TFSL - Third Federal Savings & Loan

[NoCalledStrikes]

I recently wrote a long post on my blog for TFSL, http://nocalledstrikes.com/2014/08/21/the-hidden-value-at-third-federal-savings-and-loan-tfsl/.  As I'm really into obtaining disconfirming data points, please feel free to politely shoot holes in my thesis. 

 

My basic points are:

The way step one mutual thrifts account for shares at the mutual holding company overstates the proper share count to use when calculating financial ratios.

TFSL is really cheap, but doesn't show it because of the share count issue.

TFSL is grossly overcapitalized and is aggressively buying back stock at highly accretive prices. 

TFSL is about to restart its dividend.

TFSL's profits and problem loan trends are all headed in the right directions.

I think the biggest issue outstanding is whether it is wise to buy a S&L should interest rates go up.

 

My valuation paragraph is:

 

"Using scenario B, book value would rise to $30.33 from the reduction of shares below book value as 31 million shares would be purchased over 2.5 years. The thrift is likely to retain approximately 3 million per month after dividends or 90 million over these 30 months which would add $2 to book value (not included in above chart). Additionally, 70 cents in dividends would be received. The return on a $13.60 investment would be 14.1% per annum if the stock continues to trade at 56% of book, but at a more reasonable 75% of book, the return would be 28% per annum."

 

Comments?

 

[muscleman]

Very good article! Thanks for sharing.

Google finance shows the PE is 64. If the share count is adjusted, it will be 15.5, which is still not cheap.

The P/B is low but its earnings potential seems a little bit less attractive.

[NoCalledStrikes]

I agree that a 15.5 P/E is not cheap for an S&L, however, I do think there are some factors which will improve the P/E ratio over time.

 

(1) TFSL's financials are trending favorably, so unless we re-enter a recession, the forward P/E is going to continue to improve as loan losses continue slowing down and more loans are written (and TFSL certainly has the capital to write more loans).

 

(2)  Let's says its earnings never really improve on an aggregate basis, then we would still have the earnings per share increase by 12-15%/ year as the share purchases aggressively continue. This will lead to a corresponding drop the P/E ratio. If the buybacks continue for several years, which is consistent with the thrift's history, then this will start to be significant.

 

Mostly, however, I think of the opportunity of TFSL as a return of capital play, not an earnings play. If it can meaningfully raise earnings as well, then it will sell for an even higher valuation than I am estimating.  But I am not counting on the company to out-perform on its earnings, I just need them to not do anything really stupid. 

 

Thanks for your comments.

 

 

[rogermunibond]

Has Marc Stefanski made any pro-shareholder value noises about the 2nd step demutualization?  I looked at TFSL five years ago when they did the first step.  My opinion is that Stefanski runs the S&L for customers mostly.  Their rates are ridiculously low (my brother used them for his re-fi).  They had the big ding of getting hit by their regulator for not having up-to-date accounting systems in place and over-reliance on home equity line of credit products.

[oddballstocks]

Very good article! Thanks for sharing.

Google finance shows the PE is 64. If the share count is adjusted, it will be 15.5, which is still not cheap.

The P/B is low but its earnings potential seems a little bit less attractive.

 

This one trades on book, not earnings.  Knowing which banks/thrifts trade on book vs earnings is critical to relatively valuing these things.

 

Great writeup, I agree this is too cheap.  I haven't heard any rumors of a 2nd step, and agree with rogermunibond, my parents refi-ed with them due to their rock bottom rates.

[Wilson-TPC]

Holy jesus this is cheap.

 

Thanks for the write up.

[NoCalledStrikes]

Has Marc Stefanski made any pro-shareholder value noises about the 2nd step demutualization?

Marc Stefanski's life is this bank.  He's run it for 25 years, and his father ran it for 50 years before that.  If he was going to do a full demutualizaton, he would have done it 20 years ago.  So, no I don't expect TFSL  to do a second step.  There is one exception, if new regulations coming out of Dodd-Frank makes operating as a mutual too onerous, they would do the second step.  However, the dividend waiver vote required by DF, which could have been such a trigger, didn't cause a problem for TFSL, but just the discussion of such rules did nudge some other step one mutuals to convert earlier this year .

[oddballstocks]

Has Marc Stefanski made any pro-shareholder value noises about the 2nd step demutualization?

Marc Stefanski's life is this bank.  He's run it for 25 years, and his father ran it for 50 years before that.  If he was going to do a full demutualizaton, he would have done it 20 years ago.  So, no I don't expect TFSL  to do a second step.  There is one exception, if new regulations coming out of Dodd-Frank makes operating as a mutual too onerous, they would do the second step.  However, the dividend waiver vote required by DF, which could have been such a trigger, didn't cause a problem for TFSL, but just the discussion of such rules did nudge some other step one mutuals to convert earlier this year .

 

The trigger on these things will be regulatory.  This morning on a flight I was reading the following pdf: http://www.haas.berkeley.edu/groups/finance/Conversions%20Report%20May%2020061.pdf

 

It goes into great lengths discussing the downsides of the Credit Union structure and why Credit Unions will most likely be forced to become mutuals and full stock companies.  If you read between the lines the discussion applies to mutuals as well.  Acquisition is difficult as is raising capital.

 

If Third Federal wants to acquire someone it would need to be another mutual, at this point in the game there aren't that many great mutuals that are worth acquiring that'd move the needle.  Instead they'd need to demutualize.

[Wilson-TPC]

Has Marc Stefanski made any pro-shareholder value noises about the 2nd step demutualization?

Marc Stefanski's life is this bank.  He's run it for 25 years, and his father ran it for 50 years before that.  If he was going to do a full demutualizaton, he would have done it 20 years ago.  So, no I don't expect TFSL  to do a second step.  There is one exception, if new regulations coming out of Dodd-Frank makes operating as a mutual too onerous, they would do the second step.  However, the dividend waiver vote required by DF, which could have been such a trigger, didn't cause a problem for TFSL, but just the discussion of such rules did nudge some other step one mutuals to convert earlier this year .

 

The trigger on these things will be regulatory.  This morning on a flight I was reading the following pdf: http://www.haas.berkeley.edu/groups/finance/Conversions%20Report%20May%2020061.pdf

 

It goes into great lengths discussing the downsides of the Credit Union structure and why Credit Unions will most likely be forced to become mutuals and full stock companies.  If you read between the lines the discussion applies to mutuals as well.  Acquisition is difficult as is raising capital.

 

If Third Federal wants to acquire someone it would need to be another mutual, at this point in the game there aren't that many great mutuals that are worth acquiring that'd move the needle.  Instead they'd need to demutualize.

 

Well said.

[NoCalledStrikes]

It is official, dividends resume to public holders...

 

TFS Financial Corporation Declares Dividend

Company Release - 08/28/2014 16:00

CLEVELAND, Aug. 28, 2014 (GLOBE NEWSWIRE) -- TFS Financial Corporation (Nasdaq:TFSL) (the "Company"), the holding company for Third Federal Savings and Loan Association of Cleveland (the "Association"), today announced that the Board of Directors declared a quarterly cash dividend of $0.07 per share, payable on September 26, 2014 to stockholders of record on September 12, 2014. Third Federal Savings and Loan Association of Cleveland, MHC, (the "MHC") has waived its right to receive the dividend on the 227,119,132 shares of common stock it owns.

 

On July 31, 2014, the MHC received the approval of its members (depositors and certain loan customers of the Association) with respect to the waiver of dividends, and subsequently received the non-objection of the Federal Reserve Bank of Cleveland, to waive receipt of dividends on the Company's common stock the MHC owns up to $0.28 per share during the four quarters ending June 30, 2015.

 

"We are pleased to announce the reinstatement of our dividend," said Chairman and CEO Marc A. Stefanski. "Now we can actively manage all aspects of our three-dimensional approach to adding value for our shareholders. We have been buying back stock since last spring, and continue to grow. We now offer our products in 22 states, representing more than half the U.S. population. We're excited about our future, and look forward to continuing to deliver value to our shareholders, customers, associates and communities we serve."

 

Third Federal Savings and Loan Association is a leading provider of savings and mortgage products, and operates under the values of love, trust, respect, a commitment to excellence and fun. Founded in Cleveland in 1938 as a mutual association by Ben and Gerome Stefanski, Third Federal's mission is to help people achieve the dream of home ownership and financial security. It became part of a public company in 2007 and celebrated its 75th anniversary in May, 2013. Third Federal, which lends in 22 states, is dedicated to serving consumers with competitive rates and outstanding service. Third Federal, an equal housing lender, has 21 full service branches in Northeast Ohio, eight lending offices in Central and Southern Ohio, and 17 full service branches throughout Florida. As of June 30, 2014, the Company's assets totaled $11.7 billion.

[Mephistopheles]

I recently wrote a long post on my blog for TFSL, http://nocalledstrikes.com/2014/08/21/the-hidden-value-at-third-federal-savings-and-loan-tfsl/.  As I'm really into obtaining disconfirming data points, please feel free to politely shoot holes in my thesis. 

 

My basic points are:

The way step one mutual thrifts account for shares at the mutual holding company overstates the proper share count to use when calculating financial ratios.

TFSL is really cheap, but doesn't show it because of the share count issue.

TFSL is grossly overcapitalized and is aggressively buying back stock at highly accretive prices. 

TFSL is about to restart its dividend.

TFSL's profits and problem loan trends are all headed in the right directions.

I think the biggest issue outstanding is whether it is wise to buy a S&L should interest rates go up.

 

My valuation paragraph is:

 

"Using scenario B, book value would rise to $30.33 from the reduction of shares below book value as 31 million shares would be purchased over 2.5 years. The thrift is likely to retain approximately 3 million per month after dividends or 90 million over these 30 months which would add $2 to book value (not included in above chart). Additionally, 70 cents in dividends would be received. The return on a $13.60 investment would be 14.1% per annum if the stock continues to trade at 56% of book, but at a more reasonable 75% of book, the return would be 28% per annum."

 

Comments?

 

 

Hey, that was a great write up.

 

Beginner questions: Why should we not include the 74% owned by the depositors in calculating BVPS? And let's say they do the 2nd step, why does the money flow to the association? Since the 74% is owned by depositors, shouldn't they be the ones getting paid for selling their stake?

[muscleman]

Do they have plans to improve profitability? The net interest margin in only 2.3%, compared to the 3.8% peer average. In the long term I would rather pay a higher price/book ratio in exchange for the earning power.  :)

[Guest wellmont]

there are still quite a few MHC banks trading. the problem is they tend to be dead money unless they convert. and it's hard to figure out which ones will. if you're just collecting undervalued stuff and waiting these can be good additions to the port. one strategy is to wait till they announce and buy after the new shares are offered and then sold for a short term gain. you can usually enter at a good price.

[TeddyLampert]

@wellmont

 

You make an interesting point. Have you noticed if these same MHC's (which you observe to be dead-money) have also been buying back stock? In other words, in spite of a big buy back program, are they still dead money? 

[Guest wellmont]

buying back stock is a good sign. if it is done before the conversion it may indicate they plan to convert. the question is when. A CEO in his early 60s is also something to look for. most of them buy back stock after the conversion because they are often pressured by activist investors to do so. once converted they generally are candidates to sell the company after the 4 year anniversary. I would focus on ones where known activist or event driven investors have positions.

[TeddyLampert]

@wellmont

 

Are your comments specific to TFSL? Or are they being made generally? If I had to summarize what has been written and said so far about TFSL, there are no plans for a long while to take the second step to fully convert. Right now, the thesis with TFSL is that it is going to buy back stock aggressively because it is cheap, and the company is overcapitalized. The 7/31 conference call was enlightening. As an aside, it would be really great if the stock traded down or sideways from here so that the company can continue to do accretive repurchases. 

[NoCalledStrikes]

 

Hey, that was a great write up.

 

Beginner questions: Why should we not include the 74% owned by the depositors in calculating BVPS? And let's say they do the 2nd step, why does the money flow to the association? Since the 74% is owned by depositors, shouldn't they be the ones getting paid for selling their stake?

 

That is an excellent question. On the surface, I agree that it doesn't seem right that the members don't get anything beyond the right to buy shares at the conversion for their share of the ownership, why can't they just get paid a special distribution of the retained earnings? Its their bank right?

 

The pragmatic answer to your question is that those rights to purchase are sufficiently valuable that no one ever complains.  But the real answer lies in the regulations that were created eighty years ago for demutualization. The process was created to allow mutuals to raise more capital and be a stronger bank and not for allowing members to cash out.  Mutuals are an anachronism from a different era and their rules/charters reflect that.

 

Rules of course can be changed.  The recent Dodd Frank requirements of a member vote before waiving dividends is the most obvious example. Several MHC's were concerned enough over the dividend waiver issue to do their second step earlier this year, and many analysts have predicted Dodd Frank will eventually force all the remaining MHCs to convert over to stock holding corporations. 

 

 

 

 

 

 

[TeddyLampert]

Whoa!

 

This 8-K is a big update and a positive signpost to the TFSL thesis. Surprised not to have seen this posted here yet, so I have included it below.

 

This latest repurchase program represents around 14% of shares outstanding.

 

The stock is still unbelievably cheap on a P/B basis. Buying back shares at these valuations is ridiculously accretive to shareholders.

 

Rarely do I come across the proverbial "value hiding in plain sight" situation, but fortunately for us the case due to the complicated mutual ownership structure. 

 

It is really great to see that management is living up to their word and aggressively following through on shareholder friendly capital allocation. It's one thing to hear about it on a conference call, but it's another thing to it actually happening. I strongly recommend listening to the latest conference call. It's a management team that "gets it" 

 

 

 

-------------------------------------------------------------------------------------------------------------------------------

 

https://www.bamsec.com/filing/138166814000069?cik=1381668

 

TFS Financial Corporation Announces Sixth Stock Repurchase Program

 

(Cleveland, OH - September 9, 2014) - TFS Financial Corporation (NASDAQ: TFSL) (the “Company”), the holding company for Third Federal Savings and Loan Association of Cleveland (the “Association”), today announced that the Board of Directors of the Company approved the Company’s sixth stock repurchase program, which authorizes the purchase of up to 10,000,000 shares of the Company’s outstanding common stock. The Company’s fifth repurchase program, which authorized the repurchase of 5,000,000 shares and began April 9, 2014, is expected to be completed soon. Currently over 4,700,000 shares have been repurchased under that plan at an average cost of $13.58 per share.

 

“This stock repurchase program is the latest step in our three-dimensional approach to adding value for our shareholders,” said Third Federal Chairman and CEO Marc A. Stefanski. “Now that we are paying a dividend, buying back our stock, and growing our company, we have great momentum as we head into our new fiscal year.” 

[NoCalledStrikes]

Thanks for posting the 8-K.  The company is effectively purchasing the maximum allowed to buy back this volume of stock.

 

I know some people make the point that step one MHC's are dead money, and that you should wait for the second step, but I really think their commitment to buy backs at such accretive prices makes this a different story.  I will hold so long as they buy back stock below 80% book value and currently they are buying at 60%.

 

[TeddyLampert]

I will hold so long as they buy back stock below 80% book value and currently they are buying at 60%.

 

 

This is what I am planning to do as well.

 

Thanks for alerting us to this idea.

[oddballstocks]

Thanks for posting the 8-K.  The company is effectively purchasing the maximum allowed to buy back this volume of stock.

 

I know some people make the point that step one MHC's are dead money, and that you should wait for the second step, but I really think their commitment to buy backs at such accretive prices makes this a different story.  I will hold so long as they buy back stock below 80% book value and currently they are buying at 60%.

 

Agreed!

[muscleman]

I have a couple questions:

1. Right now public holders owns 26% of the bank and the mutual depositors own 74%.

When we say "book value per share", we assume that the entire $1.8 bn book value is owned by the public holders. I wonder what would happen if this bank liquidates? Assume this bank liquidates tomorrow, will the $1.8 bn book value be dispatched to all share holders or only the public share holders?

 

2. Do you know any other mutual S&L that remains indefinitely at step one?

 

3. For other mutual S&Ls that completed both steps, when it comes to step two of demutualization, what price did they offer to mutual depositors? Is that a discount to the current trading price of the stock?

[oddballstocks]

I have a couple questions:

1. Right now public holders owns 26% of the bank and the mutual depositors own 74%.

When we say "book value per share", we assume that the entire $1.8 bn book value is owned by the public holders. I wonder what would happen if this bank liquidates? Assume this bank liquidates tomorrow, will the $1.8 bn book value be dispatched to all share holders or only the public share holders?

 

2. Do you know any other mutual S&L that remains indefinitely at step one?

 

3. For other mutual S&Ls that completed both steps, when it comes to step two of demutualization, what price did they offer to mutual depositors? Is that a discount to the current trading price of the stock?

 

1. Won't happen, I'd say this discussion is irrelevant.

 

2. There are a number of MHC's, but regulators don't like the mutual structure.  So to say these will remain like this forever is to say the impossible.  There is a very strong push to demutualize for most of these institutions.

 

3. Depends on the bank and demand.  Pricing depends mostly on demand, for something like Third Federal I'd imagine you'd see a lot of demand because they can take larger deposits.  Might be like Investors who went recently at book or slightly above.  Many of these things were demutualizing well above book before the crisis.

 

Conversion isn't a matter of the current stock price but rather a function of demand and pricing based on this demand.  If they can get between Max and SuperMax I don't see why this wouldn't price close to or above book.

[muscleman]

3. Depends on the bank and demand.  Pricing depends mostly on demand, for something like Third Federal I'd imagine you'd see a lot of demand because they can take larger deposits.  Might be like Investors who went recently at book or slightly above.  Many of these things were demutualizing well above book before the crisis.

 

Conversion isn't a matter of the current stock price but rather a function of demand and pricing based on this demand.  If they can get between Max and SuperMax I don't see why this wouldn't price close to or above book.

 

So when you said "Investors who went recently at book", do you mean that they assume all of the $1.8 bn belongs to public shareholders, so they divide that by the share count, which is 74 Million to get to $24 per share, and then say, ok, for the rest of you mutual holders, you will pay $24 per share to get your shares? I think that would be fair. The other unfair formula would be like this: Ok, you public share holders owns 26% of this bank, so you own $0.46 bn, which is $6 per share. So for the rest of you mutual holders, you can pay $6 per share to get your shares.

Which is the "industry norm" here, if there is one?

 

The other question: Why is the CEO's compensation so high? $4 mn for last year? I've seen much larger banks whose CEO's compensation is half of this number.

[oddballstocks]

3. Depends on the bank and demand.  Pricing depends mostly on demand, for something like Third Federal I'd imagine you'd see a lot of demand because they can take larger deposits.  Might be like Investors who went recently at book or slightly above.  Many of these things were demutualizing well above book before the crisis.

 

Conversion isn't a matter of the current stock price but rather a function of demand and pricing based on this demand.  If they can get between Max and SuperMax I don't see why this wouldn't price close to or above book.

 

So when you said "Investors who went recently at book", do you mean that they assume all of the $1.8 bn belongs to public shareholders, so they divide that by the share count, which is 74 Million to get to $24 per share, and then say, ok, for the rest of you mutual holders, you will pay $24 per share to get your shares? I think that would be fair. The other unfair formula would be like this: Ok, you public share holders owns 26% of this bank, so you own $0.46 bn, which is $6 per share. So for the rest of you mutual holders, you can pay $6 per share to get your shares.

Which is the "industry norm" here, if there is one?

 

The other question: Why is the CEO's compensation so high? $4 mn for last year? I've seen much larger banks whose CEO's compensation is half of this number.

 

The 74% will be offered to depositors at either $8 or $10.  They will re-adjust the number of shares based on a conversion ratio to reflect ownership. 

 

Investors Bancorp was a straight conversion I believe, not a MHC.  You can look at other MHC conversions to get a sense of how the mechanics work.  But what you're looking at is an IPO and then public shareholders who get converted at a certain ratio.  Most of the depositors who purchase this thing are professional depositors.  When these things go people who are keeping a foot in the door with a $5k account suddenly step up and buy millions of dollars worth of the stock.  There are a few hundred professional depositors who make the rounds of mutual banks, there are a few on the board.