Why Everything Is About to Change for Toronto-Dominion Bank

For Toronto-Dominion Bank (TSX:TD)(NYSE:TD), rising interest rates in 2017 could potentially mean billions of extra profit in the next several years and the end of an era of low rates, which have plagued bank stocks for years. Here’s what investors need to know.

| More on:

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Many prominent investors and economists have stated that Donald Trump’s election means a possible end to the era of low interest rates that have been a massive tailwind for bank stocks during the past several years. Net interest margins for Canadian banks have been on a fairly steady downward trajectory since 2003.

Considering many of Trump’s policies are extremely pro-growth (massive tax cuts, de-regulation, infrastructure spending) analysts at Goldman Sachs see three rate hikes by the Federal Reserve in 2017 with their short-term Fed Funds rate hitting 1.5% by the end of the year (a full percentage point above where it is today).

For Toronto-Dominion Bank (TSX:TD)(NYSE:TD), this is perhaps more important than for any other Canadian bank. TD has the highest interest rate sensitivity of any Canadian bank. This means that as rates rise, TD can be expected to see a larger profit boost than it peers, but it also means that when rates fall (as they have been), TD will suffer.

It is important to remember that banks earn a portion of their revenues by effectively borrowing money from consumers via deposits, paying a low (or no) interest rate on these deposits, and then lending and investing these funds long term in mortgages, bonds, and other products. As rates rise, a bank can lend at higher rates and earn a greater margin.

As U.S. rates rise (and as Canadian rates presumably follow), TD is set to benefit in two ways. Firstly, TD has large U.S. exposure (34% of 2016 operating earnings). Secondly, TD is a deposit-rich bank, especially in the U.S. TD has $234 billion in deposits in its American operations compared to only $141 billion in loans, and the excess is largely invested in a bond portfolio. As interest rates in the U.S. rise, TD will earn more interest from its bonds, while the interest on its deposits will only rise marginally, meaning a big boost in revenues.

How much would extra would TD earn from a 1% boost in interest rates?

A one percentage point boost in interest rates across the board would have a massive effect on TD’s earnings and would certainly be a tailwind, especially for TD’s U.S. operations.

While TD declined to provide interest rate sensitivity during its last earnings conference call, TD did provide information back in 2013, and it is possible to use this information to provide a back-of-the-envelope calculation to give an idea of how much TD would benefit from a one percentage point hike in rates.

TD has approximately $325 billion in non-maturity deposits. About 60% of these deposits are non-rate sensitive. These are things like cheuquing and savings accounts, and the bank does not have to pass on much of the benefit of rising rates to these depositors. The remaining 40% of the deposits are rate sensitive, and the bank would have to pass on approximately half of any gain from rising rates to these depositors.

What does this mean? It means that on 40% of the deposits ($130 billion), the bank would have to pass on half of a one percentage point increase to consumers ($650 million), but it would realize $650 million in extra profit immediately.

The remaining 60% of deposits ($195 billion) are not rate sensitive, so the bank would not have to pass anything on, which means the bank would realize an extra $1.9 billion from a one percentage point boost in rates. Combined, this is a massive $2.5 billion in extra profits from an increase in rates.

If rates only increase in the U.S., this would be about $1 billion, or a sizable 11% of 2016’s operating income. It is important to note that not all of this increase would come immediately in 2017 (since many of the bonds and fixed rate mortgages that TD invests in need to mature and re-price at the higher rate).

Nonetheless, in a scenario where rates increase in both Canada and the United States, the potential impact for TD could be sizable and could help serve as a cushion against some of the headwinds being faced by banks (like a weakening housing market).

Should you invest $1,000 in Firstservice Corporation right now?

Before you buy stock in Firstservice Corporation, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Firstservice Corporation wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $20,697.16!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 29 percentage points since 2013*.

See the Top Stocks * Returns as of 3/20/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Adam Mancini has no position in any stocks mentioned.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Bank Stocks

a person looks out a window into a cityscape
Bank Stocks

Where I’d Invest $7,000 During the Current Market Pullback

Investing in quality ETFs and stocks amid a volatile macro backdrop should allow you to generate outsized gains in the…

Read more »

Middle aged man drinks coffee
Bank Stocks

TD Bank: Buy, Hold, or Sell Now?

TD stock is giving back some recent gains. Is it time to buy?

Read more »

An investor uses a tablet
Bank Stocks

Better Bank Stock: CIBC or Scotiabank?

These two bank stocks offer great dividends and income, but what does the future hold for both?

Read more »

dividends can compound over time
Bank Stocks

Here’s How Many Shares of CIBC Stock You Should Own to Get $2,000 in Yearly Dividends

This dividend stock is a prime option for investors, and it's from more than dividends.

Read more »

shopper buys items in bulk
Bank Stocks

How I’d Allocate $1,000 in Domestic Stocks in Today’s Market

Got $1000? Here's how I'd play the tariff war with Canadian domestic stocks this April! Royal Bank of Canada (RBC)…

Read more »

man touches brain to show a good idea
Bank Stocks

How to Approach Royal Bank Stock in 2025

Royal Bank is down more than 10% in 2025. Is the stock now oversold?

Read more »

Investor wonders if it's safe to buy stocks now
Bank Stocks

Where Will Royal Bank of Canada Be in 2 Years?

Down 12% from all-time highs, RBC stock trades at a sizeable discount to consensus price target estimates in April 2025.

Read more »

open vault at bank
Bank Stocks

3 Canadian Bank Stocks to Shield Against Market Downturns

Canadian bank stocks are some of the best options on the market, and these three are probably the top ones.

Read more »