Up until the financial crisis, when many U.S. banks were nearly destroyed by disastrous amounts of leverage and risky bets on mortgage backed securities and complex derivatives, banks were a favorite sector among dividend investors thanks to their generous yields and solid histories of payout growth.
The memory of the great financial crash is still fresh in the minds of many, which is why some income investors have sworn off banking stocks entirely.
While most bank stocks fall outside of my circle of competence and have opaque balance sheets, there are a select few banking institutions that have truly impressive track records of very conservative banking principles and deserve a high Dividend Safety Score.
Toronto-Dominion Bank (TD) could be one such bank, but because it’s headquartered in Canada, many investors overlook it.
Let’s take a look to see if this bank, which yields nearly 4%, deserves to be on your radar and in our list of safe high dividend stocks.
Business Description
Founded in 1855 in Toronto, Canada, Toronto-Dominion is one of Canada’s six oligopolistic mega-banks. Strict regulations largely protect these top banks and have allowed them to enjoy 90% of Canada’s domestic banking market share (Toronto-Dominion’s market share is 40%).
Today, Toronto-Dominion’s 65,384 employees serve about 22 million global customers through its network of 2,411 branches, and 5,571 ATM machines.
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Source: Toronto-Dominion Bank Investor Presentation
However, thanks to its 2007, 2008, and 2016 acquisitions of Banknorth, Commerce Bancorp, and Scottrade’s online bank, respectively (as well as its 42% stake in TD-Ameritrade), Toronto-Dominion has diversified successfully into the U.S. and grown to become the 5th largest bank in North America.
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While the majority of the bank’s earnings still come from its home market, Toronto-Dominion is making great strides to quickly grow and diversify its foreign businesses in order to become a true global financial force.
It’s worth noting that over 85% of the bank’s earnings are from retail activities, too. Unlike many mega banks, TD doesn’t really have meaningful exposure to trading operations and investment banking, which are generally riskier, more volatile activities.
Instead, Toronto-Dominion focuses on simple lending businesses, such as residential mortgages, credit cards, home equity lines of credit, indirect auto loans, and more.
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Business Analysis
Banks primarily make money by gathering deposits and loaning them out for interest income. Their customers want to borrow money at the lowest rates possible and receive reliable access to financing.
Essentially, banking is a commodity business, one in which the lowest cost and most conservatively managed operators tend to win out in the long run.
Toronto-Dominion has the largest and fifth largest deposit bases of any bank in Canada and the U.S., respectively, providing it with numerous cost advantages.
TD’s extensive operating history, respected brand, and convenient ways to bank (both physical branches and online) have enabled a steadily growing stream of low-cost deposits from consumers and businesses that it can lend out at higher interest rates.
In 2016, Toronto-Dominion paid 0.5% interest on the $193.6 billion Canadian dollars of personal deposits it held in Canada and 0.11% interest on its $206.8 billion Canadian dollars of personal deposits in the U.S. Interest paid on deposits made to businesses was also under 1%.
Meanwhile, the company’s total interest-earning assets had an average rate of 2.68%. The company’s cheap funding base ensures it can continue generating a healthy profit spread even in today’s low interest rate environment.
As long as management remains conservative with the loans it makes, Toronto-Dominion should be well positioned to continue making a lot of cash from the cheap funds it has on its balance sheet.
Toronto-Dominion’s disciplined approach to low costs helped it to lower its adjusted efficiency ratio (operating costs/revenue) from 54.9%, to 53.9%. That is not just an impressive year-over-year increase, but also among the lowest efficiency ratios of any global bank, reflecting the firm’s scale, low-cost deposit base, and conservative operations.
