TD Bank stocks: Higher interest rates could become problematic (NYSE: TD)

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Investment thesis

TD Bank (NYSE: TD) is a staple for many Canadian and American income-seeking investors. In 2020 and 2021, after rates edged closer to zero and after much fiscal stimulus, Canadian bank stocks not only saw a rebound but a solid rally. In 2021, TD shares provided a 36% annual return for its investors. That being said, the party appears to be ending as Canadian interest rates rise, which I suspect will slow earnings growth as HELOCs, mortgages and various other retail bank lending decline. Finally, while I think the next 6-18 months for TD will be problematic, I would look to add or take a position should a significant enough downside occur.

Data by Y-Charts

TD: excellent retail banking segment, but poor economic conditions

There is no doubt that TD Bank has an incredibly robust retail banking segment, the business has almost 27 million customers around the world and approximately one-third of Canadians do business with TD Canada Trust. Moreover, the company has developed an adequate positioning in the American market, becoming one of the 10 largest American banks. However, with 2022 Canadian mortgage rates surging to 4.5% and the Bank of Canada raising rates by 50 basis points, it looks like the cheap money provided by the Bank of Canada is starting to dry up. . The outcome of the credit crunch is expected to hamper financial services growth, but is expected to have the biggest impact on retail banking earnings. This is problematic for all Canadian Tier 1 banks, but TD appears to be less well positioned than its peers. For starters, when you compare TD to its biggest competitor, Royal Bank of Canada (RY), you’ll notice that retail banking represents a minority of RBC’s revenue at just 40%, while TD represents 58% of the bank’s income. Additionally, in terms of non-interest revenue growth, TD is in the middle of the Tier 1 bank pack.

Growth in BMO's non-interest revenue versus its peers


The reason TD lags behind Bank of Montreal (BMO) and RBC is that TD’s revenue is more dependent on HELOC financing, mortgages and various other personal loans. While BMO and RBC both have strong capital market and commercial banking segments. Finally, when you look at TD’s quarterly earnings per share since 2020, you can see a fair correlation between EPS growth and cheap money and economic recovery.


Excel, author’s calculation

Notice how in quarters 3 and 4 of 2020 we saw impeccable EPS growth, primarily due to the economic recovery after reopening, fiscal stimulus and low interest rates. This led TD to grow EPS by 51% and 131% in those two quarters respectively, but EPS growth has since stalled. With recent stagnant EPS growth, combined with the end of the Bank of Canada’s quantitative easing program in the fourth quarter of 2021 and a 50 basis point rate hike in the first half of 2022, the retail segment is thriving of TD, as well as the future performance of the rest of its operations, concerns me. in trimesters 2 to 4.

Inflation, mortgage stress test and consumer credit all point to lower lending

Along with interest rate hikes, inflation, stress tests and consumer credit data all point to lower lending. First, although mortgage rates rose before that, Office of the Superintendent of Financial Institutions (OSFI) increased credit stress testing services that banks use to determine a customer’s mortgage eligibility to 5.25%. This may not be the rate the customer will pay on their mortgage, but it is needed to qualify for a mortgage with a Tier 1 Canadian bank. Now that interest rates are rising, it will become increasingly difficult for Canadians to get approved for a mortgage, which could hurt TD’s Canadian customer base. Second, inflation and economic stagnation appear to be reducing consumer confidence with declining consumer credit data for Canadians.



It almost seems that inflation and stagnation have become a precursor to declining consumer credit and that a decline in consumer credit could lead to lower lending at the end of 2022. This is problematic for the segment of TD’s retail business, of which the Canadian retail banking segment constituted 60% net income for the last quarter.


TD Bank is overvalued when considering the company’s price-to-book ratio relative to other Tier 1 banks.

Data by Y-Charts

TD’s P/E ratio is pretty high and the company doesn’t even have superior operating performance. When we look at the return on equity comparison of the major banks from the previous year, we see that TD’s above-average price-to-book ratio is not justifiable.

Data by Y-Charts

Due to a higher P/E ratio than its peers and a lower ROE, my consensus is that TD’s stock is currently slightly above the price.

Conclusion: expect a potential downside and an average drop

Due to rising interest rates, inflation, falling consumer credit and mortgage stress tests, I suggest investors considering TD wait until late 2022 or early 2023 before taking or adding to their position. The company enjoys impeccable brand recognition, a robust retail banking segment and operates in an extremely narrow-moat sector. That said, the economy looks problematic for the cyclical retail banking sector. Shareholders need to hang in there, 2022 looks like a bumpy ride.

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