If the true test of an acquisition is being able to generate returns that exceed the cost of the money it takes, then Toronto-Dominion Bank's U.S. retail strategy is only approaching the levels where it makes sense.
For TD, that means generating returns close to 10 per cent a year. National Bank Financial analyst Peter Routledge puts the cost of capital for TD at about 9.3 per cent, and says that would rise by about 1 percentage point in a more normal interest-rate environment. TD uses a 9-per-cent number in its last annual report.
Against that yardstick, the numbers in the U.S. are heading in the right direction, but they are not there yet.
The bank reported return on common equity last year from U.S. banking of 6.4 per cent. In 2010 and prior years, the bank used a different metric, return on invested capital, but one that tells a similar story. ROIC was 7.5 per cent in 2011, 5.8 per cent in 2010 and 4.5 per cent in 2009. At those earlier levels, TD shareholders probably would have been better off taking the money in dividends.
Those returns are depressed by the acquisition capital, as Mr. Routledge points out, and running the bank would take far less and produce a better ratio. Take out the goodwill from acquisitions, and return on equity would look more like 15 per cent.
That's good, but nothing close to what TD makes in Canadian banking, where return on equity was 43 per cent. Comparisons to Canadian banking are likely never going to look that good. The big capital outlays in Canadian banking are long behind a bank like TD, with only the capital necessary to run the business really counting at this point.
What's more, it is not like TD could throw billions of dollars in excess capital at its Canadian business these days to grow it. There are few assets left for TD to buy. And the bank is also raising its dividend steadily to distribute cash to the shareholder base.
So it's U.S. or bust.
(Boyd Erman is a Globe and Mail Reporter & Streetwise Columnist.)
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