The Inoculated Investor http://inoculatedinvestor.blogspot.com/
Quick idea for Toronto-Dominion Bank (NYSE: TD)- 12/14/09 ($62.26)
Does exposure to the US warrant a valuation discount?
Toronto-Dominion Bank (TD) is a Toronto-based financial institution divided into four separate business lines. Collectively,Canadian Personal & Business Banking, Wealth Management, Wholesale Banking and US Personal & Commercial Bankingmake up what is known as TD Bank Financial Group. Through these subsidiaries the company offers a multitude of productsand services, ranging from asset management to retail banking to insurance. In addition, included within the results of theWealth Management segment are the earnings generated by the bank’s approximate 45% equity stake in TD AmeritradeHolding Corp. (NASDAQ: AMTD), a publicly listed brokerage company that caters to retail investors. Historically focusedon the Canadian market, TD has recently expanded its retail banking operations into the US through the acquisitions of BankNorth (completed in April 2007) and of Commerce Bancorp (completed in March 2008). The company now has around1100 branches in Canada, 1000 branches in the US, and serves over 17M customers worldwide. As of October 31
, 2009 TDhad over $170.9B in assets under management, $391B in deposits and $557.2B in total assets (all in Canadian dollars).
Investment PositivesStrong balance sheet and limited exposure to troubled markets and assets make TD a safe haven:
Given the toughoperating environment for banks as a result of the recent financial crisis and subsequent recession, the most importantoperating metrics to analyze are capital ratios and credit quality. On that basis TD is clearly viewed by investors as being oneof the safest banks in North America. Even though the bank’s tangible equity to tangible asset (TE/TA) ratio is a paltry3.29%, its tier one capital ratio is now up to 11.3%. While, most bank analysts look for a TE/TA ratio close to 5%, TD’slimited exposure to the worst real estate markets in the US and the relative resilience of the Canadian economy allows TD tomaintain lower tangible capital levels than its more stressed US-based peers. Specifically, according to company presentations the bank has no loan exposure to the weakest housing markets in Arizona and California and never engaged insubprime, Alt-A or low-doc lending. Nevertheless, the company has indicated that it expects to see continued stress in thefollowing portfolios: Canadian credit cards, Canadian and US commercial loans, and US commercial real estate loans.However, with nonperforming loans (NPLs) to total loans at only .90% and net charge offs (NCOs) to total loans at .58%, (asof 10/31/09) even a further spike in credit losses is not likely to be unmanageable.Additionally, sustained strong earnings in the Wholesale Banking segment and in Canadian retail banking should allow TD toearn its way through the cycle without any further dilutive capital raises. It should be noted though that the managementteam has indicated that the huge increase in Wholesale Banking net income from 2008 to 2009 was an extraordinary eventthat should not be viewed as sustainable. From only $65M of net income in 2008, mostly due to mark to market write downsand other trading losses, 2009 net income in this segment jumped to over $1.1B. This impressive reversal was driven bytighter credit spreads, improved asset values (especially in the bank’s proprietary investment portfolio), and higher demandfor underwriting. From a trading loss of $77M in 2008, TD recognized trading-related income of about $2.23B in 2009.These results clearly reflect the unusual operating environment in 2009 and analysts would be wise to normalize tradingincome when attempting to come up with a reasonable estimate of run-rate EPS.
Opportunity to expand TD’s footprint even further:
Given the unemployment situation in the US, it is not hard to make acase that the regional banking sector will remain under duress for the foreseeable future. Accordingly, if share prices were tostart to fall again or the FDIC was poised to take over a bank with an attractive footprint, TD could become an opportunistic buyer. Many of the recent FDIC-assisted transactions, including the Colonial Bank-BB&T deal, were very favorable for theacquirers as the FDIC backstopped a large percentage of the most impaired assets. Therefore, in a situation in which manyother buyers are hamstrung by toxic assets of their own, TD’s relative strength could allow the company to pick up assetsand/or deposits at very attractive valuations. In fact, on the Q4 2009 conference call the CEO indicated that TD could beinterested in smaller, tuck-in deals or accretive FDIC-assisted transactions.
The investment in TD Ameritrade will continue to pay dividends:
The stock market declines over the past two years thathave crushed the portfolios of many investors (even with the huge rally since March 2009) has left many people with thefeeling that actively managed funds and investment advisors may not be worth the substantial fees they earn. Consequently, itwould not be a surprise to see retail investors move more towards self-directed investing in the coming years. In that case,AMTD appears to be in a perfect position to capitalize on this secular trend given its focus on retail investors and an ever-expanding suite of easy to access products and capabilities. According to AMTD’s most recent monthly metrics report, clientassets have rebounded from $241 billion in October 2008 to $297 billion in October 2009 and the company continues to
Sources: Capital IQ, TD Company filings and presentations, Yahoo Finance, Google Finance, Personal Calculations, FDIC.gov