HF Financial Corp. (HFFC): HF Financial: A Small Bank With Lots Of Hidden Potential

Investment Thesis

HF Financial Corporation (HFFC) is the parent company of Home Federal Bank and other supplemental financial services companies. HF Financial displays some traits that mark it as a possible takeover target and as an undervalued investment opportunity. However this doesn’t mean that HFFC is a worthwhile investment opportunity. Here are the traits that make HFFC attractive, we’ll discuss the risks a little later:

Reasons An Opportunity Might Exists

Thrift conversions and small community banks, while known to value investors, are usually under-followed by the market. However this isn’t the whole story.

HFFC is a quite illiquid stock and given its sub $ 300 mil market cap and its lack of any sell-side coverage, it’s most likely to be unknown to most institutional investors. And since growth prospects are meager for small community banks, growth investors don’t even bother to look at this part of the market.

Furthermore the company with a current TTM ROE below 5% and its price close to BV it doesn’t appear as favorably to banking screens.

Company Overview

HF Financial Corporation is a unitary thrift that was formed in November 1991 for the purpose of owning all of the outstanding stock of Home Federal Bank which it acquired on April 1992.

Home Federal Bank was founded in 1929 and is a federally chartered stock savings bank headquartered in Sioux Falls, South Dakota.


HFFC’s loan portfolio is an interesting one since it has a wide variety of loan types:

Residential Real Estate: In this category the company includes loans that are backed by existing real estate and loans that are originated for the construction of residential real estate. These loans are about 7.2% of the total.

Commercial Real Estate: Commercial real estate is HFFC’s biggest loan class. In it the company includes multi-family real estate loans and commercial real estate construction loans. This class accounts for 46.2% of the loan portfolio.

Agricultural: These are loans made to serve the needs of the agricultural community. The may be loans that help fund various aspects of the farmers’ business operations or that help them acquire agricultural real estate. This loan class is about 25% of total loans.

Consumer: This loan class includes direct and indirect consumer loans, home equity loans and overdraft and reserve loans. It is about 11.4% of the loan portfolio.

Credit Health

Non-performing assets have been fluctuating from 0.9% of total assets up to 2.9% during the past five years and currently are at 1.82%. HFFC’s credit quality is more volatile than usual due to the company’s focus on commercial and agricultural lending. The serviceability of such loans is inherently tied to the economic cycle and are affected by various external factors like commodity prices and the local climate.

Funding & Deposits

HFFC’s asset base apart from equity is funded by deposits and borrowings. Deposits are about 75% of total liabilities and borrowings 14%. Most of the company’s deposits are interest-bearing and HFFC pays on total deposits an average 0.53% annual interest. On its borrowing the company pays on average a 3.5% annual interest.

Investment Portfolio

HFFC has an investment portfolio of $ 392 million with 95% of it in agency residential mortgage backed securities (RMBS). And this is where the opportunity is hiding. HFFC pays a 3.5% on its own borrowing but is earning just 1.3% in income from its investment portfolio.

However if the company liquidated its investment portfolio and paid off all of its debt then it would find itself with $ 241 million of surplus cash. This potential cash is what makes HFFC valuable for shareholders. If this cash was put to work in loans as productive as those HFFC already has, the company would earn 65% more on pre-tax income or about $ 15 million compared to the $ 8.9 million it earned in 2012.

Keep in mind that this situation doesn’t necessarily imply a bad management team. There may be legitimate reasons why the company didn’t expand its loan portfolio and chose instead to invest in RMBS. There may not be enough demand for loans in South Dakota or the terms for attracting more business may be unfavorable.


Ignoring its hidden earnings potential that we saw above HFFC should worth as much as its tangible book value which as of September 30, 2013 was $ 12.92 or 3% below its current valuation.

However HFFC’s true earning power as we demonstrated is about $ 15 million pretax or about $ 10 million at the current tax rate. Taking this into consideration HFFC’s intrinsic value skyrockets to 10x pre-tax earnings, which would be about $ 150 million or about $ 21/share.

The reason HFFC is worth at least 10x pre-tax earnings is that historically this is the minimum valuation conservative acquirers usually pay for low-risk businesses with stable cash flow.


However, with the exception of an impending catalyst to unlock its potential earning power, HFFC is currently trading at too high levels for prudent investors. So lets take a look at potential catalysts down the road:

The chart below demonstrates how powerful the consolidation within the banking industry has been over the years. The reasons behind the consolidation are simple. Regulatory costs have become more and more burdensome over the years and small banks in particular have seen their bottom line shrink because of this. In order to survive small banks are forced either to merge with each other or to sell operations. According to SNL, since 2010 there have been over 713 deals executed and below you can see how dramatically the number of banks/thrifts has declined over the past 30 years.

Given the almost 12% stake HFFC’s management has in the company we can be quite certain that they would look after shareholder interests by assuring the best price possible in the case of an acquisition. Unfortunately, we can’t know if an when a potential acquirer will show up.

Fortunately for shareholders though there is one more catalyst investors can count on. On June 30, 2012 HFFC signed a confidentiality agreement with Jacobs Asset Management (JAM) (its biggest shareholder) in order to allow the two parties to “exchange views about the business” and allow JAM to review the company’s books. The agreement was valid until HFFC’s annual shareholders meeting on November 21, 2013.

This move by JAM is a solid sign that (A) they like what they saw (since they didn’t sell any stock) and (B) they are making moves to help or push management to unlock value for the company’s shareholders.



HF Financial is a fairly valued bank that under a certain set of circumstances may create a huge amount of value for its shareholders. Unfortunately there isn’t a strong catalyst in the horizon and investing at its current price level is a gamble. However if it becomes available at a 10%+ discount it will probably be a great investment opportunity.

What Next?

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