What do you recommend people do with their Toronto-Dominion Bank (TD-T) shares now that it is facing more than US$3-billion of fines and other penalties for its failure to combat money-laundering through its U.S. branches? And what do you expect will happen to its dividend?
First, let me tell you what I’m doing with my TD shares: nothing.
True, the punishment TD is facing is severe. In addition to slapping TD with stiff financial penalties, regulators have imposed a cap on its U.S. retail banking assets, which will likely constrain the bank’s growth for years to come.
But the market understands this, which is why TD’s shares have cratered about 10 per cent since the full extent of the penalties became public on Oct. 9. One could argue that the bad news is already baked into the stock price, and that the downside from here may be limited. More on that in a moment.
Another reason I’m not selling my TD shares is that my portfolio was built to withstand this kind of shock. In both my personal portfolio and model Yield Hog Dividend Growth Portfolio, I hold four of the Big Five banks: TD, Bank of Montreal (BMO-T), Canadian Imperial Bank of Commerce (CM-T) and Royal Bank (RY-T). (Nothing against Bank of Nova Scotia (BNS-T); I just didn’t feel the need to add yet another bank when four provides plenty of diversification.)
It’s at times like these when diversification proves its worth. While TD’s shares have been sinking, other banks have been going up. CIBC and Royal Bank, in particular, have been standout performers, gaining about 75 per cent and 58 per cent, respectively, for the year through Oct. 17, including dividends.
If you hold only one or two banks, now might be a good time to spread your bets around. For those who prefer not to own individual stocks, a low-cost bank exchange traded fund such as the BMO Equal Weight Banks Index ETF (ZEB) can provide all the exposure you need with a single purchase.
As severe as TD’s penalties are, it’s important to keep them in perspective.
The asset cap, for example, applies only to TD’s U.S. retail operations. The business accounts for an estimated 27 per cent of TD’s cash earnings, Doug Young, an analyst with Desjardins Capital Markets, said in a note.
Other business lines, including investment banking and TD’s Canadian and global operations, are not affected.
“Outside U.S. retail banking, TD’s other businesses are performing well. And while the U.S. [anti-money laundering] issues remain a concern, we believe this is partially reflected in TD’s valuation,” Mr. Young said.
The shares are now trading at about 9.6 times estimated fiscal 2025 earnings, compared with an average of about 11.4 times for the rest of the Big Five. Unless there are more skeletons in TD’s closet, its discounted valuation could indicate that the stock is nearing a bottom.
As for TD’s dividend, analysts expect that it will continue to grow, albeit at a slower pace than before. Darko Mihelic of RBC Dominion Securities, for instance, previously expected TD to boost its dividend by about 7 per cent. Now, he’s projecting an increase of about 3 per cent. TD typically announces a dividend increase when it releases fourth-quarter results, which are scheduled for Dec. 5.
Finally, even at the current annual dividend rate of $4.08 a share, TD provides an attractive yield of about 5.2 per cent, which is second-highest among the Big Five behind Scotia Bank’s yield of about 5.7 per cent. So investors get paid to wait for TD to recover from its current mess, which is exactly what I plan to do.
An update on TC Energy’s spinoff of South Bow
In my column last week about TC Energy Corp.’s (TRP-T) spinoff of South Bow Corp. (SOBO-T), I mentioned that information about the “adjusted cost base allocation” between the two companies would be forthcoming.
The details are now posted on TC Energy’s website under “Liquids Spinoff” and “Canada Tax Information.” The notice indicates that 91 per cent of an investor’s original cost base should be allocated to TC Energy shares, and the remaining 9 per cent to South Bow shares.
Let’s look at an example. Say you purchased 100 shares of TC Energy several years ago at $50 a share, for a total cost of $5,000. (Any commissions should also be added to the cost of the shares.)
Effective with the spinoff on Oct. 1, you would have received 0.2 share of South Bow for each share of TC Energy held, for a total of 20 South Bow shares.
Using the above allocation formula, the new ACB of your TC Energy shares would be 91 per cent of $5,000, or $4,550. This works out to an ACB for each share of $45.50. When you eventually sell your TC Energy shares, you would use this number to determine your capital gain, or loss.
The ACB of your new South Bow shares would be 9 per cent of $5,000, or $450. Dividing that by 20 gives you an ACB for each share of $22.50 for your South Bow shares. Again, you would use this to calculate your capital gain, or loss, when you eventually sell your South Bow shares.
Important: The above example is for illustration purposes only, and it assumes an investor purchased TC Energy at $50 a share. Results will be different for TC Energy shares purchased at higher, or lower, prices.
TC Energy includes a disclaimer on its website: “The Companies believe the allocation … is reasonable for Canadian income tax purposes. However, such allocation is not binding on shareholders or the Canadian tax authorities.”
My suggestion is to use the above methodology, then compare the numbers to the “average cost” or “book value” provided by your broker. Brokers have been known to get these numbers wrong. If there is a large discrepancy, contact your broker.
If the ACBs are close, on the other hand, you should feel comfortable using either set of numbers when you eventually sell your shares. As long as you are making a good-faith effort to report your capital gain, or loss, accurately, you shouldn’t have to worry about running afoul of the Canada Revenue Agency,
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.