As a large-cap stock with market capitalization of CA$143.05b, The Toronto-Dominion Bank (TSE:TD) falls into the category of a major bank. As these large financial institutions revert back to health after the 2008 Financial Crisis, we are seeing an increase in market confidence in 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 bank level regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions 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. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Toronto-Dominion Bank’s leverage level of 16.75x is significantly below the appropriate ceiling of 20x. This means the bank exhibits very strong leverage management and is well-positioned to repay its debtors in the case of any adverse events since it has an appropriately high level of equity relative to the debt it has taken on to remain in business. If the bank needs to firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
What Is TD’s Level of Liquidity?Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, consistent with Toronto-Dominion Bank’s case with a much lower ratio of 48.45%. This means less than half of the bank’s total assets are tied up in the form of illiquid loans, leading to high liquidity, perhaps at the expense of generating interest income.
Does TD Have Liquidity Mismatch?Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans tend to be fixed term which means they cannot be readily realized, however, customer deposits are liabilities which must be repaid on-demand and in short notice. 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. Since Toronto-Dominion Bank’s loan to deposit ratio of 69.02% is well-below than the appropriate maximum of 90%, this 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. 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. Below, I’ve compiled three key 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 firstname.lastname@example.org.