Provisioning Still Eating Into TD’s Profits

But costs are receding and capital is solid

Eric Compton 27 August, 2020 | 3:38PM
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Capping off a strong quarter of earnings for the Canadian banks, wide-moat rated Toronto Dominion (TD) reported less robust third-quarter results, with EPS down 30% year over year and return on equity coming in at 10.4%. The earnings decline was the second worst result we saw this quarter, behind Scotiabank. TD's provisioning remained a bit more elevated than peers, and revenue, while growing 2% year over year, didn't come in as strong as some of its peers. The bank's U.S. retail segment reported a 7% year-over-year decline in revenue, while the Canadian retail segment was down 2% year over year. The bank also disclosed that 7%-8% of its loan book is within industries (including energy) that are more likely to be negatively affected by COVID-19, which is a bit higher than peers, although still a manageable level in our view (especially as many of the U. S. banks that we cover are closer to the 10% range).

While there was some relative weakness in results, the overall theme this quarter for TD and the other Canadian banks was that credit costs are already receding while revenue is generally holding up. Meanwhile, what pressure there has been on retail and commercial banking revenue has been offset by strength within capital markets and wealth operations, and the ratios for provisions for credit losses have declined across the board. While we don't expect what has been a record level of capital market activity to continue indefinitely, fee income should continue to recover and provisioning should continue to recede (assuming a return to a more normalized economic environment). TD's reserve levels are some of the highest among its peers, and the firm has a good underwriting history along with the highest relative capital levels, leaving the bank well positioned, in our view, to manage through the pandemic-driven downturn. As we work to incorporate third-quarter results into our model, we do not anticipate materially changing our fair value estimate of $ 80.

As we have seen with TD's peers, the initial deferral stats generally look promising, although we are admittedly still in the earlier stages of the process. We'll know a lot more by the end of the year. Deferral balances have generally declined for TD, although they still remain at roughly 6% of total loans. Impaired loans have continued to trend higher, but the increases have been within a predictable range, while write-offs haven't materialized just yet, although we would expect write-offs to trend higher for the foreseeable future. Many management teams have commented that impairments and write-offs will largely be a 2021 event, with current reserves hopefully enough to absorb these future credit costs.

On a segment level, Canadian retail banking saw a yearover-year net-income decline of 33% as provisioning continued to eat up profits. Lower net interest margins also led to a 7% decline in net interest income, while the wealth and insurance units within the segment helped drive fees higher by 3%. Lower rates are likely here to stay, and while there are mixed economic signals, there are some positive signs within that mix, which could aid a continued recovery in fees.

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Eric Compton

Eric Compton  Eric Compton is an equity analyst for Morningstar,

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