FFD Financial (FFDF): A Conservative Community Bank with a High ROE Trading at Less than 10x Net Income

by REID HUDSON           

FFD Financial Corp. (FFDF) is a small Ohio bank holding company that owns all the outstanding shares of First Federal Community Bank.  It is headquartered in the town of Dover, Ohio, where it also has its two largest branches.  The bank has a market cap of just under $54 million and is listed on the OTC Pink Sheets.  It is extremely illiquid, with average daily volume over the past year at 173 shares, representing around .02% of shares outstanding (although that daily average has jumped to 232 shares in the last three months).  The bank delisted from the NASDAQ stock exchange in 2012, pursuant to relaxed reporting requirements put in place by the JOBS Act for companies with less than 1200 shareholders.  This allowed FFD to save money by avoiding periodic filings with the SEC as well as NASDAQ compliance.  The company does, however, still file annual reports with the SEC and posts them on its website. 

FFD is an interesting potential investment because of the way it has been able to vastly outperform almost all community banks and most large commercial banks when it comes to return on average equity (ROAE) and return on average assets (ROAA).  The bank has also decreased the cost of its deposit base since the financial crisis, with CDs as a percentage of total deposits going from 54% in 2008 to around 30% in the third quarter of FFD’s fiscal year 2019. 

FFD just released its unaudited financial statements for the fiscal year-end 2019.  Its total assets stood at just under $414 million, its loans at about $336 million, its deposits at around $371 million, and its shareholders’ equity at just over $39 million.  Also, FFD’s borrowings are down significantly, standing at just $257,000 compared to over $13 million at year-end 2018.  This financial data, however, is unaudited.

The bank’s fiscal reporting year ends on June 30 each year, and its audited financial statements, as of June 30, 2018, show total assets at $382 million, total loans at around $306 million, deposits at about $332 million, and shareholders’ equity at about $34 million.  FFD’s audited financial results only go back to 2004, so that is the earliest year I will be able to reference in this report.  From 2004 to 2018, FFD’s assets grew at a CAGR of 7.66%, its loans grew at 7.28%, its deposits at 8.5%, and its shareholders’ equity at 5.1%.  These results have increased in recent years because of the company’s higher returns which it is able to retain to fuel deposit and loan growth.  In the last five years, FFD’s deposits have grown at a rate of 9.3%. 

FFD’s 2018 year-end ROAE was at 15.3% and its ROAA was 1.35%, and its unaudited year-end 2019 ROAE was at 17.4% and its ROAA at 1.59%.  Obviously, as a small bank this is very impressive, especially considering FFD has been able to achieve this by utilizing only a traditional banking business model.  Most small banks you find that generate high returns on equity are doing so through the use of a large mortgage origination operation or some other kind of non-interest income revenue source.  I consider banks relying primarily on mortgage origination income or SBA loan origination income to be much riskier than a bank like FFD.  

Mortgage origination is not necessarily a repeatable income source.  To bring in this kind of income, a bank must continuously source new customers to sell mortgages to.  A bank must also incur a lot of leverage to fund the origination before it is sold off or securitized.  While this business model results in operating leverage at the normal banking branch level, it does not result in the same operating leverage that can be achieved by organic deposit and loan growth.  A bank usually compensates mortgage origination personnel in a way that incentivizes them to generate more business.  This usually means that compensation costs increase as income increases.  You can see this by looking at the American Banker top 200 community bank list.  Most of the small banks on that list generate a lot of non-interest income, and most banks are increasing non-interest expense at a rate over 10%.  You may have to discount these results, however, because the list also shows FFD’s non-interest expense growth as 12.69%.  In reality, FFD’s non-interest expense growth was at around 10% from 2017 to 2018, but in the years preceding that, it has ranged from 3-6%.  Regardless, even the publication notes that the growth in non-interest expense is a troubling statistic.

While FFD has been able to keep non-interest expenses relatively steady, what has been really impressive is the way it has been able to dramatically decrease interest expense while substantially increasing its deposits.  In 2008, the bank’s deposits stood at about $141 million and its interest expense was over $5 million.  At the end of 2018, its deposits were about $332 million and its interest expense was just under $2 million.  If you want a rough estimation of interest costs at these two points in time, dividing the interest expense number by total deposits should give you a general picture of the cost of funds.  This calculation translates to a rough interest expense rate of about 3.5% in 2008 versus an expense of about 0.6% in 2018.  I know that interest rates have decreased over this time period, but FFD’s total deposits have grown at a rate of 135% over a decade while its total interest expense shrunk by almost 62%.  This is very indicative of a new and lower source of funds for the bank.  FFD’s unaudited interest expense as of fiscal year-end 2019 has risen to just over $3 million.  This may seem like a lot, but with deposits growing to over $370 million, the effective interest expense only increased to about 0.8%.

Business Model & Competition

FFD Financial Corp.’s business model is the epitome of a well-run community bank.  It has seven branches as of fiscal year-end 2019, and it is concentrated in small towns in the two Ohio counties of Tuscarawas and Holmes.  Tuscarawas County, Ohio, is the bank’s original place of business, and it has five branches there.  FFD is the second largest bank by deposit market share in Tuscarawas County with deposits of $283.7 million.  It has 19.72% of the market, and the leader, Huntington Bancshares, Inc., has 22.93% with $329.9 million in deposits.  In Dover, its original market, FFD has two branches with $210.3 million of deposits and 43.71% of the market.  In second place is J.P. Morgan Chase with $100.1 million and 20.81% of the market.  FFD’s deposit market share in Dover increased to 43.71% in 2018 from 40.51% in 2017, while J.P. Morgan’s stayed relatively consistent at 20% and the third-place bank – Huntington Bancshares – decreased from 25% to 20%.   

FFD is not as established in Holmes County, Ohio.  In terms of deposit market share, it is in third place with only 5.69% of the market.  The top two banks hold around 40% of the deposits each.  FFD is relatively new to Holmes County, with its first entrance occurring in 2009 when it constructed a branch in Berlin, Ohio.  FFD then purchased a Holmes County branch in Mt. Hope from CSB Bancorp in 2017.  While FFD is a distant third in the deposit market in Holmes County, it did experience the fastest growth in deposits out of any bank in the county in 2018 – over 23%. 

FFD Financial is a conservative bank, with its net charge-off ratio averaging 0.11% since 2005 (furthest back I have data from) and 0.004% in the last five years.  The nonperforming loan to total loan ratio has averaged 1.29% since 2004.  Keep in mind the long-term averages of both of these ratios include the financial crisis.  FFD’s highest net charge-off ratio was 0.36% and occurred in 2011.  During 2008, 2009, and 2010, its net charge off ratio never exceeding 0.20%, showing that the bank was almost completely insulated from the chaos that was decimating much of the banking sector. FFD has never been a bank that has targeted a specific growth rate, yet it has been able to grow while remaining conservative in its lending.  Trent Troyer has been the president of FFD since 2000 and has overseen the bank through the financial crisis as well as recent years of growth. 

In my opinion, to analyze a bank you have to look at it the opposite way you would look at any other kind of business. Obviously, banks are very highly leveraged institutions.  This could be construed as an indication of their relative riskiness compared to other kinds of businesses, and is one reason why they are so highly regulated (besides the fact that they hold the funds and savings of almost all the citizens in a given country).  Because of this, a bank’s liabilities should be viewed as assets and its assets should be viewed as liabilities.  This primarily means that commercial banks are usually able to differentiate themselves, and therefore earn higher returns, because of the quality of their deposits, not their loans. 

Bank loans are essentially commodities.  It is very difficult for a bank to earn a higher return on its loan book than other banks without taking on more risk.  Obviously, this analysis is not taking into account any fee-generating revenue sources a bank may have access to, but for now let’s just stick to general commercial banking operations.  Most banks, especially community banks, are going to be competing with each other on loans and earning the market rate of return on those loans.  Therefore, it is essential that these loans bring in the market-level interest rate consistently, and that they do not cease to bring in this interest income because of default.  Because of this, I think that a bank’s loan book should be assessed primarily on its sustainability and riskiness, not its ability to generate above-average rates of return. 

Deposits, on the other hand, are the primary way that a commercial bank may be able to differentiate itself and earn high returns on its equity.  If a bank is borrowing or issuing bonds to fund its lending, then it is probably paying a higher rate than it would on deposits, if it could bring them in.  Deposits are, for the most part, a cheaper way to raise capital than most other forms.  At one end of the spectrum are time deposits (CDs, brokered deposits, etc.), which pay out the highest rate of any form of deposits and are not very sticky at all.  Banks must compete for these kinds of deposits, and therefore, must offer higher interest rates to attract them.  This means that these deposits are actively seeking the highest rate, and are likely to leave as soon as the deposit period ends.  On the other end of the spectrum, you have demand deposits and even savings accounts that are much stickier and usually pay lower or no interest.  Banks that have and develop deposits based on relationships with customers are usually the banks with the best kind of deposits and the best competitive advantage. 

I don’t know if FFD has the strongest possible relationships with its customers, or if it develops deposits based on relationships with businesses or other kinds of depositors.  What I do know, however, is that FFD is based in small towns.  Primarily, small towns where it is the leading or one of the leading banks based on deposit market share.  This indicates to me that FFD likely has sticky, long-term deposits that are probably cheaper than deposits acquired through a CD offering or a deposit broker.  Think about it, if you live in a small town where one bank serves almost half or 20% of the people living in that community, and you and your family have been depositing your money in that bank for as long as you can remember, you are probably going to keep depositing your money there. 

Like I said, I don’t know what kind of relationships FFD has with its customers, but I’m pretty sure they are better relationships than the relationships a national bank would be able to form if it came to town. There isn’t much a new bank is going to be able to do that will make a lifelong depositor in one bank switch to a new one

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