As a large-cap stock with market capitalization of CA$134.90B, The Toronto-Dominion Bank (TSX:TD) is classified as a major bank. As these large financial institutions revert back 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. After the crisis, a set of reforms called Basel III was created with the purpose of strengthening regulation, risk management and supervision in the banking sector. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like banks to vulnerabilities. TD operates predominantly in CAD and is held to stringent regulation around the type and level of risk it can take on, exposing it to higher scrutiny on its risk-taking behaviour. Investors are viewing TD with a more cautious lens and analysing these stocks using bank-specific metrics such as liquidity and leverage. Today we’re going to take a look at these metrics to gain more confidence investing in the stock. See our latest analysis for Toronto-Dominion Bank
Why Does TD’s Leverage Matter?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. While financial companies will always have some leverage for a sufficient capital buffer, Toronto-Dominion Bank’s leverage ratio of less than the suitable maximum level of 20x, at 17x, is considered to be very cautious and prudent. With assets 17 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. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
How Should We Measure TD’s Liquidity?Due to its illiquid nature, loans are an important asset class we should learn more about. Usually, they should not be higher than 70% of total assets, consistent with Toronto-Dominion Bank’s case with a much lower ratio of 48.14%. This ratio suggests that less than half of the bank’s total assets are made up of loans, but the bank’s strong liquidity management may be at the price of generating higher interest income.
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, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. This mismatch between illiquid loans and liquid deposits poses a risk for the bank if unusual events occur and requires it to immediately repay its depositors. Relative to the prudent industry loan to deposit level of 90%, Toronto-Dominion Bank’s ratio of over 69.21% is markedly 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 passes all of our liquidity and leverage checks which shows it is prudent in managing those factors. This gives us confidence in the operational side of the business, an important aspect to consider before investing in the stock. Its high liquidity and low leverage levels mean the bank is well-positioned to meet its financial obligations in the case of any adverse and unpredictable macro events. We’ve only touched on operational risks for TD in this article. But as a stock investment, there are other fundamentals you need to understand. I’ve put together three essential factors you should further examine:
- 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.