CFFN is a 2^nd step conversion that will likely price somewhere next week. The book closes on Monday.

CFFN is a overly conservative run thrift, soon to be bank, based in Kansas and 2 counties in Missouri. It has 46 branches with an average deposit base per branch of $113.9 million according to the offering doc. (I get to a range of $101 to $106 million)

Post 2^nd step its tangible equity to assets will be more than 20%.

It's NPA over assets pre 2^nd step is 0.47% which will decline to 0.42% or less post 2^nd step. The pre 2^nd step NPL to total loans is 0.62%. Both numbers compare very favorably to the industry.

The offering is the following:

At the minimum CFFN wants to issue 118.15 million shares at $10 which results in a TBV per share of $11.92 or a PtoTBV of 0.84.

At the midpoint CFFN offers 139 million shares at $10 which results in a TBV per share of $11.09 or a PtoTBV of 0.90.

At the maximum CFFN will offer 159.85 million shares at $10 which results in a TBV per share of $10.47 or a PtoTBV of 0.96.

But there is also potentially a better way of getting the shares. 29.5% of the post 2^nd step shares are already outstanding and carry the following exchange rates.

If the minimum amount of shares are issued then the exchange ratio is 2.2637 shares per pre 2^nd step share.

If the midpoint amount of shares are issued then the exchange ratio is 2.6632 shares per pre 2^nd step share.

If the maximum amount of shares are issued then the exchange ratio is 3.0627 shares per pre 2^nd step share.

So lets say you buy the pre 2^nd step CFFN shares at the current price of $24.30, at the minimum issuance you pay $10.73 per share or 0.90 times TBV. But if the midpoint number of shares are issued, you pay only $9.12 per share or 0.82 TBV and if the maximum number of shares are issued, you pay only $7.93 per share or 0.76 times TBV.

Here is an overview of what you would pay based at different prices of the pre 2^nd step CFFN stock

So there are two decisions to be made. A. Do you believe that at the $10 issuance price that CFFN shares are cheap? And B. What do you believe the number of shares issued will be?

Lets start with CFFN and why I believe it to be an attractive risk reward.

CFFN's issuance price even if the maximum amount of shares are issued will have a PtoTBV of 0.96 (at the low end of the offering it will be 0.84), while comparable banks trade at significantly higher multiples if adjusted for size, tangible equity to total assets and non performing assets to total assets.

Here is a list of comps

As one can see, CFFN will have by far the highest level of TE to Total Assets, the lowest level of NPA to Total Assets and with about $10 billion in assets it is has enough size for larger institutions to be interested. Size does matter I believe when it comes to these second step conversions and you tend to see that as they often price at higher multiples upon their conversion than institutions with small asset bases.

As you can see almost all are currently trading at a multiple of more than 1.2 times TBV, most trade in a range of 1.3 to 1.5, all the while having much lower TE/Total Assets and higher NPA/Total Assets. The most relevant outliers are HCBK and NWBI. HCBK trades at 1.11 times TBV, but it has close to 5 times the NPA/Tot Assets than CFFN will have post conversion and it is also exposed in a large way to jumbo loans, a continuing worry for many. NWBI sells for 1.08 times TBV and has 2.1% NPAs, also more than 5 times that of CFFN post conversion.

One important piece of information regarding CFFN's current offering valuation is related to its failed effort to do the conversion over the summer. This was related to the widespread sell off of the banks from April 2010 through the end of August 2010. The closing date was supposed to be August 24, 2010. In the 70 days prior to August 2010, 6 2^nd step conversions came to market and 5 of them were selling below their offering price. Given the uncertainty surrounding the whole banking sector at that time interest was lacking.

Anyway all that was a real negative for CFFN as it required a new appraisal. And this time the appraisal came in 18.2% lower than the first one. The appraisal was mostly based upon comps, recently completed conversions and the failed CFFN deal. So in essence the deal got scuffled because of the decline in bank stocks and then that decline in bank stocks resulted in a lower appraisal, right before the valuations of the same comps went up again. Talk about bad timing. Actually, it was quite obvious that the appraisal had to come in lower as management really needs this to get done as the OTS is about to go away and the OTS itself does not like prices to break the offering price.

The result of this all was that instead of the minimum - maximum offering range of 144.5 million to 195.5 million shares offered over the summer, the number of shares offered went to a range of 118.15 million to 159.850 million shares offered or 18.3% cheaper than over the summer, all for the same 70.5% ownership percentage.

I don't think it makes much sense to value CFFN right now on an ROE basis as its TE/TA is about to increase markedly. The company has said that its options for the excess capital are to acquire other banks with a profile of strong core deposits and/or open more branches or to buy back stock/pay dividends. Since they have to wait at least one year to buy back stock I assume in the short-term an acquisition and/or building more branches is more likely. Management tends to be very conservative, so the hope is that they will not overpay. A positive though is that the employee ownership plan and management will have significant ownership and upside, which hopefully prevents them from allocating capital in a subpar manner.

Another potential upside would be selling the company in 3 years. Many of these deals go for 2 times book or more, especially those with strong core deposits, good efficiency ratios, low NPAs and a strong balance sheet/excess tangible equity.

Regarding the dividend, CFFN will pay out 100% of total earnings for the first two years, expected to be about 30 cents and will also pay a 60 cents welcome dividend for a year one dividend yield of 9%.

When it comes to deposits, CFFN has the second largest market share of 7.6% in Kansas, after the 7.78% for BofA.

Here is a listing of deposit metrics for the state of Kansas.

* The FDIC data stated $4,563,623 in deposits ($106.1 million per branch), but I decided to go with the current numbers in the offering document.

I did not review the Missouri numbers as with only two branches, that seem pretty new, the numbers are not very insightful.

As one can see that the Kansas market is still fairly fragmented and it seems that CFFN might be an attractive takeover candidate by a large bank trying to increase its market share in state or one that wants to enter the market with a bang. Just comparing markets share, in CA BofA has a 26.28%, while WFC has a 19.19% market share.

CFFN also has the second highest deposits per branch, 28.44% more than third ranked BofA ($79.2 million), and after WFC's $145.5 million per branch.

The efficiency ratio for CFFN is 42.65%

Regarding sources of funds, as of June 30, CFFN had total deposits of $4.373 billion. Advances form FHLB were $2.396 billion. In addition other borrowings were $713.609 million. CFFN has a policy that brokered deposits cannot be more than 10% of total deposits. On June 30, total brokered deposits were $83.7 million or 2% of all deposits. The other borrowings were mostly repurchase agreements ($660 million or 8% of total assets). In addition post conversion, CFFN will have between $1.99 and $2.37 billion in tangible equity.

If you want the detail on the sources of funds, look on page 105 of the November 12 S-1.

When it comes to assets, CFFN has $8.543 billion in assets.

As of June 30, one to four family real estate loans totaled $5.06 billion or 94.4% of the total loan portfolio and 59.3% of total assets. All loans are full doc and serviced internally. All loans with an LTV over 80% carry mortgage insurance. Multi family and commercial loans are $67.12 million or 1.3% of total loans, construction is $36.31 million or 0.7% of total loans. Consumer loans are $196.28 million or 3.6% of total loans.

Besides internally generating one to four unit mortgages, CFFN also purchases loans. All loans have to be underwritten according to the CFFN underwriting guidelines.

Of the $5.6 billion in mortgages, $4.1 billion is fixed and 0.95 billion is adjustable.

For a detail on the mortgage loan book (including delinquent and non-performing) look at page 98 of the S-1.

Below is a layout of the mortgage loan book including exposure by state.

As you can see, most of the delinquencies are related to 2004 and 2005 vintages. Most of those losses are related to $210 million in 2004 and 2005 vintage Interest Only loans that were purchased in 2005. CFFN stopped buying Interest Only loans in 2006. The current NPLs related to that Interest Only portfolio are $16 million or half of the total NPLs.

Total delinquent loans (30 to 89 days) at June 30 represented 0.27% of total assets, a decrease of about $3.7 million over September 30, 2009. (For detail see page 96 of S-1) Of all delinquent loans about 38.9% cured over the last 12 months. Non mortgage related delinquencies were $892K out of a total of $23.112 million. Total non-performing loans (+90 days including ROE) represented pre 2^nd step 0.47% of total assets. Post 2^nd step that will decline to 0.42% or less. NPAs increased by $1.7 million over September 30, 2009. Of all NPAs, $552K was non-mortgage related out of total of $40.330 million.

As of June 30, the allowance for loan losses was $15.7 million or 38.9% of all NPAs.

The average LTV as for purchased loans as of June 30 was 58% with an average FICO (updated June 30) of 741. The average LTV for originated loans was 66% with an average FICO of 761. Below is a matrix from the S-1 that lays out the LTV/FICO exposures. As one can see, the majority of the loans has a FICO of 751 or above and an LTV of less than 70%. (See page 95 of S-1)

CFFN also holds a book of securitizations of $1.62 billion. Except for $3.6 million private label MBS all are related to Fannie, Freddie or Ginnie.

On the investment securities side, CFFN owns $1.2 billion, mostly debentures issue by Fannie, Freddie and Ginnie as well as munis. Over the last year it grew from $480 million to $1.2 billion. About 1 billion of that has a WAL of 1.1 years.

In addition, CFFN holds $136 million in FHLB stock and $179.52 million in other assets.

The interest rate spread for the year through August was 1.78% and the net interest margin 2.06%.

The existing employee ownership plan plans to buy 4.0% of the offering. In case that maximum amount of shares are issued, the employee ownership plan would own 6.08% of the company. In addition there are the pre-conversion ownership and post-conversion stock based incentive plans. The OTS requires that all restricted stock and options vest at the earliest in 5 years (except in case of a buyout). Total inside ownership if all planned restricted stock and options vest will be 12.93%. Besides the 6.08% employee ownership, there will be 1.62% outstanding in restricted stock and 5.23% in options. 1.7% of the options are pre-conversion and 3.53% will be post-conversion ($ exercise price of $10).

Pre-conversion there are 405,031 options outstanding which translates into between 916.9K options and 1,240.5K options post-conversion depending on the # of shares issued. The average exercise price pre-conversion is $34.11 which translates into a new exercise price of $15.1 per share in case the minimum amount of shares are issued and $11.1 in case the maximum amount of shares are issued. (Of the 405,031 options outstanding, 305,081 were exercisable.) For details see page F-47 of the S-1.

Lastly, based on the midpoint shares issuance, John B. Dicus (dad) and John C. Dicus will own post conversion 1.554 million and 1.587 million shares, representing a total monetary interest at $10 of $31,491,970. Management and directors in the aggregate will own a total of 5.263 million shares (2.7%) post-conversion.  This does not include options and restricted stock awards.

Risks:

- The asset quality is worse than expected. Could be, but given that we are now in year 4 of this mortgage/credit mess, one would assume that NPAs by now are somewhat representative of current asset quality.

- Leverage can be an issue too with banks as most of us noticed over the last few years, but with TE/TA of more than 20% post-conversion it is difficult to see how this bank goes out of business, especially given its current level of delinquencies and NPAs. We'd have to see quite the reversal in asset quality to see this bank go out of business.

- The biggest risk I believe is capital allocation. What is management going to do with all that TE? Now if it was Ken Lewis running this place I'd be worried. But this management is known to be very conservative. The branches are clearly well run and its book of assets has done significantly better than its competitors. Management pre-conversion already had a boat load of capital, still it did not reach for earnings which is a good sign. So I feel somewhat confident they will do the right thing. They surely are incented to do so.

- Of CFFN's mortgage loan book, 73.2% is related to Kansas and 15.2% related to Missouri.

Concluding, I feel that CFFN makes for an attractive risk reward. For one, despite having the lowest level of NPA/TA, the highest TE/TA and above average total assets, it is clearly trading at a fairly large discount to comps, 30% plus even in case the maximum amount of shares are issued. CFFN should probably be trading a premium to its average comp, given the quality of its balance sheet and its total size of assets.

So there are three ways to get a hold of this company. Either one buys the currently trading CFFN stock and hope that as many shares are issued as possible. Or one can sign up to the offering and hope that only the minimum amount of shares are issued. Remember the book will likely close this coming Monday. And lastly, one can just try to buy the stock once it starts trading post-conversion.