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Morningstar | Lower Capital Markets Activity and Heightened Investments Hit Wholesale Unit for TD in 1Q

Wide-moat-rated Toronto-Dominion Bank reported OK fiscal first-quarter results, which were affected by the same themes we have seen across the Canadian banking sector. Toronto-Dominion's wholesale banking segment was hit particularly hard in the quarter, as lower client activity, reduced trading margins, and higher expenses led to negative net income. After making some minor adjustments to our model to account for slower earnings growth in 2019, we are maintaining our fair value estimate for Canadian shares at CAD 81, and our fair value estimate for U.S. shares remains $61 per share.

The adjusted return on common equity dropped to 15% for the quarter, not unexpected given the more difficult environment. Adjusted net income was flat year over year, while earnings per share were up 2.4%. Management admitted that, with the slower start to the year, earnings growth was likely to come in at the lower end of guidance, or roughly around 7% EPS growth. The Canadian retail segment's adjusted net income growth of 6% was better than many peers. Loans were up 6%, and wealth assets (under management and under administration) were up 6%, and the bank still managed to achieve 40 basis points of operating leverage in the quarter. U.S. retail saw strong growth from its TD Ameritrade stake, which, along with rising interest rates, led to net income growth of 21%. The wholesale banking unit endured the most headwinds, as lower market activity combined with increasing expenses related to segment investments led to net income of negative CAD 17 million. Predictably, this unit will experience volatility from time to time, and this was just one of those quarters of lower overall activity for the industry. Given the recovery in markets at the start of 2019, it would not be unreasonable to expect some pick-up in issuance and deal activity for the remainder of the year.

Credit quality remained relatively steady, although Toronto-Dominion also saw a spike in impairments related to the U.S. utility sector, one of three Canadian banks to call this out. Gross impaired loans did creep up slightly within certain Canadian consumer portfolios, as well as within the U.S. consumer portfolio. The U.S. increases in impairments were largely related to seasonality within the auto and credit card portfolios. Overall, these developments seemed reasonable, and the U.S. utility situation is certainly idiosyncratic. Canadian home equity loan growth did slow down a bit during the quarter, growing at just under 4% annualized quarter over quarter. TD has a history of prudent underwriting, and we do not expect that the culture has materially deteriorated.