I’m Putting Real Money on First Financial Northwest

The latest buy for my Special Situations portfolio is First Financial Northwest (NASDAQ: FFNW  ) . Like one of the prior buys in my portfolio, this bank has demutualized and is knee-deep in the process of cleaning up from the financial crisis. It trades below tangible book value and has another catalyst, which I'll explain in further detail below. On the next market day, I'll buy $1,000 of the stock.

First Financial Northwest
First Financial demutualized many years ago but has had a troubled history, leading to its current valuation below book.

Since becoming a fully public institution about seven years ago, the company has come under the regulator's thumb, with an outstanding memorandum of understanding (MOU) to its name. According to the latest 10-Q, the MOU "contains provisions concerning the management and directors of the Bank, interest rate risk, minimum capital levels, the allowance for loan and lease losses, ... [and] lending and collection policies" as well as other matters. First Financial had a failed acquisition of a mortgage warehouse and, of course, suffered through the financial crisis, taking its market cap well below its tangible book.

So, what's to like?

Despite these issues, the bank was profitable over the last year, and its tangible book value has not just held steady but actually gained 6% over the last nine quarters. Its average equity is a very high 17.2% of assets -- well above the regulatory minimum. And non-performing assets as a percentage of equity is way down, from 79% in early 2010, to just 23% in the most recent quarter.

First Financial's price to tangible book now stands at a cheap 0.78, so there's still time for us to profit on the return to a 1 times multiple. Eventually the bank will clear the MOU, plus with the catalyst below, I think we have plenty more potential for upside.

The special situation
The catalyst at First Financial is the presence of noted thrift investor Joseph Stilwell, whose fund owns 9.4% of the company. Stilwell dug in his teeth at First Financial, running his own candidate during last year's director election and eventually won, though not without suing the bank to realize that victory. Stilwell and the company settled last month, agreeing to the appointment of Stilwell's candidate to a three-year term and the eminent departure of Victor Karpiak as chairman.

Other activists also own the stock, including O-Cap Partners, which has agitated for "strategic alternatives," including selling the company. That would fit well with Stilwell's modus operandi, which frequently includes selling off the banks he owns.

The typical buyout price for a demutualized bank is 1.6 times tangible book value, implying about a double from today's price, even if the company cannot grow tangible book. Whether it goes for anything near that, I still think we have the makings for a great investment, here. Regardless of how this plays out, I expect Stilwell to agitate for value-creating moves, which could also include a buyback. Plus, the position makes up about 8% of Stilwell's fund, so he's sufficiently interested in First Financial.

Foolish bottom line
On the next market day, I'll be buying $1,000 in First Financial Northwest in my Special Situations portfolio.

Interested in First Financial Northwest or have another stock to share? Join me on my discussion board and follow me on Twitter (@TMFRoyal).


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