Truist Financial Stock: Most Of The Negatives Are Priced In (NYSE:TFC)

Thesis

Based on my understanding, it seems that most risks related to the US banking sector are already reflected in the price of Truist Financial Corporation (NYSE:TFC) (TFC.PI) shares – both common and preferred ones. I see this as an attractive opportunity to buy TFC because the potential rewards outweigh the risks for income-seeking individuals in the long run.

Why Do I Think So?

Truist Financial Corporation, formed through a merger between BB&T Corp. and SunTrust Banks in December 2019, is a prominent bank with approximately $574 billion in assets; the merged bank at the time was valued at $66 billion [market cap]. As the sixth-largest bank in the US, Truist operates as a holding company and offers a wide range of banking and trust services, primarily serving the Southeastern and Mid-Atlantic regions. Originally known as BB&T Corporation, the company rebranded as Truist Financial Corporation and was established in 1872, with its headquarters located in Charlotte, North Carolina.

The company is divided into 3 segments [net of Other, Treasury & Corporate eliminations], based on the 10-Q and 10-K filings:

1. Consumer Banking and Wealth [47.7% of total net income, Q1 FY23] – encompasses 3 primary businesses. Retail & Small Business Banking offers banking, borrowing, investing, insurance solutions, and advice through branches, ATMs, digital channels, and contact centers. It provides a range of financial products and services such as deposits, credit cards, loans, mortgages, brokerage, and insurance. It also includes Mortgage Banking, offering residential mortgage products through retail and correspondent channels. Consumer Finance Solutions provides consumer lending solutions through direct-to-consumer and point-of-sale offerings. Wealth management and banking products, including trust, brokerage, investment advisory, and family office services, are provided to individuals and institutional clients through the Wealth division.
2. Corporate and Commercial Banking [47.2%] – consists of 4 primary businesses. Corporate and Investment Banking offers strategic advisory, capital raising, risk management, financing, liquidity, and investment solutions to both public and private companies. Investment Banking serves specific industry segments, while Corporate Banking serves clients across diversified sectors based on size and complexity. Commercial Community Banking provides traditional banking products and solutions to commercial clients, including not-for-profit organizations, governmental entities, healthcare, aging services, and auto dealers. Commercial Real Estate offers credit, deposit services, and tailored financing solutions for commercial real estate projects, including community development and affordable housing. It also provides banking and advisory services to REITs, funds, and public home-builders. Wholesale Payments delivers treasury, merchant services, and commercial card solutions to a range of business clients, from small businesses to large corporate institutions. ; and
3. Insurance Holdings [5.1%] – a significant insurance agency/brokerage network, offering property and casualty, employee benefits, and life insurance to businesses and individuals. It provides a range of services, including workers’ compensation, professional liability, surety coverage, and title insurance for small businesses and corporations. Additionally, the IH segment encompasses Prime Rate Premium Finance Corporation, which includes subsidiaries AFCO Credit Corporation and CAFO Holding Company.

During the first quarter of FY23, Truist Financial Corporation showcased a mix of positive and challenging factors. The company reported a net income of $1.4 billion or $1.05 per share, representing a 6% increase compared to the same quarter last year. Adjusted pre-provision net revenue [PPNR] grew by 19% year-over-year, reflecting a strong start to the year. The company achieved 310 basis points of positive adjusted operating leverage, indicating improved efficiency.

But its net interest income decreased by 2.8% sequentially, primarily due to higher funding costs and 2 fewer days in the quarter. The net interest margin declined by 8 basis points, while the core net interest margin decreased by 7 basis points.

The management now projects 5-7% revenue growth for FY2023 (down from 7-9% previously). The guidance also calls for adjusted expense growth of 5-7%, with much of that attributable to pension costs, higher FDIC premiums, wage increases, and acquisition expenses. Truist recorded a loss provision reversal of $813 million in 2021, followed by provisions of $777 million in 2022. Reserves for losses look sufficient, but an increase in loss provisions is likely this year due to a slowing economy – pay attention to the forecast for the net charge-off ratio guidance [it’s expected to rise to 42.5 in the mid-range, due to more possible loans written off]:

On the positive side, we see that the company has achieved merger synergies by reducing its combined expense base by $1.6 billion – cost reduction includes personnel, back-office integration, branch consolidations, third-party spending, and corporate facilities.

Average deposits experienced a modest decline of 1% sequentially and 2% YoY as customers sought higher-yielding alternatives. TFC has the lowest investment securities portfolio yield as of 1Q FY23 versus its peers, according to Credit Suisse analysts [May 19, 2023, proprietary source]. Also, since the end of April 2023, TFC has experienced one of the largest EPS downward revisions in the entire peer group – perhaps this is what led to such poor total return performance compared to the other banks.

Another reason that led to such a sharp decline in TFC’s share price is its relatively high loan-to-deposit ratio of 81%, well above the median of 75%. The worst-performing bank – Citizens Financial Group (CFG) – is the only one in the group with a higher metric [90%]:

A high ratio can lead to higher profitability and interest income generation but may also indicate higher credit risk if loans are not adequately managed – amid expectations of higher net charge-offs, this is going to hurt Truist’s profitability, and the market adjusted for that really quickly as we can see.

However, Argus Research analyst Stephen Biggar writes in his post-earnings note [April 20, 2023 – proprietary source], that Truist remains well-positioned with its deposit base. Yes, in light of the lowered revenue guidance, which reflects higher deposit and funding costs, he lowered TFC’s EPS for FY2023 to $4.65 from $5.19, and the FY2024 forecast is now $4.79 from $5.36. But he attracts readers’ attention to the firm’s deposit franchise, which looks strong, in his view.

Also from the chart above, we see a lower-than-median Average Cost of Interest Bearing Deposits ratio that suggests that Truist is able to attract interest-bearing deposits at a relatively lower cost. This can sustain the bank’s net interest margin and profitability since it can generate income from loans and investments at a higher spread relative to its funding costs.

Truist exhibited a robust financial position with a tier 1 capital equity ratio of 9.1% as of March 31, 2023, surpassing the regulatory minimum of 4.5% required for being considered well-capitalized:

As one of the largest U.S. banks has been sold off due to the above issues, its current dividend yield has risen to 6.8% – even during the 2020 corona-crisis, we didn’t see such a high yield:

Even the company’s Series I preferred shares, which can be redeemed after Dec. 15, 2024, at $25 per share, are now trading below $19.5 apiece:

The rate of these preferred shares is variable, so the dividend is determined based on what’s greater: 1) 0.53% above the 3-Month LIBOR rate (which is a benchmark interest rate) on the specific date when the dividend is determined or 2) a fixed rate of 4.00%. When the board approved a regular quarterly cash dividend of $0.52 per share for common shareholders after Q4 results, it also announced a dividend per Series I preferred stock at ~$0.33119 per DS, which would now be equal to ~6.83% of annual yield.

LIBOR is now at 5.39% and hasn’t fallen much despite market expectations for a faster rate cut by the Fed.

If the rate hike cycle indeed ends soon and the Fed flattens (my expectation), then LIBOR will remain at a relatively high level. So TFC’s Series I should have to continually pay income-seeking investors up to December 2024. There is limited upside room here of course, but from what I can see from the company’s financials, despite all the challenges, it appears to be fundamentally OK and should be able to continue to make preferred payments going forward.

The common stock appears to me to be relatively fairly valued with an average tangible book value of 0.481 per share:

Seeking Alpha’s data shows a forwarding price-to-earnings ratio of 6.81x for TFC stock, which is quite low for one of the largest U.S. banks. With about the same market cap as U.S. Bancorp (USB), TFC’s dividend yield looks larger at about the same TBV per share – it’s just a matter of sustainability here, as USB has a slightly lower loan-to-deposit ratio of 77%.

In my view, the potential risks associated with Truist Financial Corporation should already be largely priced into the company’s shares. The significant decrease of nearly one-third in market value since the start of the year, combined with the technically oversold condition observed at the $25-29 per share level, suggests that despite the existing risks, it may be an opportune time to consider purchasing TFC stock.

As the Federal Reserve shifts its direction, TFC stock is likely to follow suit. Additionally, the preferred shares of the company also appear appealing, as they should exhibit sensitivity to interest rates similar to common equity.

The Verdict

At this point, it’s hard enough to be optimistic about the U.S. banking sector as deposits continue to fall as households run out of funds and there are higher yielding options among money market instruments.

Banks like TFC, which have quite aggressive lending policies, are at serious risk if deposit outflows continue. TFC’s share price could hit new lows despite its historically high dividend yield, which will become questionable if this risk comes true.

But the way I see it, TFC stock looks very attractive to income-seeking investors over the long term – I’m talking about both common stocks here. ​TFC’s preferred stock, where the company has the right to buy back 29% above the current price past the end of 2024, and whose dividend yield is about the same as its common stock, also looks interesting. If the Fed rate falls below 3-4% at some point, the nominal price could rise – perhaps management will have to buy them back.

It’s interesting what you think about TFC – please share your take in the comment section below. Thanks for reading!