2024-01-04 23:39:18 ET
Summary
- TFS Financial Corporation is a retail bank with a unique stock ownership structure, paying dividends only to minority shareholders.
- Due to the limited number of shares eligible for dividends, TFSL can support a dividend yield of 8%.
- The company's earnings and book value differ depending on whether all shares or minority shares are considered, impacting perceptions of dividend sustainability and stock valuation.
- The dividend yield is nice and well-supported but dividend growth is lacking which may turn off some investors.
TFS Financial Corporation ( TFSL ) is a retail bank that collects deposits and issues loans to individuals such as mortgages. The bank has been around since 1938 and it's still run by the Stefanski family which founded it.
The bank's stock has a unique structure. It has two ownership groups. First is the Third Federal MHC and the second is Minority Shareholders which would be people like you and me who buy the stock in the market. Back in 2007, the stock ownership structure was two-thirds for MHC and one-third for minority or retail investors. By 2023, MHC's ownership rose to 81% and minority ownership dropped to 19% through share repurchases. Why is this information important? Because due to the company's unique structure, it pays dividends to only minority investors.
This creates a unique situation for the investors of the company. If less than 20% of shares are eligible for dividends, that means there are more dividends to go around for each share. The company can basically pay 4x the dividend per share that it normally could if it paid dividends for all shares. This is why the company can support a dividend yield of 8% comfortably when most of its peers can only support a fraction of this yield.
The bad news is that the company hasn't hiked its dividends for a while so this may be more suitable for high-yield income investors than dividend growth investors. After raising its dividends for several years in a row, the company set its annual dividends at $1.13 and it's been there for a few years now.
When you look at the company's dividend safety numbers, you might see some scary numbers but again it's explained by the same reason. It appears that the company's dividend payout ratio is as high as 418.5% which means the company is distributing more than 4x times the amount of money it's making but keep in mind that the company pays dividends on only 18% of its shares so the actual payout ratio is much lower. In fact, the company's dividend payout ratio is closer to 75% when you account for this unique dividend practice. It could even get lower in the future if the company continues on with its practice of buying back minority shares and reducing their overall percentage as it's been doing since 2007.
Because of its unique share structure, when the bank reports earnings, it reports earnings and book value in two ways. For example, as of the company's last report, it reported GAAP earnings of 27 cents per share as well as $1.41 per minority share in the last 12 months. When you keep in mind that the company was paying $1.13 per share in dividends, the first number makes it seem like the dividend is far from sustainable whereas the second number actually shows that the dividend is easily sustainable. The same is also true for the company's book value. Its book value is either $6.87 per share or $36.20 per share depending on whether you are looking at all shares or minority shares only. According to the first metric, the company is trading at more than 2x its book value whereas according to the second metric it's trading at slightly more than one-third of its book value.
If we look at the company's metrics by minority share, they have been more or less stable over the years. After earning $1.62 in 2018 the company earned $1.53 in 2019 and $1.59 in the next year. 2022 was the company's worst year in recent history but it still managed to earn $1.36 and 2023 seems to be on the way to recovery to $1.41. Unfortunately, we are not seeing much growth in this metric which also explains why dividend growth has been absent in recent years even with all those share repurchases reducing the number of available minority shares. If you account for the fact that the company's minority shares have been declining, you can also notice that its EPS has been on a slight decline as well. While this doesn't mean that the current dividend is not sustainable for the time being, it could mean that its dividend might not get a hike anytime soon until its earnings start growing.
You'd think that the company would make far more money in the last 2 years since rates for loans and mortgages have been rising but the company's mortgage originations have been actually down significantly. In the fiscal year 2023, the company posted $1.86 billion in loan originations and purchases, down almost half from last year's $3.6 billion. This kind of makes sense considering that demand for mortgages dropped significantly as mortgage rates rose from 3% to almost 8% in as little as a year while home prices didn't drop by much, making homes significantly less affordable for most people. Still, 50% is a pretty drastic drop and investors will have to keep an eye on this number moving forward.
Since last year, the company's deposits grew from $8.9 billion to $9.4 billion while its net loans grew at the same rate indicating a loans to deposits ratio of 160% or a leverage ratio of 60%. The company's total return on assets and return on equity dropped slightly but its net interest income rose slightly to make up for this. The good news is that the quality of the bank's loans continues to hold up with a total percentage of non-performing loans dropping from 0.23% to 0.20%, indicating that it's able to collect payments from 99.8% of the loans it holds. This is especially important because interest rates have been rising significantly and more than one-third of the company's loans are at a floating rate which means they would be affected by rate increases significantly. One would think that when interest rates to higher, the percentage of non-performing loans will increase because more people will have trouble with servicing their loans but it hasn't happened yet at this bank as of last quarter.
When calculated by minority ownership shares, the stock trades at a P/E of 10 which is slightly higher than most regional banks. Typically regional banks trade at a P/E range of 6-10 and this bank falls into higher end of that range but this is mostly because of the rally we've seen recently in this stock's price. I wouldn't call this bank expensive but it is closer to the higher end of the normal range for sure.
With its unique structure of dual ownership and only paying dividends to minority owners, the stock presents an interesting opportunity for income investors who appreciate high yields but keep in mind that this might not come with much dividend growth. Also, if the company were to change its ownership structure or decided to start paying dividends to all owners, the current yield would drop significantly and you might be looking at a dividend cut of as much as 80%. As of right now, the risk of this happening is very small and the company is committed to paying dividends to only minority holders but this is not guaranteed forever. It actually gets voted and majority holders are actually asked to waive their dividends which they have done so far and are likely to continue doing so.
Also, since this is a regional bank, the risk of it getting affected in the future by a slowing economy or a recession is much higher than bigger banks with much bigger resources. Last year we already saw several regional banks fail but again those banks were making leveraged bets on bonds which this bank doesn't really do. This bank is more interested in the retail side of things where it collects deposits and issues loans and its leverage ratio is quite manageable for now.
For further details see:
TFS Financial: Income Play With Unique Ownership Structure