The Toronto-Dominion Bank (NYSE:TD) Canadian Bank CEO Conference January 9, 2023 10:50 AM ET
Company Participants
Bharat Masrani – President & CEO
Conference Call Participants
Darko Mihelic – Managing Director, Canadian Financial Services
Darko Mihelic
Hi, Bharat. Good to see you. Thanks for coming.
Bharat Masrani
Good to see you. Sorry. I have a bad cold, but i don’t have COVID. Got tested. So you’re okay with that.
Darko Mihelic
It’s okay. I had COVID over the holidays.
Bharat Masrani
You did?
Darko Mihelic
I Did. I’ve had it twice now, surprisingly.
Bharat Masrani
Twice.
Darko Mihelic
Yeah, I’ve had twice now in my life.
Bharat Masrani
Wow, that’s something.
Darko Mihelic
I had it once, but, not twice.
Bharat Masrani
Hopefully, not twice. How are you doing?
Darko Mihelic
I’m doing well. Thank you for joining us today.
Bharat Masrani
Great to be here though as usual.
Question-and-Answer Session
Q – Darko Mihelic
So before we begin, I’m just going to remind everybody that Bharat’s comments today may include forward-looking statements. Actual results could differ materially from forecasts, projections or conclusions in these statements. Listeners can find additional details in the public filings of TD Bank Group.
So with that out of the way, the topic of the day has been capital with the changes in the DSB regime and in your situation, we have the closing of a couple of acquisitions coming up. So maybe we can talk about how that might impact your capital position and whether or not you see the need for raising equity here or maybe potentially if the DSB is raised later on this summer?
Bharat Masrani
I think I’m trying to remember the exact number, but, we closed off a year at what 16.2%, 16.2% tier one capital and I think when we talked about post acquisitions, we said, we expect to be comfortably above 11% after closing both the transactions. Feel that we have enough capital levers. Some of it is well known things like the — invoking the drip discount. We’ve also talked about optimizing RWAs through our investment portfolio.
We have structures out there like our evergreen credit card, ABS, and the Cowen acquisition, we pre-funded it essentially through equity by selling a bit of a Schwab stake. So when you look at it, those are some of the examples of capital levers that we have. We feel pretty comfortable with the state of our capital position and if traditionally the bank’s history is prudent capital management, that’s been part of our brand, part of our whole market TV. So I feel comfortable where we are on capital.
We generate good access capital 15 basis points to 20 basis points a quarter. So if you kind of do all the math, puts and takes here or there, feel comfortable as to where TD is placed with respect to capital.
Darko Mihelic
And that’s irrespective of whether we go to the upper end of the DSB this summer or…
Bharat Masrani
DSB is interesting. DSB obviously has an influence on — as one of the inputs is why we think about it, but not the only input. We talked about being comfortably or 11% before DSB was moved. So that’s how we thought about at the time. I think with the DSB, if things turn out to be worse than what people are forecasting and we get into a major slowdown, than the — and osprey [ph] had signalled this that the way they look at DSB is, they would drop it at that point, if things turn out to be from an economic perspective.
So we’ll see how things turn out, but I think overall, we feel comfortable based on our own situation, how we are forecasting the next year to play out. I think last quarter end, I talked about as to where we feel earnings will come out for the current fiscal year. If you add the two acquisitions, the profitability from those, if you look at interest rate tailwind because if you annualize some the rate increases as to what it does to TD given the type of businesses we are in, look at some of the volume growth, particularly in areas such as credit cards where we are geared more towards luxury and travel, which is come back quite smartly post the pandemic.
Now, things could change quite dramatically if things go sideways in the economy, then of course, it might be more difficult, but with all those things working out, we feel comfortable that we could be well within our earnings target growth of 7% to 10% and there’s a chance we might exceed it.
So if you kind of add all those numbers up and you say, well, where the DSB goes well, wherever it goes, it’ll go, but we think we have a lot of levers to manage around.
Darko Mihelic
One of the levers that you mentioned, you mentioned the drip, your organic capital. You didn’t mention the Basel reforms, Basel 4. How is that going to affect the year for TD? Is that a factor we should think about as well?
Bharat Masrani
I said the headline on Basel 4 it’s a manageable situation for us, but let’s — there’s various moving parts on that. So an operational risk under Basel 3 and now Basel 4, I don’t know whatever we call it, that’s going to be probably a negative item for us because retail revenues would be viewed similarly to other types of revenues. We have a large retail base. So, that’ll be a negative. There will be a positive on the credit recite because a lot of the advanced approaches would apply, probably slightly negative on the market risk side depending on the fundamental review of trading books as to how exactly when that gets invoked.
But on the other hand, there might be a positive when Schwab stake and then somewhat unknown and we are doing a lot of modelling on this is the variability that will come from First Horizon, but the reason I give you all those headlines is tells you how many moving parts there are is how they could work out, but overall, we’ve done a lot of work on this. We think it’s a very manageable situation for us.
Darko Mihelic
So in the end, it doesn’t sound like much has changed sort of business as usual over at TD and managing capital going forward now with a wide DSB range, does it necessarily say to us that from an acquisition point of view, future acquisitions are facing a higher hurdle rate, now with the hierarchical requirement. Does it change your appetite for what you would look at, given that you’re getting Cowen, would you, for example say, we don’t need to acquire any more in capital markets because of the capital constraints or so on and so forth. So just trying to dig into whether or not this sort of change in regime so to speak on the capital front changes anything for your capital deployment going forward?
Bharat Masrani
I think, of course regime matters, but it is importantly for us is I think I’ve been saying this for a few years is we think of capital deployment in a particular way which has been consistent and I don’t think changes. Do we — it starts with do we have enough capital to support our organic strategies, critically important to us, and the answer is yes. Do we have any capability gaps that we may have to use capital either to invest or to buy because we want to fill that gap — capability gap out.
Do we have enough capital from an opportunistic perspective, should there compelling opportunity come up. I think Aeroplan is a good example in our sort of history here where that was a bit of a surprise and it came up and we were there because we had not only the capability, but the capital to take advantage of that. It turned out to be a terrific situation for TD given where we’ve come along in that business. And so we go through that framework and said at the end if we have and do we have any major acquisition aspiration in the market because we might have to grow certain sectors or not and if all those turned out to be, there’s no opportunity, would we buy back our share?
So that’s how we’ve been thinking about it. Has that changed and in dramatic fashion. Of course, and I don’t want to underestimate the capital regime. Of course, the economy and the state of the environment has a lot of influence in each of those components. So yes, the capital environment has an influence, but generally we’ve been talking about how we manage the bank through any cycle and capital discipline, capital prudency has been a core part of how we tend to think of the bank and so that has not changed.
Now regarding future acquisitions, what the acquisitions that we announced and I said it when we announced them, they met our four criteria we look at. Number one; was it strategically compelling? Both in First Horizon and Cowen again say yes. Was it financially attractive? Both these transactions were financially attractive. Were they within our risk appetite as in time has shown that yes, they were within our risk appetite have continued to be in our risk appetite and number four, critically important to us, are they culturally aligned?
So Darko, even with all the clouds that are in the economy and capital regime, if another situation have to come up, that hit all those four criteria, of course we would look at it seriously. So does this make sense, because those don’t happen very frequently that you meet all your criteria. So I am not saying we unlikely we do anything until we close these transactions and feel comfortable, but never is a long time.
Darko Mihelic
Okay. Fair enough. Thank you. You mentioned it, so we’re all curious closing, is there any updates you can give us on these deal on Cowen or First Horizon or on your expectations on closing or any other update you can provide given the environment that we’re in?
Bharat Masrani
See on First Horizon, there were certain aspects that needed to be done. So the shareholder of vote — the First Horizon shareholders had to the vote on the transaction and that did take place and folks who decided to vote 99% of them decided to vote in favor. That was great. There was a public meeting and organized by the regulators and that went pretty well. I think, there was a lot of support among the community groups with TD’s application as to how TD is viewed in the markets in which we operate in the United States. So that was very good.
Another aspect in the US that has become pretty common is agreeing on a Community Benefit agreement and that we are negotiating with the various groups that are stakeholders in that part of our arrangements and that’s going pretty well. We haven’t signed one yet, but it’s going pretty well and I expect us to get there on that.
And the final one is the regulatory approvals by the major agencies in the United States. Now that is an unknown, the US, the latest deals seem to take longer than what it used to. One deal that was approved took, I don’t know, 14 or 15 months or something like that. Another deal that was announced approximately two and a half, three months ago before our deal got announced, we are into about nine or 10 months into our I think end of February when we announced First Horizon with a deal that was announced couple of months, two or three months before ours is not yet been approved.
So given all that we — last quarter, I said that instead of original expectation of closing within the first fiscal quarter of this year will be the first fiscal half, which seems to be appropriate, given all the other stuff that’s been going on. So that’s our expectation on when that gets done. On Cowen, again the shareholder approval, Cowen shareholders approved it overwhelming. Again, it was 99% of people who voted.
A couple of approvals are already in hand and so that we are expecting. I think it’s the first calendar quarter of this year to close and so that’s our expectation on both these transactions.
Darko Mihelic
Okay. Thank you. That’s helpful. Maybe switching gears a little bit talking about Canada’s situation with housing, price declines, large increases in mortgage payments for a cohort, you have a large mortgage book in Canada. So maybe you can walk us through how you view the vulnerability in the sense how much of your book faces increased trigger payments? How many of them will be facing a significantly higher payment this year and next and are we worried about something like how big of a part of that — of your mortgage book is facing what I would consider a difficult situation of 30% or higher increase in mortgage payments?
Bharat Masrani
Yeah. I know there’s lots of discussion on this. I think, few people before me talked about this as well. So it’s a common theme and to be expected given the environment we are in, we’ve not seen rates go up at this pace and so much over the recent past. So obviously, it’s a right topic to be focused on, but I think it’s important to keep it in perspective.
Look back many, many years, as to what’s been the experience on Canadian mortgages, through very difficult periods and you look back at least from a TD perspective, if you look at our historical situation on Canadian mortgages, I’m not even talking of losses. I’m talking of impaired formations. It has been in the low single digit basis points perspective. historically, if I’m looking at multiple years here and you say why is that? Why does this asset class behave so well through circumstances and it starts with a basic problem that we have in Canada.
This year, I think everybody saw that nearly half a million new immigrants entered Canada. In Canada, we build homes, new homes to the tune of 200,000 homes to 250,000 a year. So every year there’s a chronic supply problem that gets worse. So even if magically, we flick a switch and all of a sudden, supply of new homes goes up to 0.5 million think of the backlog that has to be cleared.
So you start with the premise as to what are the fundamentals of this business? And then from a TD perspective, we are a huge scale player, but a vanilla player. We are not an alternative mortgage player. We don’t play on the margins. We are not a subprime mortgage provider, and that’s what we do.
Thirdly, less than 1% of TD’s mortgages are uninsured, have a bureau score of less than 650, and where loan-to-value is over 75%. So let’s talk, from a basic quality perspective is the quality of the book. Then you say from a macro perspective, so our estimate is through this rate cycle and probably have more to come that approximately there have been increase in mortgage payments of $200 per month to $600 per month, like if you look at from a modeling perspective.
And against that, this excess savings that have been built up through the pandemic to the tune of 30% of excess deposits still compared to pre-pandemic levels. So you’re looking at a long period before all those things get exhausted. Then you say, “oh my God, there might be a big problem”. And even when you get there, you have to think about that somebody has lost their job and loan-to-value is over 100% before you start seeing major problems. So you say, all right, what scenario can you see where loan to value is over 100% for a bank like TD that is not in the subprime mortgage business or alternative mortgage business where somebody has lost the job and excess deposits have been run off and they don’t have other levers to pull back on expenses.
So there are a lot of scenarios at play, but so I’m just trying to give you a perspective as to how I’m thinking about this business. Of course, can there be a bump? Of course, we are in that business and we manage that. And that’s why every quarter, you ask Ajai and you say, “oh, yes, of course, Darko am building this, and he should”. But historically, this is how this asset class has behaved and do I see a dramatic shift in the behavior? I don’t. Do I see a bump? Of course, I do. We would not — I shouldn’t be paid what I’m paid if we can’t manage through bumps. And that’s how we are looking at it. It’s a great business to be in. It’s a great asset class.
And final point is that, in our case, we’ve taken lots of questions from a lot of our analysts, including you, Darko, that I think it was six months ago, eight months ago, how come we are not growing as much as the others? So where we are consistent underwriters through a cycle. That’s how we kind of manage this business, and that’s been the historical sort of record for us in that business. So feel comfortable with the quality of our mortgage book, how the asset classes we have historically, how we see the future playing out, the support that there is there against this asset with excess savings, etcetera. So feel comfortable as to where we are.
Darko Mihelic
So asset — so the mortgage asset class, we’ve covered that. So the next sort of segue where this takes me is, when I look at what you guys use for your forward-looking indicators, it doesn’t look that bad. Your unemployment rate base case scenario goes up a little bit in 2023. And yet what I’m hearing is mortgage payments have risen, they might dip into their excess deposits. It sounds like there could be a drag in the economy. So, okay, we won’t have any defaults in mortgages. But we’ll have a drag on the economy.
So how do I think about your forward-looking indicators not necessary showing a recession, not necessary showing any sort of bumps or bruises? And how do I think then about your reserves that are on trace sheet relative to what I view as a relatively okay forward-looking indicators and many people in this crowd think there’s a recession coming? Can you…
Bharat Masrani
I am not suggesting there’s a 100% chance, there’s no recession. When rates go up so much is there a slowdown to be expected? Yes. But on the other hand, the job market has been remarkably strong and continues to be strong. And I think one aspect that I am sure history will write a lot of books on this is impact on the economy post pandemic. With such an event and the level of fiscal stimulus that took place, the level of monetary easing that took place as to how long does it take for that to play out? 1 thank time will tell.
So am 1 saying for sure that this is going to be just a benign environment? No, absolutely not And that’s why everybody is looking at what happens. But the part to watch in employment and if you want to look at losses, If you want to look of what happens in that’s the indicator as to what’s going to go on. Now each of these asset classes has nuances like I talked about supply of housing etcetera and even if we don’t get to a recession, much slower growth is going to feel the a recession I’m sure there are a lot of sectors right now. I talked to a lot of clients are feeling they’re already in a recession.
So I don’t want to undermine the environment here, but is it going to be a deep recession like what we had post the global financial crisis for a while, around the world, I’m taking perhaps Canada we did not feel it as much or what folks are testing in March of 2020 as to what because the pandemic, when there is a forced lock down? It’d be more of an interest rate caused recession. And if you want to look at what modelling is out there, would there be a showdown? Of course, there’s going to be a slowdown and all of us are prepared for that and managing through. And frankly, our modelling in showing that’s how we will manage the bank through.
But are we seeing a depression here with some of the questions you were asking me say, ‘Oh my God, the world is coming to an end” We don’t see that.
Darko Mihelic
And so one of the tailwinds you’ve had at your bank has been ret interest margin expansion, fairly strong, NII growth. And in fact, when I look of consensus estimates, looks like you’ve got very high growth expectations for this year in a year where PCLs are normalizing, in other words, rising. So in that environment, are we getting carried away with net interest income growth for TD? What’s your view on that? Is that going to be the big swing factor that-on EPS this year? Is it — our NIM’s peaking? How should I think about your net interest income growth? And I’m going to say, excluding the acquisitions.
Bharat Masrani
Yes. So firstly, just to folks might feel that we position the bank to be interest rate sensitive that that is the core objective of the strategy. I think the important thing to note is we are interest rate sensitive is an outcome of the strategy we run at the bank. We are a huge, what I’d call, non-interest rate sensitive deposit gatherer and what does that mean?
Huge checking bank, huge transactions, accounts bank. And the outcome of that is makes us on the deposit side more interest rate cone because those are non-rate sensitive deposits and when rates go up, beta on that is zero, and therefore, your margins expand and that’s the outcome of the strategy that we run.
So I think important to clarify that this is not that, less position the bank because Barrett has a view as to what rates are going to be 4’O clock in the morning lightning bolt, and here we are. And that’s not the way it is. This is how the strategy is designed and that’s how the bank is configured. So as rates go up, we benefit because of this strategy that we are running. And so the rates have gone up and you’ve see what’s done that to NII and NIM, etcetera in the bank and as rates increase even more, who knows?
They don’t know what is 100% clairvoyant or we know exactly what work out. As long as rates go up, of course, our margin will benefit from it. And we also have a tailwind on annualizing some of the rate increases from last year. So that’s a benefit here. But you pointed out what are the offsets against it? Well, the offsets are there might be a slowdown in the economy. So volumes might suffer. Mortgages are already slowing down. So that is to be expected and to some extent, welcome given where we are in the cycle.
So that will be the offsetting part over there. So that’s how we look at it and so look, I don’t want to talk about consensus. That’s what you folks do for a living, but we feel and 1 was quite clear with the guidance on warnings growth, given where rates are, animalization of those rates, the acquisitions, ignore acquisitions, but assuming that they happen.
We’re looking at warnings growth of more than our medium-term target and can things, this is forward-looking. So there’s no guarantee it’s going to happen. Could things turn out to be different? Timing of acquisitions could be different. The economy turn out to be much difficult than what we are forecasting. The geopolitical situation might turn out to be uglier than what it already is. So a lot of moving parts here. But overall, given the strategy we run, we feel there is, that’s core part of our business model, more consistency and predictability in our earnings, and that’s the reason I said what I did in December.
Darko Mihelic
Sounds good I’m going to take a look here at the questions that are — actually the question is, what if rates fall but I guess that’s back half question?
Bharat Masrani
It’s a great question because I thought you would ask me that saying, do we see another alt of TD here. So that’s interesting because it’s not as if our margins go through the floor when rates were zero. It want too long ago, and we were doing quite well then too. So it’s not as if we don’t have experience as to how to manage the bank in the low rate environment. We’ve been doing that for the past 12 years and why is that? So simplistically, the asset sensitivity on rates it’s again, I’m simplifying and 1 want to quality that is you would think that all the banks are similar in mat side how much fixed rate loans we have versus others or whatever.
The main difference comes on the deposit side as to what happens on non-rate sensitive deposit growth versus rate sensitive deposit growth? So non-rate sensitive deposit growth as you know and Darko, we’ve talked about it in our earnings call and one-on-one meetings and all that, that we tractor those deposits.
So when rates fall by the time they work through our P&L there’s time. There is — it’s not an instant thing that you drop away. And as rates go up, it helps you very quickly because not only the old tractors are repriced higher, but your new deposits are priced at a higher level because you’re tracking at the higher level.
On your rate-sensitive deposits, your beta works immediately, right? If rates drop, your deposit rates drop immediately. So that’s the way to look at it from a — when rates drop is to how it would impact TD? The pressure on our deposit margins will work through over a few years, whereas on the rate sensitive, it is not a small part of our business that’s an immediate impact, but that’s no different than any other hank.
So it’s a long way to describe how actually the TD’s deposit book works because sometimes it’s not well understood. And it’s important to clarify that. But I feel that we’ve shown in a low rate environment that we are able to manage the bank with consistency and within expectation.
Darko Mihelic
Okay. We’re running down a little bit on time and I am going to ask another question from the audience. But before we do, I think, I have on opportunity here because you’re up here and you’ve got a large credit card book, you talked about Aeroplan, but it’s much bigger than that and so one of the things that I wanted to ask with you being here is, is there’s some work on towering the interchange fee here again in Canada. And not only is there supposed to be an industry led solution and then the government is suggesting. Hey, if we don’t like that solution. We’ll come up with our own solution. So in there any update you can give us on this process and can you give us your perspective on a bad outcome, let’s say, if interchange fees are dropped significantly? How do you react? What does TD do?
Bharat Masrani
Think of the credit cant business, there’s a business model attached to it, right and the convenience, the credit availability, the fraud management around it, all those aspects create a value proposition for the holder of a credit card, and the rewards critically important as to how what value you’re providing to your customer.
Attached to that value proposition is a series of costs and revenues and so, of course, if any component changes here, the value proposition has to change. So we’ll see how plays out. Unfortunately, credit cards have been in the headlines for many years. It’s not a new phenomenon. A lot of stakeholders that have a desire for certain costs to go down, but not the benefits to go down, but I think banks generally have managed well on how to adjust their value proposition. We had a change and interchange a few years ago, about three years ago or something like that and people thought, Oh my God, the whole situation might change quite dramatically, it didn’t because the value proposition adjusted to the new reality.
So my hope is that we do come up with a sensible solution here. I think some of the objectives laid out makes sense for the small businesses. We also want to make sure that our small businesses are added in a particular manner and relative to some of the big retailers that might be out there. So we’ll see how all these things play out; but overall, it’s a business, business has cost and revenues attached to it. And if one of those components change, something has to change because that’s how the business is run and managed. So I’d expect that to continue.
Darko Mihelic
Fair enough. I guess the concern would be that it would be a rapid drop in the interchange, and therefore, there would be a big change in the business model rather than the previous interchange drops which we minor and so I don’t know if you can comment on anything like what they’re talking about in terms of the degree of the drop?
Bharat Masrani
Hard to talk about specific discussions with various stakeholders and let’s not forget, this is not just TD or the big banks. You got the networks that are in the middle of it. You’ve got various other stakeholders, various merchants, different sites of those merchants that are at play here. You’ve got the government having a say in it. So it’s a multiparty situation that is ongoing. So time will tell exactly when we end up.
But I have confidence that we come up with a sensible solution with the definitive view that if you pull one side, something else is going to get impacted: This is not like there are only one thing one side happens. If it happens like your speed at which something happens, something else is going to happen at speed as well to offset it. That’s how the works. It is a business and businesses work on ensuring that the cost revenue ratios remain within sensible ranges.
Darko Mihelic
I guess I might be able to kiss my points goodbye. Hopefully…
Bharat Masrani
Do you have a TD card. Let’s see what card you carry.
Darko Mihelic
I actually carry a number of cards. We won’t reveal which ones.
Bharat Masrani
That’s actually good answer.
Darko Mihelic
So maybe with that we can finish off the session, Barrett with handing over to you and just maybe you can provide us with your key messages for investors and shades for 2023.
Bharat Masrani
So notwithstanding firstly great to be here, Darko. Thanks for asking me. Notwithstanding the unpredictability of the environment, the volatility, high rates, high inflation, risk of a recession, I feel pretty good about TD going forward. If we look at our balance sheet, the size of our business, the scale, the market share we have the market positioning we have in various markets feel great, notwithstanding our size in Canada. We see huge opportunities for growth in our wealth business, in our credit card business.
With the acquisition of Cowen, it helps our Canadian business as well, to a great deal on the capital market side. The US, what can I say? We are a very young franchise the First Horizon acquisition, highly complementary. They bring huge capabilities First Horizon on middle market banking, on commercial bonking, TD prolific on what I’d call very traditional products on the retail side, and we bring these banks together as to what we can do.
We become the sixth largest domestic bank in the US without looking at the rest of TD and so feel great about that as to how we are portioned. And we’ve shown that we can manage the bank very effectively and very profitably in various scenarios, and our conservative risk culture, capital management bodes well given the uncertainty in this environment. So I feel very excited and again, thank you, folks for your confidence in TD.
Darko Mihelic
Okay With that we will wrap up this session. Thank you very much, Bharat.
Bharat Masrani
Thanks Darko. Thanks very much.
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