The Toronto-Dominion Bank (NYSE:TD) Scotiabank 23rd Annual Financials Summit Conference September 7, 2022 12:30 PM ET
Company Participants
Bharat Masrani – Chief Executive Officer
Conference Call Participants
Meny Grauman – Scotiabank
Meny Grauman
It’s my pleasure now to welcome to the stage Bharat Masrani, the President and CEO of TD Financial Group. Welcome Bharat.
Bharat Masrani
Nice to see you, Meny.
Meny Grauman
Nice to see you again, in person.
Bharat Masrani
Well, it’s great to see all of you in person as well. It’s been a while. Good to see people really exist.
Meny Grauman
I was questioning it for a while.
Bharat Masrani
Yeah, I know. Same here.
Question-and-Answer Session
Q – Meny Grauman
So Bharat, lots to talk about. You’ve had busy number of months from an M&A perspective and I thought I would start there with talking about First Horizon and Cowen. Maybe first on First Horizon just to get into it, and if you could just remind investors in the room here the rationale behind the deal and how it fits into your broader U.S. strategy?
Bharat Masrani
Good place to start. I’d start with — I’m even more excited today about First Horizon than I was when we made the announcement. I mean, obviously, I knew Bryan Jordan for many, many years, but over the last few months I’ve been able to meet with more management folks, be in their markets, meet their wider employee base as well and really feel good about the culture and how they go to market, the strategy they run. And obviously, you’ve seen – as a public company, you’ve seen their numbers. So feel good about how they’re performing and frankly, how — when it comes together with TD, how powerful this can be.
Just to go back to your question. For many years I’d been saying that, scale in our U.S. business matters, and it’s important to be a scaled player, a sufficient scaled player. The Southeast and the south of the U.S. was particularly important to us strategically. It made sense, contiguous market, population growth that is expected to be 50% higher than the national average. This huge move pre and through the pandemic, folks going to the State of Tennessee and moving South, that’s an important contribution to what’s going on in that market.
And First Horizon was perfect fit on that strategic rationale that I’d been talking about for many years before we announced the deal. And on top of that, of course I knew Bryan Jordan, I’ve known him for more than 10 years. We served on the Federal Advisory Council when I was in the U.S. many years ago. This is a advisory council to the Board of Governors in Washington. And kept in touch, and so I was very impressed as a fellow executive as to what values he brings to the bank. The teams he would put together, the strategies he runs, his own risk appetite, so how he wants the bank to be positioned. So that was our strategic rationale.
And so, I said to all our investors, listen, “we run a great bank, we got a terrific U.S. franchise, and we are not going to do a deal just for the sake of doing a deal. It would have to make strategic sense and this did.”
On top of that, it made financial sense. This is the highest return on invested capital deal we’ve done in the banking space in the U.S. over all these years. And so that made a lot of sense to us. As well, risk — is it within our risk appetite? And the answer is absolutely yes. And are we culturally aligned? How do they look at the customer centric model, what do they do in the communities in which they operate? How do they view customers’ interest versus the bank interest or whatever else that might be out there. And again, very aligned with how TD operates.
So not often can you go out there and say, well, you got four big picture boxes you want to take, and this was perfect from that perspective, strategically compelling, financially attractive within our risk appetite and culturally aligned.
Meny Grauman
And when I speak to investors about this deal, one concern is integration risk and they point to the history of First Horizon, how it came to be in terms of quite a number of acquisitions and sort of wondering about the implications of that? So thought I would ask you to address that concern that some people have.
Bharat Masrani
Well, it’s a legitimate way of looking at it. But also to keep in mind that because of their acquisition, First Horizon actually was trading, the stock price was trading below their peers by a couple of turns. And that was to address that risk, specific risk. And we spent a lot of time, and not only do I — like I said, I know Bryan as to how he operates. And by the way, this is not a new phenomena in U.S. banking that banks come together through consolidation.
But I knew exactly how Bryan had done it, and then we spent a lot of time after we started our negotiations and due diligence as to how can we get comfortable on integrating this banks, not only from a technology perspective, which we are a proven player, but from a culture perspective and we’ve had a good record in the U.S. to bring banks together under what we call our wild culture. And it matters to us and felt very comfortable that this was something that we can certainly manage and frankly, actually benefit from it.
The other part, particularly they are more commercially oriented than TD Bank America’s Most Convenient Bank. And this applies to any business in the U.S. Retention of talent becomes key, particularly in their case because they’re already bringing two banks together. So we identified that issue upfront. I thought it was a good structure, unique structure to put the convertible pref in it, out of which $150 million was used for retention purposes.
And the part that probably has not been talked about as much is normally when you acquire a bank, particularly in the United States, there is an all cash deal, which is what this is. Then whatever retention they have in their own bank, like in deferred comp and all, that gets paid out in cash. We made it very clear that, that was unacceptable to us. That whatever deferred comp they had, which was sizable, because they had come together, so they were looking at the same risk when they came together needed to be converted to TD instruments. And that was the final deal that got done.
So very comfortable with how we have approached this. They did their technology conversion I think three or four days before our announcement came out. So we wanted to make sure that we are comfortable with that. And so, I think we have a proven track record of bringing these banks together and some of the unique features that I just talked about addresses some of the risks you mentioned.
Meny Grauman
And in terms of that retention, obviously the deal hasn’t closed yet but as you look at sort of the churn in the commercial bankers at First Horizon, is there anything happening there that is notable right now?
Bharat Masrani
I’m very happy as to how things have gone. I don’t know all the people down there, but the impression I have is that, we haven’t lost anybody we didn’t want to lose. So it’s a good thing.
Meny Grauman
The other question that I get a lot about First Horizon is just from the perspective of TD’s Wealth platform in the U.S. and positioning? And the question is, how does First Horizon move that wealth strategy forward in any way? And so also, thought I would ask you that question from a Wealth perspective, what does the First Horizon do or not do?
Bharat Masrani
Well, it’s got a nascent wealth business. It’s not huge. But what this does and whether a scale matters is one of the big nut to crack when you’re building a business in the United States in Wealth or whatever you do, is to actually have the customer. So we start with a good position that once this deal closes, we are going to have more than 10 million Americans banking with TD.
And Leo, our leader in the U.S, I think many of you know him, ran our Global Wealth business and did a terrific job over the past 10 years or so in building that out. And he is fully aware and very passionate about it, and very dedicated in building out a first-class Wealth business. So even this year, notwithstanding the pandemic and then some of the uncertainties out there, the number of advisers we are putting in our stores, we are looking more at a mass affluent wealth player. We are not looking at what we do in Canada as a full service wealth player. No. We are looking at what makes sense for our clients. And of course, we also have a fantastic strategic relationship with Schwab that helps us as well.
So overall, yes, this First Horizon in itself is not a wealth acquisition, but it does provide us the scale, it does give us access to more customers. It does put us in markets which are particularly attractive for the mass affluent type of offerings. And now we certainly have the products and now building out the distribution, like we did in Canada. We were one of the few ones that did not go out and buy a sales force or anything like that, it was organically built. So I think we’re working on that. And of course, where I sit, I’d like it to be faster, but it is impressive as to how the teams are coming along.
Meny Grauman
I wanted to switch gears to Cowen, obviously, a much smaller deal, but interesting nonetheless. And I guess, the same kind of question, why Cowen? Why now? Especially with First Horizon still being in the process of I don’t know if you call it digested or the deal still needs to close. So why now?
Bharat Masrani
Well, one thing we’ve always been very mindful of in any acquisitions — and I mean, let’s be transparent, we learned the hard way. That no point buying something that is really made available for sale, because generally it’s dressed up for sale and not much is left after you become proud owners.
In our case, we’ve been good acquirers. I think legacy Commerzbank was a terrific acquisition that was not dressed up for sale because circumstances made it available in the market. South Financial also fits that description. And frankly, First Horizon as well, because they were going through their own integration, bringing those banks together. So it was not actually dressed up for sale.
Same applies to Cowen. They were not looking — a terrific company, did very well. And — but we had identified Cowen. Riaz and his team were looking at Cowen for a while. It fills out a particular capability, we think, is important for us to have a few years down the road, thinking of — in the U.S. equity capital markets, investment banking business, some of the core businesses there in with TD’s strength and balance sheet and rating and funding advantages that kind of supercharges that growth.
And the part that sometimes is not well known is that First Horizon is a terrific middle market business, and Cowen is uniquely positioned in the middle market side as well. So that’s an added benefit that we see. And then lastly, in Cowen, felt very comfortable with the management team and the individuals, very TD-like from a cultural perspective.
So again, I go back to — it’s not often you sort of do a deal where strategically it makes sense, financially attractive, 14% ROIC deal. Risk appetite, very comfortable. In fact, they generate all these revenues without a balance sheet, so feel good about that. And culturally, we felt very comfortable.
So it does a lot for our TD Securities business. It’s very complementary to what we’ve said we want to do. Your point, doing 2 deals. They are separate deals. And we’re not looking at disturbing either one of them. It’s a different segment. We are a large bank, and we think we can manage that.
Meny Grauman
Related to Cowen, it seems like there’s a general orthodoxy among bankers that says that buying investment dealers, especially foreign banks buying Wall Street investment dealers, it’s just a very risky proposition. It might work in the short term. But in the long term, how do you retain the talent?
And so I thought I would pose that to you and wonder out loud maybe does the experience with Newcrest, is that some part of the answer. Does that give you confidence in your ability to do this, obviously, south of the border in this case, but is that part of the calculus for you?
Bharat Masrani
Well, in fact, the premise you set up doesn’t only apply to investment banking. I think people say that any foreign bank going to the U.S. and any financial services ultimately fails and goes back home, takes a writedown or whatever.
I think we have proven that at TD, we are different. We’ve been there for many years and quite successful with our U.S. strategy. I think one thing we’ve always done is whenever we acquired — this is historic, this is not over the past few years, we very much value the management team we acquire. And when you think about it, any of these acquisitions, we’re paying a good premium and they don’t come for free. And most of the value that’s being created is through that management team.
So why go there and destroy it? I don’t understand many buyers do that, but at TD, we don’t. If you look at our management team in the U.S. on the retail side at TD Bank, America’s most Convenient Bank, most of the talent, the top talent there, the most senior management is acquired talent on the banks we bought: Commerzbank, South Financial, Bank North. And that’s the way we’ve set it up.
And you talk about Newcrest, well, Bob Dorrance came from Newcrest. Robbie Pryde came from Newcrest. You look at the whole part of TD Securities and Bob ran it and still is very much involved as Chairman of TD Securities. Same applies to my predecessor, Ed Clark. When we acquired Canada Trust, we said, “well, listen, I’ll go destroy it.” We paid. I don’t know how many times booked, but it was quite expensive, but turned out to be great, and we were able to retain the talent.
So I think we’ve got a history, a tradition and a track record of maintaining the people we acquire because they find TD’s culture welcoming. They have a bigger platform in which to operate. And in fact, with First Horizon, Leo just made an internal announcement of a new structure where some of the First Horizon executives would have a bigger role in the combined entity. And I expect Riaz to do that in the next — shortly to announce a structure that will make sure that folks at Cowen have a meaningful and a large role within TD Securities.
So I think those things matter, and TD is a welcoming culture. They’re going to create value with the advantages we bring. Godspeed, we’re quite happy to accommodate.
Meny Grauman
I wanted to turn to capital. When you announced Cowen you made a few interesting comments that are capital related. You talked about putting on a hedge for the First Horizon deal, for the interest rate risk of the First Horizon deal. You sold down part of your Schwab stake to fund Cowen in fact. And you talked about at closing, the CET1 ratio would be comfortably above 11% pro forma First Horizon.
So first, on — and this came up a little bit on the call, but just in terms of the rate hedge related to First Horizon. Just to clarify, you didn’t go out into the market to buy swaps. You redesignated swaps you already had. Can you explain why you did this?
And what you had to — I guess the question I’m getting is from a lot of investors, what you had to give up in order to put this hedge on? It seems like it was cost less, but it’s hard for people to understand that concept. So maybe you could explain it more.
Bharat Masrani
Yes. So firstly, why the hedge when we did it and why not earlier or why not later or whatever the case might be? When we announced the deal, we said that there is — if rates move, the fair value of fixed rate loans are going to be impacted and it’s a fixed-price deal and hence, goodwill will go up and they will be a negative to the capital.
But that additional goodwill gets accreted back into income because as the loans are held to maturity, it’s not a trading book. And as they get repaid, it comes back. So there’s a natural hedge. Secondly, in a rising rate environment, all of TD is rate sensitive and very positively plays from a rising rate environment. So that provides us an additional hedge.
But we also said that, listen, the volatility that’s out there, like, you have these rates moving in the largest bond market known to humankind, can move at 12, 15 basis points in a day. And you can see the volatility on your capital levels there as to what happens. So we said, all right, given the volatility we are now seeing compared to when we did the deal this time to mitigate this risk, and that’s how we looked at it.
And I think what our teams did, Kelvin Tran, our CFO, Barbara Hooper, who runs our Treasury and balance sheet practice, came together, and I think came out with a very creative idea as to how we’re going to do this because we could have gone into the market and bought a bunch of bonds out there and hedged it in that way. But think of the friction cost there, the cost of doing that, funding costs, et cetera, et cetera, and then ballooning your balance sheet.
So I think what we did made a lot of sense. So simplistically, how does this work? If rates keep on going up, so the fair value of those fixed rate loans would go down and the amount of goodwill goes up. But the swaps, now because they’re attached to that, provides you the offset against that goodwill. And you say, all right, so you took that, redesignated that. And what happens to the bonds that were hedged in the first place? So they’re held to maturity firstly, those bonds, and we found the match because we got a large investment book in the U.S.
If you look at U.S. balance sheet, the amount of funding and deposits we have relative to loans, so we have that flexibility because we have their investment book, out of which we can take these existing swaps, redesignate it. And then whatever is the negative carry on that, that happens over time, right, that gets offset by the additional income you’re getting on the loans.
So I mean it is a very neat idea. And it is an accounting hedge, and that’s how the accounting works. And what it did was actually put a pin on what’s the worst capital position that we’ll find ourselves in, and that’s the way to manage this acquisition. So that’s what we have done in a simplistic way.
But I’d encourage, Kelvin has 13 different questions coming different way. And he’s at one of your [conference] — tomorrow, I think he is coming in, ask him, and he’ll give you the key accounts as to how the cash flows move here or there. But trust me, this works well.
Meny Grauman
Okay. Got it. You say trust but verify. So —
Bharat Masrani
Trust but verify. But an interesting thing is we — hey, we are a public company, we’ve got a lot of oversight on what we announced. So it’s — yes, already verified, Meny.
Meny Grauman
Just moving over to what you did on the Schwab stake. I think a lot of investors took comfort in that in the sense that they said, okay, you sold down your stake to 12.5%. Below 10%, some privileges start to be lost or privileges do start to be lost.
So we’re comforted in the fact that between 12.5% and, let’s say, 10%, 10.1%, there’s a lot of capital there that if whatever happens — if things go sideways, there’s a precedent now set that TD can use that as a source of capital effectively.
And so the question is, is there anything mistaken in that thinking that you have — there’s no difference between 12.5% and 10.1% when it comes to your Schwab stake? Is that how you’re thinking about it?
Bharat Masrani
I think overall, Schwab, which is consistent with what I’ve said, what we’ve said, is usually an important stake for us. It’s a strategic investment. We have a long-term, very large deposit agreement. We use Schwab — used to be legacy TD Ameritrade platforms and now they’re Schwab platforms for our U.S. business. I think there’ll be more opportunities as we move forward. As you can expect, at Schwab, they’re very busy with integrating TD Ameritrade and also fully understandable. But I think over time, there is a potential for even further strategic relationship here.
So very happy with our investment in it. Like you said, we got governance rights, and I’m on their board. So it’s another TD designee on the Schwab board. It’s a terrific company. I mean just a terrific business model, look at their growth metrics, what they do. They’ve got more than $7 trillion with a T, dollars in client assets on their platform. So just a terrific business model.
And then — so we — very happy with it. Nothing has changed. Yes, we took our stake down here a bit. I think we went down to 12%, Meny, I just want to clarify that. And — but we have no plans. I don’t have any plans right now saying, well, let’s go sell more of it to do this or that. It is strategic and that has not changed through this transaction. I was happy to see that Schwab, the company themselves bought back $1 billion of the amount we sold. So great, terrific relationship between the 2 companies.
Meny Grauman
I wanted to talk about margins. Obviously, an important focus for this quarter and a very good news story for TD, in particular. And I don’t want to minimize that, especially in the U.S., where — you saw over 40 basis points of sequential margin expansion.
But one thing that I do want to revisit is just the Canadian margin expansion of 7 basis points was at the lower end of the group. And if you would have asked me to kind of forecast ahead of time what that would look like, I would have thought it would have been a lot bigger given what we’ve seen across — what we saw across the peer group, given the strength of TD’s deposit base and just the overall rate sensitivity.
So — it came up on the call, but I thought I’d revisit and just talk — ask you to maybe help us better understand what impacted the margin this quarter. And more importantly, what the outlook is going forward.
Bharat Masrani
I think on the Canadian side, firstly, if you look at TD’s scale as to how big a business we have and then you go through the balance sheet, the loan categories, the deposit categories, and it’s far more complicated than to take one number at the policy rate and say, “okay, can I from that, take a couple of calculations and get to a margin.” So I think a lot of moving parts there.
Secondly, comparison to the U.S., just to give you some data points there. Firstly, the U.S. rate cycle started to move earlier than Canada. So there’s more benefit there that is now being rolled into our quarter fully rather than partly in a quarter. And Canada is lagging, but it’s catching up quickly.
Thirdly, in U.S., if you look at our balance sheet, we have a lot more deposits than loans. And now we’re seeing loan growth come back because, notwithstanding the higher rates and all that, but fundamentally, on the ground, if you look at the jobs numbers, what companies, commercial clients are doing, et cetera, there’s good loan growth that is coming in.
So how do we fund that in the U.S.? Well, we’ll take our excess deposits that are placed in low-yielding investments because we want to make sure we’re managing capital and risk appropriately and optimally. So we would liquidate those and use those funds for loans so that you get a double-barrel effect on your margin. Because in Canada, we are short funding. We have more loans than we have deposits. So you see the reverse of that playing out, particularly given our size.
So that kind of explains the difference between the two. I think your point on, okay, can you tell us what the outlook here is, again, too many moving parts, and sometimes forecasting is a mug’s game. But as long as if you take the premise that we’re in a rising rate environment, given the type of business we have, the outcomes that our strategy generates particularly where we are very strong and continue to be even in this market, in a rising rate market. If you look at our checking accounts and savings accounts in Canada and the U.S., impressive growth continues to be, notwithstanding the high rate environment.
So if you expect rates are going to — still going to be increasing here from where we are now, that should be a good tailwind for the bank. And so that should continue for a while.
Meny Grauman
Got it. I wanted to ask about credit. Your Q3 ACL ratio dipped down 2 basis points to 85 basis points. Some investors I speak to see that — to the dip as a little bit of a sign of concern. But from your perspective, how should investors be looking at your reserve positioning? And how do you view where you’re positioned right now from a risk perspective?
Bharat Masrani
Let’s start with the last part of your question first. We are not sensing any weakness in any of our credit metrics. That includes our unsecured exposures with credit cards. We are not seeing delinquencies and feel — I mean it’s a great environment. If you’re a risk manager, what you look at from the metrics, at least in our book, and I can talk about our book.
But how are we managing — how are we managing allowances, which is where the reserves, where you’re coming from? So we took the view at TD. And Ajai Bambawale, who’s our Chief Risk Officer, terrific at this. And I think many of you, Meny, you’ve spoken to him as well. When things were looking better, actually, we were not interested in releasing too many of the allowances that we had built up through the pandemic.
So we still have, from a pre-pandemic sort of ratio to talk about absolute dollars of allowances, we still have $1.6 billion of additional allowances compared to what pre-pandemic levels are. I think that the ratio moves because we’re also generating new loans. And so the denominator, it goes up, so the ratio moves a bit.
Thirdly, what we did was when the models were not suggesting such a downdraft, now we look at these various scenarios, recessionary scenarios, et cetera, we didn’t use that opportunity to release, we kept it as an overlay. And now through this quarter, we used part of that overlay because it became reality that becomes more of a downside scenario that we are sort of applying to how we are managing the book.
So a long way to say, we feel very comfortable as to the reserve levels we have. We’ve been consistent in that, right through the cycle. The metrics we are looking at are very healthy. But most importantly, and I know this was a discussion point from many of our analysts, that we’ve been through the cycle lenders. We don’t say, all right, this quarter looks good, so let’s change our risk parameters to sort of throttle up our lending in a particular area. No, I think at TD, we’ve been consistent through the cycle lenders and that bodes well when we get into choppy markets.
Meny Grauman
On credit, tying it back to Cowen, there’s definitely questions I get about whether the Cowen client is really the right risk for TD, that mid-market. You have biotech, you have potentially riskier areas of the economy. When you were talking about Cowen, you’re talking about the asset side that TD brings, the loan book.
How does — when you look at Cowen from a credit perspective, and the potential there, how does that fit together? Are these concerns misplaced from your perspective?
Bharat Masrani
Well, first to start with, Cowen doesn’t actually have any balance sheet to speak of. So they’re not big lenders. So the revenues they generate is purely on advisory and trading and bringing value-added services to those issuers. And TD, we — once the combination closes, and we bring the companies together? Of course, are we going to use that balance sheet? Absolutely.
That’s what TD’s strength is. We are good at it. And we’ll be very mindful of what’s the risk reward, and that’s been our record. I mean there’s lots of discussion right now on leveraged loans, big articles and so what’s going to happen there.
Well, we’ve always said — I mean, every bank defines leverage loans as a different definition. In our world, we think of the riskier part of the portfolio where loan is rated B and the leverage is more than 5.5x. That — if you historically look at, that’s where the correlation kind of break and so that’s where the losses happen. And for us, it’s a nominal part of our book.
And so I think we’ve shown through the cycle that — listen, I’ve been a Chief Risk Officer, myself, lousy lending is unforgiving and don’t need to start now.
Meny Grauman
We have a few more minutes left. I thought I would just touch on the U.S. white label cards business. During the quarter, you talked about establishing relationship with Restoration Hardware, Blue Nile. Your white label card business creates a lot of accounting noise, so a lot of headaches for analysts. But not too many people shed tears for us.
Bharat Masrani
You get paid a lot of money, Meny, but think of yourself.
Meny Grauman
But it’s also not a real cross-sell driver. So the question is, what’s so attractive about this business? And the second part of the question is, as — when the First Horizon deal closes, as your U.S. franchise gets that much bigger and sucks up more of those excess deposits, like is this going to be as critical — or as attractive a business, let’s say, as it is right now?
Bharat Masrani
Firstly, just to clarify, like the Restoration Hardware, those — the smaller deals, they don’t make accounting noise. We have a separate business we call Retail Card Services, where you have these smaller players part of that. So that doesn’t create the accounting noise.
The accounting noise happens where we also have a strategic major relationship, and that is Nordstrom and Targe where we have very large relationships. This provides us — it gives us geographic diversification right across the country. So when we have other aspirations to go into new markets, in our auto business, we are a national player, auto financing business, indirect auto.
So this provides us more understanding of different sides of America. We don’t have any loan book of any size or any — nothing meaningful in the state of Arizona or even California. And this gives us access to those markets. So that’s an advantage.
Secondly, risk-adjusted returns are fantastic. At least, the way we look at it, that’s how this business works. Particularly when you have the advantage of TD, which is really low-cost funding or look at the cost of deposits at TD versus any of our peers, and so we find that attractive.
Thirdly, we have a strategic relationships with these partners. It’s a terrific brand affiliation. We don’t do these deals with anybody out there. It’s important to us as to what it means to our brand, what it means to their brand. So it fits in very well.
Now when you say that — so if the U.S., magically somehow gets into the Canadian type of profile where we don’t have enough funding and more loans, might be a different story. But that’d be a good problem to have, Meny. We wouldn’t be worrying about the strategic card portfolio. We might have other forums of discussion.
So — but given where we are now, it makes a lot of sense. These are great relationships, and I see them continuing for the foreseeable future.
Meny Grauman
I think that’s a good way to end. We should only have good problems.
Bharat Masrani
Terrific.
Meny Grauman
Thank you so much.
Bharat Masrani
Thanks, Meny. It is great to see you. All the best. Alright. Thank you. Thank you.
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