In late 2019, BB&T and SunTrust completed the largest bank deal in a decade to become Truist Financial Corp (TFC -0.13%), the sixth-largest bank by assets in the U.S.
The closing of the merger, however, kicked off nearly three years of integration efforts that required heavy one-time costs and really blurred the story that the franchise was trying to tell. Since the start of 2020, Truist's stock has fallen more than 13%. Meanwhile, the KBW Nasdaq Bank Index (NASDAQ: BKX) is down about 2%, so investors have been waiting for the benefits of the merger to come through.
In its recent fourth-quarter earnings call, Truist's management team said the last of the merger-related costs have been incurred, which will allow the bank to shift to the offensive. Now, it's time for management to show the merits of the merger.
Starting to see progress
As the merger integration has progressed, management has consistently said it expects the combined entity to be able to deliver industry-leading numbers, including a return on average tangible common equity (ROTCE) in the low 20s percentile, as well as an efficiency ratio (expenses as a percentage of revenue) in the low 50s percentile.
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In the fourth quarter, Truist had an adjusted efficiency ratio, which strips out merger-related costs, of 54%, its lowest since closing the merger. In the fourth quarter, Truist had an ROTCE of 27.6%. For the full year, the bank's ROTCE was nearly 23%. Keep in mind, though, that the environment for banks in 2022 was favorable due to strong loan growth, higher interest rates, and benign credit quality. The impact of higher rates on deposit costs also did not really start to hit until the fourth quarter.
Speaking of loan growth, this was a bright spot for Truist, which grew average loans by 3.6% in the fourth quarter, while most banks are starting to see what was a strong year for loan growth in 2022 slow down. This reflects some of the very attractive Southeastern markets that Truist now has scaled in as a result of the merger.
Truist is also seeing its deposit betas perform better than expected, at 27% in the fourth quarter. A deposit beta shows how much a bank will raise its deposit costs in response to the Federal Reserve's interest rate hikes over a set period of time (the lower the beta, the better). However, with the Fed having raised rates aggressively in 2022, banks are in unchartered waters, and it remains to be seen if Truist's betas will continue to outperform this year.
Still, during the merger integration, Truist invested heavily in its technology and moved most of its banking products onto one digital cloud platform. This -- in combination with its new scale in attractive banking markets -- is why management believes its deposit base is going to perform better over time.
The outlook for operating leverage
Given the higher interest rate environment, most banks generated good positive operating leverage in 2022, which is when revenue grows faster than expenses. Most banks are also expecting to do that in 2023.
Truist had slightly positive operating leverage for the full year, but it was nothing that special. However, on a quarterly basis, Truist began to see its operating leverage accelerate, generating 2.6% of positive operating leverage in the third quarter and 3.7% in the fourth quarter. Truist is aiming for about 2% of positive operating leverage or more this year.
That's significantly higher than the operating leverage the bank just had in 2022, but it doesn't stand out in its peer group. PNC Financial (PNC 0.29%) looks like it very well could generate 4% positive operating leverage this year , while Citizens Financial Group (CFG 1.57%) is also expecting 4% or 5% of operating leverage.
Looking for more evidence
Truist has all the makings of a great bank stock. It's in attractive markets and has several good sources of fee income from areas such as its insurance business. I'm guessing the bank still needs to work through some things post-merger until the business can really start to hum. There's been progress, but I'm still ultimately looking for more evidence that the bank can be a leader within its peer group.
