The Dow Jones Industrial Average, an index composed of 30 large publicly traded U.S. companies, is in the green this year but has far underperformed the broader market. It’s only up roughly 1.7% in 2023.

While the index has been known to generate solid returns if held consistently for a long period of time, I think this cash-gushing stock can beat the Dow after it endured a big sell-off.

A strong super-regional bank in the making
Truist Financial (TFC) is a roughly $555 billion asset bank and one of the largest in the U.S. The brand was formed in 2020 after BB&T and SunTrust merged.

Like a lot of super-regional banks, Truist sold off intensely after the banking crisis earlier this year and now is down about 30% in 2023. Truist invested in lower-yielding, longer-duration bonds right before the Federal Reserve rapidly increased interest rates, which has put most bank bond portfolios underwater because interest rates and bond values have an inverse relationship.

At the end of the first quarter, Truist had close to $20 billion of unrealized losses in its available-for-sale (AFS) and held-to-maturity (HTM) bond portfolios. That’s a significant amount considering the bank has about $25.9 billion of tangible common equity, although keep in mind that the AFS unrealized losses are already factored into the tangible common equity calculation.

While the unrealized losses will be recouped as the bonds mature and interest rates stabilize, the concern here is that if Truist ever had to sell these bonds while they trade at a loss to cover deposit outflows, they would destroy a significant amount of shareholder equity. This dynamic contributed greatly to the failures of SVB Financial‘s Silicon Valley Bank and Silvergate Capital earlier this year.

Assessing capital
I doubt Truist will find itself in similar straits because it has a very strong deposit base in fast-growing markets that consists of a large retail, commercial, and corporate client base. For instance, 55% of Truist’s total deposits are from retail and business banking customers, with an average balance of $17,000.

At an industry conference at the end of May, Truist Chief Executive Officer Bill Rogers said deposits at the bank were down less than 2% in the quarter, but he attributed that to quantitative tightening — in which the Federal Reserve pulls liquidity out of the economy, thus draining bank deposits — as well as seasonal factors. The diversity of Truist’s deposit base makes any kind of bank run very unlikely.

Another concern among investors is that regulators are going to soon require super-regional banks like Truist to factor in their unrealized AFS bond losses into their capital ratios such as the Common Equity Tier 1 (CET1) capital ratio, which looks at a bank’s core capital as a percentage of its risk-weighted assets such as loans. At the end of the first quarter, Truist’s CET1 ratio was 9.1%.

But if you factored in these unrealized AFS losses, the CET1 ratio would fall drastically to 6.2%, which is below its 7% regulatory requirement. Banks use excess capital above their CET1 requirement to pay dividends and conduct share repurchases, so if Truist was short on capital, the sustainability of its dividend could come into question. But Truist’s current capital ratios do not include the $1.95 billion of fresh capital the bank is about to get from the sale of a minority stake in its insurance division. Truist also still expects to generate organic capital from earnings, and I also suspect regulators will give banks time to make the transition.

A healthy dividend that is sustainable
After the sell-off this year, Truist’s dividend yield has jumped to a whopping 6.9%. At the conference, Rogers said the dividend “is really important in terms of maintaining a strong dividend and a really good dividend yield and good return for our stakeholders.” So, I do think Truist has the capital capacity and the management desire to maintain the dividend.

Finally, I also believe that as the regulatory outlook becomes clearer, unrealized bond losses begin to come down, and deposit costs stabilize, Truist will see its stock price rebound to more historical levels over a longer time horizon.

Truist will also eventually realize the benefits from its merger, which has required a ton of work to integrate over the past three years. All of this should enable shareholders to beat the Dow by owning Truist’s stock through a combination of passive income from the dividend and stock price appreciation as well.

— Bram Berkowitz

46-Year-Old CEO Bets $44.2 Billion on One Stock [sponsor]
Netflix is NOT the future of entertainment. It's only a small fraction. And one billionaire CEO is taking charge of what Netflix DOESN'T do and leading the way for the next generation of entertainment. His forward-thinking company, which many people haven't even heard of yet, doesn't only want to compete with Netflix... It wants to rule the world...

Source: The Motley Fool