Scotia Capital, 3 September 2010
Event
• TD operating EPS declined 2% to $1.43, in line with expectations.
Implications
• Earnings were solid, driven by a strong performance at Canadian P&C (TDCT) with earnings up 24% YOY, followed by U.S. P&C up 19%, and Wealth Management up 10%, offset by a 45% decline in Wholesale. The bank viewed the Wholesale, earnings decline as normalization. The major weakness was in Wholesale driven by a decline in trading, although trading was solid in the context of the market. LLPs declined as credit trends improved. Retail margin was flat QOQ with overall margin declining. ROE was 13.6%, RRWA was 2.65%, Tier 1 Capital is 12.5%.
• TDCT continues to be the main driver in earnings with revenue growth of 8% driven by volume as the bank gained market share in both personal & business lending.
Recommendation
• Our 2010E EPS is unchanged at $5.85. We have reduced our 2011E EPS to $6.50 from $6.60 due to lower economic growth outlook and moderating net interest margin as the prospect for higher interest rates is delayed. Our one-year target price is unchanged at $90. We maintain our 1-SO rating based on strong retail franchise and improving earnings in the U.S.
Items of Note
• Reported cash earnings were $1.41 per share including a $9 million after-tax or $0.01 per share gain in fair value of CDS hedging the corporate loan book, $14 million after-tax or $0.02 per share loss in fair value of derivatives hedging the reclassified portfolio, and $5 million after-tax or $0.01 per share restructuring charge relating to U.S. P&C acquisitions.
Canadian P&C Earnings Increase 24%
• Canadian P&C (TDCT) earnings increased 24% to $841 million from $677 million a year earlier, with high revenue growth driven by strong volume, lower loan loss provisions, and controlled expenses.
• Real estate secured lending was strong increasing 12% (incl. securitization), with consumer loan volumes increasing 13% and business loans and acceptances increasing 5%.
• Deposit growth was also strong with personal deposits up 4% and business deposits increasing 14%.
• TDCT had solid revenue growth of 8.1% with expense growth of 4.4% for positive operating leverage of 3.7%.
• Retail net interest margin was flat sequentially and declined 4 bp from a year earlier to 2.92%.
• Card service revenues were solid at $216 million versus $197 million the previous quarter and $197 million a year earlier.
• LLPs declined to $236 million from $256 million in Q2/10 and from $290 million a year earlier.
• Insurance earnings were weaker this quarter with insurance revenue, net of claims, at $239 million versus $287 million in the previous quarter and $253 million a year earlier.
Total Wealth Management Earnings Solid
• Wealth Management earnings, including the bank’s equity share of TD Ameritrade, were solid at $179 million, an increase of 10% YOY.
Canadian Wealth Management Earnings Increase 23%
• Domestic Wealth Management earnings increased 23% YOY to $117 million.
• Operating leverage was positive 4.2%, with revenue increasing 9.6% and expenses increasing 5.4%.
• Mutual fund revenue increased 18% to $216 million from a year earlier.
• Mutual fund assets under management (IFIC, includes PIC assets) increased 11.1% YOY to $62.4 billion.
TD Ameritrade – Earnings Solid
• TD Ameritrade contributed $62 million or $0.07 per share to earnings in the quarter versus $56 million or $0.06 per share in the previous quarter and $68 million or $0.08 per share a year earlier. TD Ameritrade’s contribution represented 4% of total bank earnings.
U.S. P&C Earnings Increase 19% - Reg. E to Reduce EPS (est.) $0.03- 0.04/Quarter
• U.S. P&C earnings increased 19% YOY to $287 million or $0.33 per share from $242 million a year earlier, representing 19% of total bank earnings. Earnings were negatively impacted by $25 million due to a strong Canadian dollar. Earnings also increased 17% sequentially due to strong retail fee growth from new pricing structure post Commerce integration and the Riverside acquisition.
• Loan loss provisions in the U.S. declined to $131 million or 0.80% of loans versus $168 million or 1.10% of loans in the previous quarter and $183 million or 1.06% a year earlier.
• Net interest margin declined 12 bp from the previous quarter primarily due to lower prepayment speed on loans and securities. Spreads on deposits and loans remained stable.
• TD disclosed that Regulation E is expected to reduce revenue beginning in Q4/10 by approximately US$40 million-50 million a quarter after taking into consideration mitigation strategies. This is expected to reduce earnings by US$25 million-$35 million or $0.03-$0.04 per share per quarter. The reduction represents approximately 10% of U.S. P&C segment earnings or 2% of overall bank earnings.
• The amendment of Regulation E, Electronic Fund Transfer Act, prohibits financial institutions from charging fees to consumers for paying automated teller machine and point of sale transactions that result in overdraft.
• The negative impact of Reg. E, net of mitigation strategies is slightly greater than expected but not significantly material overall.
U.S. Platforms Combine to Represent 23% of Earnings
• U.S. P&C and TD Ameritrade contributed $349 million or $0.40 per share in the quarter, representing 23% of total bank earnings from operations in the third quarter, down from a high of 29% in Q4/08.
Wholesale Banking Earnings Weaken
• Wholesale banking earnings were $179 million, down 45% from $327 million a year earlier, although down only 19% from $220 million in the previous quarter. The bank views these wholesale earnings as a more normal level.
Trading Revenue Declines but Doesn't Collapse
• Trading revenue declined to $300 million versus $402 million in the previous quarter and a record $633 million a year earlier.
• Interest rate and credit trading revenue was weak at $107 million versus $440 million a year earlier and $193 million in the previous quarter. Equity and other trading revenue increased to $94 million from $39 million a year earlier but declined from $105 million in the previous quarter. Foreign exchange trading revenue declined to $99 million versus $154 million a year earlier and $104 million in Q2/10.
Capital Markets Revenue Stable
• Capital markets revenue was $318 million versus $368 million in the previous quarter and $342 million a year earlier. Underwriting and advisory included in capital markets revenue was down at $77 million versus $83 million in the previous quarter and $105 million a year earlier.
Security Gains Low - Unrealized Security Surplus Modest
• Security gains were low at $10 million or $0.01 per share versus $47 million or $0.04 per share in the previous quarter and a loss of $90 million or $0.07 per share a year earlier. Unrealized security surplus declined to $269 million from $285 million in the previous quarter.
Securitization Revenue and Economic Impact
• Loan securitization revenue declined to $110 million from $123 million in the previous quarter.
• Securitization economic impact was positive $68 million pre-tax, or an estimated $0.05 per share after-tax, versus $0.07 per share in the previous quarter and $0.04 per share a year earlier. Securitization activity is recorded in the Corporate segment.
Loan Loss Provisions
• Specific loan loss provisions declined to $339 million or 0.51% of loans from $425 million or 0.67% of loans in the previous quarter and from $492 million or 0.76% of loans a year earlier.
• We have reduced our 2010 LLP forecast to $1,650 million or 0.61% of loans from $1,800 million or 0.67% of loans. Also, we have reduced our 2011 LLP forecast to $1,300 million or 0.47% of loans from $1,600 million or 0.56% of loans due to improving credit trends.
Loan Formations Decline
• Gross impaired loan formations before debt securities and FDIC covered loans declined to $835 million versus $852 million in the previous quarter, the lowest it has been since Q4/08. U.S. gross impaired loan formations declined to US$375 million from US$393 million in the previous quarter.
• Gross impaired loan formations were $1,181 million in the quarter, including $346 million in debt securities classified as loans and FDIC covered loans versus $1,273 million including $421 million in debt securities classified as loans in the previous quarter.
• Gross impaired loans increased to $3,337 million (including $1,160 million in debt securities reclassified as loans and FDIC covered loans) or 1.25% of loans from $3,032 million (including $814 million in debt securities) or 1.16% of loans in the previous quarter.
• Debt securities gross impaireds increased in the quarter, however the fair value of this portfolio (Commerce acquisition, March 2008) is greater than the book value or carrying value.
• Net impaired loans increased to $758 million from $430 million the previous quarter due mainly to the debt securities reclassification.
Tier 1 Capital – 12.5%
• Tier 1 ratio increased to 12.5% versus 12.0% in the previous quarter and 11.1% a year earlier. Total capital ratio was 16.0% versus 15.5% in the previous quarter.
• Tangible common equity to risk-weighted assets (TCE/RWA) increased to 11.7% versus 10.3% the previous quarter.
• Book value per share increased 7% from a year earlier to $43.41.
• Risk-weighted assets were flat from a year earlier at $189.2 billion and increased 1% QOQ.
• • • • • • • • •
;
Event
• TD operating EPS declined 2% to $1.43, in line with expectations.
Implications
• Earnings were solid, driven by a strong performance at Canadian P&C (TDCT) with earnings up 24% YOY, followed by U.S. P&C up 19%, and Wealth Management up 10%, offset by a 45% decline in Wholesale. The bank viewed the Wholesale, earnings decline as normalization. The major weakness was in Wholesale driven by a decline in trading, although trading was solid in the context of the market. LLPs declined as credit trends improved. Retail margin was flat QOQ with overall margin declining. ROE was 13.6%, RRWA was 2.65%, Tier 1 Capital is 12.5%.
• TDCT continues to be the main driver in earnings with revenue growth of 8% driven by volume as the bank gained market share in both personal & business lending.
Recommendation
• Our 2010E EPS is unchanged at $5.85. We have reduced our 2011E EPS to $6.50 from $6.60 due to lower economic growth outlook and moderating net interest margin as the prospect for higher interest rates is delayed. Our one-year target price is unchanged at $90. We maintain our 1-SO rating based on strong retail franchise and improving earnings in the U.S.
Items of Note
• Reported cash earnings were $1.41 per share including a $9 million after-tax or $0.01 per share gain in fair value of CDS hedging the corporate loan book, $14 million after-tax or $0.02 per share loss in fair value of derivatives hedging the reclassified portfolio, and $5 million after-tax or $0.01 per share restructuring charge relating to U.S. P&C acquisitions.
Canadian P&C Earnings Increase 24%
• Canadian P&C (TDCT) earnings increased 24% to $841 million from $677 million a year earlier, with high revenue growth driven by strong volume, lower loan loss provisions, and controlled expenses.
• Real estate secured lending was strong increasing 12% (incl. securitization), with consumer loan volumes increasing 13% and business loans and acceptances increasing 5%.
• Deposit growth was also strong with personal deposits up 4% and business deposits increasing 14%.
• TDCT had solid revenue growth of 8.1% with expense growth of 4.4% for positive operating leverage of 3.7%.
• Retail net interest margin was flat sequentially and declined 4 bp from a year earlier to 2.92%.
• Card service revenues were solid at $216 million versus $197 million the previous quarter and $197 million a year earlier.
• LLPs declined to $236 million from $256 million in Q2/10 and from $290 million a year earlier.
• Insurance earnings were weaker this quarter with insurance revenue, net of claims, at $239 million versus $287 million in the previous quarter and $253 million a year earlier.
Total Wealth Management Earnings Solid
• Wealth Management earnings, including the bank’s equity share of TD Ameritrade, were solid at $179 million, an increase of 10% YOY.
Canadian Wealth Management Earnings Increase 23%
• Domestic Wealth Management earnings increased 23% YOY to $117 million.
• Operating leverage was positive 4.2%, with revenue increasing 9.6% and expenses increasing 5.4%.
• Mutual fund revenue increased 18% to $216 million from a year earlier.
• Mutual fund assets under management (IFIC, includes PIC assets) increased 11.1% YOY to $62.4 billion.
TD Ameritrade – Earnings Solid
• TD Ameritrade contributed $62 million or $0.07 per share to earnings in the quarter versus $56 million or $0.06 per share in the previous quarter and $68 million or $0.08 per share a year earlier. TD Ameritrade’s contribution represented 4% of total bank earnings.
U.S. P&C Earnings Increase 19% - Reg. E to Reduce EPS (est.) $0.03- 0.04/Quarter
• U.S. P&C earnings increased 19% YOY to $287 million or $0.33 per share from $242 million a year earlier, representing 19% of total bank earnings. Earnings were negatively impacted by $25 million due to a strong Canadian dollar. Earnings also increased 17% sequentially due to strong retail fee growth from new pricing structure post Commerce integration and the Riverside acquisition.
• Loan loss provisions in the U.S. declined to $131 million or 0.80% of loans versus $168 million or 1.10% of loans in the previous quarter and $183 million or 1.06% a year earlier.
• Net interest margin declined 12 bp from the previous quarter primarily due to lower prepayment speed on loans and securities. Spreads on deposits and loans remained stable.
• TD disclosed that Regulation E is expected to reduce revenue beginning in Q4/10 by approximately US$40 million-50 million a quarter after taking into consideration mitigation strategies. This is expected to reduce earnings by US$25 million-$35 million or $0.03-$0.04 per share per quarter. The reduction represents approximately 10% of U.S. P&C segment earnings or 2% of overall bank earnings.
• The amendment of Regulation E, Electronic Fund Transfer Act, prohibits financial institutions from charging fees to consumers for paying automated teller machine and point of sale transactions that result in overdraft.
• The negative impact of Reg. E, net of mitigation strategies is slightly greater than expected but not significantly material overall.
U.S. Platforms Combine to Represent 23% of Earnings
• U.S. P&C and TD Ameritrade contributed $349 million or $0.40 per share in the quarter, representing 23% of total bank earnings from operations in the third quarter, down from a high of 29% in Q4/08.
Wholesale Banking Earnings Weaken
• Wholesale banking earnings were $179 million, down 45% from $327 million a year earlier, although down only 19% from $220 million in the previous quarter. The bank views these wholesale earnings as a more normal level.
Trading Revenue Declines but Doesn't Collapse
• Trading revenue declined to $300 million versus $402 million in the previous quarter and a record $633 million a year earlier.
• Interest rate and credit trading revenue was weak at $107 million versus $440 million a year earlier and $193 million in the previous quarter. Equity and other trading revenue increased to $94 million from $39 million a year earlier but declined from $105 million in the previous quarter. Foreign exchange trading revenue declined to $99 million versus $154 million a year earlier and $104 million in Q2/10.
Capital Markets Revenue Stable
• Capital markets revenue was $318 million versus $368 million in the previous quarter and $342 million a year earlier. Underwriting and advisory included in capital markets revenue was down at $77 million versus $83 million in the previous quarter and $105 million a year earlier.
Security Gains Low - Unrealized Security Surplus Modest
• Security gains were low at $10 million or $0.01 per share versus $47 million or $0.04 per share in the previous quarter and a loss of $90 million or $0.07 per share a year earlier. Unrealized security surplus declined to $269 million from $285 million in the previous quarter.
Securitization Revenue and Economic Impact
• Loan securitization revenue declined to $110 million from $123 million in the previous quarter.
• Securitization economic impact was positive $68 million pre-tax, or an estimated $0.05 per share after-tax, versus $0.07 per share in the previous quarter and $0.04 per share a year earlier. Securitization activity is recorded in the Corporate segment.
Loan Loss Provisions
• Specific loan loss provisions declined to $339 million or 0.51% of loans from $425 million or 0.67% of loans in the previous quarter and from $492 million or 0.76% of loans a year earlier.
• We have reduced our 2010 LLP forecast to $1,650 million or 0.61% of loans from $1,800 million or 0.67% of loans. Also, we have reduced our 2011 LLP forecast to $1,300 million or 0.47% of loans from $1,600 million or 0.56% of loans due to improving credit trends.
Loan Formations Decline
• Gross impaired loan formations before debt securities and FDIC covered loans declined to $835 million versus $852 million in the previous quarter, the lowest it has been since Q4/08. U.S. gross impaired loan formations declined to US$375 million from US$393 million in the previous quarter.
• Gross impaired loan formations were $1,181 million in the quarter, including $346 million in debt securities classified as loans and FDIC covered loans versus $1,273 million including $421 million in debt securities classified as loans in the previous quarter.
• Gross impaired loans increased to $3,337 million (including $1,160 million in debt securities reclassified as loans and FDIC covered loans) or 1.25% of loans from $3,032 million (including $814 million in debt securities) or 1.16% of loans in the previous quarter.
• Debt securities gross impaireds increased in the quarter, however the fair value of this portfolio (Commerce acquisition, March 2008) is greater than the book value or carrying value.
• Net impaired loans increased to $758 million from $430 million the previous quarter due mainly to the debt securities reclassification.
Tier 1 Capital – 12.5%
• Tier 1 ratio increased to 12.5% versus 12.0% in the previous quarter and 11.1% a year earlier. Total capital ratio was 16.0% versus 15.5% in the previous quarter.
• Tangible common equity to risk-weighted assets (TCE/RWA) increased to 11.7% versus 10.3% the previous quarter.
• Book value per share increased 7% from a year earlier to $43.41.
• Risk-weighted assets were flat from a year earlier at $189.2 billion and increased 1% QOQ.
