Why Everything Is About to Change for Toronto-Dominion Bank

For Toronto-Dominion Bank (TSX:TD)(NYSE:TD), rising interest rates in 2017 could potentially mean billions of extra profit in the next several years and the end of an era of low rates, which have plagued bank stocks for years. Here’s what investors need to know.

| More on:

Many prominent investors and economists have stated that Donald Trump’s election means a possible end to the era of low interest rates that have been a massive tailwind for bank stocks during the past several years. Net interest margins for Canadian banks have been on a fairly steady downward trajectory since 2003.

Considering many of Trump’s policies are extremely pro-growth (massive tax cuts, de-regulation, infrastructure spending) analysts at Goldman Sachs see three rate hikes by the Federal Reserve in 2017 with their short-term Fed Funds rate hitting 1.5% by the end of the year (a full percentage point above where it is today).

For Toronto-Dominion Bank (TSX:TD)(NYSE:TD), this is perhaps more important than for any other Canadian bank. TD has the highest interest rate sensitivity of any Canadian bank. This means that as rates rise, TD can be expected to see a larger profit boost than it peers, but it also means that when rates fall (as they have been), TD will suffer.

It is important to remember that banks earn a portion of their revenues by effectively borrowing money from consumers via deposits, paying a low (or no) interest rate on these deposits, and then lending and investing these funds long term in mortgages, bonds, and other products. As rates rise, a bank can lend at higher rates and earn a greater margin.

As U.S. rates rise (and as Canadian rates presumably follow), TD is set to benefit in two ways. Firstly, TD has large U.S. exposure (34% of 2016 operating earnings). Secondly, TD is a deposit-rich bank, especially in the U.S. TD has $234 billion in deposits in its American operations compared to only $141 billion in loans, and the excess is largely invested in a bond portfolio. As interest rates in the U.S. rise, TD will earn more interest from its bonds, while the interest on its deposits will only rise marginally, meaning a big boost in revenues.

How much would extra would TD earn from a 1% boost in interest rates?

A one percentage point boost in interest rates across the board would have a massive effect on TD’s earnings and would certainly be a tailwind, especially for TD’s U.S. operations.

While TD declined to provide interest rate sensitivity during its last earnings conference call, TD did provide information back in 2013, and it is possible to use this information to provide a back-of-the-envelope calculation to give an idea of how much TD would benefit from a one percentage point hike in rates.

TD has approximately $325 billion in non-maturity deposits. About 60% of these deposits are non-rate sensitive. These are things like cheuquing and savings accounts, and the bank does not have to pass on much of the benefit of rising rates to these depositors. The remaining 40% of the deposits are rate sensitive, and the bank would have to pass on approximately half of any gain from rising rates to these depositors.

What does this mean? It means that on 40% of the deposits ($130 billion), the bank would have to pass on half of a one percentage point increase to consumers ($650 million), but it would realize $650 million in extra profit immediately.

The remaining 60% of deposits ($195 billion) are not rate sensitive, so the bank would not have to pass anything on, which means the bank would realize an extra $1.9 billion from a one percentage point boost in rates. Combined, this is a massive $2.5 billion in extra profits from an increase in rates.

If rates only increase in the U.S., this would be about $1 billion, or a sizable 11% of 2016’s operating income. It is important to note that not all of this increase would come immediately in 2017 (since many of the bonds and fixed rate mortgages that TD invests in need to mature and re-price at the higher rate).

Nonetheless, in a scenario where rates increase in both Canada and the United States, the potential impact for TD could be sizable and could help serve as a cushion against some of the headwinds being faced by banks (like a weakening housing market).

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Adam Mancini has no position in any stocks mentioned.

More on Bank Stocks

Path to retirement
Dividend Stocks

Retirement Wealth: 2 Top Dividend Stocks for TFSA Investors

Parking a sizable portion of your savings in reliable dividend stocks is a time-tested wealth-building strategy appropriate for a wide…

Read more »

Financial technology concept.
Bank Stocks

Canadian Bank Stocks Are Crashing: Should You Buy the Dip?

As bank stocks like Royal Bank of Canada (TSX:RY) are crashing this year, should you go shopping for value plays?

Read more »

calculate and analyze stock
Bank Stocks

Canada’s Financial Powerhouses: Unveiling the Top Bank Stocks

EQB Inc (TSX:EQB) is Canada's top bank stock for growth. Who wins on valuation and profitability?

Read more »

Bank sign on traditional europe building facade
Bank Stocks

You Don’t Have to Pick a Winner in Bank Stocks

Why fret over which bank stock is best when you can easily buy them all?

Read more »

data analyze research
Bank Stocks

Is goeasy Stock a Buy in September 2023?

Does GSY stock look attractive after a recent downside correction in its prices? Let’s find out.

Read more »

stock research, analyze data
Bank Stocks

Is EQB Inc’s Growth Sustainable?

EQB Inc (TSX:EQB) is possibly Canada's fastest-growing bank. Can it keep up the growth?

Read more »

Young woman sat at laptop by a window
Bank Stocks

Feeling the Pinch in High Mortgage Payments? 2 Easy Ways to Make More Money

Short-term cash needs should stay in safe fixed-income investments. You can aim to make more money by investing long-term capital…

Read more »

Meeting handshake
Stocks for Beginners

Buy This Blue-Chip Dividend Stock and Relax

A blue-chip dividend stock is the best way investors can create passive income and relax, but how do you create…

Read more »