Merry Christmas Eve! This week’s post comes early since tomorrow is Christmas. I also want to experiment with release days in the coming weeks so don’t be surprised if your inbox gets its weekly edition on Friday, Sunday or Monday as opposed to Saturday. Thanks to everyone who has subscribed to Conversion Confidential and engaged with me via Twitter, Substack comments, or directly. Looking forward to what 2022 has in store!
Back when I was working at a local asset management firm, I would occasionally write anonymously about investment ideas on a personal blog. Once I had a buddy of mine create my firm’s website on Squarespace, I lost many of the posts on the transition unless I had saved drafts in Microsoft Word. Fortunately for me and readers of Conversion Confidential, I had the draft for FFBW Inc. saved. In this two part series, I’ll first republish my initial write-up from sometime in Spring of 2020 (I’d like to think I’ve improved since then because a few lines feel cringeworthy upon rereading). Then, in part two, I’ll provide a few updates, revisit the investment thesis, and assess management’s execution so far as FFBW approaches its second year conversion anniversary.
First Federal Bank of Wisconsin (FFBW) is a four branch community bank headquartered in Waukesha, Wisconsin with a market cap near $65M. It may interest community bank investors for inclusion in a basket of cheap stocks because it combines several attractive characteristics. FFBW is a micro-cap (overlooked), a recently converted thrift (over-capitalized and thus safer) and will likely be an acquisition target down the road. Meanwhile, FFBW trades at a significant discount to tangible equity.
I first saw this bank come across the SNL conversion pipeline earlier in the year, having completed its second step conversion at the maximum offering on January 16th, 2020. I decided to research it further when I saw a tweet from Phil Timyan noting the smart investor base involved in FFBW (Stilwell Value, FJ Capital, Warren Mackey). The latter name is new to me, so if anyone knows more about him, I’d be happy to hear from you. Since that time, the price action has really worked in our favor.
I think one of the biggest draws may stem from a timing/reporting issue with the conversion. As far as I can tell, the data providers all seem to have FFBW trading just under 1x TBV…which is true as of YE19 financials. However, the conversion completed in January so no reporting period yet captures the incremental capital they raised, except for the prospectus with its pro forma estimate of TBV at $12.63 (based off 1H19 figures). I estimate YE19 TBV to be ~$12.72/share. At a price near $8.75, FFBW is realistically trading more like 0.7x TBV and went as low as 0.53x TBV with the recent market decline. That distortion should hopefully be recognized a bit more when 1Q20 results are announced.
FFBW has historically been an underperformer with ROEs that disappoint, but with the excess capital base, valuation should be based more on book value than earnings in my opinion. Furthermore, things may be changing for the better with results showing improvement since new management took the helm in 2016. Ed Schaefer, formerly CEO of Citizens Community Bancorp in Eau Claire, Wisconsin, seems to have the right priorities. Again, if anyone knows more about his time at his previous bank, I’d like to hear from you (I haven’t had enough time to fully dig in with all that’s going on currently). From their YE investor presentation, here are a couple graphics.
To be sure, the efficiency ratio was (is?) dreadful, but is trending in the right direction. This is not uncommon for a super small thrift for one, but if FFBW can continue grabbing an increasing amount of commercial fee income (boosting total income), this should help normalize expenses to a more appropriate level. FFBW has added a handful of lending officers since 2016 which immediately increase costs, but rarely bring business from day one to balance out the increased expenses.
Meanwhile, it wasn’t long ago that credit quality was more of an issue vs. today’s NPL ratio of 0.57%. The chart doesn’t fully show it, but back in 2014 and 2015, the NPL ratio stood at 2.25% and 1.99%, respectively. From 2017 and on, when new management was brought it is when we see some meaningful cleaning up of the balance sheet. Now, I can’t tell you what the impact from Coronavirus will be (it will be bad) and I do have some reservations on how FFBW expanded the loan book outside core residential in what appears to have been late cycle, but I also understand the reasoning. I can’t stress “I don’t know” enough.
Strategically, FFBW’s plan calls for expansion in their local and neighboring markets, as well as a greater emphasis on CRE. In the past two years, they’ve grown in the commercial space at about 16%/yr which gives me some pause. Commercial lending is fine, but does incur higher risks due to loan size and complexity of underwriting cash flows/collateral. Besides, the bank’s legacy is mostly in residential so if that growth rate sustains, it would strike me as too high. I’d like to speak with management about what opportunities they are seeing in this space and how they are able to grow so rapidly as a small player without risking poor credit quality. If I get on the horn with them and have anything worthwhile to conclude, I’ll post an update. At 10% of loans, construction and development also concerns me. This was only 1% of the portfolio as recently as 2017 so that could be another risk. However, I can say, that unless I’m missing something big, even under onerous conditions, FFBW should have plenty of capital to see itself through to the other end.
Below I run two quick scenarios to see what the hit to equity might be…one based more on loss rates I could find historically for FFBW from the FDIC’s site and another based on loss rates for the banking industry as a whole going back through various past recessions. Like I said above, I have no idea what actual NCOs will look like, but I think they’ll be high over the next couple years and I think this hopefully captures a pretty severe scenario. The gist is that FFBW should survive and looks both well capitalized and cheap even after registering large loan losses. Perhaps that’s what management has concluded as well with their recent open market purchases occurring into mid-March. Unrecognized value is good.
The market FFBW operates in appears to be satisfactory. Nestled next to Milwaukee, WI, Waukesha benefits from being a stones throw from a major metro and is part of a total MSA covering 1.6M people. The prospectus notes that Waukesha County has an est. population of ~400k, is primarily a suburban community and is the 2nd wealthiest county in Wisconsin with a median household income of $81,000 vs. $57,000 for Wisconsin. This probably explains why their credit quality looks pretty good in residential going back historically.
According to US Census data, the local MSA grew a lowly 0.15% annually from 2010-2019 but is expected to grow faster at 0.28% through 2024. Unfortunately, FFBW’s position within the market is tenuous, at best. According to the FDIC, FFBW had a 0.30% deposit market share in their home MSA (Milwaukee-Waukesha) as of June 30th, 2019. Within Milwaukee County, it is a tiny 0.11%. This figure improves a bit to 1.08% when accounting for only Waukesha County, but is nothing to write home about. Meanwhile, core deposits tally only $97.4M according to the 10-K, or 45% of the total. These factors explain why deposit costs are high, have increased materially in the past couple years and why management is focused on increasing core deposits to alleviate such pressures. All this to say, we probably shouldn’t expect huge earnings power/returns out FFBW, but that isn’t the play here anyway and shouldn’t be required for a successful investment.
Conclusion: The investment thesis is going to come down to execution. Execution of the standard conversion playbook, where a bank sits on excess capital, deploys it wisely over a couple years (which will help right size the balance sheet and increase returns modestly simply by way of increasing leverage), expands into adjacent markets, initiates buybacks once allowed (also removes excess capital), and perhaps even sells itself. The latter can’t occur for at least three years as a recent thrift conversion. Anything that deviates from this high-level plan probably breaks my thesis. We know they plan to grow organically and inorganically, but an acquisition outside of Southeastern Wisconsin would be a red flag to me. Similarly, if progress on improving standard banking metrics were to stall or reverse for an extended period of time, it might be time to conclude the market is too competitive or FFBW’s position within it too weak.
CEO Ed Schaefer and other insiders have already given a couple clues on their intentions. There have been a handful of open market purchases in February and March. Further, on March 13th, FFBW requested the approval/non-objection of the Fed to initiate a 5% repurchase program. As a recent converted thrift, they are required to get permission to do so within one year of the second step conversion, which is unfortunate, but hey, regulatory issues are part of the banking world. In my mind, it shows management and the board have the right ideas (and are taking action!) to increase shareholder value regardless of what the Fed allows. This could also speak to the influence of the smart investor base on board with the stock.
I’d like to hear your thoughts/feedback. Thanks for reading!
Disclosure: long FFBW
Okay, now the stage is set for part two. Stay tuned next week for an update on where things stand for FFBW Inc. as we get ready to start 2022.
Warren has an excellent track record as fyi