Thursday, February 26, 2009

TD Bank Q1 2009 Earnings

RBC Capital Markets, 26 February 2009

We view TD's Q1/09 as neutral to our view on the stock: core operating results were close to our expectations and the capital position was higher than we expected. On the negative side, provisions for credit losses were higher than we expected and GAAP EPS fell short of our estimates.

We have lowered our 2009E core cash EPS to $4.55 from $4.80.

• About 60% of the decline reflects higher expected loan losses.

• Management noted on the call that it would be an accomplishment if TD had flat EPS in 2009 (TD views its 2008 EPS as $4.88 on an adjusted basis).

• We will publish our estimated EPS for 2010 for TD and other banks as part of our industry review following the release of all of the banks' Q1/09 results.

Our Underperform rating on TD has reflected our view that:

• TD has the second-largest exposure to U.S. lending and has a large presence in Ontario - two areas where the outlook for credit is poor. We also think that the bank's outperformance in U.S. credit will not be as strong as it was in 2008. Q1/09 results did not change our view.

• Unrealized loss on available for sale securities are larger than for other Canadian banks, relative to Tier 1 capital. We need to see other banks report but unrealized losses on AFS securities grew to 12% of Tier 1 capital from 7% in Q4/08.

• Capital ratios were in the bottom half of the Canadian banks. Q1/09 capital ratios were higher than we had anticipated for TD; we have yet to see the results of other banks.

• Price to tangible book was highest among the Canadian banks, but the currency-driven increase in tangible book value (31% sequentially) has lowered the bank's trading multiple.

• TD trades at 0.9x BV versus a range of 0.8x - 1.5x for peers, 1.8x TBV versus 0.9x - 2.2x and a dividend yield of 6.8% versus 6.7% - 10.9%.

As is normally the case during bank reporting periods, we will wait until after all of banks have reported to reassess our relative rankings and to review our 12-month target prices.
Financial Post, David Pett, 26 February 2009

While Toronto-Dominion Bank is receiving kudos on the Street for its capital position, analysts remain less than impressed with the bank's eroding credit.

"We view TD's results quite positively and believe that its share price will likely benefit in the near term on both an absolute and relative basis on the strength of the quarter."said Dundee Securities analyst John Aiken in a note to clients. "However, we do not believe that TD (or its peers) will be able to fight off the pending additional credit deterioration and earnings will continue to decline,"

While TD's Tier 1 capital ratio, now above 10%, is less of a concern now for Mr. Aiken than it was a week ago,, he remains worried about the fact TD's credit provisions increased significantly from the previous quarter. He maintained his "neutral" rating and cut his price target from $44 to $41.

Brad Smith, analyst at Blackmont Capital downgraded his rating from "hold" to "sell" after cutting his price target to $38.

"In addition to confirming the long anticipated acceleration of credit deterioration in the bank's US lending portfolios, the results also evidenced a growing deterioration in both domestic commercial and consumer credit portfolios," he said in a note to clients.

The Blackmont analyst reduced his cash EPS outlook for 2010 to $4.80 per share and looks for additional capital pressures to unfold in 2009.

Others on the Street are less bearish, including UBS' Peter Rozenberg. Despite the credit loss provision rising earlier than expected, the analyst thinks TD's valuation at 7.4x EPS and 0.86x P/B continues to discount a worst case outlook for PCL’s. He maintained his "buy" rating and cut his price target from $57 to $53.
Bloomberg, David Scanlan, Theophilos Argitis & Sean B. Pasternak, 25 February 2009

David Denison, who oversees investments for Canada’s pensions, says his country’s banks are the best in the world right now and Barack Obama, like so many money managers from Beijing to Paris, can’t disagree.

Before President Obama made Ottawa his first visit to a foreign capital earlier this month, he couldn’t resist telling the Canadian Broadcasting Corp.: “In the midst of the enormous economic crisis, I think Canada has shown itself to be a pretty good manager of the financial system and the economy in ways that we haven’t always been.”

The comment was something of an understatement, as no country among the so-called industrialized nations is showing as much confidence in its bankers as Canada. Not one government penny has been given to any of the 21 banks from British Columbia to Quebec since credit worldwide seized up in August 2007. Since then, American taxpayers have provided $300 billion to bail out more than 450 companies, led by Citigroup Inc. and Bank of America Corp., two of the three largest banks measured by assets.

Obama isn’t the only important person “looking at Canada” in a belated attempt to figure out how to fix a broken financial model, Denison said.

“Solid funding and conservative consumer lending criteria are key features” of Canadian banks, said John Haynes, senior U.S. equity strategist at Rensburg Sheppards Plc in London, which oversees the equivalent of $17 billion. “This has meant that they have had their hands caught in the cookie jar to a much more limited extent than their American and European counterparts.”

Money managers from Brazil, China, France, Ireland and Australia scheduled visits to Denison’s Toronto office in the past two weeks to learn how Canada and its banks and pension funds are weathering the financial crisis. The visitors include the AustralianSuper Fund and the French National Reserve Fund, which together have assets of $53 billion, he said.

“They have assembled a high-quality team,” said Ian Silk, chief executive officer of AustralianSuper, who visited Denison in May along with three other executives from the Melbourne-based fund and remains in contact with the Canadian money manager.

Canada’s higher capital requirements and loan limits that European banks exceeded by 50 percent helped Canadian lenders avoid most of the writedowns and losses crippling competitors worldwide, even as the nation’s economy slipped into a recession and the jobless rate jumped to a four-year high.

Just two Canadian regional banks have failed since 1923. The only government support has been a pledge to buy as much as C$125 billion in mortgages, allowing the banks to increase lending to companies and consumers.

“The Canadian banking system is a very good story,” said Denison, chief executive officer of the Canada Pension Plan Investment Board, which manages C$108.9 billion ($86 billion) for retired Canadians. “People are looking at Canada” to determine how to fix their broken financial models, he said.

Canadian banks are more constrained than their international peers in the amount of loans they can extend. The nation’s lenders are required to set aside a minimum 7 percent for Tier 1 capital, compared with 6 percent for U.S. commercial banks. At the end of October, Canada’s eight publicly traded banks were above the minimum, at 9.6 percent, according to data compiled by Bloomberg.

Canada’s banking regulator says institutions can lend as much as 20 times their capital base. According to Bank of Canada data released in December, European bank non-risk weighted assets were more than 30 times capital, while that ratio for U.K. banks and U.S. investment banks was above 25.

Europe’s largest financial companies have reported $321 billion in writedowns and credit-related losses since the collapse of the U.S. subprime mortgage market in 2007 spread to other continents. The market turmoil has forced European lenders to raise $370 billion in fresh capital and sparked government-led bailouts in countries including the U.K., Germany and Switzerland, according to Bloomberg data.

European deficits have ballooned as governments committed more than 1.2 trillion euros ($1.5 trillion) to save their banking systems from collapse.

“When the crisis started emerging on those fronts, Canada was less affected,” said Matthew Strauss, a senior currency strategist in Toronto at RBC Capital Markets, a unit of the country’s biggest bank. “Canada has always had a fairly conservative banking sector.”

While Bank of America and Citigroup cut their dividends to 1 cent a share from as high as 64 cents, the payouts at Canada’s five biggest banks haven’t been reduced since the Great Depression. Toronto-based Royal Bank of Canada is now the third- biggest bank in North America by market value, almost three times the size of Citigroup, while Toronto-Dominion Bank ranks fifth. Royal Bank is almost three times bigger than European lenders Royal Bank of Scotland Group Plc and Deutsche Bank AG.

The Canadian banks, which begin reporting first-quarter results today, probably will say profit declined an average of 12 percent, the biggest drop in almost seven years, according to Scotia Capital analyst Kevin Choquette. By contrast, Bank of America reported its first quarterly loss since 1991 last month, and Citigroup posted a fifth straight loss.

The World Economic Forum in October ranked Canada’s financial system the soundest in the world.

The Canadian banks haven’t been in this position of global strength since between the two World Wars, said Charles Goodhart, a professor of finance at the London School of Economics, and a former Bank of England policy maker.

“They’re very diversified, didn’t get heavily involved in the international investment banking industry and they’ve benefited from good central banking,” Goodhart said.

Countries need more “boring” financial systems like Canada’s, Finance Minister Jim Flaherty said Feb. 14 in Rome, where he was attending a meeting of finance ministers and central bankers from the Group of Seven industrialized nations.

The federal government in October set up a C$218 billion program to guarantee bank debt to help Canadian lenders compete in international markets with government-backed U.S. banks. None of the country’s lenders has tapped the credit.

“The Canadian government has a lot of firepower these days, not just because this has been such a well-managed economy, but frankly, because the Canadian government has not been bailing out the Canadian banks,” Toronto-Dominion Chief Financial Officer Colleen Johnston told investors Jan. 28 in New York.

Toronto-Dominion reported today that fiscal first-quarter profit fell 27 percent to C$712 million, or 82 cents a share, because of higher loan-loss provisions. Results topped analysts’ estimates.

Toronto-Dominion and Royal Bank are among just seven banks in the world with the top credit rating of Aaa from Moody’s Investors Service.

Canadian regulators resisted pushes from some bank executives to loosen lending restrictions when the economy was booming, says David Dodge, 65, who stepped down as Bank of Canada governor a year ago.

“The banks at the top of the cycle thought we were being too tight-assed,” Dodge said in a telephone interview.

Even the strength of Canada’s banks hasn’t kept the economy from being dragged down by the global crisis. The world’s eighth- biggest economy will shrink by 1.2 percent this year, in part due to falling exports of oil and other commodities, according to Bank of Canada projections. Employers cut a record 129,000 jobs in January.

“We have major problems,” said Stephen Jarislowsky, the 83- year-old chairman and founder of Montreal-based money manager Jarislowsky Fraser Ltd., which manages about $31.8 billion. “Our commodity boom is over for a long time.”

Canada recorded its first monthly trade deficit in more than three decades in December, as exports plunged 9.7 percent. The country ships more than three-quarters of its goods to the U.S.

“We have some unique advantages, but we are being profoundly affected by the global crisis,” Bank of Canada Governor Mark Carney said in a Feb. 14 interview from Rome.

Canada’s housing market has also held up better than in the U.S., where prices declined a record 19 percent in December from a year earlier, according to the S&P/Case-Shiller index. Resale home prices dropped 9.9 percent in Canada during the same period, the Canadian Real Estate Association said. Last year, Finance Minister Flaherty scrapped 40-year mortgages when they started to gain popularity among homebuyers seeking to reduce their monthly mortgage payments.

Canadian banks are less willing to lend to homebuyers with low credit scores: Subprime loans account for just 5 percent of the total. That compares with 20 percent in the U.S., where independent mortgage brokers and lenders competed with commercial banks to win business by attracting high-risk borrowers.

Another restraining factor is that Canadians, unlike their U.S. neighbors, can’t take mortgage interest as a tax deduction, removing an “inherent bias” to take on too much debt, Prime Minister Stephen Harper said in September.

Canada was the only Group of Seven nation to balance its budget for 11 consecutive years, before a stimulus package aimed at sparking growth pushed the country to a deficit for the fiscal year ending March 31, according to a government forecast.

The relative strength of the financial system may help Canada recover from the recession faster, Carney said. The Bank of Canada is forecasting growth of 3.8 percent for 2010, in anticipation of rising commodity and oil prices. Canada’s oil sands in Alberta contain more reserves than any region outside Saudi Arabia.

“Once this uncertainty is removed, and it will be removed ultimately,” Carney said in an interview, “these strengths will kick in and that will have a bigger impact in our opinion in terms of the recovery in Canada.”