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TFS Financial Corporation (NASDAQ:TFSL) is a bank stock we started to get excited about over a year ago, when we rated the bank stock a buy after reviewing the key metrics of the company, specifically noting the huge increases they had seen in originations. We were impressed by the fact that TFS Financial issued more loans in 2020 than any other year in the company’s history. That was something.
However, stocks have been crushed badly in 2022, and banks were obliterated for about a year straight. Pretty ugly charts for the sector. Now, fast-forward to October 2022 here. We think the sector is one of the best to buy as rates are rising. While there is some macro risk of a possible recession stemming from the Federal Reserve’s actions to battle inflation, we strongly believe the financial sector is set up for years of strength by being able to issue higher interest loans. Margins should expand. Dividends should have fuel to be raised. With TFS Financial, there has been some pressure on the stock and on operations, but the stock now yields over 8%. This could be a warning sign of pain to come, but assuming that yield remains, and the bank performs even with average efficiency, buying the stock here is justifiable, and the stock is still attractive on valuation metrics.
Headline Q4 2022 performance
In Q4, the company reported results that exceeded consensus estimates. Based on strong loan growth and widening net interest income, the company reported net income of $25.4 million, compared to net income of $17.1 million for Q3 2022. There were strong sequential increases. EPS was $0.09, improving from $0.06 in the sequential quarter and a year ago. That is a nice improvement, and it was driven by a stronger loan portfolio.
Loans and deposits
Remember that community-oriented banks tend to be more traditional lenders. What we mean is that they rely on growth in loans and deposits, taking in money at a low interest rate and lending at a higher one. This is the so-called net interest spread, or margin, which is something we watch closely. We also like to watch for any changes in bad loans through loan loss allowances or delinquency. The latter has improved a lot since the crisis began but is key to watch. The company has worked hard to grow loans in this environment.
Total loans held for sale were $14.26 billion at the end of the quarter, which is up 14% from $12.51 billion a year ago. There was a high degree of loan originations in the last few months, including first mortgages and home equity lines of credit. Those were up about 10% from last year to $5.8 billion.
While lending activity is healthy, we always want to see deposits coming in to help fund those loans. Like a lot of other banks we cover, deposits slipped. Deposits were down $72.6 million, just under 1% from last year. They were $8.92 billion at quarter end vs. the $8.99 billion a year ago. The decrease was the result of a $169.3 million decrease in certificates of deposit and an $82.3 million decrease in money market deposit accounts. On the other hand, both checking and savings account deposits were up $178.6 million combined. Chairman and CEO Marc A. Stefanski commented in the release:
Our efforts have given us a strong quarter and year of growth during a time of rate volatility…..our loan growth of $1.7 billion this year is a result of our aggressive pursuit of new mortgage customers and opportunities. We continue to meet the challenges of the current economic climate head on.
So the company has been aggressively growing the portfolio, but with the concerns in the economy, we need to be sure that the loans are of high quality.
Asset quality
While loan activity is strong, there was a notable decrease in the allowance for credit losses, but overall loan health has improved. Total loan delinquencies decreased $3.5 million to $21.2 million, or 0.15% of total loans receivable, down from $24.7 million a year ago.
We like that the total allowance for credit losses was $99.9 million, or just 0.70% of total loans. While there were more dollars for credit losses, last year the allowance was $89.3 million, or 0.71% of total loans.
One thing we have noted with most other banks that we have looked at is that loan loss provisions have been rising for most banks. Here, to end the fiscal year, the company had actually less provisions for credit losses than a year ago thanks to more recoveries in the year. The total provision for credit losses was $1.0 million for the whole year compared to a $9.0 million credit – or so-called release of provision – for last year. At the end of Q4, there are no provisions, but we suspect this will change into next year when a recession possibly lands. Now, all this said, we saw earnings rise. This was due in large part to better margins.
Margins
Net interest margin has improved from last year on the back of new loans being issued at higher interest rates. The interest rate margin was 1.88% for the year, up sizably from the 1.66% last year. This led to net interest income rising by $35.8 million, or 15%, to $267.4 million for the fiscal year. Strong performance.
Return metrics
Finally, we always like to look at important metrics like the return on average assets, and the return on average equity. The higher the better for these, of course. We were happy to see strong quarter-over-quarter improvements on both of these metrics. Return on average asset increased from 0.46% to 0.65%, while the return on average equity increased from 3.75% to 5.53%. We like this improvement.
Shareholder friendly
To continue paying the dividend in the amount it is being paid to shareholders, the “mutual holding company” owns 80% plus of shares. While it has done this in the past, there is no guarantee this will happen again in the future. But it got the waiver for this year and paid out $1.13 in dividends. At the same time, the company is buying back shares to boost earnings. The company indicates that “dividends, managed portfolio growth, and strategic share repurchases will represent the focus for future capital deployment.”
We think this is exactly the kind of focus you want from the management of a company like this. It has a unique structure but is a hidden gem in our opinion. We like it here, especially as book value expanded.
Final thoughts on TFS Financial
Originations continue to be strong. Asset quality has improved. Rates were improving and that helped fuel higher-margin loans. With the recent turnaround in rates, we believe that investors should start to scale in as the stock has been crushed. The dividend yield is solid on this stock.
TFS Financial Corporation is working to benefit shareholders. The structure of the company is unique, so we would encourage possible investors to understand this structure. Overall, we love regional banks here, but TFS Financial Corporation is a unique and solid choice at bargain-basement prices.
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