Toronto-Dominion Bank (TD 1.75%) stock has a hefty 5.2% yield, which is way above the banking sector norm of around 3%, using SPDR S&P Bank ETF as an industry proxy. If you are a dividend investor looking to buy a bank stock, that should probably interest you. But, before you buy TD Bank, as it is more commonly known, you should understand both the positives and the negatives you are taking on.
TD Bank is an industry leader
Based out of Canada, Toronto-Dominion Bank is one of the largest banks in North America. It is the second-largest by deposits in its home market and the sixth-largest on that metric across all of North America. It is important to understand the two different pieces of the business.
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Canada has a highly regulated banking industry. Those regulations have, effectively, resulted in the largest banks having an entrenched market position. So TD Bank faces competition, but it is highly unlikely to fall out of the top echelon in the Canadian market. And the strict regulation has created something of a conservative ethos within the largest Canadian banks, including at TD Bank. All in, Canada is a strong foundation for Toronto-Dominion Bank.
The United States, which makes up most of the rest of the business, is TD Bank's growth market. There is less stringent regulation, and the U.S. banking industry is highly fragmented. That has allowed TD Bank to expand both organically by opening new locations and inorganically, by acquiring smaller banks. Right now, TD Bank mostly operates on the East Coast, which means there are a lot of geographic expansion opportunities ahead.
Meanwhile, TD Bank has an investment-grade-rated balance sheet and one of the best Tier 1 Ratios in North America (the Tier 1 Ratio is a measure of how well a bank is prepared for adversity). There's no particular reason to believe that the company, which has paid dividends annually for over 100 years, is at any risk of going out of business. Add in the historically high dividend yield of 5.2%, and investors should be quite interested in the stock.
Why is TD Bank's yield so high?
Before dividend investors jump aboard, however, it pays to look at the reasons for TD Bank's unusually high yield. There are two main issues, and one of them is likely to be of particular concern to most investors, but notably so for anyone who has a short-term focus.
First off, TD Bank's Canadian business is dealing with a big change. For a long time, the country's housing market was rising. Then, inflation led to interest rate increases, which increased the cost of the mortgages used to buy homes. The housing market has since started to cool off. Higher interest costs reduce demand for loans and can increase the number of problem loans a bank has to deal with. Investors have to understand that TD Bank is materially exposed to the slowing Canadian housing market. That isn't unique to TD Bank, of course, but it is still a headwind.
The second problem is largely self-inflicted, which is why TD Bank's stock has been heading lower even as the shares of most of its Canadian peers have been heading higher. In 2023 U.S. regulators scuttled TD Bank's effort to buy a regional U.S. bank. That happened because TD Bank's money laundering controls weren't strong enough. While it is working with regulators to solve the issue, it is likely to face a large fine and be left on the sidelines with acquisitions until it rebuilds trust with U.S. regulators.
So, in the near term, TD Bank will probably report weak results because of one-time charges. Over the medium term, growth is likely to be slower than some investors might like because it won't be allowed into the U.S. acquisition market. Investors have reacted to these issues by pushing the stock lower. That's probably justified, but it also opens up an opportunity for investors that think in decades and not days, as both of these problems will, eventually, pass. It's just going to take some time, and the headlines over the next few months, or even few years, could be tough to read.
Go in with your eyes open
TD Bank is, generally, a well-run bank with a long history of success behind it. So, even more conservative investors would be well advised to consider it. However, you have to understand that the news flow over the near term could be pretty ugly, which might leave the stock in the doldrums relative to peers. There's no clear way to know how long the malaise might last, which may turn off some investors. However, given the high dividend yield, the risk-to-reward balance seems reasonable, assuming you don't mind collecting a fat dividend check while you wait for the company to muddle through its near-term headwinds.
