The Toronto-Dominion Bank (TSE:TD) is a large-cap stock operating in the financial services sector with a market cap of CA$132b. As major financial institutions return to health after the Global Financial Crisis, we are seeing an increase in market confidence, and understanding of, these “too-big-to-fail” banking stocks. Following the crisis, a set of reforms termed Basel III was enforced to bolster risk management, regulation, and supervision in the financial services industry. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks to vulnerabilities. As a large bank in CAD, TD is exposed to strict regulation which has focused investor attention on the type and level of risks it is subjected to, and higher scrutiny on its risk-taking behaviour. We should we cautious when it comes to investing in financial stocks due to the various risks large banks tend to face. Today we will analyse some bank-specific metrics and take a closer look at leverage and liquidity.
Is TD’s Leverage Level Appropriate?A low level of leverage subjects a bank to less risk and enhances its ability to pay back its debtors. Leverage can be thought of as the amount of assets a bank owns relative to its shareholders’ funds. Though banks are required to have a certain level of buffer to meet its capital requirements, Toronto-Dominion Bank’s leverage level of 16.64x is very safe and substantially below the maximum limit of 20x. With assets 16.64 times equity, the banks has maintained a prudent level of its own fund relative to borrowed fund which places it in a strong position to pay back its debt in times of adverse events. If the bank needs to firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
How Should We Measure TD’s Liquidity?Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Normally, they should not exceed 70% of total assets, which is consistent with Toronto-Dominion Bank’s state given its much lower ratio of 49%. At this level of loan, the bank has preserved a high level of liquidity but perhaps at the cost of producing interest income from illiquid loan.
Does TD Have Liquidity Mismatch?TD profits by lending out its customers’ deposits as loans and charge an interest on the principle. These loans may be fixed term and often cannot be readily realized, however, customer deposits are liabilities which must be repaid on-demand and in short notice. The discrepancy between loan assets and deposit liabilities threatens the bank’s financial position. If an adverse event occurs, it may not be well-placed to repay its depositors immediately. Compared to the appropriate industry loan to deposit level of 90%, Toronto-Dominion Bank’s ratio of over 70% is noticeably lower, which means the bank is lending out less than its total level of deposits and positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits. There is opportunity for the bank to increase its interest income by lending out more loans.
Toronto-Dominion Bank ticks all the boxes for operational prudency in terms of liquidity and leverage. These factors often sideline next to other fundamentals but are equally important to consider as part of the investment thesis. The bank’s favourable liquidity and leverage position exposes it to less risk when it comes to repaying financial obligations, in particular, in the case of an adverse macro event. Today, we’ve only explored one aspect of Toronto-Dominion Bank. However, as a potential stock investment, there are many more fundamentals you need to consider. There are three important factors you should look at:
- Future Outlook: What are well-informed industry analysts predicting for TD’s future growth? Take a look at our free research report of analyst consensus for TD’s outlook.
- Valuation: What is TD worth today? Has the future growth potential already been factored into the price? The intrinsic value infographic in our free research report helps visualize whether TD is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.