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Written by Andrew Walker at The Motley Fool Canada
TD (TSX:TD)(NYSE:TD) soared in the first half of 2021, but the share price has since pulled back, and investors are wondering if TD stock is now undervalued as we head into the final few months of the year.
TD’s fiscal Q3 2021 results show that borrowers are hanging in there, as the economy continues to reopen. TD booked a recovery of provisions for credit losses (PCLs) of $37 million in the quarter compared to PCLs of $2.2 billion in Q3 2020.
The bank saw revenue grow at a healthy clip in the personal banking and commercial banking segments. Wealth management results also improved with wealth assets up 20%.
Strong home sales fuelled by low mortgage rates are part of the personal banking revenue story. At the same time, a surge in consumer spending on renovations and other projects around the house likely led to better results from businesses that have done well serving this segment during the pandemic.
Looking ahead, retail and hospitality should perform better for the banks now that restrictions have eased and revenue is flowing.
Overall, the Canadian retail banking group saw revenue increase 9% in the quarter compared to Q3 2020. Net income rebounded considerably to $2.1 billion.
South of the border, TD actually operates more branches than it does in Canada. Revenue increased 5% in the U.S. retail operations, and the group posted US$1 billion in net income for the quarter.
Investors need to keep an eye on inflation and the potential impact of future interest rate increases by the Bank of Canada. The Canadian and U.S. central banks are of the opinion that recent spikes in inflation above target levels are transitory, and that things will normalize in 2022.
If that turns out to be the case, the Bank of Canada and the U.S. Federal Reserve will have the flexibility to increase interest rates by small amounts at a measured pace. This would give businesses and homeowners who are highly leveraged time to adjust to higher payments. In this scenario, gradual rate hikes tend to be a net benefit for the banks.
Persistently high inflation, however, could trigger large rate increases in a shorter period of time. This could lead to a wave of loan defaults and trigger a crash in house prices, particularly in Canada. In this scenario, TD could take a larger hit than the market anticipates.
The bank finished fiscal Q3 2021 with $328 billion in Canadian real estate loans. Loan-to-value ratios are below 50%, so things would have to get pretty bad before the bank sees meaningful losses, but the risk is worth considering when evaluating the stock.
TD and its peers put dividend increases on hold last year due to a government directive. Once the banks get the green light to raise payouts, TD investors should see a generous increase. The bank finished fiscal Q3 2021 with a CET1 ratio of 14.5%. This means TD is sitting on significant excess cash.
Should you buy TD stock now?
TD trades near $83 per share at the time of writing compared to a 2021 high around $88. Buying the stock on dips in the past has proven to be a rewarding move for long-term investors. If you are of the opinion that the housing market will cool off in a measured way as rates rise, TD looks attractive here for a buy-and-hold portfolio.
Otherwise, it might be best to search for other opportunities. If interest rates jump too high too quickly, the banks could be in for some pain.
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The Motley Fool has no position in any of the stocks mentioned. Fool contributor Andrew Walker owns shares of TD Bank.