Banks can make money in a variety of ways. There's the traditional business of accepting deposits and originating loans. There are extremely complex, modern businesses such as derivatives, market making, and trading. Each income stream has its own individual characteristics, both good and bad.
Before you invest in a bank, it's imperative that you understand exactly how that bank makes its money. Today, we'll start that process with Toronto Dominion Bank (NYSE:TD), commonly known as TD Bank.
A retail bank through and through
Fortunately for us, TD Bank runs a pretty simple business model. The lion's share of the bank's income comes from retail operations. That's the old-school model of making loans to individuals and businesses.
What makes TD Bank unique among other large retail banks is that it straddles both the geographic border and the regulatory divide between its home market of Canada and the United States. For the 2014 fourth quarter, 66% of the bank's revenue came from the Canadian side of the border, 28% from the U.S., and the remaining 6% from other markets.
That limited geographical footprint hasn't limited the banks size. The bank reported $945 billion in total assets as of Oct. 31. A bank that size would rank fifth in total assets among U.S. banks, just ahead of Goldman Sachs (NYSE:GS), but still about $700 billion short of fourth-place Wells Fargo (NYSE:WFC).
Growing to such a size hasn't forced the bank to enter complex and potentially risky businesses, though. Its branch network and corporate banking centers have proved sufficient to propel growth while sticking to easily understood old-school banking.
A deep dive into the bank's revenue
In the bank's fiscal fourth quarter, which ended on Oct. 31, TD Bank reported that 92% of its adjusted net income is attributable to its retail operations.
That concentration in retail operations yields a healthy mix of both net interest income and non-interest income. Net interest income is the profit a bank makes by paying a small amount on deposits and collecting a larger interest rate on loans. Non-interest income consists of fee income from deposits, loans, and other businesses such as wealth management or treasury services, among other possibilities.
As the following data from S&P Capital IQ shows, the bank relies on net interest income for about 60% of its revenue. That's particularly true (and consistent) in the past few years following the financial crisis.
On the net interest income side, the majority of the bank's earning assets are residential mortgages. Twenty-one percent of the bank's total assets are residential mortgages, 14% are loans to businesses or governments, and 7.6% are other consumer loans such as home equity lines, car loans, or personal loans.
On the non-interest income side, the bank relies pretty heavily on its TD Waterhouse brokerage subsidiary and its insurance unit. The following chart breaks out the key drivers of the bank's non-interest income. The total investment and securities services segment includes brokerage, investment management, and mutual fund management.
For bank investors, this breakdown is a beautiful thing. The bank's business, first and foremost, is making loans to individuals and businesses. That business is supplemented and protected by strong investment services and insurance income streams.
That extra, lower-risk income gives the bank flexibility to price loans competitively to win the best deals. It also mitigates the risk of low interest rates, as in the current environment, and it cushions the top line from economic and market gyrations throughout the credit cycle.
There's a lot more to analyzing a bank stock than just looking at revenue, but this is as good a place to start as any. And for TD Bank, the analysis is off to a great start.