Improving credit quality as a result of post-recession recovery has led to a strong growth environment for financial institutions. Large banks such as The Toronto-Dominion Bank (TSE:TD), with a market capitalisation of CA$134b, have benefited from this momentum. Growth stimulates demand for loans and impacts a borrower’s ability to repay which directly affects the level of risk Toronto-Dominion Bank takes on. With stricter regulations as a consequence of the recession, banks are more conservative in their lending practices, leading to more prudent levels of risky assets on the balance sheet. Since the level of risky assets held by a bank impacts its cash flow and therefore the attractiveness of its stock as an investment, I will take you through three metrics that are insightful proxies for risk.
How Much Risk Is Too Much?Toronto-Dominion Bank is considered to be in better financial shape if it does not engage in overly risky lending practices. So what constitutes as overly risk? Loans that cannot be recuperated by the bank, also known as bad loans, should typically form less than 3% of its total loans. Bad debt is written off as expenses when loans are not repaid which directly impacts Toronto-Dominion Bank’s bottom line. Since bad loans make up a relatively small 0.54% of total assets, the bank may have stricter risk management, or its risks may not have had time to materialise yet.
How Good Is Toronto-Dominion Bank At Forecasting Its Risks?
Toronto-Dominion Bank’s forecasting and provisioning accuracy for its bad loans indicates it has a strong understanding of its own risk levels. We generally prefer to see that a provisions covers close to 100% of what it actually writes off, as this could imply a sensible and conservative approach towards bad loans. With a non-performing loan allowance to non-performing loan ratio of 105.52%, the bank has cautiously over-provisioned by 5.52%, which may suggest the bank is anticipating additional non-performing loans.
How Big Is Toronto-Dominion Bank’s Safety Net?Toronto-Dominion Bank profits from lending out its various forms of borrowings and charging interest rates. Deposits from customers tend to carry the lowest risk due to the relatively stable interest rate and amount available. The general rule is the higher level of deposits a bank holds, the less risky it is considered to be. Since Toronto-Dominion Bank’s total deposit to total liabilities is within the sensible margin at 74% compared to other banks’ level of 50%, it shows a prudent level of the bank’s safer form of borrowing and an appropriate level of risk.
The recent acquisition is expected to bring more opportunities for TD, which in turn should lead to stronger growth. I would stay up-to-date on how this decision will affect the future of the business in terms of earnings growth and financial health. I’ve bookmarked TD’s company page on Simply Wall St to stay informed with changes in outlook and valuation. This is also the source of data for this article. The three main sections I’d recommend you check out are:
- 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.
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