Once again, Toronto-Dominion Bank (TSX:TD)(NYSE:TD) has the dubious honour of being Canada’s most shorted stock—that is to say, it’s the stock that institutional investors are most heavily betting against.
This bearish outlook seemed to extend within TD Bank itself as well; it experienced net selling from insiders in 2015. The CEO, officers, and directors of TD ended the year with about $16 million less in their personal holdings than they started the year with.
Despite this, TD actually posted the best return of the big banks for 2015 by a large margin, significantly outperformed the broader TSX, and did this in a macro-environment where Canada was in a recession for half of the year, and with oil prices and interest rates at historic lows.
Going forward into 2016, the picture looks much brighter for TD. While investors may still be shorting TD on fears of a housing or further oil crash in Canada, there are several tailwinds that should lead to yet another positive year for TD in 2016.
1. TD will benefit from the weak loonie
It is hard to find consensus from analysts, but they do seem to agree on one thing—2016 will be a weak year for the loonie and TD is set to benefit. TD benefits because it reports its earnings in Canadian dollars and has a significant portion of its costs in Canadian dollars. The bank also has a large U.S. retail banking operation (30% of net income) that earns in U.S. dollars.
When these U.S. earnings are translated back into weaker Canadian dollars, TD receives a boost to earnings. Just how much of a boost? In 2015 foreign exchange movements added 3.5% to TD’s earnings. This represented about 0.16 per share of TD’s 2015 earnings per share of $4.61.
Analysts are expecting the loonie to be about 6.5% weaker in 2016 than 2015 on average.
2. TD is poised to benefit greatly from rising U.S. interest rates
TD Bank is the most sensitive of the Canadian banks to rising U.S. interest rates, and the recent 0.25% increase in U.S. rates should add to TD’s U.S. earnings immediately as well as over time.
Why is TD set to benefit? Firstly, TD has a large proportion of its deposit base (the largest of the big banks) in chequing and savings accounts. These transactional accounts are not only low to no cost, but they are also “sticky,” which means banks have an easy time retaining these deposits, since changing banks is a hassle and factors such as interest rates aren’t as important for transactional accounts.
This means as interest rates increase, TD is set to benefit since it will be able to pass less of this cost on to its customer base as opposed to a bank that has a deposit base comprised of business and term deposits that are sensitive to interest rates.
In addition to this, TD has also taken steps to position its balance sheet to benefit from rising rates by selling long-dated securities and buying short-dated ones. This simply means that now TD has short-term assets, which will mature sooner and re-price at the new higher interest rate.
The end result? Analysts at TD Bank estimate that a 0.25% U.S. rate increase would add $200 million annually by the fifth year after the increase. A 1% increase in U.S. rates would add $660 million over a five-year period.
3. TD has a highly effective cost-cutting program
TD took two restructuring charges in 2015 (about $686 million in total), and these costs went towards closing and merging branches and optimizing processes to reflect the new more digital-based banking environment.
The end result of these charges is that TD will realize $600 million of annual savings by 2017. These expenses will reduce the bank’s expense base by 2%, and lower the rate of expense growth over time, which will allow TD’s expense growth to stay under its revenue growth.
While there may be negative sentiment around TD, it is important to remember that those who have bet against TD in the past have been consistently wrong. Improving macroeconomic conditions in 2016 should lead to yet another successful year for TD.