A little while ago, I wrote about why the Royal Bank of Canada (TSX:RY)(NYSE:RY) will likely drop in share price in the next while, and told investors that when that happens, they should buy it.
It got me curious about whether there are other banks out there that hold the same, or a very different, opportunity.
That leads me to today’s subject: Toronto-Dominion Bank (TSX:TD)(NYSE:TD). I went with it because it too holds a top spot as one of the largest banks in Canada.
So let’s go over why this bank may not fare so well in the not-too-distant future.
Real risk of recession
Of the Big Six Banks, all have expanded beyond Canada’s borders. But in TD’s case, it’s only gone south, which is the first red flag for me. A potential recession in the future likely won’t just hit Canada, but the United States as well, and that’s a huge problem for TD.
TD gets 60% of its revenue from Canada and 35% from the United States, meaning that only 5% is coming from other sources. If a recession hits us and our southern neighbours, TD is in for a huge shock.
Now granted, in the short- and medium-term, TD has been doing very well. Its Canadian bank segment has shown strong profitability and returns. TD Ameritrade has also increased earnings, and should even help reach double digits, which could provide a boost to the bank’s overall growth.
But as I’ve said, when a recession hits, those numbers will plunge. And TD doesn’t have the set-up that other banks do worldwide. It depends so much on the high returns coming out of Canada that it’s unlikely to find anything equivalent anywhere else.
Lean loaner, but cashes on credit
One thing going for TD is that it’s proven to be lean when it comes to loaning. This is because it’s attracted a clientele of do-it-yourselfers who invest themselves and go to TD as a lower-cost alternative to the other big banks.
This has been beneficial for both TD customers and to TD itself. It has proven itself to be a conservative lender, focusing on businesses with low volatility that offer fewer loan losses and less earnings volatility.
But TD has taken this money and put it toward a new investment: credit cards. The bank has outbid many other companies for multiple credit card portfolios, which increases the risks of value destruction. While this could prove fruitful in the long run, making such a large investment right before a recession could prove to be a mistake.
Bottom line
TD already has to deal with the same stuff that other banks will deal with should a recession hit: a mortgage crisis and poor investments. But where it really falls short is by not investing outside Canada and the U.S. and by making large investments right before a recession.
While I don’t expect revenue to go down drastically in the next earnings report in May, I do expect it to start to fall relatively quickly when they do decline. With little investment outside of North America and a credit card debt to pay, TD will have a hard time digging itself out of a future recession.
