Description

Thesis

FFNW is a small (~$200mm market cap) off the run merger arbitrage situation in a deal with a high probability of closing offering an 7-10% gross return (11% to 17% IRR) to a year end close. The deal’s somewhat convoluted structure and novel buyer explain the relatively large spread for a deal that has a very high probability of closing. 

The Transaction

On January 11th, FFNW announced that it had agreed to sell its banking subsidiary to Global Federal Credit Union – an Alaska based credit union with $11.9 billion in assets (17th largest credit union in the U.S.)– for $231.2 million in cash subject to certain adjustments after which FFNW would immediately enter liquidation and distribute the remaining cash after settling holding company liabilities to its shareholders. The company currently estimates that its shareholders will receive a distribution of approximately $23.18 to $23.75 per share. The transaction is expected to close in Q4.  

After a prior attempt to sell FFNW collapsed in July 2023, the company told its investment bankers Janney to shop itself. On July 21, 2023 the company met with Global Federal for the first time and conversations for a potential transaction began. In late September, Global Federal proposed an asset purchase and liability assumption agreement and a structure for the transaction. 

Importantly, as conversations became more serious in early December, the two companies jointly met with the FDIC, Federal Reserve, Washington State Department of Financial Institutions, and the NCUA to talk about the potential combination and listen to their potential concerns.

Shortly thereafter the 2 sides started drafting the asset purchase agreement and on January 10th the 2 sides executed the agreement. 

The deal requires regulatory approval from the NCUA, FDIC, WDFI, and standard DOJ/FTC antitrust approval. With the deal getting put to paper a couple days after the NCUA, FDI, WDFI, and Federal Reserve meetings it would seem reasonable to infer that the 2 companies didn’t hear any material concerns about the deal or its structure in those meetings. 

It is worth noting that Global Federal has been a serial acquirer in recent years and has never had any issues getting acquisitions approved by the NCUA.

DOJ/FTC risk in this merger should be negligible given the size of the institutions. FFNW is the 14th largest bank headquartered in WA state.  

It is worth noting that Global Federal while headquartered in Alaska has operated branches in Washington State for over 40 years. Global currently has 27 branches in WA State. 

The purchase price for FFNW’s banking subsidiary is $231.2mm minus any dividends, minus $142,000 to remove storage tanks at one of their properties minus up to $500k in employee bonuses minus up to $3mm if deposits fall more than 10% minus losses on disposition of loans Global is legally not allowed to purchase minus $821k to terminate the pension plan minus excess costs above $150k to liquidate the bank minus taxable gain on sale of bank's assets minus unexpected costs. FFNW withdrew from its defined benefit plan and purchased a single premium group annuity during Q1 settling the pension plan liability at a cost of $1.2 million. 

Remaining at the holding company is FFNW’s deferred tax asset, $150k of cash, and the rights to all tax refunds (if any), prepaid expenses, and bank employee plan assets. 

Liabilities not being assumed by Global that remain liabilities of FFNW.

The bank has a June 1st deadline to sell/refinance the loans that Global Federal is not legally allowed to acquire. The purchase price of the acquisition will be reduced by an amount equal to 10% of the amount by which the aggregate outstanding principal balance of the excluded loans that were not refinanced or sold exceeds $30mm. 

Putting these together assuming no value for the retained assets at the holding company and no additional liabilities coming out of left field we get estimated values for the liquidation consistent with management’s guided liquidation value even after the slightly higher than expected cost to defease the pension liability.

Company Overview

FFNW is the bank holding company for First Northwest Bank – a community bank that operates in the Seattle suburbs. The company went public through a demutualization in 2007 as a single branch bank. 

Over the last 9 years, the company expanded through the acquisition of 4 branches from competitors and through de novo expansion. The bank currently has 15 branches.

Since current management took over 11 years ago the deposit base has been transformed from 70% CDs to currently 74% core deposits (checking and money market accounts.) 

Over ½ the deposit base comes from business accounts. 

While FFNW has mediocre returns on assets and equity the bank’s balance sheet is pristine with a 10.4% tier 1 leverage rate and only 2bps of nonaccrual loans compared to an allowance of 1.3%.

Credit has been pristine in recent years.

The loan book is primarily composed of single family homes and commercial real estate. 

The majority of the loan book is adjustable rate loans.

Tangible book at the end of Q1 was $17.32/share. The company had a small loss in Q1 related to the purchase of the single premium group annuity to defease the pension liability and expenses related to closing the merger.

Note: FFNW has 9.159mm shares outstanding.

Other

FFNW’s institutional shareholder base is almost exclusively quant funds, index funds and insiders.

Historically the company has been very aggressive buying back its own stock having reduced shares outstanding by over 50% in the last decade.

The deal comes to roughly a 1.4x tangible book valuation. 

The transaction multiple is in line with where other banks are transacting in Washington State.

Source: S&P Global

Risks

FFNW would be the largest bank ever acquired by a credit union. There is some political pushback from the community bank trade associations who don’t want credit unions to become larger competitors. Doing anything to block this merger or other credit union acquisitions of community banks likely would require an act of Congress or an act of the WA legislature which isn’t going to happen in an election year. It is worth noting that some states like Mississippi have enacted legislation making it more difficult for credit unions to acquire banks and there is legislation being considered in MA, SC, and WV on this issue. There has been no action at the Federal level or in WA state regarding this.

Bank buys raise questions about the 'credit union difference' | ABA Banking Journal

The largest attempted credit union takeover (Vystar’s attempt to acquire Heritage Southeast Bank) was called off after a year so there is some precedent for bank acquisitions by credit unions failing.

Global Credit Union Plans Second Largest Bank Acquisition | Credit Union Times (cutimes.com)

The ICBA a community bank lobbying association filed a Community Reinvestment Act protest against the acquisition back in February. Worth noting FFNW has high CRA ratings so this likely won’t be an issue. 

ICBA files protest of largest-ever credit union bank acquisition

FFNW’s financial performance relative to other banks in WA state has been relatively poor. For example it’s ROE in 2023 of 5.03% trails its peers 9.51%. If the deal were to break for whatever reason, FFNW would likely return to trading at a discount to tangible book value. FFNW shares traded ~$13.70/share prior to the deal with Global being announced and a return to something around $14/share (80% of tangible book) seems possible in a deal break scenario. 

Source: S&P Global

Catalyst

Merger closes on the agreed upon terms. Company follows through on plan to liquidate and distribute the proceeds back to shareholders.