The basic banking business isn't really very complex, but that doesn't mean you should ignore the inherent complications that face the industry.
That's particularly important today as banks look to grow their businesses in a time of rising interest rates. Here's why conservative income types will probably prefer Toronto-Dominion Bank (TD 1.23%) over Bank of America (BAC 1.59%).
1. The yield
If you are a dividend investor, one of the first things you probably look at is a stock's dividend yield. TD Bank, as most people refer to Toronto-Dominion, wins hands down with a forward yield of 4%. By comparison, Bank of America's yield is a more subdued 2.3%. There are some caveats here, though.
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Notably, TD Bank is based in Canada, so it pays its dividend in Canadian dollars. That means the amount U.S. investors receive varies along with exchange rates.
And because TD Bank is from Canada, U.S. investors have to pay foreign taxes on their dividends. Those taxes can be clawed back when you file your taxes in April, but it's an extra headache you wouldn't have to deal with if you owned Bank of America.
2. The streak
Another issue that's usually near and dear to a dividend investor's heart is a company's dividend history. The preference is clearly to focus on names that have increased their dividends over time. On that front, Bank of America and TD Bank both sailed through the 2020 coronavirus pandemic and historically short recession in relative stride. Some of their peers weren't quite so lucky.
That said, if you pull back a few years to include the Great Recession between 2007 and 2009, the picture looks vastly different. That period was particularly nasty for U.S. banks, given the downturn was led by the housing market.
Bank of America materially reduced its dividend, and the quarterly payment is still well off its historical high-water mark. TD Bank, on the other hand, didn't cut its dividend. That's another point for TD Bank if you are a conservative type.
3. The boringness of Canada
One of the fundamental differences between these two banks is their home markets. The U.S. banking market tends to be less stringent than Canada's. And that's left TD Bank with a conservative ethos, if you will, that permeates all its operations.
In fact, Canadian regulations are so strict that the large banks in that country have little competition from upstarts and aren't even allowed to merge. So, TD Bank's market position in Canada is very well protected, so long as it sticks to the rules.
And thus, risk is top of mind at all times for TD Bank. That may not be something you can say with as much certainty of Bank of America, given the massive dividend cut during the Great Recession.
That's not to suggest that Bank of America throws caution to the wind and, willy-nilly, takes on excessive risk, but simply that TD Bank's approach is less aggressive overall, and that matters when the industry is facing headwinds.
4. The tier levels
Instead of simply accepting point three, investors can look at what's called Tier 1 capital ratio. A lot goes into the figure, but it basically provides an idea of how well a bank will handle adverse market conditions. The higher the number, the better.
Bank of America's Tier 1 capital ratio is 10.4%. TD Bank's Tier 1 capital ratio is 15.2%. Not only is that materially higher than Bank of America's, but it also happens to be the best Tier 1 capital ratio in North America. Put three and four together, and TD Bank gets another couple of points in this banking matchup for conservative types.
5. The growth prospects
This point is a bit subjective, but Bank of America is massive and has a global footprint. TD Bank is much smaller and really only operates in Canada and the U.S. The two banks' market caps show the difference, with Bank of America weighing in at about $300 billion and TD Bank at less than half that, with a roughly $130 billion market cap. It's usually easier to expand a smaller business.
And on that front, it's important to note that TD Bank only operates in 22 U.S. states. It has a huge amount of room to grow just by expanding its reach south of the border. It's working to do just that, too, as it recently announced an agreement to buy First Horizon for $13.4 billion.
That's a notable deal for TD Bank -- a deal it expects to be immediately accretive -- but would have a much smaller impact on Bank of America's results.
A shift in direction suggests a safety-first approach
All this information has to be couched in the fact that U.S. interest rates -- and rates in many countries around the world -- are heading higher. There are positives for banks in this shift, given that they can charge more for loans. But today's rising rates are spurring recession fears, which would be bad for banks since it would likely mean an uptick in defaults and a general downturn in the business environment.
TD Bank, which has a higher yield and stronger dividend history, looks better positioned than Bank of America to weather such a hit. And given its smaller size and expansion opportunity in the U.S. market, it could actually end up using such an economic downturn to its advantage by acquiring another bank. All in, for most conservative income investors, TD Bank is probably the better option than Bank of America today.
