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While deteriorating economic conditions are weighing heavily on the beaten-up financial sector, some names are marking down their portfolios aggressively and building the reserves needed to offset future write-offs. This should make them positive outliers in terms of credit quality.

One of those companies is Toronto-Dominion Bank (NYSE:TD), according to Merrill Lynch’s Sumit Malhotra. The analyst recently upgraded the shares to a “buy” from “neutral” citing TD’s marks against its Commerce Bancorp loan and securities portfolio when the US$8.5-billion acquisition of the New Jersey-based bank closed earlier this year. TD’s reserves also continue to exceed net charge-offs, he said in a Sept. 14 note.

“In addition, the strong retail deposit franchises of both CBH and TD Canada Trust are very important attributes in this period of significantly increased funding costs,” Mr. Malhotra said.

While cutting his earnings per share estimates (EPS) by 1% for 2008 and by 5% in 2009 as a result of growth that is forecast to come in below the goal of 7% to 10%, along with a price target reduction from $73 to $68 per share, the analyst considers TD’s current price an attractive entry point for long-term investors. For the near term, the bank’s earnings power is expected to exceed that of most of its peers.

Mr. Malhotra highlights six reasons to like TD:

  • Domestic retail business should continue to outperform despite a cooling housing market.
  • With roughly 90% of the bank’s earnings coming from retail, 2009 EPS estimates are more sound.
  • There is low risk of a major U.S. acquisition in the near term, unlike other large cap Canadian financials.
  • Year-over-year EPS changes probably bottomed in the third quarter.
  • Higher funding costs make TD’s strong retail deposit franchises in Canada and the U.S. all the more important.
  • TD’s loan loss ratio is less worrisome than most Canadian banks.
Source: Merrill Analyst: Six Reasons to Like Toronto-Dominion Bank