Despite the media hype about how upstart digitally native finance companies are eating into the traditional banking business, the corner bank is still a vital business model. However, with concerns that rising rates could push the economy into a recession, investors should be careful about which banks they own. That's why conservative investors will likely be much happier owning Toronto-Dominion Bank (TD -0.42%) than Wells Fargo (WFC -0.56%).
Stories matter
Wells Fargo was founded in 1852. The 170-year-old bank has gone through various shifts and transformations over its life -- it started out serving miners in the California gold rush -- but at its core Wells Fargo has focused on being a simple bank. That means providing customers with savings and checking accounts, making mortgage loans, and operating in a fairly conservative manner. For a very long time, Wells Fargo was considered a gold-standard name in the banking industry, even becoming a major investment for Warren Buffett's Berkshire Hathaway.
Image source: Getty Images.
But over the past decade, the wheels have fallen off the stagecoach. The most famous of Wells Fargo's problems is probably the scandal in which bank employees opened accounts without the approval or knowledge of customers. That, among other things, prompted the Federal Reserve to place an asset cap on Wells Fargo, wanting to see changes in the bank's approach before it could look to meaningfully grow its business again. Berkshire Hathaway has since sold almost all its shares. A once-proud bank tarnished its image in a massive way, and it's still working its way back.
Toronto-Dominion Bank, which usually goes by TD Bank, traces its founding to 1855, not long after Wells Fargo was founded. TD Bank has gone through some changes over the years, notably the merger that formally created the Toronto-Dominion combination. That said, it has also long focused on providing local customers with local services. Notably, however, when the company was accused of similarly opening unwanted accounts, the accusation fell flat and amounted to nothing. And TD Bank has continued along its merry way, even increasing its dividend roughly 6.5% in 2020, a very difficult year for the world as a whole.
For this reason alone, most conservative investors will likely prefer TD Bank and its still pristine image over Wells Fargo's somewhat tarnished name. Wells Fargo's dividend yield is around 2.2% at Tuesday's closing price, while TD Bank's yield is a far more generous 3.9%. So not only does TD Bank allow you to avoid the baggage Wells Fargo is carrying around, but TD Bank is also paying you more to own it. That said, TD Bank pays its dividends in Canadian dollars, so the amount a U.S. investor receives will vary with exchange rates.
Operating on another tier
There's another factor here. As noted, TD Bank is based in Canada, even though it has material U.S. operations. The Canadian banking system is highly regulated, and its banks tend to operate in a conservative manner. For example, TD Bank's tier 1 capital ratio is roughly 15.2%, the most conservative ratio in North America. A bank's tier 1 ratio basically provides an idea of how prepared it is for adversity, with a higher ratio being better. Wells Fargo's tier 1 ratio is around 10.5%. TD Bank appears materially better positioned for the next economic downturn.
This isn't some far-off thought. Interest rates are set to rise meaningfully this year and possibly into next year. That's not an inherent negative for bank stocks, because it means they can charge more for the loans they originate. But the fear today is that swiftly rising rates will trigger a recession. Economic contractions often result in less business and, worse, loans defaulting. Those are both bad for banks. Being better prepared for such an outcome gives TD Bank a material leg up on Wells Fargo -- and all of its other peers as well.
Meanwhile, TD Bank has recently agreed to buy First Horizon for $13.4 billion. The move expands TD Bank's reach into the Southeast U.S. while providing an opening into key markets in Georgia and Texas. The deal is still pending, but the summary here is that financially strong TD Bank is still growing. And, with operations in just 22 U.S. states, it continues to have plenty of opportunity for further growth ahead of it.
Go with the best
Wells Fargo is a turnaround story right now. There's nothing inherently wrong with that, so long as that's what you want to buy and you understand the risks involved. However, for most investors and particularly conservative dividend types, you'll likely be better off with TD Bank. It doesn't come with the same baggage, it is stronger financially, and it continues to grow its business. That's a winning combination to go along with a generous 3.9% yield.
