Wednesday, January 28, 2009

TD Bank Sees Rising Loan Losses; No Dividend Cut

Reuters, 28 January 2009

Toronto Dominion Bank's chief financial officer expects its provision for credit losses to increase this year as the effects of the recession deepens, but she remained confident that Canada's second-largest bank would not cut its dividend.

For all of 2008 the big Canadian bank had provisions for credit losses at just under C$1.1 billion ($827.1 million), which represented about 0.54 percent of its total loans, Colleen Johnston, the bank's chief financial officer said during an industry conference in New York on Wednesday.

Johnston was not certain by how much the bank's provisions for losses would increase in 2009, but added that it was not its "base case" to allow the level to double to 1 percent.

The bank's ability to absorb bad loans has been questioned by analysts recently, but Johnston moved to assure investors that it was in good shape.

"The high quality of our loan portfolio and our disciplined credit culture has served us very, very well in this current credit environment," she said. "We do continue to expect to be a positive outlier in terms of our credit performance."

Canadian banks are facing a fallout from the global economic and stock market downturn, such as weaker profits from wealth management and rising loan loss provisions.

Loan loss provisions are set aside by the banks for bad loans such as customer defaults.

Johnston also said that the bank was expected to move through 2009 without cutting its dividend. The bank, which was the only Canadian bank to increase its dividend twice in 2008, declared a quarterly dividend of 61 Canadian cents in December.

The CFO said the bank has managed its dividend at the low end of its payout range giving it more leeway as earnings slow down or decline, adding that the bank's dividend growth would track its earnings growth.

"Frankly we do not see a scenario where we would consider cutting our dividend," she said.
RBC Capital Markets, 26 January 2009


Pressure on fair values of securities has resulted in a higher level of unrealized losses in the banks' available-for-sale (AFS) portfolios.

• We believe unrealized losses will grow again in Q1/09 as spreads on structured finance assets have continued to widen since Q4/08 ended, cash bonds are also trading at wider spreads and the value of hedges with monolines would have come down given wider spreads on the credit default swaps on those companies.

For unrealized losses on AFS securities to impact earnings and Tier 1 ratios, bank managements have to deem valuation declines as permanent, which is assessed each quarter. We believe there are two primary factors that would influence that view:

• A change in the underlying credit quality, which would impair cash flows. Important factors to track for CDOs of corporate debt, CLOs, ABCP with CDOs of corporate debt are corporate defaults. An increase in corporate defaults would reduce subordination in those structures and might cause managements to question their assumptions. For RMBS and CMBS, default rates and real estate prices are important factors to follow.

• The length at which assets trade below their book value, which likely forces managements to question their valuation assumptions. Unrealized losses are deemed temporary when managements can argue that a liquidity discount is the primary reason as to why there can be gaps between current market prices of securities and the expected realization of value closer to the maturity of the assets. We believe that, when asset prices are below accounting values for an extended period, managements may be more likely to deem some of the valuation declines as permanent.

While we accept the fact that many unrealized losses on AFS securities are temporary in nature, and can be offset by unrealized gains, banks with greater unrealized loss balances on AFS securities are more at risk of potential writedowns down the road that impact Tier 1 capital, all else being equal.

• Relative to Tier 1 capital, gross unrealized losses (before unrealized gains) are highest at TD, BNS and RY. The banks also have gross unrealized gains on AFS securities, although some of these could potentially be realized to offset losses, and our analysis assumes that writedowns happen in a vacuum, which is overly conservative as it gives no credit to the earnings banks generate on a "core" basis.

• That is one reason why, when assessing relative capital strength, we believe investors should consider both Tier 1 ratios (the most important for the Canadian regulator) and tangible common equity (TCE) ratios as TCE ratios are more stringent in that they only include the strongest form of capital and they take into account unrealized losses (and gains) on AFS debt securities.