[Letterhead of First Federal Bankshares, Inc.]
July 14, 2006
Mr. John P. Nolan
Securities and Exchange Commission
Division of Corporate Finance
100 F Street NE
Mail Stop 4561
Washington, DC 20549
Re: First Federal Bankshares, Inc.
File Number: 000-25509
Dear Mr. Nolan:
Thank you for your inquiry dated June 16, 2006, regarding certain
disclosures in recently filed Forms 10-K and 10-Q of First Federal Bankshares,
Inc. (NASDAQ: FFSX). I would also like to express my appreciation for the verbal
extension of time that Mr. John Spitz of your office granted us to respond to
your inquiry.
Following is the information that you requested:
Timeline of Facts and Circumstances
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Fiscal Year Ended June 2005--During this period multiple loans totaling
$4.2 million to Borrower A, a commercial electrical contractor, were
restructured and were added to FFSX's classified assets. Because of lingering
doubts regarding Borrower A's ability to meet its obligations even after the
restructuring, a specific loss allowance of $2.3 million was established based
on the estimated liquidation value of the collateral (refer "Source of
Collateral-Based Information," below, for additional discussion). The $4.2
million loan and related loss allowance of $2.3 million supported the amounts
referenced in the discussion on page 7 of Form 10-K dated, September 13, 2005.
The restructured loan to Borrower A was not included in non-performing assets
and was not charged-off as of the fiscal year-end because the borrower had met
the terms of the restructuring as of that date. In addition, management was not
certain at that time that additional future restructurings would be necessary,
so charge-off of all or a portion of the allowance was not considered necessary
or appropriate at that time.
Nine-Months Ended March 2006--Despite $0.4 million in payments that reduced
Borrower A's outstanding loan obligation to $3.8 million during this period, the
borrower was unable to honor the terms of the restructuring. A second
restructuring was initiated during this period which reduced the borrower's
obligation to $2.7 million and triggered a $1.1 million charge-off against the
previously established loss allowance. The restructured loan amount, as well as
the resulting charge-off, was based on discussions with the borrower, current
and projected financial information provided by the borrower, and management's
judgment. The remaining loss allowance of $1.2 million ($2.3 million original
amount less the $1.1 million charge-off) remained appropriate given continued
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doubts about the borrower's ability to meet its obligations under the second
restructuring and the estimated liquidation value of the collateral. In
addition, the restructured loan was placed on non-accrual and was included in
non-performing assets during the period. In addition to this loan, an unrelated
$1.1 million loan to Borrower B, a commercial earth-moving contractor, was
placed on non-accrual and was included in non-performing assets during this
period. These two loans ($2.7 million from Borrower A and $1.1 million from
Borrower B) were the principal reasons non-performing assets increased during
the nine-months ended March, 2006, and were intended to support the $4.3 million
cited on page 11 of Form 10-Q filed on May 10, 2006. Unfortunately, an error in
drafting the Form 10-Q caused the amount to be disclosed as $4.3 million rather
than $3.8 million. In addition, the charge-off disclosed as $1.4 million in the
same sentence should have only been $1.1 million. Furthermore, the sentence was
awkwardly structured because the reader may be led to believe that the
charge-off amount should be subtracted from the loan amount cited in the
sentence to arrive at the explanation for the dollar increase in non-performing
assets during the period. This, of course, would not be correct because the loan
amount cited in the sentence is already net of the charge-off. These errors are
regrettable, but were not noted until research was conducted for this response.
Management does not believe these errors are significant or that they were
materially misleading to any readers of the Form 10-Q. Furthermore, the errors
had no impact on any other disclosures or financial information contained in the
document.
Current Status--During the quarter ended June 2006, the loan relationship
with Borrower A was restructured for a third time as a result of continued
difficulties in the relationship, as well as directives from FFSX's new CEO and
new CFO to resolve this troubled relationship (the former was hired in January
2006 and the latter in April 2006). The restructured loan amount of $1.8 million
was based on discussions with the borrower, current and projected financial
information provided by the borrower, and management's judgment. This third
restructuring triggered an additional charge-off of $0.9 million which will be
reported in a future filing with the SEC. The remaining allowance of $0.3
million ($1.2 million at the beginning of the quarter less the $0.9 million
charged-off) remains appropriate given continued doubts about the borrower's
ability to meet its obligations under the third restructuring and the value of
the collateral. However, it should be noted that Borrower A remains an
"operating entity" and has returned to profitability during the first four
months of calendar 2006. Therefore, it is possible Borrower A may be able to
meet the terms of the third restructuring. As a result, an additional charge-off
is not considered appropriate at this time. In addition, recovery of the
remaining loss allowance of $0.3 million is not considered appropriate given the
limited amount of time over which the borrower has demonstrated profitable
operations, as well as the inherent nature of the collateral. The restructured
loan will remain classified and will remain on non-accrual until the borrower
establishes a longer track record of profitable operations, as well as a
satisfactory repayment history.
Source of Collateral-Based Information
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Collateral supporting the restructured loan to Borrower A consists of a mix
of real estate, inventory, accounts receivable, and equipment. Throughout the
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workout of this troubled relationship, collateral valuations have been based on
original or updated appraisals, financial information provided by the borrower,
and physical inspections by FFSX personnel, with appropriate liquidation
discounts applied based on management's experience and judgment. The value of
the collateral has fluctuated only modestly during the period and primarily in
response to the borrower's continued operations. You may have noted in this
discussion, however, that the liquidation value of the collateral declined from
$1.9 million to $1.5 million between the first and second loan restructurings.
This occurred because the borrower funded the previously mentioned loan
repayments of $0.4 million primarily through a liquidation of the underlying
collateral (i.e., accounts receivable and inventory).
* * * * *
I hope this response addresses your concerns. Please do not hesitate to
contact me at 712-277-0222 or mdosland@firstfederalbank.com if you have
additional questions or concerns.
Sincerely,
/s/ Michael W. Dosland
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Michael W. Dosland
President and Chief Executive Officer
cc: Mr. John Spitz, SEC
Registrant Legal Counsel
Registrant Independent Auditors
Registrant Board Audit Committee
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