Financial Federal Downgraded

We are downgrading our recommendation on the shares of Financial Federal Corp. (FIF - Analyst Report) to Underperform as we think that negative factors for the company will more than offset the positives over the near term.
 
Financial Federal’s fourth quarter fiscal 2009 (ended Jul 31) earnings of 35 cents per share came in two cents short of the Zacks Consensus Estimate. The earnings for the quarter were also down 29% from 49 cents in the prior-year quarter.
 
Though the company has benefited from lower funding costs and improved net interest margin, originations have continued to weaken, given the current state of the economy.
 
Results were also negatively impacted by higher provision for credit losses and increased expenses. However, a significant improvement in net interest margin and strong liquidity were impressive during the quarter.
 
Originations have remained a matter of concern for the last few quarters. The decline in originations particularly emerged from lower business opportunities as a result of recessionary economic conditions and a more selective approach in approving transactions. Though there are some early signs of economic recovery, we expect the declining trend in originations to persist for a while.
 
We also saw a significant moderation in credit quality (though still acceptable) during the last several quarters due to challenging market conditions, a trend that we expect to continue in the near future as well. Though the strength of its underwriting policies and an in-depth knowledge of the markets served could help improve the credit quality, we don’t expect any significant improvement any time soon.
 
Receivables growth had been soft for a couple of years as the domestic economic slowdown discouraged purchases of large capital equipment that Financial Federal finances. Liquidity and access to capital have somewhat shrunk in the recent quarters and we don’t expect any significant recovery of Financial Federal’s asset generation capabilities in the near term.
 
On Nov 23, 2009, People's United Financial Inc. (PBCT - Snapshot Report) said that it will acquire Financial Federal for about $738 million in stock and cash. The transaction is expected to close in the first quarter of 2010.

Under the terms of the acquisition, Financial Federal shareholders will receive $11.27 in cash and one share of People's United common stock. Calculated with the closing price of People's United shares on Nov 20, the transaction is valued at $27.74 per Financial Federal share. As a result, the shareholders of Financial Federal will receive a slight premium on the Nov 20 closing share price. Also, the receipt of People's United stock by shareholders of Financial Federal is expected to be tax-free.

Overall, after being acquired by People's United, Financial Federal will overcome its difficulties and build a larger market share. The combined portfolio will rank People's United 13th among U.S. bank-owned equipment finance businesses.

In all, the business deserves to be closely monitored for the time being, as we are concerned with the continuing weakness in originations and anticipate a further moderation in credit quality.

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