Big Changes In This Bank Could Lead to Big Gains

Mike is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

According to the U.S. Office of the Comptroller of the Currency, the Memorandum of Understanding that circumscribed the activities of the Third Federal Savings & Loan Association of Cleveland has been cancelled. This is notable because Third Federal is the primary subsidiary of Cleveland-based thrift bank TFS Financial Corporation (NASDAQ: TFSL).

Since the middle of 2010, TFS Financial has been subject to onerous financial restrictions thanks to two Memorandums of Understanding that were applied to the holding company as well as its primary subsidiary. With the lifting of one set of restrictions, the company now appears to have a clear path towards a reinstated dividend, share buybacks and a potential tender offer. In theory, an aggressive share buyback program could initiate as soon as the second Memorandum of Understanding is cancelled.

About TFS Financial

TFS Financial Corporation is a financial holding company that operates the Third Federal Savings & Loan Association of Cleveland and conducts certain other peripheral business activities. As a thrift bank, TFS primarily engages in mortgage and auto lending, the administration of interest-bearing checking and savings accounts, the maintenance of its customers' retirement and wealth-management accounts, and the issuance of certificates of deposit. Its customers comprise a wide range of private individuals and commercial entities in northeastern Ohio and Florida. TFS currently has about 40 physical branches and operates a dedicated customer-service call center as well as several loan-origination offices.

In 2012, the company earned $11.4 million on $184.7 million in total revenues. Despite its relatively paltry revenues, the company enjoys a market capitalization of about $3 billion. Although its financial health has improved dramatically since the financial crisis, the company remains heavily indebted. It currently has about $616 million in debt and $308.7 million in cash. Since most of its debt is tied up in low-interest senior notes, it appears likely that the company will begin to return cash to its shareholders during the coming months.

Potential Tender Offer

It has been speculated that TFS will use a portion of its cash reserves to finance a tender offer with a third party. While the company does not have nearly enough cash on hand to finance such a bid on its own, plenty of its competitors and peers could afford to do so. Alternatively, a single deep-pocketed activist investor might be able to put together such a bid. However, TFS has no outspoken stakeholders or star investors. As such, it appears more likely that a tender offer or buyout bid would come from a consortium of executives and third parties.

With the company's stock currently sitting near $10 per share, any tender offer for the company would probably be priced between $11 and $12 per share. This would represent a premium of between 10 and 20 percent for shareholders who took advantage of it. Such an offer would value the company at anywhere from $3.3 to $3.6 billion. If the deal involved significant amounts of leverage, it could account for up to 50 percent of the company's outstanding shares. In the aftermath of such an offer, TFS's stock price could rise by a similar amount.

Potential Share Buybacks

Although a tender offer could provide a final premium of up to 50 percent for shareholders who chose not to tender their shares, it could be hampered by certain logistical and procedural hangups. While a focused program of share buybacks might not provide immediate returns of this magnitude, it would serve to support the company's stock price over the long term. With over $300 million in cash, TFS could single-handedly finance a buyback of 10 percent of its outstanding shares at cost basis of $10. As it continues to accumulate cash, the potential reach of the buyback program could grow. A program of this size could boost the company's shares by 10 percent.

Potential Dividend Reinstatement

Until the second quarter of 2010, TFS issued a quarterly dividend of seven cents. The expiration of the Memorandum of Understanding makes it likely that the company will move to reinstate its dividend in the near future. It should be noted that the company's dividend amounted to five cents per quarter during its first several quarters of public trade. Should TFS choose to reinstate its dividend, it would initially be equivalent to this post-IPO payout. However, even a five-cent dividend would provide the company's shareholders with a yield of 2 percent.

Relative to its peers and competitors, such a dividend would put TFS on solid but not spectacular footing. Buffalo, New York-based First Niagara Financial Group (NASDAQ: FNFG) issues a quarterly dividend of eight cents per share and currently yields about 4 percent. Bridgeport, Connecticut-based People's United Financial (NASDAQ: PBCT) pays out 16 cents per quarter and currently yields about 5 percent. These companies both operate in accordance with the conservative principles of thrift banking and have recovered substantially from the ravages of the financial crisis. First Niagara has quietly increased its income since the crisis from $79 million to $174 million.  Its payout ratio is almost 100% so this growth occurred without much profit reinvestment.  People’s United also doubled its income, although to keep up with its dividend, it had to payout over 200% of its profits for a couple years.

Given that the recession was particularly acute in TFS's home markets, it is understandable that the Cleveland-based bank has taken longer to recover. After laboring for nearly three years under the weight of twin Memorandums of Understanding, it finally appears poised to break out and begin returning value to its shareholders. This will certainly reward any value-minded investors who can wait for a year or more to realize the full implications of TFS's pending moves.


mthiessen has no position in any stocks mentioned. The Motley Fool owns shares of TFS Financial. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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