Short Thesis Still Intact at FirstFed 11 comments
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I have been bearish on FirstFed Financial (FED) for sometime and despite the stock’s recent run up and what would appear at first glance to be a slight improvement in the company’s underlying fundamentals, I believe that the short case for the company bears reiteration.
FirstFed, like all California mortgages lenders, has been absolutely devastated by the terrible events out in California. The company specializes in ARM mortgages and has only recently been making an effort to move into the traditional mortgage market in scale. While this has definitely been a good decision on the part of management, I am not sure that it will be enough to prevent the company from being forced to do a massively dilutive share offering in the near future. Such a transaction would be in the best interests of the depositors of the bank and I cannot imagine why management has not already tried to sell shares of the company into the recent strength shown by the company’s stock.
The management of FirstFed, in stark comparison to that of other banks, has been brutally honest with its shareholders and the investment community. In a commendable act of baring it all to the investment community, management releases monthly updates on the health of its company. In the most recent report, the bank at the end of July showed that it had $123.3M in loans 30-59 days delinquent as opposed to $126.2M in loans delinquent at the end of June. This brief bit of news, coupled with a decline in loans that were regarded as non-accrual from $491.6M in June to $437.1M at the end of July sent the stock soaring, as investors believed it would be capable of surviving the current turmoil in not only California but also in the financial and credit markets as a whole.
Nevertheless, the company’s July report leaves out critical data points that are needed to analyze the company properly. Some of the more important numbers left out were the level of the bank's capital base, the amount of charge offs taken during the month, the number of impaired loans and the amount of real estate held on the bank's books as a result of foreclosure proceedings. In addition, I believe that a more detailed discussion of the bank’s deposit base would be warranted given the dramatic change of its composition. Some of these concerns and the metrics that support them can be found in the company’s quarterly report, which came out slightly before the July update.
For me the two most glaring numbers that showed up in the company’s second quarter report were the number of loans that had become impaired and the surge in the bank’s real estate owned portfolio. At the close of the second quarter, the bank had $332M in impaired loans and $96M in its real estate owned portfolio. In comparison, in the first quarter the bank had $131M in impaired loans and $45M in its real estate owned portfolio. To me this is emblematic of the sharp deterioration that is occurring in the bank’s loan portfolio and I would imagine that the dollar value of loans that are delinquent should begin to rise again going forward.
In addition, the company also provided information in its most recent quarterly report related to the losses that it has realized in its ARM loans that have reset over the last six months. According to the company, the bank had $648.6M of loans reset, of which $308.7M were modified by the bank. It appears that during the modification process, the bank took a loss of $26.3M or about 4% on the total value of the loans that reset during the first half of the year.
If this trend were to hold steady, the bank should expect losses of $10-12M because of the modification process in the second half of 2008 and $25-30M during 2009. This will have a significant impact on the company’s equity base. The holding company currently has a book value of $550.8M so an additional $35M in losses would add further strain on the company, especially given its current loan portfolio.
Two additional questions that I had relating to the July report were the amount of charge offs that that the company will be taking going forward on its loan portfolio and what exactly happened to it's deposit base. A good portion of its non accrual loans will likely need to be charged off going forward as banks typically begin to aggressively charge off loans 120-180 days after they go non-accrual. By my best guess, I would say that a portion of the bank’s non-accrual loans would be eligible sometime in the third quarter. Typically, bank regulators do not like to see banks with an overly large non-accrual loan portfolio so I would not be surprised to see charge offs growing significantly going forward.
The second concern that I had with the bank’s July update was its deposit base. According to the company, the number of wholesale or brokered deposits jumped to $1.247B in July from $691M in June, while retail deposits declined from $3.169B to $2.912B in the same period. As a result of this action, the bank likely has a high level of uninsured deposits. This has been a trend at the bank and I am disappointed to see it continue. As a reference, at the end of June the bank had over $800M in uninsured deposits, I would not be surprised to see this figure grow in the next quarterly report. Such an unsteady deposit base will likely make the bank prone to liquidity issues going forward should its wholesale depositors ever get nervous.
In a previous article, I talked a little bit about the “Texas Ratio,” which was developed by Gerard Cassidy and the “California Ratio” which I came up with a while back in an effort to try to have an even earlier warning system for distressed banks. A description of the Texas Ratio and what goes into calculating it can be found here. My article on the need for a “California Ratio” can be found here.
Cassidy defines the “Texas Ratio” as the following:
The ratio is calculated by dividing a bank's non-performing loans, including those 90 days delinquent, by the company's tangible equity capital plus money set aside for future loan losses.
At of the end of the second quarter, FirstFed Financial, by my calculations (which you might want to double check) had a “Texas Ratio” of 60.7%.
I have defined a “California Ratio” (and it's still a very rough metric) as the following:
Calculate the California Ratio by dividing the bank’s non-performing loans (including those less than 90 days delinquent) by the company’s tangible equity capital and the money set aside for future loan losses. The tangible equity capital should be marked down to account for a reduction in value for the bank’s real estate owned portfolio and its impaired loans. The bank’s real estate owned portfolio should be marked down to 50% of its stated value while the bank’s impaired loans should be carried at 80% of their stated value.
At the end of the second quarter FirstFed Financial had a “California Ratio” of 101%.
While FirstFed has not quite yet hit the “danger zone” set by IndyMac’s failure, where the firm failed shortly after its “Texas Ratio” hit 150%, the company is nevertheless in a precarious position going forward. I would expect that the firm’s charge offs will begin to take a toll on FirstFed’s capital base over the next several quarters, causing its capital ratios along with its Texas and California Ratios to deteriorate.
In addition, the firm’s large level of wholesale deposits could also cause the bank to take rapid losses should these depositors begin to flee the bank with their uninsured deposits and force the bank to sell parts of its loan portfolio at a significant discount to face value. The bank is simply in the wrong market at the wrong time. The stock is clearly one that should be avoided, and for those adventurous souls, I would advise shorting the stock at these levels.
For Further Review:
The Company's Most Recent Quarterly Report
Disclosure: None.
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This article has 11 comments:
1. FED does not voluntarily provide the monthly report. It is required by one of their regulators. Note that Downey provides essentially the same information monthly as well. Perhaps someone could clarify which regulator requires that filing?
2. While the dollar value of 30-59 day late non accrual loans was fairly steady at 123M vs. 126M one month ago, the 60-89 day bucket increased to 101M to 81M. Total Non Accrual loans in the pipeline went up 17M in the month.
3. Cash was 562M at the end of July, but wholesale deposits spiked during the month by 556M. This spike in wholesale deposits was unprecdented in the history of FED and seems very susupicious. During the month, as you point out, ordinary retail depositors withdrew 257M. There is no further detail about the source(s) or this "wholesale" deposit. Note that is may have been only on deposit for a short time. We are also not given any information as to the terms provided to the depositor(s). It seems hard to beleive that anyone would put their capital at risk with an uninsured deposit at FED given its precarious balance sheet. Note that in the absence of this miracle deposit, the bank would have been out of cash, and needed to tap the FHLB, which would, of course have attracted still more regulatory attention.
4. Very important to always remember with respect to FED that almost all of its loans are in California (a few in Arizona as well), and primarily in the absolute worst hit part of California, LA, the inland empire, and San Diego. The loss severities for them will be very significant.
This bank is in very big trouble....
The article today, with the follow-on comment from exec Goddard, is a tell. They are desperate to blame their problems on the "shorts", as if the shorts devised and executed this high-wire business plan.
Goddard and his partners are afraid that no one will hire their sorry asses after this hits the fan, and are in full
'Bagdad Bob' mode now.
Especially the point you make about the monthly report not telling the whole story. REOs we know went up dramatically from Q1 to Q2. However, once a property is foreclosed, it is removed from the delinquent loan figures.
So the moderation in growth (not by any means a decline) in total delinquent loan figures could be because (1) suddenly Californians with toxic loans decided to start paying them at a higher rate (2) a lot of bad loans are no longer delinquent, but now are REOs.
As for the decrease in NPA ratio (1) total assets increased because of the funding of new loans and increase in uninsured "hot money" (2) write-downs of the value of NPA decrease the amount of NPA.
On Aug 28 07:22 PM Kinabalu wrote:
> Just a comment on uninsured deposits. These deposits are usually
> demand deposits and are the most attractive deposits a bank can have.
> As a result when the FDIC takes over a failed bank they can sell
> the demand deposits to other banks for more than the face value.
> So the depositor doesn't have to take a loss as the new bank is happy
> to take over their business. There really isn't any more incentive
> for the uninsured depositor to participate in a run on the bank than
> for an insured depositor.
You don't think what is accurate? As a CFO at a bankholding company in the late '80's and early '90's, I put together bids to purchase deposits of failed banks that were being sold by the FDIC. I don't know anything about First Fed's deposit base, I'm just providing you some basic information about uninsured deposits in response to your assertion of "This spike in wholesale deposits was unprecdented in the history of FED and seems very susupicious" (sic).