Toronto-Dominion Bank Stock

TD Bank has 1,772 million shares outstanding. TD Stock has not been the best investment over the past three years, but over a more extended period of time, it has rewarded its investors handsomely.

The fiscal year for major Canadian banks starts on November 1 and ends on October 31 of the following year. Thus, Q1 begins on November 1 and ends on January 31. Q2 starts on February 1 and ends on April 30. Q3 begins on May 1 and ends on July 31. Finally, Q4 starts on August 1 and ends on October 31.

The large fluctuations in quarterly income are mostly due to the financial engineering TD did around its planned acquisition of First Horizon Bank. Large increases in both net write-offs and provision for credit losses (PCL) suggest a deterioration in macroeconomic conditions as more borrowers are unable to pay their debt while even more are expected to fall behind.

Allowance for Credit Losses (ACL) is the pool of money a bank has set aside for loans that will not be paid. Provision for Credit Loss is the money a bank adds to ACL in a specific period of time. PCL reflects the amount of additional losses a bank expects compared with the last period. Banks are expected to model and estimate how much of their extended loans would be lost. Calculating the expected loss is not limited to non-performing loans already defaulted. It also includes performing loans and even newly extended loans.

When macroeconomic conditions improve, the models might suggest that the bank's credit loss would be less than its ACL. In such cases, PCL would become negative and called recovery of credit losses.

During the 4th quarter of 2023 and the first half of 2024, TD is engaged in restructuring its business operations. This restructuring mainly involves reducing headcount. As a result of the restructuring, TD incurs significant severance costs over the last quarter of 2023 and the first quarter of 2024. Instead, it saves the salaries of the affected employees going forward.

TD is the 6th largest bank in North America based on its asset size. The ten largest North American banks are, respectively, JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Royal Bank of Canada, TD Bank, Goldman Sachs, Morgan Stanley, Scotiabank and Bank of Montreal.

TD is the largest financial sector employer in Canada and has 95,000 employees. TD serves 28 million customers around the world and currently has 16.7 million customers with digital access to their TD bank accounts. As of the end of October 2023 (2022), TD had around 2,240 (2,220) branches in North America. TD’s income is sourced 44% (41%) from Canadian Personal and Commercial Banking, 37% (35%) from U.S. Retail Banking, 14% (15%) from Wealth Management and Insurance Services and 5% (8%) from Wholesale Banking. TD has $1,957 billion ($1,900) in assets, including $896 billion of loans and holds $1,198 billion of deposits.

Fiscal Year 2023

2023

TD offers a full set of banking services, insurance, and wealth management services in Canada. These services include chequing accounts, savings accounts, GICs, home insurance, auto insurance, tenant insurance, mutual funds and a trading platform. They also offer residential mortgages, commercial mortgages, HELOCs, lines of credit and many credit cards.

TD’s posted mortgage rates are not very competitive mortgages, but its mortgage specialists are able to get you rates lower than their posted rates. At the end of January 2024, TD had $321,670 M of residential mortgages and $128,283 M HELOCs on its balance sheet. By the end of fiscal 2023 (end of October 2023) TD’s mortgage book included $263.7 billion of mortgages in Canada. This amount was 13% of the total outstanding mortgages in Canada. $37.4 billion of these mortgages are negatively amortizing. A negatively amortizing mortgage is a mortgage whose periodic payments are insufficient to cover the interest. Thus, the principal balance of the mortgage is growing over time. At current payment rates, 24.6% of TD mortgages amortize over 25 to 30 years, while 1.4% of them amortize over 30 to 35 years, and 19.2% have amortizations longer than 35 years.

TD has the largest HELOC portfolio among Canadian banks. It specifically has $117.6 billion of HELOC on its balance sheet, including $86.9 billion of amortizing HELOCS. TD also holds $56.5 B in mortgages in its US retail banking division.

As with most other corporations, TD’s management wants to grow it. Canada’s banking market is mostly saturated with 6 large banks and a number of smaller banks. The Big 6 Canadian banks are the Royal Bank of Canada (RBC), TD Canada Trust, Scotiabank, Canadian Imperial Bank of Commerce (CIBC), Bank of Montreal (BMO) and National Bank. The first 5 are large banks active all over Canada, while National Bank is mostly concentrated in the province of Quebec.

In their attempt to grow in Canada, the Big 5 banks offer welcome bonuses to their new customers. They also offer free accounts (monthly account fee rebates for a limited time) to newcomers and students. These measures could be effective if employed by any of the large banks, but when all large banks are offering such incentives for new customers, customers are incentivized to move their bank account frequently from bank to bank (Bank account churning).

Moreover, over the past decade, digital banks have challenged traditional banks. Digital banks do not pay for the upkeep of their branches and use fewer employees per customer. Therefore, they can and do offer chequing accounts without charging a monthly fee and high-interest savings account interest rates significantly higher than traditional banks.

Thus, big banks, including TD, must look outside Canada for growth opportunities. Among the big 5, Scotiabank has sought growth opportunities in the less-tapped Latin American market, while the other four have sought growth in the huge US market. TD has a significant presence along the east coast of the United States.

In 2023, the Bank acquired Cowen Inc. for a price of US$39 per share and merged it into its wholesale banking segment. This acquisition cost TD $1.96 billion. Cowen had about $10.8 B in assets and $9.88 B in liabilities.

Cowen Inc. is a diversified financial services firm that operates in various areas, including investment banking, research, sales and trading, and investment management. The company provides a range of services to corporations, financial sponsors, institutional investors, and individuals.

Cowen Inc. is known for its expertise in healthcare, technology, media, telecommunications, consumer, and more sectors. They offer services like mergers and acquisitions advisory, equity and debt underwriting, private placements, and other financial advisory services. In addition to traditional investment banking, Cowen is involved in alternative investments and asset management.

TD sold 28.4 million Schwab shares, part of its holding in Schwab, for US$1.9 billion to finance its purchase of Cowen. This reduced TD’s stake in Schwab from 13.4% to 12%. This increased TD’s 2022 income by $1 billion.

The more important story about expansion is TD’s attempt to acquire First Horizon Bank. First Horizon Bank (FHB) is the fourth largest regional bank in the Southeastern United States. In February 2022, TD announced its intention to acquire FHB (which was trading above US$17 per share in January 2022) at US$25 per share for a total of US$13.4 B in cash. The regulatory approval dragged on while the market learned about the vulnerabilities of the US regional banks.

As interest rates climbed in 2022 and early 2023, deposits left regional banks. At the same time, rising rates had caused the cryptocurrency bubble to burst and the assets of these banks (loans and treasuries) to decline in value. A few regional US banks were exposed to cryptocurrencies, while most had long-term bond exposure. This resulted in a banking crisis where depositors became worried about the solvency of some banks and accelerated the withdrawal of their deposits. This became known as the 2023 banking crisis.

The largest bank failure in US history occurred during the 2007-2008 financial crisis with the collapse of Washington Mutual. Washington Mutual was the sixth-largest US bank before going into receivership. The second, third and fourth largest US bank failures occurred during the 2023 banking crises. The failed banks were First Republic Bank, Silicon Valley Bank, and Signature Bank, respectively. Regional US banks' share prices were hit very hard as a result of this crisis. This made it clear that TD Group has agreed to overpay for FHB.

TD cited the regulators dragging their feet and terminated the agreement to purchase FHB. In connection with this transaction, TD had invested US$494 million in preferred First Horizon stock. As FHB's valuation declined, TD had to recognize a US$273 million (55%) loss on this investment. Further, TD paid a breakup fee of $306 million to FHB. In December 2023, when the dust from both banking crises and the takeover has settled, FHB stock is trading around US$13.5. Compare it with TD’s offer to pay over US$25 for each share.

However, the most important aspect of this transaction was that TD had planned for the effect of interest rates on FHB’s assets. TD knew that rising rates could bring down the value of FHB assets while they had already agreed to the price. The money which they would overpay relative to FHB assets would be recorded as goodwill and subtracted from their capital for regulatory capital requirements. If this capital reduction is large enough to bring their capital adequacy ratio below the regulatory requirement, they must sell shares or stop paying dividends.

TD had significant interest rate exposure itself, but this risk was prudently hedged using swap contracts. They had entered into swap contracts to hedge the effect of changing interest rates on their assets. To avoid complications related to compromising their capital adequacy ratio, TD de-designated a significant amount of their interest rate swaps. This means that they stopped considering these swaps as hedges. They recognized large gains from rising interest rates by treating these contracts as part of their trading book. They did not have to adjust the value of their bond and loan portfolio (which used to be hedged by these instruments) to market prices. TD’s income significantly gained from these swap contracts in the fiscal year (FY) 2022, yet it had to recognize some losses from the effect of these swaps for FY 2023.

Bharat Masrani has been CEO and President since 2014, when former CEO Edmun Clark retired. Mr. Masrani is among the highest-paid Canadians. He started his career as a commercial banker with TD and has been with TD for over three decades.

Brian Levitt is the chairman of the TD Group's board of directors. Mr. Levitt, a corporate lawyer, has been on TD’s board of directors since 2008 and its chair since 2011. He was appointed an officer of the Order of Canada in 2015. Mr Levitt used to be chairman and CEO of Imasco Limited.

TD Board members are: Cherie Brant, Amy Brinkley, Brian Ferguson, Colleen Goggins, David Kepler, Brian Levitt, Alan MacGibbon, John MacIntyre, Karen Maidment, Keith Martell, Bharat Masrani, Claude Mongeau, Jane Rowe, Nancy Tower, Ajay Virmani and Mary Winston.