As Banking Stocks Tumble, I Turn To Bank Of America And Toronto-Dominion
Contributor since 2013 / 19728 Followers
Summary:
- Recession fears have weighed on bank stocks in recent months as economic declines generally lead to lower demand for loans and higher default rates.
- Last week saw bank stocks hit hard with the KBW Bank Index (BKX) sliding 3.9% on Thursday alone.
- Long term, the better banks should fare well, and panic selling could present a buying opportunity.
andresr
On Thursday, SVB Financial (SIVB) stock plunged 60% over liquidity concerns and the bank’s failure to raise capital. However, SVB is not the only financial institution that is at best treading water.
First Republic (FRC), suffering from reduced deposits from startups, crypto-friendly Silvergate Capital’s (SI) decision to liquidate Silvergate bank after its digital asset customers withdrew deposits, and Signature Bank’s (SBNY) move to reduce digital asset banking deposits, all contributed to a swoon in the shares of banking stocks last week.
Flash forward to Friday and we find SIVB is now under the control of the FDIC.
Along with these lesser tickers, the big names in banking were apparently deemed guilty by association. Shares of Bank of America (NYSE:BAC), Wells Fargo (WFC), JPMorgan Chase (JPM), and Citi (C) all suffered mid single-digit declines on Thursday.
However, the stream of negative news related to SVB and the like are not the only concerns weighing on banking stocks. Declines in the housing market and auto industry, an increase in credit delinquency rates, and recession fears were working against financial stocks before this latest headwind emerged.
Nonetheless, it is reasonable to ask if these developments offer a good entry point for the stronger banking stocks. After all, Bank of America is Berkshire Hathaway’s (BRK.A) (BRK.B) second largest holding. Following the Oracle of Omaha’s lead might be a good move here.
Furthermore, Bank of America’s last earnings report was largely positive.
And while I’m in agreement with Mr. Buffett that BAC is one of the better investments in the banking industry, I’m also looking north of the border to Toronto-Dominion (NYSE:TD).
TD has a long history of strong performance, and the Canadian banking system differs in ways that provide Canadian banks with certain competitive advantages.
Bank of America: Last Quarter’s Results And More
As the second largest bank by assets in the US, BAC is one of the biggest beneficiaries of rising interest rates. The Feds move to raise rates pushed the bank’s net interest income (NII) in Q4 up to $14.8 billion, a 29% increase year over year and a 6.5% gain over Q3.
Management estimates that if benchmark interest rates keep rising, it would net the company $5.3 billion in annual NII over 12 months.
A second strength of BAC is that a large share of the bank’s loans are variable rate. Consequently, the bank’s loan yields will increase as the Fed pushes interest rates higher.
Bank of America also has a lower-cost deposit base than any of its peers. According to S&P Global, of the 10 largest banks, Bank of America had the second-lowest deposit cost in the third quarter. The average opening balance for the bank’s new accounts is $5,000, and BAC added more than 1 million new accounts in FY 2022. All in all, that resulted in a 10% growth in customer checking accounts over 2019.
Additionally, Bank of America routinely outperforms its peer group in terms of deposit betas, a measure used to represent the increase in the interest it pays on deposits following Fed interest rate hikes.
Overall Q4 results, which were reported in the middle of February, were positive. Revenue was up 11% year over year, the bank’s global wealth and investment management unit recorded $87 billion in inflows, and investment banking fees increased to the point that BofA now stands as the number three bank in that category versus a number four ranking last year.
ROE was 11.2% versus 10.9% a year ago, and management expects expenses to trend lower. The expectation is that expenses will hit $62.5 billion in FY 2023, just 1.8% higher than 2022, and well below the prevailing inflation rate.
The bank’s Tier 1 ratio increased by 25 basis points to 11.2%, and the bank’s outstanding share count declined by 5% over the past year.
The firm’s investment accounts recorded $115 billion in net inflows, and digital sales increased by 22% year over year. On the down side, investment banking results were weak, but that is endemic to the industry of late.
A key forecast provided in Q3 also fell short of the mark. Management had guided for an increase in NII in Q4 over Q3 of $1.25 billion at minimum, but NII only grew by $900 million. For the coming quarter, NII is projected to fall from $14.8 billion to $14.4 billion.
Charge-offs, a concern when confronting prospects of a weak economy, stood at 0.26%, a low figure relative to pre-pandemic levels. Even so, there are signs that consumer spending is weakening. BofA reported credit and debit card spending increased by 5% in the fourth quarter, a figure that fell below the inflation rate.
Understanding Toronto-Dominion
To evaluate an investment in Toronto-Dominion, one must understand the differences between the U.S. and Canadian banking systems. Barriers to entry in the Canadian system are quite high due to regulations that stymie foreign competition. Furthermore, investors residing outside Canada are limited to a 25% stake in Canadian banks.
Domestic competition is also stunted. Consequently, the top six banks in Canada hold a 90% market share. In turn, this provides certain economies of scale with fixed costs spread across a relatively large operating base. Consequently, Canadian banks post returns on equity that approach 20%, well above the global standard.
All of these factors work to make Canadian banks some of the safest investments in the industry.
Ranked by assets, Toronto-Dominion is the 6th largest bank in North America. Roughly 55% of the bank’s revenue is derived from Canada and 35% from the U.S. TD is the top card issuer and ranks among the top two banks in terms of retail banking products in Canada.
In February, TD Bank revealed a $13.4 billion deal to acquire First Horizon (FHN). That followed an August announcement to acquire investment firm Cowen Group (COWN) for $1.3 billion.
The latter deal closed and is expected to be modestly accretive to TD’s FY 23 adjusted EPS. Cowen brings a research, sales, trading, and execution platform under TD’s banner.
The move to acquire First Horizon, which is pending approval, would result in TD having the 6th largest banking operation in the U.S. and give the bank a presence in 22 states.
Via its investment in TD Ameritrade, the bank holds a 12%% stake in Charles Schwab (SCHW), a solid company in its own right.
A Side-By-Side Comparison
Toronto-Dominion’s Tier 1 ratio ended the quarter at 15.5%. BofA’s Tier 1 stands at 12.8% as of December 31, 2022.
Advantage TD
TD’s debt is rated AA- by S&P and Fitch and Aa2 by Moody’s. BAC’s credit is rated A- by S&P, A2 by Moody’s, and AA- by Fitch.
Advantage TD
TD’s yields 4.54%. The payout ratio is a bit above 42%, and the 5-year dividend growth rate is 7.98%.
BofA yields 2.91%. The payout ratio is a hair below 27%, and the 5-year dividend growth rate is 14.97%.
While Bank of America has a lower payout ratio and a higher dividend growth rate, assuming both bank’s grow the dividend at the current 5-year dividend growth rates, it will take eight years for BofA’s dividend yield on cost to match that of TD.
Advantage TD
TD has a 12 year dividend growth streak. It very well might be longer, but during the Great Recession, Canadian regulators froze all dividends.
TD has paid an annual dividend since 1857.
In 2009, BofA slashed the quarterly dividend from $0.32 to $0.01. While I believe Bank of America is a better bank today than during the Great Recession, it’s hard to argue against Toronto-Dominion’s dividend payment history.
Advantage TD.
TD trades for $60.55 per share. The four analysts that rated the stock over the last six months have an average one year price target of $102.50, a 69.28% premium to the current share price.
BAC trades for $30.27 a share. The average one year price target of the 6 analysts that rated the stock following the last earnings report is $38.70, a 28.7% premium to the current share price.
Advantage TD
TD’s forward P/E is 9.39x versus the 5-year average P/E of 11.29x.
BAC’s forward P/E is 9.49x versus the 5-year average P/E of 12.45x.
TD’s forward PEG is 1.05x as opposed to BAC’s forward PEG of 0.72x.
Advantage BAC
Risks To Consider
Both banks are tied to macroeconomic developments. If the economy experiences an extended or deep recession, it could weigh heavily on both stocks.
While I view the current regulatory environment in Canada as a net positive, regulators in that nation have been raising capital requirements for a decade. At this juncture, that makes TD a safer investment; however, the possibility exists that Canadian regulators could raise capital requirements further, resulting in “too much of a good thing” weighing on Canadian banks’ profitability.
TD has a greater exchange rate currency risk than BAC.
Summation
With one of the stronger retail branch networks as well as one of the lower cost deposit bases, Bank of America ranks among the pre-eminent U.S. banking franchises. The bank is among the top four U.S. credit card issuers and also operates a sound commercial banking franchise as well as Merrill Lynch.
Even so, I’ve provided evidence that Toronto-Dominion is perhaps the better investment of the two. The regulatory environment in Canada provides the larger banks with a competitive advantage, and TD’s acquisitions in the U.S. arguably means TD is profiting from a best of both world’s environment.
The events related to the bank failures in the U.S., coupled with the negative effects a potential recession could have on the banking industry are not to be taken lightly. Nonetheless, I would posit that long-term investors should profit handsomely by investing in the stronger banks at this juncture.
I rate BAC as a Hold.
I rate TD as a Buy.
I added moderately to my position in TD last week. I will be monitoring the situation closely, and I am likely to add incrementally to my investment in TD as the situation warrants.
I may also initiate a position in BAC in the near future.
Disclosure: I/we have a beneficial long position in the shares of TD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have no formal training in investing. All articles are my personal perspective on a given prospective investment and should not be considered as investment advice. Due diligence should be exercised and readers should engage in additional research and analysis before making their own investment decision. All relevant risks are not covered in this article. Although I endeavor to provide accurate data, there is a possibility that I inadvertently relay inaccurate or outdated information. Readers should consider their own unique investment profile and consider seeking advice from an investment professional before making an investment decision.
