Chaos aside, it was a strong start to the fiscal year for Canada’s Big Banks. In the first quarter, all but one of Canada’s Big Five topped analyst estimates on both the top and bottom lines — a nice change of pace after several quarters of mixed results.
The lone bank to miss on earnings was Toronto-Dominion Bank (TSX: TD)(NYSE: TD). Usually a lock to at least perform in line with the group, TD Bank has been quietly disappointing investors.
In the quarter, earnings of $1.66 per share missed by $0.03 and revenue of $10.61 billion beat by $460 million, which represented growth of 5.7% and 6.1% respectively.
It marked the third consecutive quarter in which the bank missed earnings estimates, fourth out of the past five. This is quite the departure for a company that had only missed twice between 2015 and its recent string of underperformance.
As expected, lower margins and fewer trading commissions impacted TD Bank’s results. While usually strong, the U.S. and Canadian retail banking segments also showed weakness. It was also one of three banks to record higher provision for credit losses.
A key metric for the banks, bad loans amid high credit ratios have been a concern for Canada’s banks for years. At Toronto-Dominion, PCL jumped 8.1% year over year and 3.1% over the previous quarter. Although they account for only xx % of outstanding loans, the pace of increase remains a concern.
Declining interest rates are also an impending headwind. In the later part of 2019, the Feds south of the border reduced rates twice. This has a negative impact on banks as their net interest margin (NIM) gets squeezed in an environment of lower rates. Since TD has the largest exposure to the U.S., it has seen a greater impact than its peers.
Speaking of rates, the pace at which the COVID-19 is spreading and impacting the global economy, we may yet see further rate cuts. Although banks are prepared for a prolonged bear market or recession, lower interest rates will impact profitability.
On its quarterly conference call, TD executives admitted that it will be a choppy year. They expect “full-year (EPS) growth to be moderate again this year.” That said, while this will be true of most banks, it’s a bigger headwind for Toronto-Dominion.
Over the past decade, TD Bank has commanded a premium over its peers. Why? The company got a head start on expanding south of the border and fully benefited from a strong U.S. economy. As a result, it has great earnings and revenue at a faster clip than its peers. Over this period, it was the best-performing bank.
Now that growth is expected to slow, TD is at risk of underperforming its peers. The premium may no longer be warranted and other Big Five banks may present more attractive propositions.
It’s not all bad, however. TD Bank still has one of the highest expected growth rates and is still best positioned to benefit once the global economy bounces back. Similarly, it raised the annual dividend by 6.76% along with earnings. This is still trending to be above the average dividend growth rate of its peers.
After last week’s correction, TD Bank is also undervalued and a great long-term buy at today’s prices. Over the short term however, Toronto-Dominion shareholders should temper expectations.
