these NPLs even under scorched earth assumptions.  With the stock trading at ~50% of tangible book, the market has already discounted expected losses from these NPLs and is essentially pricing the company as if it going to fail. In reality, the housing market in Seattle is bottoming (prices are leveling and volumes are picking up significantly) which should allow the company to make significant progress on reducing NPL levels over the next 6-12 months.  In addition, the company is a conservative underwriter and therefore ultimate loss severities on non-performing loans are likely to be much lower than market expectations. We anticipate a worst case tangible book around $8/share vs. current tangible book of $10.88/share. We expect the stock to trade towards tangible book as the company's NPL levels decline over the course of the year.  In addition, the Company was forced to curtail its dividend (more below) which we believe will be reinstated next quarter along with a special dividend for the recently curtailed dividend.  Since demutualizing in 2007, the company has a history of shareholder friendly behavior such as large share repurchases.  We would expect to see management step up share repurchases once the OTS recognizes the strength of their balance sheet.  We're not the only ones who think the bank is cheap as management and the board have been purchasing shares recently on the open market at higher than current prices.

     

    Overview of the Company

    FFNW is a single branch community bank based in Renton, WA. First Savings Bank Northwest was founded in 1923 in Renton, WA as a Washington state chartered savings and loan. FFNW converted to a federal mutual savings and loan in 1935 and to a Washington state charted mutual savings bank in 1992. In October 2007, the company did an IPO in conjunction with its conversion from a mutual holding company to a stock holding company at a price of $10/share with KBW as the lead underwriter. FFNW is the 19th largest bank in the state of Washington with 0.83% deposit market share. In King County, WA (Seattle) FFNW is the 8th largest bank with 1.81% deposit market share.

     

    The Balance Sheet

    FFNW's bank capital ratios are very strong with Tier 1 leverage of 11.33%, Tier 1 risk-based at 16.43% and Total risk-based capital at 17.73%. In addition, FFNW's holding company has $49.1MM of additional capital. FFNW did not take any TARP capital.

     

    FFNW Balance Sheet              
                   
    Assets Mar-10 Dec-09 Sep-09 Jun-09 Mar-09 Dec-08 Sep-08
    Cash 8,373 8,937 4,238 3,105 2,532 3,366 4,045
    Interest Bearing Deposits 107,326 96,033 36,681 49,975 31,776 600 2,736
    Fed Funds Sold 0 0 2,295 2,295 3,105 1,790 3,965
    Investments available for sale 109,593 97,383 172,207 172,586 140,644 149,323 162,877
    Loans Receivable, net of allowance 1,016,896 1,039,300 1,055,906 1,025,324 1,031,186 1,035,181 1,002,562
    Premises and Equipment 20,453 19,585 16,609 13,713 13,182 13,026 12,992
    Federal Home Loan Bank Stock 7,413 7,413 7,413 7,413 7,413 7,413 6,425
    Accrued Interest Receivable 4,716 4,880 5,265 5,387 5,794 5,532 5,457
    Federal Income Tax Receivable 12,160 9,499 1,266 0 0 0 0
    Deferred Tax Assets 5,415 12,139 14,128 15,039 8,577 9,266 8,627
    Goodwill 0 0 0 0 14,206 14,206 14,206
    Other Real Estate Owned 20,500 11,835 0 0 0 0 0
    Prepaid Expenses 8,384 8,330 3,414 3,279 3,367 4,737 3,489
                   
    Total Assets 1,321,229 1,315,334 1,319,422 1,298,116 1,261,782 1,244,440 1,227,381
                   
    Liabilities              
    Deposits 962,590 939,423 908,213 884,155 821,186 791,483 777,569
    Advances from the Federal Home Loan Bank 139,900 139,900 149,900 149,900 148,150 156,150 135,000
    Advance payments from borrowers for taxes and insurance 4,509 2,377 4,375 2,510 4,758 2,745 4,161
    accrued interest payable 402 457 522 514 494 478 117
    Federal income tax payable 0 0 0 2,001 94 336 865
    Other laibilities 3,789 4,660 5,550 5,222 3,736 3,140 3,653
    Total Liabilities 1,111,190 1,086,817 1,068,560 1,044,302 978,418 954,332 921,365
                   
    Stockholders Equity 210,039 228,517 250,862 253,814 283,364 290,108 306,016
                   
    Total Shares Outstanding 18,805,168 18,823,068 20,038,320 20,337,220 20,363,120 21,293,368 22,852,800
    % QoQ -0.10% -6.06% -1.47% -0.13% -4.37% -6.82%  
                   
    BVPS 11.17 12.14 12.52 12.48 13.92 13.62 13.39
    % QoQ -8.00% -3.03% 0.31% -10.31% 2.14% 1.74%  
                   
    Tangible Common Equity 204624 216378 236734 238775 260581 266636 283183
                   
    Tangible BVPS 10.88 11.50 11.81 11.74 12.80 12.52 12.39
    % QoQ -5.34% -2.70% 0.62% -8.25% 2.19% 1.05%  
                   
                   
    TCE Leverage 6.4 6.0 5.5 5.4 4.8 4.6 4.3
    TCE Ratio 15.6% 16.6% 18.1% 18.6% 21.0% 21.8% 23.5%

     

    The $109MM investment book is almost entirely invested in government guaranteed loans.

     

    The loan book is heavily weighted towards residential real estate. The commercial real estate book is predominately warehouses and office buildings with minimal retail and no strip malls.

     

    Loans Receivables Mar-10 Dec-09 Sep-09 Jun-09 Mar-09 Dec-08 Sep-08
    One-to-Four Family 488,210 496,731 511,279 502,930 504,663 512,446 499,214
    Multifamily Residential 152,179 146,508 132,084 109,691 103,886 100,940 80,639
    Commercial Real Estate 287,810 288,996 285,168 273,607 259,925 260,727 238,581
    Construction/land development 138,971 163,953 206,510 220,816 240,813 250,512 268,646
    Business 347 353 351 251 0 0 0
    Consumer 19,006 18,678 17,873 16,557 13,073 12,927 12,668
                   
    Total Gross Loans 1,086,523 1,115,219 1,153,265 1,123,852 1,122,360 1,137,552 1,099,748
                   
    Loans in Process 30,252 39,942 63,348 63,346 74,175 82,541 82,574
    Deferred loan fees 2,946 2,938 2,877 2,732 2,705 2,848 2,775
    Allowance for loan losses 36,479 33,039 31,134 32,450 14,294 16,982 11,837
                   
    Total Net Loans 1,016,846 1,039,300 1,055,906 1,025,324 1,031,186 1,035,181 1,002,562

     

     

    Non Performing Assets

    FFNW has seen a doubling in its non-performing assets over the past year with the increase almost entirely due to residential construction land/development loans. Note: $37.1MM of the $48.0MM non performing one-to-four family loans are non-owner occupied units held by the bank's construction/land development customers.  FFNW did not finance any high-rise developments. According to management, ~95% of non-performing loans relate to 15 borrowers.

     

    Loans Accounted for on a nonaccrual Basis

    Mar-10

    Dec-09

    Sep-09

    Jun-09

    Mar-09

    Dec-08

    One-to-Four Family

    48,035

    36,874

    40,899

    26,912

    12,013

    9,630

    Commercial RE

    14,108

    11,535

    18,052

    9,025

    5,171

    2,865

    Construction/land Development

    83,016

    71,780

    88,757

    86,361

    50,371

    44,043

    Consumer

    759

    514

    375

    0

    0

    0

    Total Nonaccrual Loans

    145,159

    120,189

    147,708

    122,298

    67,555

    56,538

                 

    Accruing Loans Past Due

               

    One-to-Four Family

    0

    0

    382

    891

    4,620

    1,207

    Multifamily

    0

    0

    0

    809

    0

    0

    Commercial RE

    0

    0

    475

    5,380

    4,212

    897

    Construction/land Development

    0

    0

    0

    0

    3,775

    0

    Consumer

    0

    0

    50

    50

    50

    0

    Total accruing loans past due

    0

    0

    907

    7,130

    12,657

    2,104

                 

    Total REO

    20,500

    11,835

    0

    0

    0

    0

                 

    Total NPAs

    165,659

    132,024

    148,615

    129,428

    80,212

    58,642

                 

    Source: Company Reports

               

     

    FFNW's NPLs are unlikely to grow materially going forward if for no other reason than 68.8% of the company's construction land/development loans are already non performing and 17.1% of the non owner occupied residential loans are non-performing. FFNW significantly curtailed its construction/land development lending in Q4 2007 and the company is not currently writing any new construction/land development loans. As a result the construction land/development book has fallen by 34% YoY. Note: $43.1MM of non-performing loans in Q1 2010 relate to 2 merchant builders who are actually current on their loans.

     

    Construction/land development Loans by County

           
                   
     

    Q1 2010

    Q4 2009

    Q3 2009

    Q2 2009

    Q1 2009

    Q4 2008

    Q3 2008

    King

    50,433

    59,905

    68,842

    73,935

    78,040

    82,900

    89,749

    Pierce

    20,155

    23,722

    36,420

    39,431

    43,965

    42,100

    46,184

    Kitsap

    15,815

    16,960

    17,040

    18,039

    19,265

    19,200

    19,193

    Snohomish

    11,491

    11,525

    12,409

    12,926

    12,940

    13,600

    13,600

    Whatcom

    6,767

    11,491

    11,648

    11,648

    11,648

    11,648

    11,648

    All other counties

    15,974

    17,195

    16,510

    16,613

    17,384

    17,352

    16,789

    Total

    120,635

    140,798

    162,869

    172,592

    183,242

    186,800

    197,163

                   

    Source: Company Reports

               

     

    FFNW has historically been a conservative underwriter - before Q4 2009 the bank hadn't had any REO in over 20 years. The average LTV at origination for the company's owner occupied residential loans is 60%. Construction loans were underwritten with maximum loan to values of 75% of the appraised value. Non-owner occupied residential loans have maximum LTVs of 80%.

     

    FFNW has been building loss reserves over the last 4 quarters.  According to management, realized loan loss severity has ranged from 0-25%. Realized losses on OREO sales were 11.1% in Q1 2010.

     

     

    Mar-10

    Dec-09

    Sep-09

    Jun-09

    Mar-09

    Dec-08

    Sep-08

    Allowance Begin of Period

    33,039

    31,134

    32,450

    14,294

    16,982

    11,837

    8,416

    Provision

    13,000

    23,705

    7,795

    18,256

    1,544

    5,500

    3,498

    Charge Offs

    -9,682

    -21,816

    -9,154

    -100

    -4,232

    -355

    -77

    Recoveries

    122

    16

    43

    0

    0

    0

    0

    Allowance for Loan Losses

    36,479

    33,039

    31,134

    32,450

    14,294

    16,982

    11,837

                   

    Source: Company Reports

                 

     

    The Seattle Housing Market is Recovering

    Residential real estate sales activity in the Seattle area increased significantly in Q1 2010 with King County (Seattle, 41.8% of FFNW's book) seeing sales volumes up 54% YoY and Pierce County (Tacoma, 16.7% of FFNW's book) seeing sales volumes up 24% YoY.

     

    Meanwhile, home price declines in the Seattle metro area appear to be moderating.

     

     

     

     

     

    Since FFNW's problem loans are almost entirely tied to residential housing in Seattle the increased sales volumes and moderating price declines should allow the bank to achieve its goal of cutting NPAs by over $60MM by the end of 2010.

     

    Valuation is cheap

    FFNW trades at 49% of tangible book value.

     

    As a stress test, we assume the bank encounters a 50% loss severity on its REO, a 40% loss severity on its non performing construction/land development loans, 25% loss severity on its other non performing loans and an additional 3% loss on all of its current performing loans. In total the bank would have $87.4MM of charge offs. This compares to its current $36.4MM allowance implying a worst case need for $51MM in additional provisions. This would cut tangible book to $153MM or $8.17/share. In other words at the current share price, the stock is trading at 65% this worst case tangible book value.  Even with $51MM in additional provisions the company would still have tangible common equity north of 11.6% and therefore the company would not need any additional capital.

     

    Shareholder Friendly Management and Board

    The company decided against taking TARP capital because it did not want to accept the restrictions on its ability to pay a full dividend and to buy back its shares. The company proceeded to increase its dividend to 8.5 cents/quarter from 8 cents/quarter in October 2008 and the company continued to buyback its stock.

     

    CEO bought 5,000 shares on May 7th at $5.03/share and CFO bought 4,000 shares on May 7th at $5.03/share. Director Gary Faull bought 1,000 shares on May 12th at $5.34/share. CEO bought 4,302 shares on March 9th at $7.54. Director Gary Kohlwes bought 2,400 shares at $7.25 on March 9th. Insiders have only bought stock since the company de-mutualized in 2007.

     

    Company has had a voracious appetite for its own stock. Since going public, the company has bought back 4.9MM shares at an average price of $8.23/share using just over $40.6MM on repurchases. In Q4 2009, the company bought back 1.2MM shares at an average price of $6.50.

     

    Income Statement

    FFNW has consistently generated ~ $3MM in pre tax pre provision earnings per quarter with PTPP earnings declining over 2009 to reflect the forgone interest from non performing loans.  As the bank stabilizes its balance sheet, management believes it can raise pre-tax pre provision earnings back to $5MM/quarter implying earnings power approaching $0.75/share.

     

      Mar-10 Dec-09 Sep-09 Jun-09 Mar-09 Dec-08 Sep-08 Jun-08 Mar-08
    Interest Income                  
      Loans 14,594 14,817 14,376 14,016 15,123 15,101 15,220 14,928 15,069
        Avg. Interest Rate 0 0 0 0 0 0 0    
      Investments 1,007 1,422 1,813 1,691 1,625 1,489 1,883 1,774 1,653
        Avg. Interest Rate 0 0 0 0 0 0 0    
      Tax Exempt Investments 0 48 0 0 0 351 132 144 0
      Fed Funds Sold 61 48 32 20 2 11 43 220 536
      Dividends from FHLB Stock 0 0 0 0 0 -17 17 36 11
                       
    Total Interest Income 15,662 16,335 16,221 15,727 16,750 16,935 17,295 17,102 17,269
                       
    Interest Expense                  
      Deposits 6,571 6,787 7,262 7,428 7,329 7,710 7,827 8,016 8,079
         Deposit rate 0 0 0 0 0 0 0    
      Federal Home Loan Bank Advances 1,023 1,239 1,310 1,312 1,246 1,159 1,137 1,021 1,029
        FHLB Borrow Rate 0 0 0 0 0 0 0    
                       
    Total Interest Expense 7,594 8,026 8,572 8,740 8,575 8,869 8,964 9,037 9,108
                       
    Net Interest 8,068 8,309 7,649 6,987 8,175 8,066 8,331 8,065 8,161
                       
    Noninterest Income                  
      Net Gain on Sale of Investments 0 1,880 -2 0 76 -51 274 10 1,373
      Other 0 0 74 55 54 55 69 120 -10
                       
    Total noninterest Income 46 0 74 55 54 55 69 120 -10
                       
    Noninterest expense                  
      salaries and employee benefits 3,189 2,577 3,077 3,037 3,039 2,796 2,459 2,192 1,761
      occupancy and equipment 425 320 343 1,293 350 301 303 290 294
      professional fees 459 384 332 389 307 366 264 552 295
      data processing 170 162 178 150 144 135 125 113 113
      fdic/ots assessments 580 351 352 896 682 0 0 127 30
      other g&a 634 533 607 736 622 639 627 512 393
                       
    Total noninterest expense 5,457 4,327 4,889 6,501 5,144 4,237 3,778 3,786 2,886
                       
    Pre-Provision Operating income 2,657 3,982 2,834 541 3,085 3,884 4,622 4,399 5,265

     

     

    Catalysts

    While FFNW suspended its dividend in conjunction with its Q1 2010 earnings release, management believes it will be able to reinstate a dividend possibly by the end of Q2 or in Q3 2010. The OTS indicated it was willing to allow the company to pay a $0.01/share dividend this quarter but management and the board are confident the OTS will allow them to pay the full $0.085/share dividend next quarter. When the OTS approves the company's ability to issue dividends, management and the board are looking at possibly doing a special dividend to reflect past dividends that weren't paid.

     

    Significant reductions in non-performing assets. Management expects to be able to cut its non-performing loans in half by the end of the year. If it is successful in doing so, then the bank will look to gain regulator approval to resume share repurchase activity.

     

    Risks

    FFNW poked its nose at its regulators in Q4 2009 by buying back 1.2MM shares when the regulators had asked banks in the Seattle area to conserve capital. In response, FFNW has been subject to a more stringent examination resulting in more of its current loans being forced into the non performing category.  In April, FFNW entered into an informal supervisory agreement with the OTS which requires the company to obtain OTS approval prior to declaring a dividend or buying back stock. The company is also required by the FDIC to obtain written non-objection before growing assets more than 5%, changing funding mix or declaring or paying dividends. The company expects to enter a formal written enforcement order with the FDIC to develop and implement plans to reduce construction/land development loans, improve credit quality and improve profitability within a specified time frame.

     

    It bodes repeating that we think management is very high quality, especially for a company of this size.  We recommend interested investor reach out to CEO Victor Karpiak and head of Strategic Development Scott Gaspard, both of whom are happy to walk through the story.

     

    Victor Karpiak: 425.255.4400

    Scott Gaspard: 425.254.2002

     

     

    Catalyst

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