FFBW: A Thrift Conversion Rapidly Repurchasing Stock

May 25, 2022 3:33 PM ETFFBW, Inc. (FFBW)7 Comments9 Likes

Summary

  • FFBW is trading below tangible book value, yet thrifts have a strong history of being acquired for more than book value.
  • The bank has been aggressively repurchasing stock, both as a first-step conversion and now that it’s fully public.
  • This thrift can be acquired starting in less than 8 months, after its three-year anniversary of being public.

Group of business persons talking in the office.

VioletaStoimenova/E+ via Getty Images

Stock repurchases at a discount to tangible book value at a thrift conversion? It's one of the top signs a management team can show you that it's looking out for shareholders' best interests. Buybacks are an even better sign when execs make them of their own free will and don't have an activist investor starting a campaign if they're not seeing any action.

And that's what we have at FFBW (NASDAQ:FFBW), a recently converted Milwaukee-area thrift that's executing one of the fastest buybacks I've ever seen. Even with mediocre returns on equity, this massively overcapitalized bank could return investors around 50% over the next 12 to 18 months, with a reasonable chance of being acquired toward the end of that period. And it's an attractive and defensive place to invest with the market hitting new lows seemingly every day.

FFBW has a number of positive characteristics that make it an attractive purchase:

  • Discounted valuation. The thrift is trading at just 85% of tangible book value.

  • Stock repurchases. The thrift has undertaken one of the most aggressive repurchase programs I've ever seen at a thrift. Full details below.

  • Massive overcapitalization. The thrift has a whopping 25% of assets as equity, meaning it has a ton of unused capital and a lot of safety.

  • Notable investor presence. Thrift investors Arles Advisors, run by Warren Mackey, and Maltese Capital Management, run by Terry Maltese, own 4.4% and 6.3% of shares, respectively, though no activist filings have been made.

  • Insider ownership. The CEO owns 2.3% of the stock - worth around $1.7 million - and insiders own a total of 4.8%. That's a modest percentage for insiders, especially as a percentage, but the CEO's stake amounts to almost four times the CEO's 2021 total compensation.

  • Change-in-control provisions. The CEO's employment contract offers three times his annual salary, bonuses, and other perks if he's terminated within 18 months following a change in control. So there's some incentive for the CEO to sell.

FFBW's background

Founded in 1922, FFBW is a Milwaukee-area thrift that went public in one of those oddball two-step conversions. In a first-step conversion, a converting thrift sells a minority stake to the public, while a mutual holding company retains the remaining majority stake. In the second step of the conversion, which can occur at any time later, the thrift sells the remaining majority stake to the public and becomes fully public, just like any other bank trading on the exchange. After a three-year period of being public, it can be acquired by a rival, which happens often to thrifts.

In the case of FFBW, the thrift completed its first-step conversion in October 2017, and then followed that up with its second-step conversion in January 2020. Now just eight months away from its third anniversary, the bank should begin seriously perking up from its low valuation.

FFBW is headquartered in Brookfield, Wisconsin, and operates with five branches out of Waukesha and Milwaukee Counties. Waukesha has the highest median household income of any Wisconsin county. FFBW has tried to expand its margins by focusing on the higher yields available as a commercial bank and gradually moving away from its residential history.

The bank has focused more on commercial real estate and commercial and industrial loans in the last decade, especially since the hiring of CEO Ed Schaefer in 2016. Commercial loans (development, real estate, and commercial and industrial) comprise about 62% of the loan portfolio now, with residential real estate about 38%. That commercial exposure was up from about 31% when Schaefer joined the company, with residential comprising the rest at that time.

Management and insiders

It's important to think about the incentives for management in these situations, and the execs at FFBW have what are fairly typical change-in-control agreements. If I had one wish here, it would be that the CEO owned more stock, giving him a greater alignment with outsiders and more upside in the event of a buyout.

Schaefer, 60, is the biggest insider holder of stock, with about 2.3% of the shares, currently worth about $1.7 million. No other named insider has more than 1%, but in aggregate insiders own 4.8% of the stock. Higher insider ownership - especially combined with the incredibly aggressive buybacks (more below) - would inspire higher confidence in alignment here.

Schaefer has a change-in-control agreement that entitles him to three years' worth of base salary and three years' worth of the highest bonus received in the prior three years as well as some other cash perks. Add those figures up, and the walkaway bonus is around $1 million. Add in a potential 50% bump in stock price to his existing holdings, and the CEO could walk away with maybe $3.6 million in assets from a buyout.

But at age 60, Schaefer may think he'd rather work for a few more years before walking away.

CFO Steve Wierschem receives one times his salary and his best bonus of the last three years in the event of dismissal due to a change in control.

As is typical in thrift conversions, the board is staggered, with directors serving three-year terms. Unfortunately, such a structure tends to entrench insiders and makes it harder for outside investors, including activists, to effect change in the organization.

Key financials

In the case of most small banks, the only endgame is to be acquired. Most are simply too small to be run efficiently. So when examining thrifts, it can make sense to check on whether the thrift can simply continue profitably until it can be a candidate for acquisition. That is, we're not looking for a bank that can thrive - most thrifts are much too small for that - but simply one that looks out for shareholders reasonably and won't dent the franchise until it can be sold.

FFBW is a bank that is awash with cash, though it's doing a fine job using it on buybacks. All that cash depresses some of the key financials, making the bank look less attractive than it otherwise might appear. But the cash also provides this bank serious ballast, and it would take some major management screw-ups to deep-six this ship.

When FFBW completed its second-step conversion in 2020, it had a staggering 36.3% equity/assets ratio. All that cash raised from its conversion went straight into its coffers, where it could be used to run the bank. Since then the bank has undertaken a small acquisition and some serious buybacks. As of its most recent report, equity/assets still runs at an incredibly high 25%, giving the bank flexibility to repurchase stock, deploy into operations or something else.

The deposit franchise is reasonably attractive, with core deposits (checking, savings and money market) at more than 74% of total deposits, an attractively high level. In fact, non-interest-bearing checking is 21% of deposits. CDs comprise most of the remainder, at 22%, and HSAs pick up the last few percent.

The loan portfolio looks reasonably secure as well. Non-performing assets were just 0.08% of total assets through March 31, 2022, and they were just 0.35% in the troubled year of 2020. It's been the same situation since at least 2016 - again, when Schaefer joined the company - and non-performing assets were 1.2%. So five years of low non-performing assets.

The bank has been profitable after 2017, when it generated a small loss of $186,000, and it also recorded a loss in 2014. In 2021, the bank earned nearly $2 million, in 2020, $1.8 million, on top of a $1.6 million gain in 2019. That puts return on equity solidly in the low single digits. (Just don't try to find the phrase "return on equity" in the 10-K - it doesn't exist.)

Unsurprisingly, the bank's efficiency ratio was a moribund 79.0% in 2021, up from 69.5% in 2020 and 64.4% in 2019.

In short, FFBW has some notable bright spots but has too much cash and is still too small to really operate efficiently, even if it's been doing something about that cash war chest.

History of stock repurchases and acquisitions

Emerging from its second-step conversion with equity at more than 36% of assets, FFBW had a lot of capital to work with. And it's done a decent job repurchasing stock and it's even made an acquisition. Let's take a quick look at both of these moves, since what management does with this wad of capital is probably the single biggest driver of investors' returns from here.

I'm a huge fan of thrifts aggressively repurchasing stock at a discount to tangible book value. In my book The Zen of Thrift Conversions, I call it the top "tell" about whether management has any interest in doing right by outside shareholders.

On that score, it was great to see FFBW announce a strong repurchase authorization just after the one-year moratorium on purchases from newly converted thrifts. In fact, FFBW came out swinging. While most thrifts announce a 5% authorization, FFBW doubled up on that - a full 10% authorization announced as of February 2021. Even better, it went about completing that authorization in about 6 months, or about 1.6% of its stock per month. It's a great sign to see an aggressive buyback at a sizable discount without the public prodding of an activist investor.

In September, the bank announced it had completed the authorization - and even better, it announced another 10% authorization. This buyback didn't move quite as quickly. In early November the company revealed that it had purchased about 10% of the authorization - about 1% of shares outstanding - in the first two months of the program. But in late March the bank acquired a huge slug of stock from Arles Advisors, which pared the investor's stake below 5%, and then shortly thereafter the bank announced that it had completed the second authorization.

Then in May, the bank announced another 10% repurchase authorization - exactly the kind of aggressive repurchase I love to see in a massively overcapitalized bank trading at a discount. FFBW has sufficient cash at the holding company to fund the repurchases, so there's no issue there.

Repurchases are a great sign for investors. At a discount to tangible book value, they create immediate value for investors, and execs have little self-interest in pursuing them, since a smaller war chest limits their ability to maneuver, self-deal and more. So they're a good (but not perfect) sign that management is thinking about investors. And that's why I'd love to see FFBW blow through this third repurchase authorization as quickly as it did the first and second ones.

It's worth noting, too, that the bank also repurchased shares when it was in the limbo state after its first-step conversion. That's an unusual step, but it can lead to solid value creation, too.

FFBW also acquired the assets of Mitchell Bank in 2020, a move that helped to grow deposits by more than $56 million. The bank paid nearly $5 million, just shy of the net assets acquired.

Valuation and potential returns

FFBW trades at an undemanding 85% of tangible book value, but I estimate that it could be acquired at 120-125% of tangible book value in the future. That figure is in line with acquisitions of other thrifts and falls below the approximately 140% takeout multiple of other thrifts.

What kind of returns could that offer investors over the next year or two if the bank is acquired?

For the sake of simplicity, let's assume the bank earns about $2 million a year (just a bit higher than recently) and that it completes its third repurchase authorization at $12.54 per share, or about 90% of current tangible book value, in the next few months, and then no more. Those moves would put tangible book value per share at about $14.81 in two years.

Work the math, and you get an acquisition price of about $17.77 to $18.51 in two years (at the 120% and 125% multiples, respectively). That's a total return of 48% to 54%, respectively. How much is that per year? About 22% over the two-year period. Too fast? Add in another $2 million in earnings to tangible book value for a third year (bringing tangible book value to $15.16), and the takeout price (at 125%) would be $18.96, or about 16.5% annualized returns over a three-year period. Those would be attractive returns for the potential risks here.

While the financial assumptions of this valuation are not particularly aggressive, the one big assumption is the potential for a buyout. Absent that, FFBW could muck around at 110% of tangible book value for a long time as the market won't award a buyout multiple to a stock that hasn't yet gotten a buyout offer. What are the upside and potential returns in that case?

At that price, you'd be looking at a total return of about 36% over two years.

The latter scenario (without a buyout) is eminently achievable and would offer attractive risk-adjusted returns. But the emergence of a well-known investor going activist could shake things up and make the higher valuation more achievable.

Two well-known thrift investors - Warren Mackey of Arles Advisors and Terry Maltese of Maltese Capital Management - already have sizable positions in the stock, a total of more than 10% between them. But they have not filed as activists, and Mackey has reduced his position substantially by selling out a huge portion of his position - at a discount to tangible book, it should be noted - as part of the company's second repurchase wave.

The emergence of another noted thrift activist such as Joe Stilwell or Larry Seidman would be an optimistic sign that FFBW would ultimately be sold and likely at a price that's attractive to investors. (Seidman is one of the largest investors in Prudential Bancorp (PBIP), which ultimately agreed to an acquisition, which I posited a few months ago.)

Those are several "ifs" in the investment thesis, but FFBW offers an undemanding valuation, so you're paying little for this potential upside (and arguably you're being paid to take it).

Risks

One near-term risk is the larger macro environment and how that impacts the bank's available-for-sale securities portfolio, which it must mark to market. With interest rates rising rapidly of late, many banks are taking write-downs on their credit portfolios. FFBW swung from an unrealized gain on its AFS credit portfolio at the end of the calendar year to an unrealized loss of about $1.2 million on a $48.3 million portfolio. Rapidly rising rates could continue to hurt this portfolio. More broadly, those higher interest rates also impact the value of mortgages written at much lower rates. A key risk for any thrift with this much cash on its balance sheet is the potential for executives to squander it, especially on a bad acquisition. Such empire-building can be rife in the thrift space, and it's one reason I like to see high insider ownership in thrifts, because it makes managers think like owners. So far FFBW's one acquisition has been modest in size, and the company has been undertaking buybacks at such a breakneck pace - may it continue! - that this worry may be overblown. But it's always a watchpoint in thrift land.

Bottom line

With a remarkably low valuation, plenty of cash on its books, and the market as a whole in the doldrums, FFBW can be an attractive defensive play. With the stock just eight months away from being able to be acquired, investors have some upside with limited risk and optionality in the form of a buyout later on, which happens to the supermajority of thrift conversions. The emergence of an activist investor could also be a notable catalyst for a buyout here, too.

This article was written by

https://www.thezenofthriftconversions.com/Focused on thrift conversions, activist investors in thrift conversions and how they can return substantial off-the-radar returns to investors.
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Disclosure: I/we have a beneficial long position in the shares of FFBW either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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