TFS Financial Corporation (“TFSL”)

In December, we purchased a position in TFS Financial Corporation (“TFSL” or “Third Federal”). TFSL is the holding company for Third Federal Savings & Loan, which is a $17 billion bank headquartered in Cleveland, OH. TFSL has a unique corporate structure. It is majority-owned by a mutual holding company, while the public shareholders own a minority stake in the bank. We think the mutual holding company structure can help create superior returns for the public shareholders. TFSL’s stock has underperformed since 2021 due to the increase in interest rates during 2022 and the inverted yield curve. We think the recent decline in short-term rates has helped TFSL turn the corner, but the stock price does not yet reflect this turn.

Before sharing our investment thesis, we share brief background on the mutual holding company structure and the opportunity for shareholders:

Mutual holding companies (“MHCs”) occupy a small but fascinating corner of the U.S. banking landscape. They are few in number, often misunderstood, and structurally complex, all of which repel generalist investors but attract us due to the leveraged structure, capital optionality, and embedded catalysts. For investors familiar with bank valuation, capital ratios, and consolidation dynamics, the MHC structure presents a unique blend of conservatism and asymmetry. The opportunity lies not in financial engineering, but in disciplined capital allocation, management incentives, and the intelligent use of time.

Before discussing MHCs specifically, it is helpful to briefly review the more familiar traditional mutual-to-stock conversion model that many bank investors actively seek out. A traditional mutual bank is owned by its depositors rather than shareholders. Depositors technically control the institution, though in practice governance is largely delegated to a self-perpetuating board. Mutual banks tend to grow slowly through retained earnings, operate conservatively, and lack access to public equity markets for capital or acquisitions.

In a full conversion, the mutual bank demutualizes entirely and becomes a conventional publicly traded bank holding company. Depositors receive subscription rights in the IPO, the mutual ownership is extinguished, and public shareholders own 100% of the institution from day one. Governance, capital allocation, and strategic control fully transition to the public company model. The IPO proceeds flow into tangible equity and are not paid out the depositors. Adding the IPO proceeds to the existing equity creates significant excess capital relative to the bank’s immediate growth needs. And, the new stock is priced at a discount to tangible book value. Management typically works down the excess capital over several years through a combination of organic loan growth, opportunistic share repurchases, modest dividends, and occasionally small acquisitions. As capital normalizes and profitability improves, the stock often rerates toward peer multiples. Ultimately, many of these institutions become attractive acquisition targets for larger banks, generating an additional valuation uplift. Investors are drawn to this model because it offers a clear playbook: discounted IPO pricing, strong tangible book value support, capital deployment catalysts, improving ROE over time, and a high probability of eventual sale.

Mutual holding companies represent a variation on this familiar framework but introduce additional leverage, optionality, governance complexity, and time arbitrage.

What Is a Mutual Holding Company?

A mutual holding company structure, by contrast, arises when a mutual bank executes a partial conversion rather than a full demutualization. Instead of selling 100% of the institution, the bank forms a mutual holding company that retains majority ownership, usually 51% to 70%, while selling a minority stake to public shareholders through an IPO.

The operating bank becomes wholly owned by a newly created public holding company, while the mutual holding company owns a controlling stake in that publicly-traded entity. Depositors remain indirect owners of the mutual holding company, preserving mutual control and influence. Public shareholders receive minority economic ownership and liquidity, but limited governance control.

Economically, both full conversions and partial conversions raise capital and increase tangible equity. The critical difference is that in a partial conversion, minority shareholders effectively own a levered economic interest in the bank’s equity and earnings, because a significant portion of the equity base is owned by depositors through the mutual holding company rather than by other public shareholders. Usually, mutual holding companies will waive their rights to dividends. Also, because anytime the mutual holding company sells shares, the proceeds go to the bank, the minority shareholders effectively have a leveraged stake in earnings and equity of the bank. Growth in tangible book value and net income accrues disproportionately to the minority float, magnifying per-share value creation when the franchise performs well.

This embedded leverage also creates asymmetry around the eventual second-step conversion, when the mutual’s retained stake is monetized and ownership normalizes. Importantly, stock repurchases further increase this embedded leverage. When shares are repurchased below the implied tangible book value based on minority shares, the remaining minority shareholders gain a larger proportional claim on slightly smaller underlying equity base. Over time, disciplined buybacks can meaningfully amplify per-share tangible book growth and earnings power for minority investors. In effect, well-managed MHCs allow patient investors to compound a levered claim on a growing bank franchise. 

Pros and Cons of the MHC Structure for Public Shareholders

Benefits for Shareholders

1.    Leveraged Exposure to Equity and Earnings Growth - Because a meaningful portion of the bank’s equity is owned by the mutual rather than public shareholders, minority investors effectively own a leveraged claim on tangible book growth and net income. As the franchise compounds equity and profitability, the per-share benefit to the public float is magnified.

2.    Repurchases Increase Embedded Leverage - When management repurchases shares below tangible book value, remaining shareholders gain an even larger proportional claim on the same equity base. Over time, disciplined buybacks can significantly accelerate per-share value creation.

3.    Attractive Entry Valuations - IPO pricing and post-IPO trading frequently anchor near tangible book value, providing downside support and attractive risk-adjusted entry points.

4.    Excess Capital and Balance Sheet Flexibility - IPO proceeds typically create capital flexibility that can support growth, acquisitions, or capital returns.

5.    Embedded Conversion and Strategic Optionality - The second-step conversion can unlock liquidity, valuation normalization, enhanced capital return capacity, and potential strategic outcomes.

Risks and Limitations for Shareholders

1.    Losses Are Also Leveraged - The same embedded leverage that magnifies upside also amplifies downside. Credit losses, margin compression, or operational missteps disproportionately impact minority shareholders because they bear a leveraged share of economic outcomes.

2.    Early-Cycle Low Profitability - Recently converted institutions often exhibit low net interest margins, elevated operating costs, excess liquidity drag, and suboptimal ROE while capital is being deployed. Value creation may take several years to materialize.

3.    Governance and Control Constraints - Minority shareholders have limited influence over strategic decisions, capital allocation priorities, and conversion timing.

4.    Liquidity Constraints - Small public floats can limit institutional ownership, increase volatility, and restrict exit flexibility.

5.    Regulatory and Timing Uncertainty - Second-step conversions require regulatory approval and favorable market conditions, making timing unpredictable.

MHC investing therefore requires underwriting not only asset quality and earnings power, but also management discipline, governance alignment, and patience.

The primary value creation lever in an MHC is compounding tangible book value at attractive rates prior to the second-step conversion. First, management must deploy excess capital productively through organic loan growth, disciplined balance sheet repositioning, and selective, accretive acquisitions. Second, capital management discipline is essential. Opportunistic repurchases below intrinsic value can materially accelerate per-share compounding. Dilutive equity issuance should be avoided unless returns justify it clearly. Third, thoughtful timing of the second-step conversion maximizes monetization of the embedded option. Fourth, operational execution, such as cost control, credit discipline, deposit franchise strength, and technology investment, quietly drives sustainable ROE improvement. 

Investment Thesis: TFS Financial Corporation (TFSL)

TFS Financial operates a traditional thrift banking model, funding predominantly fixed-rate residential mortgages with certificate of deposit (“CD”) funding. While this model has historically produced stable credit performance, it has been severely challenged by the extraordinary interest-rate volatility of the past decade. We believe TFSL is now entering a multi-year earnings recovery phase, and that the company’s unique mutual holding company (“MHC”) structure materially amplifies the upside for minority shareholders. At current valuation levels, the stock embeds limited expectations for either earnings normalization or structural optionality, creating an attractive asymmetric return profile.

1. Operating Results Are Inflecting After a Historically Adverse Rate Cycle

TFSL has endured one of the most unfavorable operating environments imaginable for a traditional thrift.

Over the past decade, long-term rates declined to extraordinarily low levels, compressing asset yields. That was followed by a rapid 500 basis point increase in short-term rates, which sharply increased deposit costs. The stress in the banking system following the failures of Silicon Valley Bank and First Republic further intensified competition for deposits, forcing banks, particularly CD-funded institutions to aggressively reprice liabilities to retain funding. These dynamics severely compressed TFSL’s net interest margin and earnings power.

The operating environment is now becoming more constructive. Over the past 18 months, short-term rates have begun to decline and deposit pricing pressure has eased. TFSL’s cost of deposits is moderating, while a meaningful portion of the bank’s adjustable-rate mortgage portfolio, particularly five-year ARMs originated in 2020 and 2021, is beginning to reprice higher. The combination of liability relief and asset repricing is already visible in improving net interest margin trends.

We expect net interest margin to continue to recover gradually over the next several years as the balance sheet reprices and excess liquidity drag diminishes. Importantly, this recovery does not require heroic assumptions, merely a normalization from unusually depressed profitability levels.

2. The MHC Structure Creates Embedded Financial Leverage for Minority Shareholders

TFSL’s improving operating results are magnified by its mutual holding company structure. TFSL has the highest percentage of mutual ownership among publicly traded MHC banks, meaning public shareholders own a relatively small minority of the total equity base.

As a result, minority shareholders effectively hold a leveraged economic claim on the bank’s equity and earnings growth. Increases in tangible book value and net income accrue disproportionately to the publicly traded shares, amplifying per-share value creation as profitability improves.

This embedded leverage becomes even more powerful when the company repurchases shares. When shares are repurchased below intrinsic value or tangible book value, the remaining minority shareholders gain a larger proportional claim on the same underlying equity base, further increasing their effective leverage to operating improvement.

TFSL resumed its share repurchase program in late 2025, which we believe meaningfully enhances the compounding potential for minority shareholders as earnings recover.

3. Structural Accounting Creates “Hidden Cheapness”

The MHC structure creates a valuation distortion that makes TFSL appear more expensive than it truly is on conventional metrics.

Reported book value per share and earnings per share are calculated using the full share count, including shares owned by the mutual holding company. However, those mutual shares are not economically equivalent to public shares. If the mutual stake were ever monetized through a second-step conversion, the proceeds would flow into the bank and become deployable capital rather than representing a claim on existing earnings and equity.

In practical terms, minority shareholders are buying a larger proportional claim on the operating franchise than headline valuation metrics imply. This “hidden cheapness” is often overlooked by quantitative investors and contributes to persistent valuation discounts across the MHC universe.

4. Long History of Capital Return Discipline

TFSL has demonstrated a consistent commitment to returning capital to shareholders through dividends and share repurchases. The company’s willingness to repurchase shares during periods of valuation dislocation has historically enhanced per-share value.

As operating performance improves with declining funding costs and asset repricing, we expect capital return capacity to expand further. Continued buybacks are particularly attractive given the structural leverage embedded in the MHC framework.

5. Market Assumes No Second-Step Conversion

TFSL completed its IPO in 2007 and has remained in an MHC structure for nearly two decades. Market sentiment generally assumes management has little interest in pursuing a second-step conversion.

We view this as a matter of timing rather than permanence. As profitability normalizes, capital levels stabilize, and strategic flexibility increases, the economic rationale for a full conversion strengthens. A second-step conversion would likely improve liquidity, normalize governance, unlock incremental capital flexibility, and potentially catalyze a valuation re-rating.

Importantly, the current valuation appears to assign little or no probability to this outcome, providing asymmetric optionality.

6. Alternative Optionality: Potential Remutualization

An alternative strategic outcome is a potential remutualization, whereby TFSL could repurchase all publicly held shares and return to full mutual ownership. Economically, this would resemble a going-private transaction.

Given the embedded leverage and improving earnings power, we believe minority shareholders would require a substantial premium to tender their shares in such a scenario. While not our base case, this outcome provides additional optionality and downside support.

7. Broader Tailwinds for Regional Banks

TFSL also benefits from several macro and industry tailwinds: A steeper yield curve and lower short-term rates support margin recovery, loan repricing of assets originated prior to 2023 improves asset yields, a more benign regulatory environment may reduce compliance burden and management distraction, and a more active M&A environment could improve sector sentiment and strategic optionality. These forces provide a supportive backdrop for earnings normalization and valuation recovery.

Key Risks

All investments carry risk. The most relevant risks for TFSL include:

1.    Interest Rate Risk - TFSL maintains significant exposure to fixed-rate single-family mortgages, creating sensitivity to adverse rate movements and reinvestment risk.
2.    High-Cost Deposit Franchise - Funding primarily through CDs is structurally more expensive and less valuable than low-cost core deposit franchises, which may limit long-term valuation multiples.
3.    Management and Governance Dependence - The MHC structure concentrates control with management and the mutual. Minority shareholders are dependent on management acting in shareholders’ best interests with respect to capital allocation, conversion timing, and strategic decisions.
4.    Embedded Leverage Cuts Both Ways - The same structural leverage that magnifies upside also amplifies downside if credit losses, margin pressure, or execution issues emerge.
5.    Early-Cycle Profitability Normalization - Earnings recovery may take longer than expected given excess liquidity, competitive pressures, and gradual asset repricing.

We believe TFSL is an interesting investment at these levels because the improving results on top of the mutual holding company structure should lead to attractive compounding of tangible book value.

Disclaimer: The discussion of any security is meant solely as an illustration of our investment and thought process and should NOT be considered as a recommendation or suggestion to buy or sell any securities. Before you make any investment, do your own research and talk to your own financial adviser. Information in this report is received from external sources. Therefore, we can make no guarantee as to the completeness or accuracy of the information provided.

Not all research is for securities currently held. Any securities for which research is provided herein may be reduced, completely closed out, or not purchased at all without notice of any kind.