Bharat Masrani has been spreading the word: He likes Toronto-Dominion Bank’s growth potential in the United States, and he’s open to doing more deals south of the border. Having run TD’s U.S. division before he took over as chief executive officer in 2014, he’s quite comfortable with the banking sector along the Eastern Seaboard.
Despite his conviction, there hasn’t been much action. Save for some smaller asset purchases, such as credit card loans, TD has largely sat still, leaving analysts and investors to wonder if Mr. Masrani is playing the long game, waiting for the perfect moment to pounce.
If so, that time could be now. TD is flush with excess capital, meaning it has more than enough cash reserves to cushion against any loan losses, and it’s also sitting on a large chunk of Charles Schwab stock after the wealth management giant bought TD Ameritrade in 2019. (TD owned 43 per cent of the discount brokerage that was swallowed.)
Put together, TD now has “vast financial resources” to do a major deal, National Bank Financial analyst Gabriel Dechaine wrote in a note to clients. By his calculations, TD could splash $11-billion south of the border simply by using excess capital. If the bank wants to go really big, it could splurge on a $30-billion deal by selling its 13.5-per-cent Schwab stake and adding in those funds.
But should it? Being able to pay for something isn’t the same as getting the best return on its money – and TD has already learned how long it can take to eke out a decent return on a major U.S. investment.
TD started its U.S. foray in 2004, then doubled down on an American expansion in 2008 with the US$8.5-billion purchase of Commerce Bank, which was headquartered just outside of Philadelphia. TD’s return on equity in the U.S. has been paltry since, largely because it paid such rich premiums to expand. Last year, TD reported a U.S. ROE of only 3.2 per cent, according to Federal Deposit Insurance Corp., and before the pandemic hit it reported 6.8 per cent in 2019. Comparable U.S. rival U.S. Bancorp, meanwhile, reported returns more than double TD’s in both years.
Yet Mr. Masrani seems to want people to know he’s considering something. Like a central bank governor, he chooses his words carefully. When TD reported its quarterly earnings in February, he reiterated, “We certainly are open to acquisitions in the U.S. market, and in the Canadian market as well, I might add.”
Two weeks ago, he went a little further. “With respect to major mergers and acquisitions in the United States, we’re very open,” he told Bloomberg News, adding the bank’s capital levels give it extra flexibility. TD declined to comment for this story.
Should the bank go for a major deal, it might take some time. Under a lock-up agreement with Charles Schwab, TD must hold its stake until June. Yet just last year, the U.S. saw a similar two-step transaction. In May, 2020, PNC Financial Services Group Inc.’s sold its 22-per-cent stake in BlackRock Inc. Six months later, it turned around and bought Houston-based BBVA USA, the American arm of Banco Bilbao Vizcaya Argentaria SA for US$11.6-billion.
Following this playbook, TD could afford something along the lines of Citizens Financial Group Inc. or M&T Bank Corp., both of which would add scale to its existing Northeast and mid-Atlantic footprint and are each worth roughly US$20-billion. Or TD can make a splash in the Southeast, where it has been piecing together some assets, by acquiring a lender such as Regions Financial Corp., which is also worth US$20-billion.
The financial analysis is compelling. Charles Schwab trades at 32 times its earnings, while Citizens and Regions trade at 20 times their own. TD could cash out its premium stake and swap it for something cheaper – but still the get the same dollar of profit.
Yet nothing is ever that simple. Charles Schwab is a high-growth business with a better ROE than many U.S. banks, and it currently delivers 9 per cent of TD’s annual earnings. For management, “the decision to [sell] is not an easy one,” Mr. Dechaine wrote.
The price tag would also limit what TD can do with its excess capital. At the moment, some of it is earmarked for dividend hikes once Canada’s banking watchdog permits lenders to boost their quarterly payouts again. While TD could sell shares to raise cash, its own stock trades at 13 times earnings, which would dent the takeover’s financial upside.
TD, then, might benefit more from picking off something a little smaller in specific markets where it doesn’t have much market share. It may also want to shift its centre of gravity because its top metropolitan areas, Philadelphia and New York, aren’t fast-growing regions anymore. Before the pandemic hit, Toronto-based Hamilton ETFs, which invests in U.S. financials, crunched the numbers by region and found the Southeast, the Southwest and the West were the fastest growing in the U.S.
TD has a small position in the Southeast, but its market share in Miami, for instance, is still in the low single digits. To add to it, regional banks such as Synovus Financial Corp., First Citizens Bancshares Inc. and South State Corp., which largely operate in Florida, Georgia and the Carolinas, would run TD between US$6-billion and US$8-billion (that’s before a takeover premium).
By no means does TD need to do a deal. The bank is heavily exposed to retail lending in the U.S., with a loan book geared toward jumbo mortgages, autos and retail credit cards, and these sectors should get a major lift from the budding economic rebound. Crucially, TD also had the fastest-growing loan books in autos and credit cards relative to its large U.S. peers over the past five years, according to a recent analysis by CIBC World Markets analyst Paul Holden.
Yet the market can move around you, and more bank mergers are expected over the next five years. As a rule of thumb, when the music starts, it usually helps to be one of the first to hit the dance floor.
This story has been updated because a potential takeover target, People’s United Financial Inc., has agreed to a merger with a rival U.S. bank.
With a report from James Bradshaw in Toronto
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