TD Bank (TSX:TD) picked up a bit of a tailwind near the end of 2023. Investors who missed the bounce are wondering if TD stock is still undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio.
TD share price
TD trades for close to $86 at the time of writing. That’s up from $76 near the end of October, but still down from the $108 the stock reached in 2022.
Bank stocks came under pressure over the past two years as investors worried that interest rate increases by the Bank of Canada and the U.S. Federal Reserve would drive the economy into a recession and cause a wave of loan defaults.
The central banks aggressively raised rates to cool off the economy to get inflation under control. In June 2022, inflation topped 8% in Canada and 9% in the United States. The situation has since improved as rate increases began to have an impact. Inflation for November 2023 was about 3% in both countries.
The rally in bank stocks over the past two months came amid a shift in market sentiment on the outlook for interest rates and the economy. Investors now expect the central banks to begin cutting rates in 2024 to navigate a soft landing for the economy as inflation drifts back toward the 2% target. The idea is that falling borrowing costs will reduce the risk of large-scale defaults by businesses and homeowners who are struggling to meet a jump in loan payments caused by higher rates.
In addition, the market is betting that the economy will avoid a recession, or go through a short and mild downturn followed by a rebound. This would keep unemployment from surging and help avoid a wave of bankruptcies.
In short, the market had driven bank stocks down to levels that would be expected during very difficult economic conditions, and bargain hunters have rushed in on the assumption things will turn out better than previously expected.
Risks?
Inflation could prove to be sticky at the 3% level or even start to rise again in the coming months. The U.S. had a strong jobs number for December. Canada’s employment report was weaker, but unemployment remains low and demand for wage increases remains persistent.
Investors need to keep an eye on bond yields, as the bond market is a good gauge of where traders think rates are headed. The plunge in bond yields that occurred over the past two months was driven by expectations of steep rate cuts in 2024. Treasury yields have started moving higher again in the past two weeks, so the market might be feeling that it got a bit ahead of itself.
If sentiment shifts again or if the central banks indicate they will need to keep rates higher for longer, there could be a sharp reversal in the share prices of the banks.
TD earnings
TD generated solid results for fiscal 2023 considering the economic headwinds. The bank reported adjusted net income of $15.1 billion compared to $15.4 billion in fiscal 2022.
A good part of the difference is due to an increase in the provision for credit losses (PCL). This is money the bank sets aside to cover potential bad loans. All of the banks have increased their PCL in recent quarters to account for the increase in the number of borrowers that are struggling with the impact of higher loan payments. This would include variable-rate borrowers who get hit immediately when rates rise, as well as fixed-rate borrowers who are forced to renew loans at higher rates. Banks tend to be conservative with the PCL number, and it is possible that the anticipated losses won’t materialize. As an example, investors saw the PCL get reversed at some of the banks after the pandemic crash when government aid helped businesses and households make their payments.
TD set aside $2.9 billion in PCL in fiscal 2023 compared to $1.1 billion in 2022. This sounds like a lot, but it is very small compared to the overall loan book. In short, TD’s loan portfolio remains in good shape.
TD finished fiscal 2023 with a common equity tier one (CET1) ratio of 14.4%. This is well above the 11.5% required by the Canadian bank regulator, so TD has abundant capital on hand to help it get through challenging economic times.
Dividend
TD recently increased the quarterly dividend by 6.3% to $1.02 per share. That provides an annualized yield of about 4.7% at the time of writing. The bank has a great track record of dividend growth and has delivered solid long-term returns.
Should you buy TD stock now?
TD isn’t as cheap as it was two months ago and investors should brace for more volatility in the sector until there is clear evidence that rates will fall and the economy will see a soft landing.
That being said, buying TD on dips has historically proven to be a savvy move for patient investors. At the current price the stock offers a decent yield, so you get paid well to ride out any additional turbulence. If you have some cash to put to work, TD deserves to be on your radar. Another meaningful dip should be viewed as a long-term buying opportunity.
