FFD Financial Corporation (FFDF)
Small Ohio bank with strong business model and cheap valuation
Summary
FFD Financial (ticker: FFDF / OTC-listed) is the holding company of First Federal Community Bank, a small ~$670mm asset bank located in Central Ohio. The bank was profitable throughout the financial crisis with very minimal losses in their loan portfolio. The same CEO is running the bank today and has created a strong business model that generates returns well above most of its local peers. This outperformance is driven by two factors: (1) “scaled” branches with ~35% more deposits at each than local peers, and (2) intelligent expense control. This creates a lower cost structure for FFDF, and thus higher profitability.
In addition, FFDF stands to benefit from two potential additional positive factors: (1) FFDF continuing to lower their expense structure as they have done successfully over the past decade, and (2) higher interest rates, widening the spread they make between loans and deposits.
FFDF is likely overlooked due to its illiquid and OTC-listed existence, offering investors a strong community bank at a cheap valuation.
Strong Business Model
As mentioned above, FFDF succeeds by doing more with less. Specifically they have ~35% more deposits per branch than local peers, only trailing their much larger regional peers in this category. Why does this matter? If a bank is able to generate more deposits than peers per branch, each dollar of deposits effectively costs less.
Take this simple example: Bank A has one branch with $100mm in total deposits and Bank B has two branches with $100mm in total deposits. Each bank has the same amount of total deposits but Bank B required a second branch to generate those additional deposits. And that additional branch creates additional expenses, mainly in the form of additional occupancy (rent, maintenance, etc.) and employee costs. The end result is that even if both example banks generate the same amount of loans, at the exact same interest rate (meaning they have the same amount of loan income), the higher cost structure of Bank B means it will produce much less in net income. FFDF succeeds by acting like Bank A. Much more extreme examples of “Bank A” exist (online-only banks) but FFDF also has many strengths that those others do not, such as dominance in its local communities (more on that in next section).
Also this “do more, with less” strategy benefits other stakeholders besides shareholders. Although FFDF has less employees they pay each above market rates on average ($86k vs. $73k for peers) which allows them to hire and retain the best talent. FFDF earned the “Great Place to Work” certification since 2019.
Despite FFDF’s net interest margin being average among peers, their expense control and scaled branches allow it to generate strong returns on assets. As of 3Q22, FFDF generates nearly the same pre-tax pre-provision income on its assets as much larger peer Huntington (see below).
Market Dominance
FFDF’s share of deposits in the markets they operate can best be defined as dominant. If you combine the deposits in the six cities that FFDF operates and consider that one market, FFDF would be #1 in deposit market share, out-ranking even the large banks that operate in its markets such as JPMorgan. Even more incredible is that FFDF has 65%+ more in deposits than the competitor that ranks #2 (see table below).
Although top positions in deposit market share are nice, it is really the direction over time that matters. Meaning, is FFDF gaining or losing market share relative to its competitors? On this metric FFDF succeeds as well – in all six cities they operate, FFDF has gained deposit market share compared to five years ago. In the New Philadelphia-Dover, OH metropolitan area, where six of their eight branches are located, FFDF has grown deposit market share consistently over the last decade (see below table). This is even true in their most mature market, the city of Dover, where they held 39% of the city’s deposits at the end of 2015. By 2022, FFDF held 49%.
Risks
The largest risk a bank faces is large loan losses or “underwriting risk”. However, the problem often times is the difficulty differentiating between a bank taking on a lot of risk and one that is not. Normally, it is only when a recession hits do you really know how well the bank has underwritten their loan portfolio - which is too late to find out.
The way to “find hints” on the loan underwriting strength of a bank is to find a management team that has shown no signs of doing anything dumb in the loan and securities portfolio over very long periods of time. With FFDF, they came through the financial crisis with extremely minimal losses on their loans. For 2007-2012, the average commercial bank experienced ~1.7% of losses on their loans per year, whereas FFDF over that same time period only experienced ~0.2%.
The lack of loan issues has continued after the financial crisis with FFDF continuing to experience extremely minimal loan losses and delinquencies. It also helps put you at ease when the top executives/directors own ~13% of the company and all other employees own another ~10% via their ESOP. They are incentivized to act properly and not put the bank, and their large investment, at risk.
Currently, FFDF has loans that are delinquent much below peer levels (0.10% of loan portfolio versus 0.68% for peers). And when the loan portfolio is reviewed by each individual loan category, FFDF has only one category that exceeds peer level delinquent rates.
Also, based on some anecdotal evidence (so take it with a big grain of salt), FFDF seems to be lending to better quality customers at above average rates. FFDF’s website posts interest rates on some of their loan products, including their single-family mortgage (largest segment of FFDF’s loan portfolio). Over the past two years that I have owned the stock, I have looked at this page every few weeks (link). For mortgages, they quote a rate for a 30-year fixed rate loan, with 25% down payment, and customer FICO of 740. Until very recently, this quoted rate was usually around ~50bps above the national average, despite the down payment level and required FICO score also being above typical national averages. The mortgage rate recently is closer to the national average.
But assuming FFDF is sticking to these quoted rates, the implication is that they are lending mortgages primarily at better rates, to better customers, with better collateral coverage. Local customers are likely taking the higher rate given that FFDF seems to have such a prominence in their local community and many people look to their bank for loans first and many times last. Another reason why FFDF’s market dominance is important.
The final point I’ll make centers around FFDF’s pre-tax provision income. On an annualized basis, FFDF currently generates ~$13mm of income before taxes and provisioning for loan losses. An investor can think of this pre-tax provision income as FFDF’s loss absorbing capacity, prior to eating into its capital.
During the financial crisis, the average bank experienced a ~2.4% loss rate, in the worst year, on their single-family mortgage and commercial real estate loans (data at FRED website). As an overly simplified exercise, if you assume FFDF’s entire loan portfolio experiences this 2.4% loss rate (on $525mm of loans), you get ~$13mm of loan losses. Meaning, FFDF’s current pre-tax pre-provision income roughly offsets loss levels of the average bank during the financial crisis. Again, the analysis is overly simplified as the next “crisis” will be different with different causes and magnitudes of losses. But, the Financial Crisis was a large banking industry downturn and, as stated previously, FFDF’s loan portfolio is likely better underwritten than the average bank.
All that being said, it does give some comfort knowing that their business model, generating strong returns on assets, can absorb quite a bit prior to any impact to underlying capital levels.
Valuation
FFDF currently generates ~2.00% pre-tax pre-provision income / assets. Due to their clean loan portfolio, FFDF has averaged a loan loss provision / assets of ~0.15% over the past ten years. This means that FFDF is currently generating ~1.85% pre-tax income / assets, and after an 18% tax rate (lower due to muni bond portfolio), ~1.5% after-tax income / assets.
Over the next five years their return on assets is likely to increase. First, their noninterest expense to average assets has declined nearly 100bps over the past decade (2.7% to 1.8%), as FFDF’s branches continued to grow deposits mostly within their existing branch network. Although growth will likely slow from the high single digit growth rate of the past decade, FFDF should still experience adequate deposit growth to help push down noninterest expense below 1.8% of assets. Combine this with the potential for higher future rates, allowing FFDF’s adjustable-rate and floating rate portfolio to continue to increase, likely increasing FFDF’s net interest margin further.
All of these factors combined means FFDF should generate anywhere from 1.6% to 2.0% in after-tax income to assets. The next question then is what are assets five years from now. Most asset growth is driven by deposit growth. FFDF has grown deposits in the high single-digits as it continued to increasingly dominate its markets. Even if it grows deposits in the mid-to-low single digits means, they are likely near $830mm in deposits five years from now.
A 1.6%-2.0% return on assets on $830mm of deposits implies net income of $13mm - $17mm (or $4.35 - $5.65 per share). With the typical high-quality bank valued at 15x earnings, this implies roughly $65-$85 per share, before excess cash generation is accounted for (i.e., dividends). FFDF’s growth of $160mm in assets (from $670mm to $830mm), will likely require it retains 10% in equity capital against that asset growth. Roughly, $16mm of net income will be required to be held at the bank to fund this growth. If FFDF generates ~$60mm in cumulative net income over the next five years, then ~$45mm will be available to investors, likely in the form of dividends. This $45mm equates to $15 per share. Add that to the $65-$85 per share range, and the total value in five years is likely $80-$100 a share. At a current stock price of $33/share, this implies a 5-year IRR of 20%+ at the midpoint.
A more than adequate return for this high quality bank, likely overlooked due to its small size and OTC-listed existence.
Disclosure: I currently hold shares of FFD Financial. I may buy more or sell my position at any time. Please do your own due diligence before making any investment. None of my posts are investment advice.
Really like the write up. Very well written. Seems like a very well run bank. I am keeping an eye on it.