Canadian banks are wading into riskier territory as they seek ways to bolster their growth at a time when expansion opportunities are increasingly hard to find.
Toronto-Dominion Bank is the latest lender to place a large bet on credit cards, agreeing on Monday to acquire the Canadian portfolio of Bank of America Corp. in a deal that will give TD 1.8 million new accounts and more than double the size of its Canadian credit card business.
TD is paying a slight premium of $100-million to get its hands on the business, which operates under the MBNA trade name. The bank will pay $8.6-billion in cash and assumed liabilities to acquire credit-card loans that are worth $8.5-billion. The acquisition makes TD one of the largest credit card issuing banks in Canada, alongside Canadian Imperial Bank of Commerce , with about 18 per cent of the market.
It is the second deal in the last eight months in which TD, Canada's second-largest bank by assets, has expanded deeper into consumer loans – which can be lucrative when the economy is good and consumers are spending, but will prove riskier than mortgages if the economy dips back into a recession.
TD chief executive officer Ed Clark said the bank spent time calculating its exposure to those risks. "Obviously that is the critical business judgment that you are making," Mr. Clark said, referring to an unpredictable economic outlook given the debt woes in the U.S. and Europe.
"You build in a degree of conservativism into it to say, 'Suppose if the world turns out to be worse – what does this feel like, are we comfortable with this transaction?'"
Canadian banks relied on mortgages and business lending for much of their loan growth in the past decade, but they must now find ways to expand their books in an ever-tightening market. Credit card portfolios are attractive because they generate fat margins from higher interest rates. However, if consumers suddenly can't pay their bills, those assets can be among the hardest-hit in terms of loan losses.
With the average Canadian household carrying record debt levels, consumer lending growth is uncertain. However, TD has moved aggressively on similar deals in the past year, believing the time is right to pick up such assets at attractive prices.
TD placed a similar bet in December when it bought auto-lender Chrysler Financial Corp. for $6.3-billion in cash. The deal gives the bank a major platform to expand its auto lending in the U.S., but also exposes the bank to the slowing U.S. economy. Should consumers buy fewer new vehicles, analysts worry the business would be affected.
TD isn't alone in acquiring consumer lending assets. CIBC bought Citigroup's $2.1-billion Canadian MasterCard business a year ago, stepping deeper into the Canadian consumer market.
UBS analyst Peter Rozenberg said Monday in a research note that the card assets come with "higher than average loss rates" but the risk for TD "appears clear and manageable." The Bank of America credit card portfolio suffers about 6.4 per cent losses on its cards, compared to 4.2 per cent at TD's own business.
TD plans to issue up to 8 million shares, worth about $600-million, in conjunction with the deal to boost its capital levels under Basel III, the international agreement that requires banks to increase financial buffers on their lending.
The deal also makes TD, which has been considered an undersized player in the credit card market in Canada, a dual issuer of both Visa and MasterCard credit cards. Royal Bank of Canada and CIBC are also dual issuers.
Late last year, Bank of Canada governor Mark Carney warned that household debt levels were concerning, saying many indebted Canadians could be in trouble if they were to lose their jobs or suddenly incur a large, unexpected expense. At the time, the average household debt level, including mortgages, had reached a record 146 per cent of personal disposable income.
TD said it will take steps to remove some of the risk from the assets. MBNA was aggressive in offering low introductory rates to entice people to sign up or transfer balances from other cards. Tim Hockey, group head of Canadian banking at TD, said the bank will pull back on the strategy of deeply discounted rates.
"They have a very high degree of promotional offers," Mr. Hockey said. "We will be fine tuning those particular portfolios [to be]more within our risk appetite. Essentially that business is going to run off over the next couple of years."
Bank of America has been under pressure in recent weeks for its exposure to the U.S. mortgage market and is now shedding credit card portfolios in other countries to raise capital, including the United Kingdom and Spain. "While the credit card remains a fundamental core product for our U.S. customers, an international consumer card business under another brand is not consistent with that strategy," Bank of America chief executive officer Brian Moynihan said.
In a similar move, HSBC Holdings PLC, the parent company of HSBC, is selling its $30-billion U.S. card business to Capital One Financial Corp. to raise cash.