Canada’s banks continue to draw considerable negative attention, particularly considering a recent report from the Bank of International Settlements (BIS); it claimed that Canada was among the economies most at risk of a banking crisis. Much of this is centered on claims of a frothy housing market and extreme levels of household debt.
That sees Canada’s largest bank by assets, Toronto-Dominion Bank (TSX: TD)(NYSE: TD), as the second most-shorted stock on the TSX. While there are certainly grounds for concern, what is increasingly clear is that Canada’s banks, especially Toronto-Dominion, will continue to perform solidly and outperform the S&P/TSX Composite Index.
Now what?
Over the last decade, Toronto-Dominion has delivered a total return, including dividends, of 143%, which is significantly higher than the 20% growth in the value of the S&P/TSX Composite. That strong performance has been underpinned by steadily growing earnings.
For the first quarter 2018, Toronto-Dominion reported that its net income was 15% higher year over year, driven by higher net-interest income and a decline in expenses.
There are signs that Toronto-Dominion will continue to unlock considerable value for investors and beat the broader market. Key among the tailwinds set to push the bank’s earnings higher is its considerable exposure to the rapidly improving U.S. economy, where it is ranked as a top-10 bank.
You see, Trump’s fiscal stimulus, notably his recently enacted tax reform, which saw the tax on corporate profits slashed from 35% to 21%, will stimulate the economy and give Toronto-Dominion’s U.S. earnings a healthy lift. Reduced taxes on profits will not only directly boost the bottom line for Toronto-Dominion’s U.S. business, but also increase spending by businesses. This should translate into improved business confidence, higher economic growth, and greater consumption.
Because of these tax cuts, the U.S. economy is expected to expand by 2.7% in 2018 compared to an estimated 2.5% for 2017.
Stronger growth will spark greater demand for credit, particularly as businesses invest in expanding their operations, further growing Toronto-Dominion’s loan book, giving net-interest income a solid lift. A stronger economy will also spark further interest rate hikes, which will see the U.S. headline rate rise, bolstering the net-interest margin for the bank’s U.S. franchise, leading to greater profitability.
Given that the bank generates just over a third of its net income from the U.S., its overall bottom line will continue to grow.
A strong balance sheet and improving credit quality will also help to lift the bank’s margins, thereby boosting its profitability.
For the first quarter 2018, Toronto-Dominion reported that its common equity tier one capital risk-weighted assets had risen by almost 10% year over year to $441 billion. The ratio of net impaired loans to total loans dropped by 0.8% to 0.37% as credit quality improved. An improving economic outlook bodes well for that to continue, further helping to boost margins and the bank’s profitability.
So what?
All these factors, along with an upbeat outlook for the Canadian economy in 2018, will give Toronto-Dominion’s growth considerable momentum, causing its stock to appreciate at a greater rate. For these reasons, it will outperform the broader market and the S&P/TSX Composite Index.
