April 4, 2008
Securities and Exchange Commission
Division of Corporation Finance
100 F Street NE
Mail Stop 4561
Washington, DC 20549
Attn: Mr. John A. Spitz, Senior Staff Accountant
Re: First Federal Bankshares, Inc.
Item 4.02 Form 8-K
Filed February 25, 2008
File Number: 000-25509
Dear Mr. Spitz:
This letter is in response to your letter dated March 20, 2008, transmitting
comments of the staff of the Securities and Exchange Commission (the
"Commission") in response to the letter we sent on March 11, 2008. That letter
was in reply to your original letter dated February 28, 2008, which related to
the Form 8-K filed by First Federal Bankshares, Inc. (the "Company") on February
25, 2008.
Background Information
Trapeza 2006-10A is a trust-preferred pooled security (TPS) with an original
face value of $500 million issued in June of 2006. It has a stated final
maturity of 35 years, but is callable after four years. The cash flows of the
TPS are derived from the trust preferred securities or subordinated debt issued
by 61 separate banks and thrifts (67%), insurance companies (6%), and
REITS/homebuilders (27%). As of December 31, 2007, no single entity in the TPS
accounted for more than $20 million or 4% of the original face value of the TPS.
The average entity-level exposure in the TPS was only $8.3 million. The TPS is
also diversified on a geographic basis, with none of seven regions in the United
States accounting for more than 26% of the original face value of the issue.
The TPS consists of eight separate classes, seven of which are senior and
one of which is subordinated. The Company owns $5.0 million of the $22.0 million
D2 Class, which is the lowest of the senior classes. The D2 Class was rated
`triple-B' by a nationally recognized rating agency at the time the TPS was
issued. However, the D2 Class was downgraded to "triple-C" on December 21, 2007,
due to the actual or anticipated default of two REITs within the TPS. These
REITs constituted $33.9 million or 7% of the original face value of the TPS. The
cash flows of the D2 Class are secured through a combination of subordination
from the lower class within the TPS structure, as well as over-collateralization
of available future contractual cash flows. The subordinated class absorbs
losses before higher rated classes within the TPS structure.
Management Responses
Following are the Company's responses to Item 1 of the staff's letter:
o Exhibit A contains a summary of the cash flows within the Trapeza 2006-10A
TPS. Exhibit B contains a sensitivity analysis of the impact future
defaults could have on such cash flows.
Management of the Company has the following observations/conclusions with
respect to the information contained in Exhibits A and B:
1. Exhibit A clearly shows that the D2 Class will receive all contractual
principal and interest payments despite the actual and anticipated
default of two REITs within the TPS (refer to columns I through N in
the exhibit). Although Exhibit A reveals that interest payments are
likely to be deferred for six quarters under the terms of the TPS
structure, the over-collateralization of cash flows inherent within
the TPS structure is sufficient to pay interest on such deferrals. It
should be noted that the cash flows in Exhibit A include no recovery
assumption on the two defaulted issuers. Management understands this
to be more conservative than the recovery assumptions often used by
the rating agencies, which typically range from 30% to 0%.
2. Exhibit B documents the defaults under various recovery scenarios that
would be necessary before the D2 Class would incur a loss of principal
and/or interest cash flows. This analysis reveals that future defaults
could range from $74.1 million (30% recovery assumption) to $39.9
million (0% recovery assumption) before the D2 Class would incur a
loss of principal and interest cash flows (refer to line 6 in Exhibit
B).
3. Exhibit B also documents the future defaults in the REIT/homebuilder
portion of the TPS that could be borne by the D2 Class assuming
30-year historical default rates are experienced in the bank, thrift,
and insurance portions of the security (a time period that included a
record level of bank and thrift defaults from 1985 to 1995).
Management extended the sensitivity analysis in this manner because
long-term historical default rates on banks, thrifts, and insurance
companies are generally well-known and documented (refer to line 7 and
Note (4) in Exhibit B). However, long-term default rate information on
REITs and homebuilders is not generally available. This extended
analysis revealed that future defaults in the REIT/homebuilder portion
of the TPS could range from $66.1 million (30% recovery assumption) to
$29.1 million (0% recovery assumption) before the D2 Class would incur
a loss of principal and interest cash flows (refer to line 8 in
Exhibit B). These default levels equate to 53% and 23% of the
remaining REIT/homebuilder exposure in the TPS, respectively.
4. In management's judgment, it is unlikely that future defaults of
banks, thrifts, and insurance companies will exceed long-term
historical default rates. Furthermore, in management's judgment,
future defaults of REITs/homebuilders at levels sufficient to
compromise the future available contractual cash flows of the D2 Class
are not probable at this time. Therefore, in the judgment of
management, the future default scenarios documented in Exhibit B
provide sufficient rationale for concluding that the impairment of the
future available contractual cash flows on the D2 Class is not
probable at this time.
o As noted by the staff in its letter, the market value of the Company's
investment in Trapeza 2006-10A D2 at December 31, 2007, was $1.875 million
and had an unrealized loss of $3.27 million or 64% of the Company's
amortized cost as of that date. In accordance with its usual and customary
practice, the Company received this indication of market value from a
third-party broker. Management of the Company does not believe this
valuation is representative of the true value of the security, and as such,
should not be relied upon as the sole and/or primary determination of an
"other than temporary" impairment. The assessment of available evidence to
determine whether a decline in fair value is "other than temporary"
requires considerable management judgment. These judgments are based on
subjective as well as objective factors, including knowledge and experience
about past and current events and assumptions about future events.
Management's judgments with respect to these objective and subjective
factors are itemized in the following paragraphs.
1. Objective factors considered by management in the case of Trapeza
2006-10A D2 include:
a. Current contractual cash flows of the TPS as of the balance sheet
date have not been compromised, as previously discussed.
Furthermore, in management's judgment outlined above, the future
contractual cash flows due on the D2 Class have not been
compromised assuming reasonable future losses based on
objectively determined historical default rates. At this time,
2
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management has no reason to believe that these historical
long-term default rates are not representative of future default
rates. Therefore, in the judgment of management, the current
valuation of the D2 Class reflects other market factors that are
external to the true value of the security, as discussed in
paragraph 2a, below.
b. The Company has the positive intent and ability to hold Trapeza
2006-10A D2 for a period of time sufficient to allow for
anticipated recovery in market value or until
redemption/maturity.
c. As of December 31, 2007, the fair value of Trapeza 2006-10 D2 had
been less than its amortized book value for only three months. In
the judgment of management, this is an insufficient amount of
time to conclude that the investment is "other than temporarily"
impaired.
2. With respect to subjective factors, management considered the
following:
a. Management believes that recent disruptions in the market for
collateralized debt obligations (CDOs) such as Trapeza 2006-10A
D2 have resulted in substantial illiquidity in the market for
CDOs. This illiquidity makes it extremely difficult to determine
whether current price declines on the TPS represent an accurate
assessment of value or whether such is caused by temporary
disruptions in the market for CDOs. These disruptions have been
caused by well-publicized difficulties in the market for
sub-prime mortgages, which has negatively impacted the market for
all CDOs, regardless of whether such securities are secured by
collateral other than sub-prime mortgages. In the judgment of
management, illiquid markets create conditions in which
participants may not receive fair price indications for
securities. Integral to the definition of "fair value" as
specified in Statement of Financial Accounting Standards No. 157,
"Fair Value Measurements" (SFAS 157), is the concept of an
"orderly transaction between market participants." In the opinion
of management, the current CDO market is not "orderly."
Therefore, management believes it would be inappropriate to
utilize recent declines in the fair value of Trapeza 2006-10A D2
as the sole and/or primary determinant of "other than temporary"
impairment. Further, management believes it would be
inappropriate and misleading to record security write-downs
through earnings that are caused by temporarily illiquid markets
that could be reasonably expected to return to normal in the
foreseeable future.
b. As previously noted, the market value of the Company's investment
in Trapeza 2006-10A D2 at December 31, 2007, was $1.875 million.
Management computed the implied cumulative future default rate
that the companies that secure the TPS would need to experience
in order for such market value to result in a discounted rate of
return on the TPS of approximately 13%. Based on third-party
information available to management, 13% was the average expected
yield on "triple-C" rated debt securities as of December 31,
2007. Management's computations revealed that the implied future
cumulative default rate would need to be 25% to 19% of the
current face value of the TPS assuming 30% and 0% default
recovery rates, respectively. In the judgment of management, this
is an unreasonable rate of future defaults that is not supported
by historical experience and/or current conditions. In the
opinion of management, this provides additional rational for
concluding that the independent, third-party price indication
received on Trapeza 2006-10A D2 as of December 31, 2007, is
impacted by the illiquid nature of the current market for CDOs
and/or other factors that are not related to the true value of
the security.
c. Credit spreads in the markets for investment grade and high-yield
corporate bonds have increased significantly in recent months.
Despite these increases, credit spreads are not substantially
wider than they were from 2001 to 2003, and in some instances are
still narrower than they were during that timeframe. Subsequent
to 2003, credit spreads narrowed significantly and rapidly, which
resulted in improved prices on debt securities that had been
adversely affected by the increase in credit spreads from 2001 to
2003. In light of this historical behavior of credit spreads, as
well as recent declines in market interest rates led by decreases
in the Fed Funds rate, management is not of the opinion that the
decrease in the fair value of Trapeza 2006-10A D2 is "other than
temporary" or "permanent."
3
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d. As previously noted, Trapeza 2006-10A D2 was downgraded to
"triple-C" on December 21, 2007, due to the actual or anticipated
default of two REITs within the TPS. Downgrades of securities are
not permanent. It is possible that this TPS could be upgraded as
the companies within the TPS prepay their debt obligations and
the remaining subordination and over-collateralization of cash
flows within the TPS structure becomes more significant relative
to the remaining exposures in the TPS. Companies in the TPS have
the option to call these obligations within the next three to
four years. It is also possible (although not probable), that the
company for which default was anticipated in the recent downgrade
will not actually default, which could result in an improved
outlook for the D2 Class. In any event, a nationally recognized
rating agency recently issued a report stating that the current
outlook for bank and insurance TPS-collateralized CDOs is stable.
In the opinion of management, these facts provide additional
rational for concluding that the decrease in the fair value of
Trapeza 2006-10A D2 is not "other than temporary" or "permanent."
3. Management of the Company is mindful of its ongoing obligation to
assess whether Trapeza 2006-10A D2 has become "other than temporarily
impaired" or "permanently impaird." The Company will continue to
monitor this security, as it does all of the securities in its
investment portfolio, as part of the regular application of its risk
management and accounting procedures. Future defaults by the companies
that underlie the security, negative actions by ratings agencies, or
deterioration in market conditions or other factors could result in
the Company concluding at some future date that this security must be
accounted for as "other than temporarily impaired" or "permanently
impaired."
With respect to Item 2 in the Commission's letter, we understand the comment
relating to the Company's determination of the effectiveness of its disclosure
controls and internal controls. We will make the appropriate revisions to Item 4
in the Company's amended 10-Q, as requested.
* * * * *
We trust this letter addresses the staff's comments. Please do not hesitate to
contact me at 712-277-0222 or mdosland@vantusbank.com if there are additional
questions or comments.
Sincerely,
/s/ Michael W. Dosland
Michael W. Dosland
President and Chief Executive Officer
Encl: Exhibit A (Trapeza 2006-10A D2 Cash Flow Summary)
Exhibit B (Trapeza 2006-10A D2 Default Sensitivity Analysis)
cc: Registrant Legal Counsel
Registrant Independent Auditors
Registrant Board of Directors
4
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Exhibit A
First Federal Bankshares, Inc.
Trapeza 2006-10A D2 Cash Flow Summary
(Information Provided by Third-Party Bond Manager)
December 31, 2007
December 31, 2007
A B C D E F G H I J K L
------------------------------------------------------------------ ---------------------------------------------
Total TPS Cash Flows Class D-2 Cash Flows (1)
- ------------------------------------------------------------------------------------ ---------------------------------------------
Balance Total Total Balance
Outstanding Paydowns Principal Interest Total Total Outstanding Interest Interest Interest
Period Date EOP & Turnover Proceeds Proceeds Defaults(2) Recoveries(3) EOP Payable Paid (5) Deferred
- ------------------------------------------------------------------------------------ ---------------------------------------------
0 15-Jun-06 500,048,000 20,000,000
7 6-Apr-08 480,048,000 0 0 7,129,594 13,948,000 0 22,000,000 478,500 0 478,500
8 6-Jul-08 466,100,000 0 0 5,715,292 0 0 22,000,000 967,407 0 967,407
9 6-Oct-08 466,100,000 0 0 5,265,547 0 0 22,000,000 1,466,948 0 1,466,948
10 6-Jan-09 466,100,000 0 0 4,995,599 0 0 22,000,000 1,977,355 0 1,977,355
11 6-Apr-09 466,100,000 0 0 4,845,626 0 0 22,000,000 2,498,862 0 2,498,862
12 6-Jul-09 466,100,000 0 0 5,023,314 0 0 22,000,000 3,031,712 0 3,031,712
13 6-Oct-09 466,100,000 0 0 5,269,505 0 0 22,000,000 3,576,152 544,440 3,031,712
14 6-Jan-10 466,100,000 0 0 5,518,132 0 0 22,000,000 3,576,152 544,440 3,031,712
15 6-Apr-10 466,100,000 0 0 5,571,632 0 0 22,000,000 3,576,152 544,440 3,031,712
16 6-Jul-10 466,100,000 0 0 5,844,907 0 0 22,000,000 3,576,152 544,440 3,031,712
17 6-Oct-10 466,100,000 0 0 6,121,468 0 0 22,000,000 3,576,152 544,440 3,031,712
18 6-Jan-11 466,100,000 0 0 6,300,769 0 0 22,000,000 3,576,152 544,440 3,031,712
19 6-Apr-11 466,100,000 0 0 6,279,360 0 0 22,000,000 3,576,152 544,440 3,031,712
20 6-Jul-11 466,100,000 38,402,953 38,402,953 7,286,232 0 0 22,000,000 3,576,152 544,440 3,031,712
21 6-Oct-11 427,697,047 1,920,148 1,920,148 6,415,245 0 0 22,000,000 3,576,152 544,440 3,031,712
22 6-Jan-12 425,776,899 1,920,148 1,920,148 6,517,133 0 0 22,000,000 3,576,152 544,440 3,031,712
23 6-Apr-12 423,856,751 1,920,148 1,920,148 6,531,666 0 0 22,000,000 3,576,152 544,440 3,031,712
24 6-Jul-12 421,936,604 1,920,148 1,920,148 6,610,321 0 0 22,000,000 3,576,152 2,123,617 1,452,535
25 6-Oct-12 420,016,456 1,920,148 1,920,148 6,758,534 0 0 22,000,000 1,962,628 1,962,628 0
26 6-Jan-13 418,096,308 1,920,148 1,920,148 6,825,596 0 0 22,000,000 478,500 478,500 0
27 6-Apr-13 416,176,161 1,920,148 1,920,148 6,742,179 0 0 22,000,000 478,500 478,500 0
28 6-Jul-13 414,256,013 1,920,148 1,920,148 6,852,869 0 0 22,000,000 478,500 478,500 0
29 6-Oct-13 412,335,865 1,920,148 1,920,148 6,971,270 0 0 22,000,000 478,500 478,500 0
30 6-Jan-14 410,415,718 1,920,148 1,920,148 7,016,977 0 0 22,000,000 478,500 478,500 0
31 6-Apr-14 408,495,570 1,920,148 1,920,148 6,919,480 0 0 22,000,000 478,500 478,500 0
32 6-Jul-14 406,575,422 1,920,148 1,920,148 7,036,645 0 0 22,000,000 478,500 478,500 0
33 6-Oct-14 404,655,275 1,920,148 1,920,148 7,152,574 0 0 22,000,000 478,500 478,500 0
34 6-Jan-15 402,735,127 1,920,148 1,920,148 7,168,539 0 0 22,000,000 478,500 478,500 0
35 6-Apr-15 400,814,979 1,920,148 1,920,148 7,014,193 0 0 22,000,000 478,500 478,500 0
36 6-Jul-15 398,894,832 1,920,148 1,920,148 7,058,563 0 0 22,000,000 478,500 478,500 0
37 6-Oct-15 396,974,684 1,920,148 1,920,148 7,119,765 0 0 22,000,000 478,500 478,500 0
38 6-Jan-16 395,054,536 1,920,148 1,920,148 7,116,853 0 0 22,000,000 478,500 478,500 0
39 6-Apr-16 393,134,389 1,920,148 1,920,148 7,052,237 0 0 22,000,000 478,500 478,500 0
40 6-Jul-16 391,214,241 391,214,241 391,214,24 9,495,221 0 0 0 478,500 478,500 0
- ------------------------------------------------------------------------------------ ---------------------------------------------
Note (4) Note (4)
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M N O P
- --------------------------------------------------------------------------------
Class D-2 Cash Flows (1)
- --------------------------------------------------------------------------------
Principal Total
Paid Paid O/C I/C
- --------------------------------------------------------------------------------
0 0 99.9% 108.2%
0 0 100.1% 110.1%
0 0 100.2% 113.3%
0 0 100.4% 113.3%
0 0 100.5% 111.9%
0 0 100.7% 110.0%
0 544,440 100.7% 112.9%
0 544,440 100.8% 112.9%
0 544,440 101.0% 111.8%
0 544,440 101.1% 110.2%
0 544,440 101.3% 113.1%
0 544,440 101.4% 113.2%
0 544,440 101.6% 112.2%
0 544,440 101.8% 125.4%
0 544,440 102.3% 120.2%
0 544,440 102.6% 120.0%
0 544,440 102.9% 119.9%
0 2,123,617 103.1% 117.2%
0 1,962,628 103.4% 120.1%
0 478,500 103.7% 120.5%
0 478,500 103.7% 120.2%
0 478,500 103.7% 117.5%
0 478,500 103.8% 119.7%
0 478,500 103.8% 119.4%
0 478,500 103.8% 119.2%
0 478,500 103.8% 116.6%
0 478,500 103.8% 118.7%
0 478,500 103.8% 118.5%
0 478,500 103.9% 118.5%
0 478,500 103.9% 116.1%
0 478,500 103.9% 118.3%
0 478,500 103.9% 118.2%
0 478,500 103.9% 118.1%
22,000,000 22,478,500 104.0% 157.1%
- --------------------------------------------------------------------------------
Note (4)
Notes:
(1) First Federal Bankshares, Inc., owns $5.0 million of the $22.0 million
Class D-2 notes. First Federal Bankshares, Inc., actual cash flows are on a
pro-rata basis.
(2) Cash flows assume an actual default of one issuer prior to April 08 ($20.0
million) and an anticipated default of another issuer in April 08 ($13.9
million).
(3) Cash flows assume no recoveries on defaulted issuers itemized in Note 2,
above.
(4) Cash flows assume the security is called in July of 2016 due to the equity
noteholder exercising the option to purchase the security in whole as
stated in the security's prospectus. Per third-party bond manager, the
equity noteholder is incented to redeem the TPS to preserve and/or
accelerate cash flows on the equity portion of the TPS structure.
(5) Includes interest on deferred interest in periods 13-25.
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Exhibit B
First Federal Bankshares, Inc.
Trapeza 2006-10A D2 Default Sensitivity Analysis
(Information Provided by Third-Party Bond Manager)
December 31, 2007
Line A B C D E
- ------------------------------------------------------------------------------------------------------------------------------------
1 0% Recovery Rate 10% Recovery Rate (5)
- ------------------------------------------------------------------------------------------------------------------------------------
Principal and Principal and
2 Interest(1) Principal (1) Interest(1) Principal (1)
- ------------------------------------------------------------------------------------------------------------------------------------
3 Cumulative Default Rate (2) 14.8% 31.4% 19.0% 33.0%
- ------------------------------------------------------------------------------------------------------------------------------------
4 Cumulative Default in Dollars 73,848,957 157,015,072 95,009,120 165,015,840
- ------------------------------------------------------------------------------------------------------------------------------------
5 Previously Defaulted Issuers (3) 33,948,000 33,948,000 33,948,000 33,948,000
- ------------------------------------------------------------------------------------------------------------------------------------
6 Additional Defaults TPS can Absorb 39,900,957 123,067,072 61,061,120 131,067,840
- ------------------------------------------------------------------------------------------------------------------------------------
7 Bank, Thrift, and Insurance Cumulative Defaults (4) 10,803,613 10,803,613 9,864,418 9,864,418
- ------------------------------------------------------------------------------------------------------------------------------------
8 Amount REIT/Homebuilder Loss TPS can Absorb 29,097,344 112,263,459 51,196,702 121,203,422
- ------------------------------------------------------------------------------------------------------------------------------------
9 Percent of Losses to Total REIT/Homebuilder (6) 23.3% 89.9% 41.0% 97.1%
- ------------------------------------------------------------------------------------------------------------------------------------
Line A F G H I
- ------------------------------------------------------------------------------------------------------------------------------------
1 20% Recovery Rate (5) 30% Recovery Rate (5)
- ------------------------------------------------------------------------------------------------------------------------------------
Principal and Principal and
2 Interest(1) Principal (1) Interest(1) Principal (1)
- ------------------------------------------------------------------------------------------------------------------------------------
3 Cumulative Default Rate (2) 20.1% 35.3% 21.6% 38.2%
- ------------------------------------------------------------------------------------------------------------------------------------
4 Cumulative Default in Dollars 100,509,648 176,516,944 108,010,368 191,018,336
- ------------------------------------------------------------------------------------------------------------------------------------
5 Previously Defaulted Issuers (3) 33,948,000 33,948,000 33,948,000 33,948,000
- ------------------------------------------------------------------------------------------------------------------------------------
6 Additional Defaults TPS can Absorb 66,561,648 142,568,944 74,062,368 157,070,336
- ------------------------------------------------------------------------------------------------------------------------------------
7 Bank, Thrift, and Insurance Cumulative Defaults (4) 8,923,304 8,923,304 7,996,235 7,996,235
- ------------------------------------------------------------------------------------------------------------------------------------
8 Amount REIT/Homebuilder Loss TPS can Absorb 57,638,344 133,645,640 66,066,133 149,074,101
- ------------------------------------------------------------------------------------------------------------------------------------
9 Percent of Losses to Total REIT/Homebuilder (6) 46.2% 107.0% 52.9% 119.4%
- ------------------------------------------------------------------------------------------------------------------------------------
Notes:
(1) Break-even default rates are the highest default rates that can be incurred
before the D2 Class suffers a loss of principal (and interest, as the case
may be).
(2) Each cumulative default rate reflects the aggregate principal balance of
underlying assets which default over the life of the transaction divided by
the initial aggregate principal balance.
(3) Refer to Note (2) in Exhibit A.
(4) Estimate for future bank, thrift, and insurance cumulative defaults are
based on actual 30-year historical default rates of 0.40% per year (banks
and thrifts) and 0.28% per year (insurance). This time period includes
record level of bank and thrift defaults from 1985 to 1995.
(5) For all of the recovery scenarios other than 0%, the cash flows assume a
15% recovery and 30% recovery on the $20.0 million and $13.9 million issues
that defaulted prior to April 2008 (refer to Note (2) in Exhibit A). These
are the actual recovery rates utilized by the rating agency in its last
analysis.
(6) REIT/homebuilder portfolio was $124.9 million or 27% of the remaining face
value of the TPS at December 31, 2007.