Following the Great Recession, when U.S. banks were struggling, Warren Buffett famously stepped in to invest in Bank of America. It was a contrarian play, as the iconic U.S. bank was struggling badly at the time. Buffett is taking profits now that Bank of America has recovered. A similar contrarian opportunity exists today with Toronto-Dominion Bank(NYSE: TD).
If you have $1,000 available to invest that isn't needed to pay monthly bills, bolster an emergency fund, or pay off short-term debt, you should consider putting it toward shares in this bank stock. Here's why.
The ugly story at TD Bank
Getting the bad news out right up front, Toronto-Dominion Bank, usually just called TD Bank, has run afoul of U.S. banking regulators. The circumstances were bad, too, since it isn't a good look when your bank gets used by money launderers. TD Bank has had to revamp its money laundering controls and will pay a roughly $3 billion fine for its past actions.
Image source: Getty Images.
However, the really troubling consequence of this unfortunate period is that TD Bank's U.S. business will be subject to an asset cap. That basically means that it can't grow its U.S. operations without the approval of U.S. regulators. That approval won't likely be given until TD Bank has regained regulator trust. Expanding in the United States was TD Bank's big growth initiative, so it is likely going to go through an extended period where it lags behind its bank peers.
And the next year or so will be a period in which the U.S. business' performance looks pretty weak. That's because TD Bank needs to rework its balance sheet to free up capacity to service its customers. The company is already warning that this will hurt its earnings.
This is what investors are buying into when they buy TD Bank today. But, with a 5.2% dividend yield, investors are getting fairly well compensated for the risk. Note that the average bank's dividend, using SPDR S&P Bank ETF(NYSEMKT: KBE) as a proxy, is yielding just 2.5% today (less than half as much!).
TD Bank's problem may not be as bad as it seems
To be fair, TD Bank is likely to be an industry laggard for a little while as its primary growth engine has now stalled out. However, the U.S. business is just one part of a much larger company. Indeed, TD Bank is still the second-largest bank, by deposits, in Canada. And its Canadian operations aren't affected by the U.S. upheaval. It also runs a substantial capital markets business. The bank won't be hitting on all cylinders, but the car hasn't stalled out completely.
Meanwhile, the big fine is already paid for. TD Bank owns a sizable stake in Charles Schwab. It recently sold roughly $2.6 billion worth of its position, which isn't likely to be a coincidence (it had already put aside the other $400 million or so). Put another way, the financial hit to the company is actually pretty minor when you look at day-to-day operations. Yes, ongoing costs will likely be higher because of the upgraded controls, but that's a manageable change.
So, from a long-term perspective, TD Bank seems highly likely to survive this difficult period and, eventually, turn its business around. This shouldn't be shocking for a bank that has paid a dividend every year since 1857. And given that the big fine is already covered, there's likely little reason to worry about the dividend getting cut. So you are basically getting paid very well to sit through a period of middling performance.
TD Bank is worth the risk
Is there more uncertainty in owning TD Bank relative to other banks? Probably. But the risk seems relatively low, and in time the company will do what it takes to regain regulator -- and Wall Street -- trust. When that happens the valuation gap between TD Bank and the rest of the banking industry should close.
If you don't mind collecting a fat yield between now and then, perhaps compounding your investment by dividend reinvesting, TD Bank is a low-risk turnaround story you'll want to look at right now. It might even be the best high-yield bank stock you can buy, whether you have $1,000 or $100,000 to put to work.
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Charles Schwab is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Reuben Gregg Brewer has positions in Toronto-Dominion Bank. The Motley Fool has positions in and recommends Bank of America. The Motley Fool recommends Charles Schwab and recommends the following options: short December 2024 $67.50 calls on Charles Schwab. The Motley Fool has a disclosure policy.
