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Fin 410 Commercial Bank Management - Toronto-Dominion Bank (td Bank)

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Assignment 3- Select a Bank

(TD Bank)

Jermaine C. Taylor

Professor: Joseph Arbeiter

Fin410 Commercial Bank Management

November 29, 2015

Toronto-Dominion Bank (TD Bank), headquartered in Cherry Hill, N.J, America’s most convenient bank, is one of the ten largest banks in the United States. It provides more than 8 million customers with a full range of retail, small business and commercial banking products and services at approximately 1,300 convenient locations.  Also, TD Bank and its subsidiaries offer customized private banking and wealth management services through TD Wealth, vehicle financing and dealer commercial services through TD Auto Finance.

When managing interest rate risk TD Bank, invests in interest-earning assets and are obligated on interest-bearing liabilities. Also, they earn fees on the arrangements they have with TD Bank USA on money market mutual funds that are subject to interest rate risk. Changes in interest rates can have an effect on the interest earned on assets in a different way than interest paid on liabilities. A rising interest rate environment results obtaining a larger net interest spread. On the contrary, a falling interest rate environment results in earning a smaller net interest spread. TD Bank’s most prevalent form of interest rate risk is referred to as “gap” risk. This risk usually occurs when the interest rates they earn on their assets change at a different incidence or amount than the interest rates that they pay on their liabilities. TD Bank uses an asset/liability committee that has the responsibility for managing interest rate risk, including also gap risk.

TD Bank uses a net interest simulation technique that models and evaluates the effect of the changes in interest rates on pre-tax income. Their model includes all interest-sensitive assets and liabilities of the company and interest-sensitive assets and liabilities associated with the arrangement of the sweep deposit account. The simulations involve expectations that are naturally unclear and, as a result, cannot precisely predict the impact that changes in interest rates will have on pre-tax income. Actual results may differ from the simulated results due to differences in timing and the frequency of the rate change. If there are changes in market conditions and changes in management’s strategy, that too will lead to changes in the mix of interest-sensitive assets and liabilities.

The impact that this has on TD Bank is that for example, when the Federal Open Market Committee lowered the federal funds rate to between 0% and 0.25% during 2009, and because of the near-zero short-term interest rate environment,  TD Bank performed a simulation of a hypothetical increase in interest rates. This simulation assumes that the asset and liability structure of the consolidated balance Sheet and the insured deposit account sweep arrangement would not be changed. The result of the simulation based on their financial position as of September 30, 2009, indicated that a gradual 1% (100 basis points) increase in interest rates over a 12-month period would result in approximately $127 million higher pre-tax income.

TD Banks risk management plan of how they use derivatives and other hedging tools are a valuable asset to the company. The majority of TD Bank’s derivatives are from over-the-counter (OTC) transactions. These transactions are privately negotiated between the owner and the counterparty to the contract. The remaining contracts are exchange-traded contracts, transacted through organized and regulated exchanges and consist primarily of options and futures. TD Bank does not maintain actual trading positions and, therefore, its hedging activity is limited to managing balance sheets and interest rate risk exposure. TD Bank does not take part in credit default swaps. TD Bank uses interest rate derivatives, such as interest rate futures and forwards, swaps, and options for managing interest rate risks.  Foreign Exchange Derivatives are used as futures, forwards and swaps in managing the foreign exchange risks. Non-trading foreign exchange risk from investments in foreign operations are far greater or less than the liabilities in that currency. TD Bank also uses credit derivatives such as credit default swaps and total return swaps in managing risks associated with corporate loan portfolio and other cash instruments. The guiding principle is to enter into these transactions with investment grade financial institutions. Credit risk to these counterparties is managed through the same approval, limit, and monitoring processes that are used for all counterparties that may have exposure to credit. Other derivatives such as equity and commodity derivatives are a part of both the exchange and over-the-counter (OTC) markets.  Using these risk management tools for derivative and hedging gives TD Bank an advantage over other banks.

Annual Income Statement (values in 000's) Period Ending:

Trend             10/31/2014             10/31/2013             10/31/2012             10/31/2011

Last             Change Bid             Ask             Volume       High               Low

54.48     0.03 (0.06%)     54.40     54.48            1,529,533     54.55    

Pre-Tax Margin        

            25%                 22%                 22%                 23%

Profit Margin        

            22%                 20%                 20%              19%

Pre-Tax ROE        

            17%                 15%                 15%                 17%

After Tax ROE        

            14%                 13%                 14%                 14%

Based on the trend from the financial ratios of TD Bank the investment in more international banks would be a great help for them as their profit margin and return on investments have should a steady increase for the last four years. Merging into other countries will impact their bottom line and have another impact on their net present value.

TD Bank time value analysis is great also as it has continued to increase its dividend for the last four years in a row. Based on my analysis, I think TD Bank is currently and comparatively fairly valued.  Based on my value calculation, TD is now trading at its average low P/E ratio, but lower as it`s an average P/E ratio. The average dividend yield and average P/S ratio, for TD Bank is now trading near its average 5-year yields and over of its historical average 10-year yields.  My calculation of discounted cash flow gives price CAD 49.21 for the net present value, meaning that 2.56% overvalues TD Bank. Based on the dividend discount model, TD Bank is worth CAD 56.45, implying that 11.8% undervalues it. Overall I feel that Toronto-Dominion Bank offers a fair value at its current levels.


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