TFS Financial Stock: Don’t Just Look At The Dividend Yield (NASDAQ:TFSL)

There is a High Risk of Jumping too Easily to Positive Conclusions About Banks in the Face of Rising Interest Rates: The Situation at TFS Financial Corporation

When interest rates are rising, it usually makes sense to invest in bank stocks as they increase profit margins and potentially have a positive impact on the stock price.

But in times of various macroeconomic and geopolitical headwinds like the current one, the risk of jumping to conclusions too easily is high, increasing the likelihood of making mistakes.

For example the situation of TFS Financial Corporation (NASDAQ:TFSL), a regional bank based in Cleveland, Ohio.

An analysis of the finances of TFS Financial Corporation points to potential problems related to the availability of funds and raises concerns about the quality of the regional bank’s assets.

Thus, this stock has so far failed to move beyond a Hold rating, despite rising interest rates. That’s the stance investors should take for the time being.

Deposits and Savings

Deposits of $8.92 billion (as of fiscal 2022) aren’t down much compared to fiscal 2021, just 1% year over year. The reason for the decrease is a small decrease in certificates of deposit [CD].

For now, the change isn’t worrying shareholders, as it’s only measurable at 2% of total deposits, but could worsen in the coming months due to the uncertainty weighing on savers’ propensity to sign certificates of deposit. A fall in demand for CDs may indicate heightened skepticism about the prospects and a sense of uncertainty among savers, who prefer to have their money freely available when needed.

For TFS Financial Corporation, like any other bank that might experience this type of trend, the decline in CD demand is affecting the certainty of available funds to fund loans, regardless of checking and savings account growth. Investors should keep an eye on this trend at TFS Financial Corporation, as well as the one below, which could also indicate an urgent need to raise capital.

In fiscal 2022, borrowed funds increased 55% year over year to $4.79 billion, which is used to fund loans. Year-over-year, borrowed funds declined 11.4% in fiscal 2021, declined 10.3% in fiscal 2020, but increased slightly by 5.4% in 2019.

With the US Federal Reserve aggressively tightening monetary policy to curb runaway inflation, rising borrowing costs are also likely to weigh negatively on interest margins at TFS Financial Corporation in the coming quarters due to the increase in borrowed funds.

TFS Financial Corporation has also used available cash to finance reinvestment transactions in loan products resulting in a significant 24% decrease in cash, totaling nearly $490 million in 2021.

Higher interest Rates Could Also Not Reflect in a Better Net Interest Income Margin for TFSL

Funds raised through people’s savings, signing certificates of deposit, opening bank accounts, and borrowing funds were used by TFS Financial Corporation to increase the stock of credit extended to households and other economic actors.

Despite higher lending rates minus lower deposit rates, the law of the banking system will result in TFSL margin benefits until subsequent rate hikes are reflected in a dramatic slowdown in credit demand.

This type of impact cannot be ruled out this year, considering the following factors: a) the level of inflation to be fought (the level of 2022 has not been reached for decades), which will lead to new aggressive rate hikes; b) the looming economic recession, which will impact households’ disposable incomes this year through job losses. And thus, on their credit score ratings and their ability to meet financial obligations; c) high inflation and the increased house prices inherited from the previous cycle of the real estate market.

These factors will force many consumer households to postpone their plans to purchase a property through mortgage loans or to renovate the property through home equity loans or lines of credit. These are practically the loans that TFS Financial Corporation makes with its customers. These are the factors likely to affect borrowers’ ability to meet financial obligations.

The Lending Activity

From a loan perspective, TFS Financial Corporation’s balance sheet at the end of fiscal 2022 reported loans held for investment totaling approximately $14.3 billion, an increase of approximately 14% over the prior year.

The number, according to the regional bank, reflects the creation of new loans among the different types of TFS Financial Corporation. Total core residential mortgage loans accounted for about 80% of the total loan portfolio in fiscal 2022, while home equity loans and lines of credit accounted for the remaining 20%.

The following comparison shows a progressive decline in credit volume over the last few years up to the 2022 financial year.

TFS Financial Corporation says loan originations (including first mortgages and equity loans and lines of credit) increased by 8% year over year to $5.80 billion in fiscal 2022 versus 22.5% year over year to 5.28 billion in fiscal 2021, versus 25% year over year to $4.4 billion in fiscal 2020, and versus a drop of 8% year over year to $3.5 billion in fiscal 2019.

In 2021 and 2020, lending certainly benefited from the US Federal Reserve’s accommodative policy, which supported the economy, which was hit hard by restrictions and lockdowns imposed to prevent the spread of the COVID-19 virus. However, this also means that many loans may have been made to borrowers with poor credit standing, and if this were the case, it would harm the quality of TFS’s asset portfolio. This problem is at risk of becoming structural in the coming months and could be exacerbated by the looming economic downturn.

Not to mention that the loan volume in FY2022 may include a refinancing, which does not necessarily benefit the quality of the loan portfolio in a highly uncertain economic environment characterized by many macroeconomic but also geopolitical problems.

The Quality of the Mass of Loans

TFS Financial Corporation says the provision for credit losses (the cash reserve the bank has set aside for bad loans), decreased by $8 million year-over-year to $1 million in fiscal 2022.

This figure could correlate with lending volumes which, as mentioned earlier, have fallen sharply amid tighter lending conditions combined with likely lower lending demand.

Plus, looking at the past few years, the following trends emerge: TFS reported higher loan loss provisions of $3 million in fiscal 2020, which was a record year in lending, while loan loss provisions were even negative $10 million in fiscal 2019 as lending declined.

Therefore, loan loss provisions are positively correlated with lending volume, and in 2020 and 2021, however, as people received subsidies and other financial support to deal with the impact of the pandemic crisis, TFS Financial Corporation built higher loan loss provisions.

Provision for loan losses may not be a perfect indicator of loan portfolio quality, and some reliability issues also arise when using net loan recoveries as an indicator of bank asset quality.

The 86.5 percent increase in net loan collections in fiscal 2022 over fiscal 2021 was attributed by TFS Financial Corporation to the reduction in provisioning requirements.

Prior years saw the following changes in net loan recoveries as a result of loan recoveries exceeding charge-offs: a 4% year-over-year increase to $5.2 million for fiscal 2021, a 23% year-over-year decrease to $5 million for fiscal 2020 and a year-over-year increase of 44.4% to $6.5 million for fiscal 2019.

With respect to this information, the company does not present the data for the fiscal year 2022 as in previous years, which specifically referenced “net loan recoveries as a result of loan recoveries exceeding charge-offs”.

The 2022 figure may also include collections of loans that may have been delegated to collection agencies after being written off in previous years.

About total allowance for loan losses (an estimate of debt that could not be collected), this was 0.70% of total loan receivables in fiscal 2022 compared to 0.71% of total loan receivables in fiscal 2021.

Loan receivables are unpaid loans that are usually expected to be repaid in less than a year.

These percentages represent a significant increase from 2020 as measured by the following data: allowance for credit losses was 0.36% of total loan receivables in fiscal 2020, it was 0.29% in fiscal 2019, and 0.33% in fiscal 2018. The increase from 2019 to 2020 was attributed by TFS to increased credit integrity risk due to employment concerns following the COVID-19 virus crisis and a deteriorating global macroeconomic environment.

Therefore, the significant increase in the allowance from 2020 to 2021/2022 should reflect a higher credit default potential, which actually reflects the current macroeconomic situation and the risk of economic recession in 2023.

Loan delinquency rates continue to decline. They were 0.15% of total loans in 2022 versus 0.20% in 2021 and 0.21% in 2020 and 0.27% in 2019.

Unaccrued loans also decreased from 0.35% in 2021 to 0.25% of total loans in 2022, and they were 0.41% in 2020 and 0.54% in 2019. These are loans that have not executed for at least 90 days and no interest income accrues to the lender.

The evolution of TFS’s delinquency rates could be affected by the slowdown in lending in recent years and the subsidies, and other financial relief people have received due to the COVID-19 virus crisis.

Given the reliability issues of the above indicators measuring the quality of TFS loans and the likelihood that loans will not be repaid, investors should consider referring to the following statistics provided by TransUnion (TRU) analysts for the sector as a whole to assess the risk of borrower default on loan from TFS.

From a default perspective, TransUnion predicts that default rates in general will continue to rise in 2023, reaching unprecedented levels compared to the past 14 years.

TFS Financial Corporation’s Net Profit

All these things related to the formation of the net interest income ($267.4 million in fiscal 2022) could continue to have a significant impact on TFS’ net income, which was down 8% year over year to $74.6 million in fiscal 2022.

The net income is largely determined by net interest income, although the latter is not much better than in the 2019 fiscal year, when interest rates were also raised. Despite the Fed’s aggressive rate hike to combat inflation in fiscal 2022, net interest income improved slightly in 2022 compared to 2019, as shown in the chart below.

The part of the TFS’ business that generates gains (or losses) from the sale of loans, and that also contributes to the formation of the annual profit, does not provide better guarantees for shareholders’ growth expectations at this time either.

Fiscal 2022 non-interest income of $23.8 million reflects a 57% decrease from fiscal 2021 due to a significant drop in net loan realization gains.

The regional bank attributes the drop in gain from the sale of net loans to less favorable pricing conditions in the market, which could be an indication that the market views TFS’ loan as lower quality than the regional banks. If so, there is a risk that the dramatic decline in net loan sales (83.2% year-over-year to $128.1 million in fiscal 2022) will leave the regional bank with a glut of poor-quality loans with an above-average risk of default.

TFS Financial Corporation Payment of Dividends

On Dec. 13, TFS Financial Corporation paid a quarterly dividend of $0.28 per common share leading to a forward dividend yield of 7.52% as of this writing.

While the dividend has been flat for the past two years, the stock price has fallen more than 17% over the past 52 weeks, significantly underperforming the financial sector.

This also explains the high dividend return on TFS Financial Corporation shares.

In addition, based on the results of the analysis of the various components of the bank’s profit, the probability that the quarterly dividend could increase seems very low. The likelihood of a dividend increase is also impacted by the challenging macroeconomic environment, and a payout ratio of 418.52% which doesn’t leave much room for additional increases.

Stock Valuation

The stock has shown some signs of recovery over the past 3 months, with the share price moving above the long-term trend of the 200-day moving average line of $14.23.

As of this writing, TFS Financial Corporation shares are trading at $15.03 per unit, giving it a market cap of $4.22 billion and a 52-week range of $12.45 to $18.36.

The next US Federal Reserve meeting is expected to take place between January 31 and February 1, 2023. At the meeting, the Federal Reserve is likely to decide on another rate hike, which should provide some tailwind for the financial services sector, benefiting TFS Financial Corporation stock as well. After this next wave of renewed interest in financial stocks, the sector could take a breather on some profit-taking, perhaps around when the initial headwinds from the expected recession begin to weigh on stock prices. Then investors should consider reducing their position in TFS. But for now, the stock deserves a Hold rating.

Conclusion

For now, the stock in the regional bank is given a Hold rating based on the above analysis and a quite challenging near-term outlook. It cannot be ruled out that the share price could experience some more bearish sentiment after the past 3 months of somewhat recovery. A further bearish stance on TFS could potentially materialize earlier in the spring as tailwinds from another Fed rate hike (meeting Jan 30-Feb 1, 2023) fade, while the US stock market may feel the first effects of the recession. Investors should try to anticipate bearish sentiment as much as possible and potentially reduce their position. Until then, this stock has a Hold rating.