Toronto-Dominion Bank’s Resilient Earnings Profile Is Appealing (TD)

TD bank.

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In an increasingly uncertain macroeconomic environment Toronto Dominion Bank (NYSE:TD)(TSX:TD:CA) is an attractive stock in the banking sector due to its strong credit quality, diversified business model and limited capital exposure market activity. Its balance sheet is also particularly asset-sensitive, which puts it better positioned to benefit from rising interest rates than its Canadian peers.

Q3 results

TD delivered better-than-expected third-quarter results on August 25 as robust loan growth and improved margins more than offset the increase in loan loss provisions caused by the deteriorating macroeconomic outlook. Adjusted earnings per share for the third quarter of 2022 were C$2.09 (~$1.52), up 6% from the same quarter last year and up 3% from the second quarter of 2022.

Its Canadian retail business, the most significant contributor to the group’s results, demonstrated resilience across a number of key performance metrics.

“Our Canadian retail segment earned $2.3 billion on record sales of $7 billion for the quarter. Personal Bank performed well. We had industry-leading market share gains in long-term deposits and contributed to 8% year-over-year growth in personal deposits. In our mortgage-backed lending business, volumes increased 3% from the second quarter – a second quarter of strong sequential lending growth, reflecting the momentum of our Investments in frontline sales channels, operations and account management. We remain confident in the quality and mix of our RESL book, supported by prudent underwriting practices… In Business Banking, TD delivered another double-digit loan growth, driven by strength across Canada in industries such as commercial real estate, agriculture, middle class, dealer finance and small business.”

Chief Executive Officer Bharat Masrani, TD Q3 Earnings Call

US Retail Bank’s performance also held up well, following solid commercial loan volumes and robust personal loan growth. Importantly, margins in the US business have improved faster in the US than in Canada, reflecting the differences in business mix between the two segments. The US NIM rose 41 basis points sequentially to 2.62% compared to an 8 basis point improvement in Canadian retail over the same period.

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On the other hand, costs are rising, especially wages. Noninterest expenses were also higher due to increased investments related to organic and inorganic growth initiatives, including acquisition and integration related costs for First Horizon. In addition, the bank’s strategy to mitigate interest rate volatility on capital at the close of the acquisition resulted in a net loss of C$678 million (~$496 million) for the quarter.

Deteriorating macroeconomic outlook

Due to the deteriorating macroeconomic outlook, provision for credit losses increased to CA$351 million (~US$256 million) for the quarter – the highest level since Q4 2020.

Looking ahead, provisions could trend even higher as concerns mount over the risk of an economic hard landing. Aggressive monetary tightening has increased recession risks in both countries, in addition to the likelihood of a housing market correction, particularly in Canada.

TD gross loan USA Canada

TD Investor Relations (Supplementary Financial Information Q3 2022)

However, risks are partially mitigated by conservative lending and diversification of the loan book, both geographically and across loan categories.

“Today we see ourselves relatively well positioned for a moderate recession. As you know, we hold C$1.6B (~$1.2B) in reserves above pre-COVID levels. What happened this quarter is that on our basis and our downside, on the macro side, a lot has changed.”

Chief Risk Officer Ajai Bambawale, TD Q3 Earnings Call

TD’s business mix positions the bank attractively against near-term risk, particularly from a slowdown in mortgage origination and funding activity. In addition, the relatively low exposure to capital markets means that the bank is less vulnerable to a slowdown in transaction activity and bond issuance due to rising interest rates.

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Rising net interest income

A 100 basis point increase in interest rates along the curve is expected to result in an increase in net interest income of CAD$1.3 billion (approximately US$1.0 billion) over a 12-month period, assuming a constant balance sheet. That represents a more than 5% increase in NII and increases annual profit by more than 9%.

With the fed funds rate expected to reach 4.4% by the end of this year and the Bank of Canada forecast to raise its policy rate by almost the same amount to 4.0%, the improvement in the NII would be very significant. And unlike growth achieved through business expansion, there are no additional operating costs to consider, meaning the benefit would have a direct impact on the bottom line.

“An important factor in determining the value of a deposit and NII sensitivity is the proportion of deposits that have no maturity; over 80% of TD’s total deposits and approximately 90% of its personal deposits are perpetual.”

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Regulatory Risks

Aside from the macroeconomic outlook, regulatory uncertainty is the main downside risk, particularly as US regulators consider potential new rules for large regional banks. Amid concerns over the increasing size of a number of regional lenders, the Fed and OCC are considering whether large regional banks should hold more long-term debt to absorb losses if they fail. The introduction of new capital requirements could drive up funding costs and reduce the competitiveness of lenders affected by the new rules.

On the M&A front, too, there is growing regulatory concern about the impact of large regional banks on financial stability. US Bancorp’s acquisition of MUFG Union Bank has been postponed as the systemic risks posed by bank mergers and market consolidation in general come under closer scrutiny.

The likelihood that TD’s two US acquisitions — First Horizon and Cowen — could be similarly halted has also increased. Although management remains confident of completing the transaction within the previously announced timeframe, analysts appear increasingly uncertain and concerned that regulators may impose additional requirements in order to gain approvals.

Final Thoughts

TD’s business mix positions the bank attractively to benefit from rising interest rates despite growing fears of an economic hard landing. Consensus EPS projections show the group is on track to post the best earnings growth among its Canadian domestic peers over the next three years.


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The bank has also had more upside earnings surprises than its “Big 5” domestic peers over the past two years — having beaten analyst expectations for both revenue and adjusted earnings per share in each of the past eight quarters.

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