Truist Financial (TFC -0.13%), the seventh-largest bank in the U.S. by assets, had a disappointing first quarter of the year, missing earnings estimates on the bottom line and lowering guidance for the year.
Like many banks, Truist is experiencing pressure on the funding side and the stock price is down close to 28% this year. While the near-term outlook remains challenging, I continue to view Truist as a buy for a reason I'll outline below.
A challenging quarter
In the first quarter, Truist generated diluted earnings per share of $1.05 on total revenue of $6.15 billion. Earnings missed estimates, while revenue beat slightly.
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The main reason for the miss was higher funding costs, which led to margin compression and drove down net interest income (NII), the money banks make on loans and securities after funding those assets with liabilities such as deposits. NII dropped 3% in the quarter, as the bank saw about $10 billion of outflows in noninterest-bearing deposits, which are those the bank pays no interest on. Furthermore, total deposit costs rose significantly in the quarter from 0.66% to 1.12%.
Management said that due to the Federal Reserve pulling liquidity out of the economy through quantitative tightening and the ability for customers to get 4% or 5% interest on risk-free assets and money market funds in the near term, it expects deposits to continue to decline about 1% to 2% per quarter. As a result, Truist lowered its revenue growth guidance to 5% to 7%, which is down from its 7% to 9% guidance last quarter.
A hefty and sustainable dividend
Despite the tough quarter and more difficult outlook, the one big reason I view Truist as a buy right now is because of its now close to 6.5% annual dividend yield resulting from the sell-off of the stock.
While it's always good to be wary of high dividend yields, Truist's dividend seems sustainable. Banks are required to hold regulatory capital so they can deal with unexpected losses while continuing to lend to individuals, families, and businesses.
One key regulatory capital ratio of banks is the common equity tier 1 (CET1) capital ratio, which looks at a bank's core capital expressed as a percentage of its risk-weighted assets. The Federal Reserve sets CET1 requirements for the largest banks and then excess capital above these requirements can be used to return capital to shareholders through dividends and share repurchases. Management usually keeps an internal buffer as well.
Truist's current CET1 requirement is 7%. At the end of the first quarter, Truist had a CET1 ratio of 9.1%. Also, keep in mind that the bank recently sold a 20% minority stake in its insurance division, which will boost its CET1 ratio to 9.4%.
The bank is also still making plenty of money through earnings that will continue to build capital. CEO Bill Rogers said he expects the bank to "blow through that 9.5% [CET1] number" over the next few quarters."
Buy the dividend, and wait for conditions to stabilize
Super regional banks like Truist face no shortage of challenges in the near term. Deposits continue to flow out of the banking system and deposit costs are rising. Credit quality is expected to normalize and regional banks likely will face higher capital requirements, as regulators make adjustments following the banking crisis in March.
But with essentially a 2.5 percentage-point buffer over its CET1 requirement, Truist should be prepared for whatever capital changes come its way while being able to continue to pay the dividend.
Shareholders can collect the 6.5% annual dividend yield and then wait for conditions in the sector to normalize. Make no mistake, Truist has a very attractive franchise including a strong deposit base, which I suspect will continue to be a strength, and the bank operates in some of the fastest-growing markets in the U.S. That's why I think the stock will eventually rebound from current levels.
