TCF Financial: Lower Expenses, Paycheck Protection Program To Drive Earnings (NASDAQ:TCF)

Earnings of TCF Financial Corporation (NASDAQ: TCF) declined to $0.14 per share in the second quarter from $0.32 per share in the first quarter of 2020. The earnings decline was mostly attributable to merger-related expenses and a decline in net interest margin. Earnings will likely increase in the year ahead because of accelerated booking of Paycheck Protection Program fees and lower provision expense. Moreover, the non-interest expense will likely decline following the completion of the integration of the Chemical Bank. On the other hand, the net interest margin will likely continue to decline, which will pressurize the bottom line. Overall, I’m expecting earnings to increase by 256% in the second half of the year compared to the first half. For the full year, I’m expecting TCF to report earnings of $2.12 per share, down 17% from last year. The June 2021 target price suggests a high upside from the current market price; hence, I’m adopting a bullish rating on TCF.

Paycheck Protection Program to Temporarily Increase Net Interest Income

As mentioned in the second quarter’s 10-Q filing, TCF funded $1.9 billion of loans under the Paycheck Protection Program, PPP. Assuming an average fee of 3.2% and funding cost of 0.35%, PPP will add an estimated total of $53 million to TCF’s net interest income over the life of the loans. The management expects 80-90% of the loans to get forgiven, and a lot of the remaining fees to get amortized in the third and fourth quarters of 2020, as mentioned in the second quarter’s conference call. Hence, I’m expecting TCF to realize most of the fees in the second half of the year, which will temporarily push up net interest income.

Excluding the impact of accelerated booking of PPP fees, the net interest income will likely decline in the remainder of the year and 2021 partly because of pressure on net interest margin, NIM. The continued repricing of assets and origination of new assets in a lower interest rate environment will likely compress NIM. Moreover, a natural decline in accretion income will pressurize NIM. On the other hand, the maturity of Certificates of Deposits, CDs, will likely ease some of the pressure on the margin. According to details given in the 10-Q filing, around $2 billion CDs, representing 5% of total deposits, will mature in the next six months. These maturing CDs carry a rate of 1.36%, as mentioned in the second quarter’s investor presentation. Additionally, another $1.2 billion of CDs, representing 3% of total deposits, will mature in the first half of 2021. Considering these factors, I’m expecting NIM to decline by 5bps in the third quarter and by 3bps in the fourth quarter of 2020. Further, I’m expecting the average NIM for 2021 to be 18bps below the average for 2020. The following table shows my estimates for NIM, excluding the impact of accelerated booking of PPP fees.

PPP forgiveness will likely reduce the loan balance in the year ahead. Moreover, the demand for commercial loans will likely remain lackluster amid the COVID-19 pandemic. The management doesn’t expect commercial loan demand to return to a normal level in 2020, as mentioned in the conference call. Further, the management expects low-to-moderate loan growth in the fourth quarter of 2020, excluding the impact of PPP. Considering these factors, I’m expecting the loan balance to decline by 4.9% by the end of the year from the end of June.

TCF’s deposits surged by 9.5% by the end of the second quarter from the end of the first quarter of 2020. The management mentioned in the conference call that they expect deposits to decline in the year ahead because the recent surge was transitory. Based on management’s guidance, I’m expecting the year-end deposits to be 3% below the June-end level. The following table shows my estimates for loans, deposits, and other balance sheet items.

TCF Financial Balance Sheet Forecast

Non-Interest Expense to Trend Downwards After Integration of Chemical Bank

TCF’s non-interest expense surged by 6.8% quarter over quarter in the second quarter of 2020 due to $82 million of merger-related expenses. According to a press release, TCF completed the integration of Chemical Bank in August 2020; therefore, the non-interest expense will likely decline in the year ahead. As mentioned in the investor presentation, the management believes it is on track to achieve the fourth quarter non-interest expense target of less than $321 million. Considering these factors, I’m expecting TCF to report non-interest expenses of around $332 million in the third quarter and $322 million in the fourth quarter, compared to $400 million in the second quarter of 2020.

Credit Risks Appear to be Mostly Manageable

As mentioned in the 10-Q filing, around $1.8 billion unpaid principal balance, representing just 5% of total loans, was on deferred status as of June 30, 2020. Additionally, exposure to vulnerable industries was limited to 10.8% of total loans, according to details given in the 10-Q filing and investor presentation, as shown in the table below. As a result of the limited amount of loan balance requiring modifications and exposure to vulnerable industries, TCF’s credit risks appear to be contained.

TCF Financial COVID-19 Sensitive Industries

TCF reported a provision expense of $79 million in the second quarter, down from $97 million in the first quarter of 2020. I’m expecting the provision expense to decline further in the remainder of the year and reach a normal level by next year.

Expecting Earnings in the Second Half to be 256% Higher than the First Half

The accelerated booking of PPP fees, lower provision expense, and a decline in non-interest expense will likely drive earnings in the year ahead. On the other hand, NIM compression and loan decline will likely limit earnings growth. Overall, I’m expecting earnings to increase by 256% in the second half of the year compared to the first half. For the full year, I’m expecting TCF to report earnings of $2.12 per share, down 17% from last year. The following table shows my income statement estimates.

TCF Financial Income Forecast

Actual earnings may differ materially from estimates because the pandemic can lead to negative surprises in the provision expense.

June 2021 Target Price Suggests a High Upside

I’m using the historical price-to-tangible book multiple (P/TB) to value TCF. The stock has traded at an average P/TB multiple of 1.24 in the first half of 2020. Multiplying this P/TB ratio with the June 2021 forecast tangible book value per share of $28.2 gives a target price of $34.8 for the mid of next year. This target price implies an upside of 29.7% from TCF’s September 1 closing price. The following table shows the sensitivity of the target price to the P/TB multiple.TCF Financial Valuation Sensitivity

Apart from the price upside, TCF is also offering a leading dividend yield of 5.2%, assuming the company maintains its quarterly dividend at the current level of $0.35 per share. There is little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of 40% for the fourth quarter and 45% for 2021, which is manageable.

Based on the high price upside, decent dividend yield, and contained risks, I’m adopting a bullish rating on TCF.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their own investment objectives and constraints before making an investment decision on the stock(s) mentioned in the article.

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