Why I Continue to Like TFS Financial

Yes, TFS Financial (TFSL) has been a miserable performer over the last year, dropping from $19 per share to around $15 today. That’s following a run-up from $15 in the prior year or so, as investors priced in increased interest rates. But with three or four rate increases expected next year and coming off its most profitable year ever, TFS Financial still looks like a compelling buy. 

Three reasons I continue to like the bank:

  • Price to tangible book value is low
  • Buybacks continue at a high (but lowered) pace
  • Loan book is levered to higher interest rates 

Huge discount to tangible book value

The first thing to know about this bank stock is that it’s not like most others. That’s because it’s in the limbo state of a second-step conversion. (I explain all of the nuances of that in this article.) As of the latest report, 80.7% of the total 281.3 million sharecount is owned by the mutual holding company. That leaves just 54.3 million publicly floated shares.

With tangible equity of $1,690 million, per-share tangible book value comes to $31.12. Today TFSL trades at $15.25, so it’s priced at just 49% of tangible book. That compares to a historical high around 70%, or nealy $22 at current tangible book. It’s reasonable that stock has some discount, because investors are pricing in the completion of the second step, which usually happens at a discount to book. But a valuation of 49% is simply much too steep.

So with an overcapitalized balance sheet, management has been taking advantage and rapidly buying back stock over the last few years. Of course, this helps to quickly increase tangible book value per share.

Rapid buybacks

The company has plowed through buyback authorizations in recent years. Since its 2007 IPO, TFS Financial has repurchased more than 50% of its float, and it wasn’t buying at all for about three years, as it was subject to a memorandum of understanding with regulators. Its massively overcapitalized balance sheet — a relic from its IPO haul — funded an accelerated buyback program for years. Even today the balance sheet remains overcapitalized.

During the spree of the last few years, the company typically repurchased about 4.5% of its float in any given quarter. Things have slowed in recent quarters, however. Management announced that more of the company’s earnings will go to increasing the dividend rather than buybacks. The most recent quarter saw buybacks of not quite 600,000 shares, or about 1% of the float. I think a reasonable estimate of repurchases would be about 5% in any year.

I think that move away from buybacks is unfortunate and suboptimal, given the huge discount to tangible book value that persists today. But the dividend — now a robust 4.5%, after a 36% bump this year — may attract more investors to buy and hold the stock.

Loan book benefits from higher rates

The bank just turned in its most profitable year ever, recording $89 million in net income. But with interest rates poised to increase in 2018, maybe as many as four times in 2018 depending on the expert you speak with, TFS Financial should be able to increase profit even more. It’s already cheap on a P/E basis, trading at just over 9 times earnings.

The bank’s loan book is heavily geared to adjustable rate mortgages. Adjustable rate first mortgages are 39% of the loan portfolio, while fixed mortgages greater than 10 years comprise 32% and fixed less than 10 years comprise 16%. A steady march higher in rates should allow the bank to keep profit moving up as well.

So those are three reasons I like the bank and have been buying at prices around $15. I estimate fair value at more than $20.

4 thoughts on “Why I Continue to Like TFS Financial

  1. I think TFSL valuation is interesting as well, but it is underperforming because they have one of the highest loan-to-deposit ratios, their deposit base is high cost, and they are vulnerable to a flat or inverted yield curve. I believe their deposits will reprice faster than their loans, so rising rates will hurt more than help.

  2. I don’t disagree about their deposit franchise. It’s just not good, and it’s something they have not really ever addressed. That’s disappointing. I do think it would help the stock reprice higher, but that second step does seem to be a huge overhang.

  3. Any thoughts on how valuations are typically set in second step conversions? Straight discount to market? Or based on book? Obviously could be material when we’re talking about 4x the free float.

    1. Have a look at the ISBC second-step in 2014. The i-bankers were willing to sell that at a premium to tangible book, close to 1.2x, and were pricing it off a discount to comps, not merely a discount to book. The pricing on that conversion varied significantly, depending on how much demand ISBC got from depositors and others. At the minimum offering, shares would be priced at about 1x tangible book. See p7 in the following filing: https://www.sec.gov/Archives/edgar/data/1594012/000119312514108455/d639821d424b3.htm

      ZJ

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