It's been a challenging year for banks that have grappled with the highest interest rates we've seen in over 16 years. While higher rates can boost banks' net interest income, the pace of recent interest rate increases has left many banks ill-prepared.
Truist Financial (TFC 0.53%) has struggled this year due to higher interest rates, falling deposits, and compressing margins. In the second quarter, the seventh-largest bank in the U.S. fell short of expectations and revised its earnings forecast downward for the second consecutive quarter.
In early August, the credit ratings agency Moody's downgraded its ratings on several banks and put others on notice for a potential downgrade if things didn't improve. Truist Financial was one of the banks in the latter group. Since the start of the year, the stock has fallen over 30% and trades at a steep discount. If you're thinking of buying the stock, consider the following first.
Truist's disappointing guidance
Truist's earnings came in below analysts' revenue and earnings per share forecasts in the second quarter. The bank also adjusted its guidance on earnings, saying it expects full-year adjusted revenue to increase 1% to 2%. Previously, the bank guided for 5% to 7% growth for the year.
The bank has grappled with interest rates that have risen faster than ever before. Since March 2022, the Federal Reserve has raised its federal funds rate from nearly zero to an upper limit of 5.5%. This change rate shocked many, especially considering how low interest rates were in the decade-plus following the Great Recession in 2008.
Target Federal Funds Rate Upper Limit data by YCharts
Deposit outflows and compressing margins have been headwinds
Banks tend to prefer higher interest rates because they can earn more on the net interest spread, or the difference between the interest paid on deposits and the interest earned on loans or other bank assets. However, rates have risen faster than expected, leaving banks in a bad position.
Interest rates on deposits at many banks haven't kept pace with the increases in interest rates. As a result, customers have pulled their deposits in sizable amounts to put them into high-yield savings accounts or other short-term investments where they can earn interest of 4% to 5%.
These deposit outflows have put pressure on banks, which have seen net interest margins decline after briefly increasing last year. Truist's average deposit balances fell nearly 6% over the last year. Its net interest margin has fallen to 2.91% after recently peaking at 3.25% in Q4 last year, leading to disappointing earnings performance.
Adding fuel to the fire are deteriorating economic conditions. Banks build reserves to account for potential losses in their loan portfolio. In the second quarter, Truist's provision for credit losses was $538 million, while net charge-offs also increased.
Image source: Truist Financial.
Here's what Truist is doing to reinforce its balance sheet
Truist is taking action to strengthen its balance sheet, focus on its core business, and manage expenses to navigate this tricky environment. It recently announced changes that would result in around $750 million in savings over the next 12 to 18 months. As part of its expense savings program, it will make "sizable reductions" in its workforce, restructure businesses, and reduce its corporate real estate footprint.
Is it a buy?
Truist Financial has had a challenging year. The bank has guided down on earnings multiple times this year, something you never like to see as an investor. The stock is priced at 6.8 times earnings and 1.7 times tangible book value, near-low points over the last two decades. Its depressed valuation makes it look like a potentially intriguing buy, but the bank must overcome obstacles in a challenging operating environment.
Banks face a lot of uncertainty about the trajectory of future interest rates, which could continue to put further pressure on deposit outflows and margins in the near term. Until the Federal Reserve ends its aggressive rate-hiking campaign and credit conditions improve, I'd avoid Truist and most other bank stocks for now.
