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My Thesis On Truist Stock
After a combination of events brought Truist Financial Corporation (NYSE:TFC) deep below its book value, the stock presents a value opportunity. In this article, I will discuss how Truist's recent insurance unit sale and the impact of lower interest rates should help get its stock price back on track in the back half of this year.
Truist has seen its stock price plummet following the early 2023 banking crisis. High interest rates, bank failures, and efficiency issues created a perfect storm, driving Truist's stock below a book value of 1. Investors who got scared by the similarities between Truist and the failed banks fled from the stock, causing its shares to take a nosedive, losing over 47% of their value in a matter of weeks. The stock has since recovered some losses, yet it remains deep below its pre-crisis levels.
Currently, the seventh-largest bank in the U.S., Truist is still navigating post-merger operational inefficiencies. Additionally, the strain from record high interest rates and the negative aftermath of the banking crisis weighed on its profitability and dampened investor appetite. However, I think that Mr. Market has overreacted, and Truist is poised for a significant rebound once interest rates start coming down.
Truist's HTM Portfolio Will Benefit From Lower Rates
First, let's look at how lower interest rates should alleviate a major point of concern - the bank's HTM (Held-to-Maturity) securities portfolio. The portfolio comprises of agency Mortgage-Backed Securities (MBS). Typically, banks invest in these low-risk assets to boost their capital ratios and secure a stable flow of income. However, Truist acquired these securities at a period of very low interest rates, leaving it off-guard when rates started rising.
According to Truist's first-quarter form 10-Q, the bank is currently sitting on HTM securities with a book value of $53.369 billion as of March 31, 2024. Currently, these securities earn a yield of 2.51%, which is far below both the rate of inflation and the current level of interest rates at 5.5%.
As interest rates rose, the mark-to-market value of these securities dropped due to their relatively unattractive yields. The 10-Q states that the HTM portfolio has an unrealized loss of $10.32 billion, or approx. -19%. These securities represent about 40% of its total investment portfolio or 10% of the bank's total assets.
Unrealized losses on HTM securities don't pose a significant risk on their own. After all, they are meant to be held until maturity, not sold. If, however, Truist was forced to liquidate these assets quickly to raise capital, such as during a bank run, it would have to realize massive losses. That is why investors perceive it as a major red flag, and why it has weighed on Truist's share price.
Despite these risks, there is a silver lining. As long as clients remain confident in the safety of their deposits, a bank run is unlikely, and as interest rates start coming down, these losses will shrink. According to a recent report, Citibank thinks that the Fed may start to cut interest rates as soon as this fall. Wall Street is expecting the first rate cut in September, with an additional one in December, as per CME's FedWatch tool.
This would massively reduce the unrealized losses on Truist's HTM portfolio. As interest rates decline, the relative value of these assets will increase, adding stability to Truist's financial position and reducing the risk of collapse.
Truist: Insurance Unit Sale Will Enhance Liquidity
Another tailwind for the stock is the capital boost provided by Truist's recent insurance unit sale. In its Q1 2024 press release, CEO Bill Rogers highlighted the planned sale of its insurance arm, Truist Insurance Holdings (TIH). TIH is one of the largest insurance brokers in the U.S. The sale has received praise from analysts for its potential to improve the bank's liquidity and capital ratios. As stated in the press release:
The sale of Truist Insurance Holdings (TIH) is on track to close in the second quarter and will strengthen our relative capital position, which will allow Truist to provide even greater support to our core banking clients, assess a potential balance sheet repositioning to replace TIH's earnings and evaluate a return of capital to shareholders via share buybacks later in 2024 depending upon market conditions.
- Bill Rogers, Truist Chairman & CEO
Truist completed the transaction on May 6, 2024. The sale resulted in after-tax cash proceeds of $10.1 billion. The bank has used these proceeds to liquidate some of its Available-for-Sale (AFS) securities at a loss, freeing up capital to invest in securities yielding twice as much. This will positively affect the bank's net interest income (NII). The bank plans to use remaining capital to enhance its core banking business, and potentially buy back shares later this year.
The additional liquidity has improved Truist's CET1 capital ratio by 230 basis points, from 10.1% at the end of Q1 to 12.4%. However, it was subsequently reduced to 11.4% by the aforementioned balance sheet repositioning. A ratio above 10% is generally considered safe, but this increase has put the bank at par with its larger peers, such as Wells Fargo & Company (WFC) and Bank of America Corporation (BAC).
Additionally, it has increased Truist's tangible book value per share by about $4, from $24.79 at the end of Q1 to $28.80, bringing the TTM P/B ratio to 0.87 from 0.96, making it relatively more undervalued. Therefore, the sale should serve as another tailwind for the stock.
Truist's Client Base Remains Robust
A major reason why investors feared the unrealized HTM securities losses is the possibility of a bank run. However, there are several reasons why Truist's client portfolio differs from the banks that failed in 2023. With only around 44% of its deposits not covered by FDIC insurance, the bank is on par with larger competitors, as compared to the high 90s at Silicon Valley Bank. This provides further confidence for depositors.
Additionally, the share of non-performing loans in Truist's portfolio has remained steady going into Q1 2024, and its provision for credit losses has declined substantially by $72 million to $500 million, suggesting that the bank anticipates improving borrowing conditions. According to its Q1 earnings presentation, Truist's consumer loans are slowly declining, reflecting the impact of higher interest rates on borrowers. However, its commercial loans remain mostly unchanged, with the average yield of its loans rising. These are expected developments given the high interest rate environment, and especially the lower provisions for credit losses are a green flag for investors regarding the health of Truist's borrowers.
In line with its peers, Truist has also massively increased its investment banking revenues as the industry gradually recovers.
Risks To My Thesis
While interest rates are largely expected to decline this fall, rate cuts are not guaranteed. Higher interest rates for longer may increase the pressure on Truist and further worsen borrowing conditions, therefore hurting its consumers and possibly causing them to leave for bigger banks, such as was the case during the banking crisis.
Additionally, while the insurance unit sale strengthens Truist's financial position, the business provided a reliable stream of revenues and a degree of business diversification, which Truist will now need to replace. I should also mention the negative trend in average deposits and loans, which despite not being at any alarming level, might pose as a risk if interest rates stay elevated.
Is Truist Stock Undervalued?
Looking at Seeking Alpha's valuation overview, you can see that Truist has an overall valuation score of B. The Quant rating shows an overall rating of "Hold", with the worst rating for Truist's growth at D-. The factors mentioned above should help Truist improve its banking business and promote growth, therefore leading to a possible improvement.
Most importantly, the stock is trading at a TTM P/B ratio of 0.87, adjusted for the sale of TIH. This is in stark contrast to both its peers and its 5-year average. As the developments mentioned above play out, I expect Truist to return to a P/B ratio closer to its peers at around 1.06, its long-term average. This could lead to the stock price appreciating by about 20% to the mid-40$ range, given that it breaks the resistance at $40.
Additionally, at 5.65%, its dividend yield is far higher than the industry average and its own 5-year average as well. A return to the mid-40$ range would return the dividend yield to the long-term average of around 4.5%. Seeing as the bank is almost on par with its industry peers in terms of financial stability, I believe that the market has priced in too much fear into this stock, which in my opinion makes it undervalued.
Truist Stock: Would I Buy, Hold, or Sell?
On the bull side, anticipated interest rate cuts should improve both the health of Truist's investment portfolio and the overall business environment. The bank appears to have sufficient liquidity and continues to drive operational efficiency, which is helped by the recent sale of its insurance arm.
On the bear side, Truist is seeing a decline in average deposits and loans, faces large unrealized losses on its investments, and has been having trouble consolidating its post-merger operations.
Taking all these factors into consideration, I believe that Truist is prepared to weather this storm, and can go into recovery mode once interest rates start to decline, improving its valuation relative to industry peers.
Therefore, I am initiating my coverage with a rating of "Buy".
I'm Looking Forward To Your Feedback
Do you have something to say about this company? Did you agree or disagree with my analysis? Do you think there's something I missed? I would love to discuss it with you in the comments to help everyone get the clearest picture!
Jakub Rochlitz
I am a passionate value investor with a focus on identifying investment opportunities in large-cap companies with risk / reward supported by fundamental analysis to reliably outperform the S&P500 index. I am also a Popular Investor on eToro, where I manage a stock portfolio copied by other investors. My passion for fundamental analysis has led me to want to share my insights and strategies with investors to help navigate the complexities of the stock market. Besides managing a market-beating portfolio, I regularly publish investment articles through various channels for my followers.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of TFC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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