Which Canadian Bank Has the Right Pitch to Millennials?

The Globe and Mail, Andrew Willis, 26 August 2017

When it comes to customer satisfaction, Canada's top-ranked mid-sized bank is Tangerine Bank, according to a recent survey from consulting firm J.D. Power. The bottom-ranked Big Five bank in the same study was Bank of Nova Scotia.

Does this strike anyone else as weird? After all, Scotiabank owns Tangerine; it launched the whimsical brand in 2013 as part of a strategy aimed at delivering low-cost, digital services to customers who increasingly prefer to do their banking online.

The fact that Canadians now have a very different view of the client experience at Tangerine compared with parent Scotiabank speaks to the uncharted territory facing the country's financial institutions as they map out a strategy for what's arguably their single biggest marketing challenge: Winning the hearts and wallets of millennials.

When it comes to digital banking, a key offering to a generation born between 1981 and 2000 and permanently tethered to their cellphones, there's now a stark split in tactics among the Big Five banks.

Canadian Imperial Bank of Commerce showed its hand last week by launching Simplii Financial, a new subsidiary created by shifting two million clients from President's Choice Financial, a unit formerly run jointly with grocer Loblaw Cos. Ltd. Like Scotiabank's Tangerine, Simplii will be a brand that's distinct from the identity of parent CIBC, which currently anchors its own advertising campaigns around Percy the penguin and his pals.

In contrast, Royal Bank of Canada, Toronto-Dominion Bank and Bank of Montreal currently anchor their digital strategies on their own long-established brands. It's worth noting that RBC, TD and BMO ranked one, two and three in that J.D. Power customer satisfaction survey, which was published in July.

What's the right way to pitch to millennials?

Financially, that's an easy question to answer. RBC, TD and BMO put all their marketing muscle behind one name. In contract, every dollar spent to establish and burnish the brand at Simplii Financial and Tangerine is a dollar that's not available to advertise CIBC and Scotiabank.

But successful brands are about more than who spends the most on advertising.

Millennials represent a new consumer mindset, according to investment bank Goldman Sachs, which calls this device-loving cohort the first generation of "digital natives." In a recent report, Goldman said winning this crowd means doing business differently. Goldman's research found "with product information, reviews and price comparisons at their fingertips, millennials are turning to the brands that can offer maximum convenience at the lowest cost."

Rock-bottom fees and easy access are central to the pitch at Tangerine and Simplii. On a conference call on Thursday, CIBC CEO Victor Dodig said: "Simplii is about growth and it's about client focus. It will meet the needs of Canadians who value no fee daily banking and great rates through online, mobile and telephone channels."

When Mr. Dodig talks about growth in the mature domestic market, he's really saying he wants to lure customers from rivals. And the clients all banks covet are millennials. Right now, the demographic makes up 2.8 million Canadian households; baby boomers are the largest slice of the population at 5.6 million households, according to Environics. Look out a decade, and Environics projects millennials will make up 5.5 million households, all in their peak earning years, compared with 5.2 million aging boomers and 4.5 million members of Gen X.

The shift in demographics represents an enormous business opportunity. Over the past generation, the pecking order in Canadian retail banking was set in stone: RBC and TD led the pack.

That status quo is now in flux. The bank that gets its millennial marketing strategy right, then backs up its brand with innovative products and robust technology, is going to dominate the domestic market going forward.

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CIBC Q3 2017 Earnings

The Globe and Mail, James Bradshaw, 24 August 2017

Canadian Imperial Bank of Commerce is reaping the early fruits of efforts to reshape its business as its newly minted U.S. arm contributed to higher third-quarter profit.

The Toronto-based bank, which is Canada's fifth-largest by assets, emerged from its fiscal third quarter transformed, having shuffled its executive ranks just as it closed a drawn-out deal to acquire Chicago-based PrivateBancorp Inc. for $5-billion (U.S.) in late June.

The American bank chipped in $23-million (Canadian) in profit in its first 39 days under CIBC's control, while solid results across the Canadian bank's business lines and lower loan losses drove better-than-expected results. The bank also hiked its dividend by three cents to $1.30 a share – an increase of about 2.4 per cent.

With a platform in place to rebuild its U.S. presence, CIBC is expecting new growth as cross-border business picks up. That would be a welcome addition as Canada's housing market shows signs of slowing, even as CIBC continues to grow its mortgage book faster than its peers. But the outlook for U.S. banks is still cloudy, with high-stakes free-trade negotiations under way and promised American tax reform measures in limbo.

As CIBC merges PrivateBancorp with its existing business and redraws its reporting lines, chief executive officer Victor Dodig told analysts the bank's "integration efforts are proceeding very well.

"We've seen lots of early referral activity across our expanded team of private bankers," Mr. Dodig said during a Thursday conference call.

The PrivateBank, as it is commonly known, also grew its loan book by 15 per cent and its deposits by 7 per cent, compared with a year earlier. But its early contribution to overall profit "is lower than we anticipated," Gabriel Dechaine, an analyst at National Bank Financial Inc., said in a research note.

CIBC is hopeful it will see benefits from anticipated interest-rate hikes this year and next, but that's "assuming U.S. trade policy does not prove to be a major barrier to Canadian economic growth," Mr. Dodig said.

Chief financial officer Kevin Glass is "optimistic" a good update to the North American free-trade agreement can be hashed out, even after recent sabre-rattling that included U.S. President Donald Trump musing about terminating the agreement. "It is an opening salvo in a negotiation," Mr. Glass said.

CIBC has also been transforming its mortgage business, and recorded a 13-per-cent spike in its mortgage balances in the third quarter – a much faster rate of growth than at other banks.

That growth has been driven partly by CIBC's decision to build up its roster of mobile mortgage advisers. With that team now intact, and with new housing regulations dampening sales in some hot markets, the bank expects the pace of its mortgage growth to begin reverting closer to its peers. By comparison, Royal Bank of Canada's mortgage portfolio grew 6 per cent in the quarter.

"It'll be a gradual and, I would say, orderly change, an orderly convergence," Mr. Glass said.

Possible changes to the so-called B-20 guideline on mortgage underwriting, proposed by Canada's banking regulator in July, could further cool housing markets by requiring tougher stress tests on uninsured mortgages. CIBC said as many as 10 per cent of its new loans would be unlikely to qualify under the draft rules, but Mr. Dodig declined to give his opinion on the wisdom of such changes. "I'm not going to go there," he said.

CIBC earned $1.1-billion in profit in the quarter that ended July 31, or $2.60 a share. That was down from $1.44-billion, or $3.61 a share, a year ago, when the bank recorded a one-time gain of $383-million on the sale of a minority stake in American Century Investments.

Adjusting to exclude the gain and other items, CIBC earned $2.77 a share. Analysts surveyed by Bloomberg expected earnings a share of $2.65.

Even so, CIBC's share price retreated nearly 1.9 per cent to $105.57 at Thursday's close on the Toronto Stock Exchange. Analysts noted that two less reliable factors propelled earnings above expectations – lower loan losses and unusually robust profit in the small "corporate and other" division.

Revenue of $4.1-billion was flat compared with the same quarter last year. But the bank's common equity tier 1 ratio – a key measure of its health – settled at an acceptable 10.4 per cent after the PrivateBank transaction.

Provisions for credit losses, or money the bank sets aside to cover soured loans, edged up 3 per cent to $209-million, thanks to larger losses in its U.S. real estate finance portfolio.

The core Canadian retail and business banking division delivered $719-million in profit, an 8-per-cent increase from the prior year, on the strength of higher volume and fees.

Profit from Canadian wealth management fell 73 per cent year over year. But adjusting to exclude certain items such as last year's gain on sale, CIBC earned $136-million, up 10 per cent. The PrivateBank acquisition also boosted U.S. wealth management and commercial banking profit 74 per cent to $40-million.

Capital markets profit fell 10 per cent to $252-million, largely due to lower equity derivatives and interest rate trading. But that "is arguably a solid result," according to Barclays Capital Canada Inc. analyst John Aiken, in a quarter characterized by low volatility and slower trading that has been hard on capital markets activity at banks across North America.

"We're very pleased with our results," Mr. Dodig said. "And we're very pleased with the consistency of our performance."

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Preview of Banks' Q3 2017 Earnings

Scotia Capital, 21 August 2017

• Despite the favourable combination of strong operating performance (13% YoY EPS growth in 1H/17) and a resurgent domestic economy that underpinned the first rate hike from the BoC in seven years, Canadian bank stocks have run in place for much of 2017, with the TSX Bank Index having moved a grand total of 1% (to the downside) 7.5 months into the year. While we expect that the upcoming Q3/17 results from the sector will continue to show solid financial performance, in our view the stall of the stocks has more to do with questions regarding the health of the Canadian housing market, particularly as sales activity in Toronto has moderated in recent months.

• The group enters reporting season trading at 11.2x our 2018E, down a full-point from the 12.2x peak that was seen in early-March. With the housing conversation remaining at the forefront, we think the key area of focus for investors will be the ability of the group to demonstrate EPS offsets in other parts of the business (net interest margin [NIM] expansion, operating leverage, growth in US / International segments), an important consideration given that 2018E revisions have been limited to ~1% so far this year.

• Given that the dispersion between the individual stocks has been limited (8% band between the best-and-worst performers within the 'Big Six' YTD), the combination of relative valuation and potential inflection points in key fundamental trends has taken on greater importance in our stock selection process. Accordingly, we are upgrading our rating on TD to a SO, and balancing this move by lowering RY to a SP.

• Bank of Montreal (BMO, $91.53, SO, $103.00) – Target priced decreased from $104.00
• Canadian Imperial Bank of Commerce (CM, $106.94, SP, $120.00) – Target price increased from $118.00
• National Bank of Canada (NA, $55.29, SO, $61.00) – Target price increased from $60.00
• Royal Bank of Canada (RY, $92.25, SP, $100.00) – Rating cut from Sector Outperform and target price decreased from $102.00
• TD Bank Financial Group (TD, $63.73, SO, $73.00) – Rating raised from Sector Perform and target price increased from $71.00

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CIBC’s Pricey PrivateBancorp Deal

The Globe & Mail, James Bradshaw, 30 June 2017

For the second summer in a row, there will be little rest for the weary at Canadian Imperial Bank of Commerce. Executives will be rolling up their sleeves to complete a long-delayed U$4.9-billion acquisition of PrivateBancorp, Chicago’s third-largest bank. CIBC tabled its first offer in June of last year, but U.S. bank stocks surged last fall and winter, and CIBC had to sweeten its bid twice before PrivateBancorp shareholders voted to accept it in May. CIBC CEO Victor Dodig was clearly relieved. “This merger is a major milestone for us,” he said in a statement. “The transaction creates a strong platform for us to serve our clients’ needs throughout North America.”

In many ways, however, CIBC has just cleared a first hurdle. The deal marks a return to territory that was a minefield for the bank: the United States. Starting in the late 1990s, John Hunkin, who was CIBC’s head of investment banking before he was appointed CEO in 1999, tried gambits that included a push into Wall Street investment banking and the U.S. launch of the Amicus electronic banking network, which operated mini-banks for U.S. grocery store chains.

None of them worked, and when Gerry McCaughey succeeded Hunkin in 2005, he reversed course and ushered in a new risk-averse era. CIBC agreed to pay U$2.4 billion to settle a class-action lawsuit with Enron investors, and the bank retreated from the U.S. market. When CIBC later swallowed billions of dollars in writedowns on exposure to U.S. subprime mortgages during the financial crisis, that pullback seemed eminently sensible.

But since then, caution has been costly. CIBC’s share price growth has lagged behind the other Big Six banks over the past decade. When Dodig assumed the top job in 2014, prospects for expansion in Canada were limited. He needed to look abroad.

On its face, Dodig has reasons to be bullish about the PrivateBancorp deal. Larry Richman, who became PrivateBancorp CEO in 2007, has cleaned up troubled assets and built a solid Midwestern lender with operations in 13 states. He is a respected relationship banker, and the deal gives him access to CIBC’s much larger balance sheet—PrivateBancorp has just $28 billion in assets, compared to CIBC’s $529 billion.

But history is littered with examples of Canadian banks’ missteps in the U.S. market. Any boost to CIBC’s earnings will likely take years to materialize. Darko Mihelic, an analyst at RBC Capital Markets, is taking a wait-and-see approach. “How exactly does [CIBC] stitch together its U.S. businesses to form a coherent brand presence in the U.S.?” he wrote in a research note. That’s a key question that remains.





The Big Six Canadian banks’ profits by geography. Royal Bank has operations in about 40 countries around the world and often wins headlines for its overseas expansion plans. But RBC, like the other Big Six banks, still generates an overwhelming majority of its profits here in Canada. The portion from foreign operations is slowly growing at RBC, but surprisingly, when you look at the Big Six as a group, it’s the domestic portion that has climbed.

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TD CEO Bharat Masrani's Quiet Revolution

The Globe and Mail, Tim Kiladze & James Bradshaw, 13 January 2017

In the summer of 2014, shortly before taking over at Toronto-Dominion Bank, Bharat Masrani was asked about his vision for Canada's second-most profitable company. For someone about to become chief executive officer, he had kept a low profile, and investors and analysts were hungry for clues about his plans. How would he change the bank?

Without a moment's hesitation, he answered by promising no revolution at all. "I feel like an equal partner of what this bank is today and hence, I don't feel compelled to change."

Mr. Masrani may have seemed bold in taking credit for building TD into a force, but he wasn't exaggerating. He worked closely with Ed Clark, TD's charismatic CEO, for more than a decade and together they made many major moves, including a decision to spend heavily to expand in the United States. With his fingerprints all over the bank's existing strategy, Mr. Masrani didn't see a reason to sell the board on a new one.

But the status quo he promised lasted less than one quarter.

In December, 2014, a month into Mr. Masrani's tenure, the new CEO laid out a new goal "to increase efficiency and streamline our cost base" – banking lingo for slashing expenses and jobs where possible.

The rationale was a sudden change in circumstances. Oil prices were crashing and Ottawa's warnings about onerous consumer-debt loads were growing louder. Ultra low interest rates had sparked a borrowing binge by consumers, and from 2009 to 2014, TD's total mortgage portfolio almost doubled in size to $199-billion. But housing-driven prosperity can only go so far (and, as U.S. banks learned a decade ago, it comes with its own risk). All of this played out against a backdrop of stubbornly low economic growth and competitive threats from new startups.

Mr. Masrani's quick fix was to endure $686-million in restructuring charges over 12 months, to strip out as many expenses as he could.

That was only the beginning. In the two years since, Mr. Masrani unveiled a revamped wealth-management strategy, complete with the launch of in-house, low-cost exchange-traded funds; embarked on a capital-markets expansion, particularly in the United States; pulled the trigger on the $1.3-billion (U.S.) acquisition of the bank operations of Scottrade Financial Services Inc. and came close to buying Richardson GMP, a Canadian firm with $28-billion in assets under management.

Under Mr. Masrani's watch, TD has invested heavily in digital banking tools, a strategy that seems a modest departure from its long-standing focus on in-person branch banking and customer service.

Most recently, the bank announced the retirements of long-time leaders in multiple business units, including Mike Pedersen, the head of the U.S. personal and commercial bank – TD's main vehicle for long-term growth.

So much for not feeling compelled to change.

"One of the hallmarks of TD is its ability to adapt to the environment it finds itself in, rather than hoping, praying that the environment will go back to the good old days," Mr. Masrani said in a recent interview at TD's Toronto headquarters.

Asked whether he reversed course on his initial promise, the CEO practically scoffs. "I wouldn't put it in your words, that there's been some dramatic shift here, because there hasn't," he argues.

Mr. Masrani said TD's decade-long expansion resulted in duplication, which justified his early cost-cutting. Bay Street largely agrees with him. "They'd had a couple of false starts on getting stricter on expenses," said Robert Sedran, an analyst at CIBC World Markets. Then, just as the new CEO took over, the prospects for revenue growth began to look more daunting, partly because of the weakness of the Canadian economy. "In that environment, the cost control became something that was no longer optional."

Expanding TD's wealth-management arm seemed equally necessary. Because baby boomers are leaving the work force in droves – Canada has 250,000 new retirees every year, a figure that could approach 400,000 soon – demand for financial planning is rising fast. On this front, TD had to play catch-up.

The bank holds a 41-per-cent stake in TD Ameritrade Holding Corp., the largest discount brokerage in the United States, and also recently increased its wealth exposure by acquiring New York-based equity-asset manager Epoch Partners in 2012. But something was still missing. As the only large Canadian bank that hadn't acquired an independent dealer after Ottawa relaxed ownership rules in the 1980s, TD didn't have a robust retail advice platform – which is crucial to landing high-net-worth clients who seek tailored service.

TD's money-management arm also wasn't well integrated with its retail network. "Selling wealth through the branches is an area where perhaps TD has not been as strong," Mr. Sedran said.

Under Mr. Masrani, TD has implemented new rules, such as shuffling wealth clients with under $100,000 in assets to its branches, where it offers more basic products such as low-cost ETFs. A closer connection between wealth and the branches is expected to help the bank cross-sell products, so a client who has only mutual funds can be offered a credit card as well, for example.

The bank also rebranded its retail wealth business to TD Wealth Private Wealth Management, and pledged to add more than 130 investment advisers by 2020 – a rare move at a time when most rivals are trimming their adviser ranks. TD was working to make up ground, which helps explain why it was considering buying Richardson GMP for $600-million last fall; the firm specializes in high-net-worth clients. Because the deal died, TD is left building out its own network over the long haul.

What Mr. Masrani is doing with TD Canada Trust, the domestic retail bank that contributes 64 per cent of total profit, has been harder to decipher. He installed a new group head in 2015. The former leader, Tim Hockey, left in a surprise move to run TD Ameritrade, and the current leader, Teri Currie, is faced with translating TD's customer-service strength to a digital world. "We spend a lot of time and effort on how we make sure this particular [mobile] functionality you have is from TD, and on creating that emotional connection," Mr. Masrani said.

There's a lot to do. TD touts its "legendary" customer service, which includes longer hours at bank branches than its competitors offered, but "technology is working to make that advantage less important in a world where you have 24/7 banking on your mobile phone," said Cormark Securities analyst Meny Grauman. Plus, all the banks are building from scratch on a relatively level playing field. "You have a dynamic where the leader is more vulnerable than the laggards in this respect."

Getting the digital shift right is crucial. The retail division's profits were flat last year, which was rare to see in the postcrisis bull market for banks, and TD also lost its coveted J.D. Power award for overall customer satisfaction to rival Royal Bank of Canada.

Mr. Masrani argues what transpired last year was a temporary hiccup. Growth will return, he says, partly thanks to expansion plans that include beefing up TD's credit-card unit. The CEO also wants to build out the bank's insurance business, despite that industry's recent struggles, and to become a prominent commercial bank that lends to small and mid-sized companies.

Of all his changes, the strategy that stands out is Mr. Masrani's emphasis on capital markets. This was a division that never got much attention under the old regime, so when he started talking more about it, some people wondered whether TD would expose itself to greater risk.

The short answer: Not on Mr. Masrani's watch. Rather than ramping up derivatives trading, TD aims to become a prominent corporate lender to big companies in the United States and then build products around that. The decision follows RBC's strategy to expand its U.S. corporate-lending book in the wake of the financial crisis, just as global banks were pulling back.

Nothing is risk-free, as TD knows well. The bank had major problems with its loans to telecom companies during the dot-com bubble, an era when it posted its first-ever quarterly loss. But it was Mr. Masrani who was assigned to clean up that portfolio of bad loans. From there, he became chief risk officer. "The bank's risk appetite is non-negotiable," Mr. Masrani explains. "We will not risk the whole enterprise with a strategy or a trade."

"A lot of what we're doing in the U.S. is actually the same as what we've done in Canada over the last 20 years … We have a fairly large personal and commercial bank in the United States from Maine to Florida that has millions of customers. A lot of them have what I would call investment-banking types of needs," he said, such as managing interest-rate risk, or vanilla derivatives. "Why would we not build those capabilities … to recreate what we did in Canada?"

To complement the capital-markets strategy, he wants to elevate the retail and commercial-bank division's status south of the border, making it more, well, Canadian. "What we are trying to create is more of a universal banking model," he says.

Now is the ideal time to do this, he says. The U.S. arm is now a top-10 bank ranked by assets in the United States, thanks to a decade spent laying the groundwork by building scale, a brand and a culture. The market also has a much more positive tone than it did when he ran the U.S. bank from 2007 to 2013. When Mr. Masrani took over as CEO, U.S. returns were still weak as the economy made a slow recovery from the Great Recession, and TD's return on equity in the U.S. arm was just 8 per cent; in Canada, it was 43 per cent.

Today, there's more oxygen. After keeping interest rates near zero per cent for nearly seven years, the Federal Reserve hiked them for a second time in 12 months in December, which boosts lending margins. "There is a sentiment change that is very positive," Mr. Masrani says.

To capitalize on that, he teamed up with TD Ameritrade on a proposal to buy discount brokerage Scottrade for $4-billion in October, absorbing Scottrade's U.S. banking assets. At a conference this week, Mr. Masrani also reiterated his desire to acquire a smaller traditional bank in the southeast United States.

There's also the Donald Trump factor. Since he was elected to be the next U.S. president, big American bank stocks have jumped an average of 24 per cent on the assumption that he will loosen regulations. It is debatable how much growth that will spur, but coupled with a plan to lower corporate taxes and boost infrastructure spending, the recovery could amp up as consumers borrow more. "These three pillars are going to mean more growth," Mr. Masrani says.

For the first time, TD isn't shy to pound its chest about its U.S. arm. A lot of institutions – both Canadian and global – have had expansion plans to the south, where a tantalizingly large market awaits, "but there have not been many instances of success," Mr. Masrani said. "We're very proud."

And the new CEO is confident he has time on his side. "The few banks that are bigger than us had a 150-year head start."

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Analysts Question Why TD Bank Lags Behind Canadian Peers

Bloomberg, Doug Alexander, 28 August 2016

Foreign investors betting against Canadian bank stocks continue to swell in numbers while stock prices in the sector grind higher. The result, for now, is considerable financial pain for the doomsayers.

Toronto-Dominion Bank’s own analyst is wondering why the lender is becoming a laggard in Canadian banking, underscoring concerns that prompted two stock downgrades.

"We’re all collectively scratching our heads on why this premium domestic retail bank isn’t keeping up with its peers," TD analyst Mario Mendonca asked Teri Currie, the head of Canadian personal banking, on a conference call Thursday after the company reported quarterly results.

Profit from Canadian banking rose 1.4 per cent in the third quarter, less than half the pace of the country’s largest lender, Royal Bank of Canada, and a quarter that of Canadian Imperial Bank of Commerce.

TD Bank posted a 4-per-cent increase in quarterly profit from a year earlier as gains from its U.S. bank and capital-markets business offset declining domestic retail operations.

Ms. Currie told Mr. Mendonca, who rates the shares a buy, that lower interest rates, competitive pricing and the cost of funds for mortgages were to blame, along with repricing on fee-based products.

Other analysts are highlighting TD Bank’s problems at home.

CIBC Capital Markets’ Robert Sedran downgraded the stock of the Toronto-based company to the equivalent of hold from buy on Thursday.

“As much as we’re heartened by the stronger U.S. performance, we expect and need better from the Canadian business relative to its peers,” Mr. Sedran said in a note to clients.

Canaccord Genuity Group Inc.’s Gabriel Dechaine also cut the stock to hold, saying the Canadian personal and commercial-banking business “is falling short of peer results and the bank’s own targets.”

TD Bank has a medium-term objective of 7-per-cent growth for its Canadian banking division, a goal Ms. Currie reiterated Thursday.

The division is the bank’s largest and generates about half the company’s profit.

Weak margins – with low rates, competition and lower mortgage-backed securities funding – along with a higher tax rate and provisions “are likely to drive below-average domestic banking earnings next quarter,” Mr. Mendonca wrote Friday in a note.

On Friday, TD Bank shares closed down 0.2 per cent to $57.29, on pace for a second day of declines.

TD Bank has nine buy recommendations, eight holds and one sell, according to data compiled by Bloomberg.

Analysts including Bank of Nova Scotia’s Sumit Malhotra and Barclays PLC’s John Aiken have suggested the bank may be easing up on Canadian growth on purpose, given concerns about sluggish economic growth and overheated housing prices.

“They’re putting the brakes on domestic growth,” said Mr. Aiken, who rates TD Bank stock a sell, in an interview.

“They’re consciously growing slower than peers because they’re worried about what’s going on with the economy.”

Canaccord’s Mr. Dechaine also noted the discrepancy, despite his downgrade.

“To be fair, it seems odd to criticize TD for its low growth in Canadian retail banking at a time when market concerns over consumer indebtedness and late-cycle credit growth in certain segments (e.g. housing in overheated markets) are elevated,” Mr. Dechaine said in his note.

“However, we also believe it is fair to compare TD’s actual performance to targets it communicated to the Street.”

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Why Are Hedge Funds Shorting Canadian Bank Stocks So Confident?

The Globe and Mail, Scott Barlow, 26 August 2016

Foreign investors betting against Canadian bank stocks continue to swell in numbers while stock prices in the sector grind higher. The result, for now, is considerable financial pain for the doomsayers.

The short positions on Canadian banks have almost uniformly resulted in losses and this had me all ready to write a “foreigners don’t understand the Canadian banking system” column. But I’m worried I’m missing something now.

The early year concern for domestic bank stocks focused on energy industry exposure. The banks repeatedly stated, however, that potential losses were minimal as a percentage of total business operations and wouldn’t affect earnings too much. With help from a partial recovery in the oil price, this has proven correct.

If oil losses were the main reason for the short positions, we’d expect the number of bearish bets on bank stocks to have decreased as the oil price recovered. This has not been the case.

Profits for Canadian banks have also been more reliant on capital markets activity – trading and investment banking operations – and in industry terms this is what’s called a “lumpy” source of profits. Capital markets profits are inconsistent on even a quarter-over-quarter basis and can double or dry up with little notice. Perhaps part of the short thesis is that this profits generator will fade, but on its own such a scenario doesn’t seem a big enough reason to short a bank.

One U.S. hedge fund manager I contacted who holds a short position on Canadian banks believes that transaction activity is about to decline significantly. They believe that corporate and household clients will repay loans early, thanks to low rates, and growth in new loans will be extremely slow. In this scenario, profits from the banks’ basic business of lending will fall.

We’ve covered the energy sector, capital markets and credit demand, which leaves the domestic housing markets. National Bank economist Warren Lovely wrote in a report released on Tuesday that real estate markets have been 'surprisingly sturdy' in recent years, but that 'cracks in the foundation are nonetheless visible,' notably in regions dependent on oil revenue. Vancouver housing sales, viewed as unstoppable until very recently, have cooled considerably as the Vancouver Sun reported that sales in the metro area have 'frozen solid.'

It has been fashionable for domestic pundits, including me, to write that foreign managers’ short positions on Canadian banks were a negligent mistake because they did not understand the Canadian Mortgage and Housing Corp.’s role in protecting major banks from losses on mortgage defaults.

But too much time has passed for that to be the case, at least in general. The U.S. hedge fund companies that hold the bulk of the short positions have analysts looking deeply into every trade and I refuse to believe they don’t understand the CMHC’s role at this point. In the majority of cases, they make too much money to be that dense.

I’ve written at least three bullish columns on Canadian banks in recent months and still lean that way. But it’s a bad idea for any investor to get so locked into a market view that they consider anyone betting the other way as stupid or uninformed. I won’t be as comfortably bullish on domestic bank stocks until I have a clearer idea what the hedge funds are thinking.

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TD Bank Warns of Impact of Oil’s Fall on Canadian Economy

Financial Times, Ben McLannahan, 17 August 2015

Bharat Masrani, the chief executive of Toronto-Dominion Bank has warned of the chilling effects of lower oil prices on the Canadian economy, which could check the lender’s ambitions in the US, its most important growth market.

The Toronto-based bank, the country’s joint largest lender by assets alongside Royal Bank of Canada, has expanded more quickly in the US than any other big foreign bank since the crisis. But in an interview with the Financial Times, president and chief executive Bharat Masrani said the latest drop in the oil price could hurt consumption in certain parts of Canada that are highly reliant on energy exports — and by extension, affect the bank’s earnings power.

Mr Masrani said that while he does not worry about the bank’s direct lending to energy companies — which at about 1 per cent of total assets of C$1tn, is less than the peer-group average of about 2.5 per cent — he is concerned about the indirect exposures for a bank with dominant shares in retail markets across Canada. “If there is a knock-on effect on consumer confidence, then obviously that is something not to take lightly,” he said.

TD Bank has been building US presence since 2004, when it bought Banknorth Group, based in Portland, Maine. But since 2008 — when it added Commerce Bank of New Jersey — TD has accelerated the pace of expansion, taking advantage of tactical retreats by overextended US and European rivals. The bank was more or less unscarred by the financial crisis, benefiting from a decision to exit structured products in 2005, well before detonations in mortgage-related markets.

TD’s assets in the US have doubled since December 2008 to $317bn at the end of last year, according to Federal Reserve data, as the bank has built out an east coast network centred on wealthy urban areas. By doing so, says Moody’s, the credit rating agency, TD has “effectively addressed the core strategic dilemma of the Canadian banks”, which is how to deploy the capital they generate in their mature, oligopolistic home market.

“We took the view 10 years ago that the US retail market would be our next growth platform,” said Mr Masrani. “We are one of the best-rated banks in the world, and we are highly liquid. Obviously we are looking to expand where appropriate.”

But oil’s renewed slide could give the bank a less stable platform. TD has about C$52bn of consumer loans in the oil-producing provinces of Alberta, Saskatchewan and Manitoba, estimates Moody’s, second only to RBC. The rating agency warns that losses could multiply in the event of a prolonged downturn in crude, which has hit a six-year low.

“If our customers suffer, we suffer; that is how we take it, but from a financial perspective, it is a manageable situation,” said Mr Masrani.

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TD Bank Bets on US Branches as Rivals Cut Back

Financial Times, Ben McLannahan, 17 August 2015

If you are idling away time in a TD Bank branch, try throwing some change in the free TD coin-counter. If your children are nagging, let them play on the jukebox-like quiz machine. If your dog fidgets, toss it a TD biscuit.

It is all part of the service at TD, the Toronto-based lender that is still a big believer in the power of bricks and mortar. In the 12 months to the end of April, TD opened more branches across the US than it closed, defying an industry-wide trend. Across the five boroughs of New York City, the lender with C$1tn in assets recently eclipsed Bank of America by branch count — a strategic goal it had set at the annual meeting in 2012 — and is closing in on the top three of Chase, Citi and Capital One.

“The physical presence continues to be central to our customers’ needs in many ways,” says chief executive Bharat Masrani, during an interview in a flagship branch opposite Sony’s headquarters on Madison Avenue.

He describes an “omni-channel experience”, where a person could start a loan application in the morning on an iPad, pick it up again on an iPhone on the train, then walk into a store at lunch to close the deal. “How can we make that experience seamless?”

TD’s belief in the branch is not unusual. Unlike in the UK and parts of Europe, for example, where banks have spent years slimming down networks, US banks have tended to want to “put branches on every street corner”, says David Haber, chief executive of Bond Street, an online lender to small businesses.

It is only recently, in fact, that the tide has turned. Data from the Federal Deposit Insurance Corporation shows the total US branch-count falling each year since a peak of 99,550 in 2009, dropping to 94,725 as of June 2014.

But for many of the big banks, the pace of closures is beginning to pick up. JPMorgan Chase wants to cut about 6 per cent of its retail footprint by the end of next year, eliminating a net 300 branches in the process. Citigroup reduced its US branch count by 7 per cent in the 12 months to June. It is now focused on six cities, down from 14, pulling out of markets such as Dallas and Houston altogether.

Analysts say that some lenders are eyeing a gradual return to more normal monetary policy from the US Federal Reserve, which could catch banks with big branch networks on the hop.

“We suspect that when [interest] rates do rise, technology will allow depositors to move their money to high interest rate accounts with a speed never before seen,” wrote Frederick Cannon, global director of research at Keefe, Bruyette & Woods, in a recent report.

Bob Meara, a senior analyst at Celent in New York, says that simple pressure from shareholders for higher returns should result in faster shrinkage of costly branch networks. “There’s no two ways around it — banks do not need the densities they used to. The scales will have to tip.”

Mr Masrani, whose rise to chief executive last November capped a 35-year career with TD, does not worry that his network-building puts him out of step with the industry. He notes that, with 1,302 US branches in April — a slight increase from 1,297 a year earlier — TD is still 10th by total branch count, well behind the likes of Chase, with 5,504.

He also sees plenty of scope for “optimisation” of TD’s US network, which after acquisitions in 2004 and 2008 stretches down the entire East Coast, from Maine to Florida. TD is now experimenting with “five, six or seven” different formats for its branches, Mr Masrani says, up from just one or two a few years ago. In Baltimore, for example, it recently opened its first teller-less branch, about one-third smaller than the previous default size, featuring three high-tech cash machines and a handful of “financial services associates” to help customers use the machines.

The important thing is to “wow” the customer, says Mr Masrani, 59, who ran TD divisions in India and Europe before overseeing the bank’s expansion in the US. He notes that every new employee does at least one course at TD University, a purpose-built campus in Mt Laurel, New Jersey, to learn the TD way. All staff are encouraged to use the phrase, “TD Bank, America’s most convenient bank” like a mantra. (The chief executive does so himself about half a dozen times during the interview.)

That is why the openings will continue. When it cut the ribbon last month on a new branch on the corner of Grand St and Allen St on Manhattan’s Lower East Side, TD brought its New York branch tally to 127. It has committed to opening another 10 by the end of the year, and may consolidate a few others. However, its chief executive cautions that the pace of expansion in the US may be held back as the falling oil price could affect the bank’s earnings power in its home market.

“We may build a new location and bring business to that location if there is a better look and feel to it, and it has better technology,” says Mr Masrani. “But that doesn’t mean we are not committed to our physical presence, because that is central to what we do.”

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For Michael Wekerle, An Old Friendship Becomes A $1.3-million Feud

The Globe and Mail, Niall McGee, 22 January 2015

Former star stock trader Michael Wekerle is embroiled in a lawsuit with a long-time business associate who wants to push the CBC Dragon into bankruptcy.

Rohit Sehgal, a portfolio manager with Dynamic Funds, alleges in court filings that Mr. Wekerle owes him $1.38-million (U.S.) from the 2014 sale of a property in New York. He alleges that he has pursued payment from Mr. Wekerle for months and now wants him "adjudged bankrupt and that a bankruptcy order be made in respect of [Mr. Wekerle's] property."

"He has repeatedly promised to pay the [debt] and hasn't done so," said Catherine Francis, a lawyer at Minden Gross LLP in Toronto who is representing Mr. Sehgal.

Mr. Wekerle, who appears on the CBC-TV program Dragons' Den, has filed a notice of dispute, explaining that he intends to oppose the bankruptcy application: "The applicant [Mr. Sehgal] is attempting to use the bankruptcy process to collect an alleged civil debt."

"Mr. Wekerle has not committed an act of bankruptcy" and is "able to pay his debts as they become due," the notice reads.

In an interview, Mr. Wekerle said he will repay Mr. Sehgal - "a guy that I took care of for 30 years" - $1.1-million and "not a penny more" and hopes to have the matter settled by the end of the month.

"I'm very upset with the way he's acting. He's putting pressure to get an additional $200,000."

The dispute dates back to 2011, when Mr. Sehgal, Mr. Wekerle and Robert Sali, a resident of Singapore, teamed up to invest in a $2.4-million condominium in New York's fashionable Tribeca neighbourhood.

According to court filings, Mr. Sehgal and Mr. Sali kicked in $1.1-million each toward the purchase price. It isn't clear how much Mr. Wekerle contributed but the property was purchased without a mortgage. The title was assigned solely to Mr. Wekerle, as condo rules did not permit joint ownership, according to court filings. Mr. Sehgal alleges that Mr. Wekerle executed a promissory note to him and Mr. Sali valued at $1.1-million each to protect their financial interests.

Mr. Sehgal alleges that in May, 2014, he learned that Mr. Wekerle had taken out a mortgage on the property in violation of their agreement. He also alleges that the new mortgage exceeded the value of Mr. Wekerle's equity in the property. Then a month later, Mr. Sehgal alleges he found out that Mr. Wekerle had put the property up for sale at $4.6-million without his knowledge.

In court filings, Mr. Sehgal said once Mr. Wekerle repaid his mortgage, the remaining proceeds were insufficient to cover what was owed to Mr. Sehgal and Mr. Sali.

Mr. Sehgal headed to court, filing a lawsuit against Mr. Wekerle last summer and adding the bankruptcy application in November.

In an interview, Mr. Wekerle denied the allegations of bankruptcy. And he said the two had done property deals before.

"This is the second time I've carried Rohit on a property," said Mr. Wekerle. "I brought him into the property ... I did all the legal work myself. I didn't charge him anything on the fees."

Mr. Sehgal declined comment.Mr. Wekerle rejected any suggestion that he is running out of money. "One hundred and ten per cent incorrect. A lot of people like to talk about me. And it's malicious. If I was bankrupt I wouldn't have just flown to Europe in my own jet, which was about $100,000," he said.

In December, Mr. Wekerle was unable to meet a $2.5-million (Canadian) margin call from his broker, Richardson GMP, on debt securities he holds in his firm, Difference Capital. At the time, Mr. Wekerle explained that his money was tied up in illiquid investments, stating that he was "asset rich and cash poor."

During the same interview, Mr. Wekerle said his single biggest asset was his investment in Difference, the publicly-traded merchant bank he co-founded in 2012. He owns 23 per cent of the company's common stock, valued at approximately $8.4-million. His debt holdings are worth around $8-million. Shares in Difference have lost 81 per cent of their value since the company went public in May, 2012, and most of the company's early investments have performed poorly. Difference has also suffered from a slew of departures of management and board members in the past year.

Mr. Wekerle himself will be on the move soon. On Wednesday, he said he plans to vacate his exclusive Toronto neighbourhood, partly because he's become disillusioned with all of the gossiping. "I'm in the process of selling my house in Forest Hill," he said. "The crowd around here in Forest Hill are too Chatty Cathy. I'm going to move back to Bayview and Steeles, where my mum lives."

Michael Wekerle says he was unable to meet a December margin call because he was 'asset rich and cash poor.'

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Banks Short Interest, as at 30 August 2013

Scotia Capital, 12 September 2013

• Canadian banks continue to be heavily shorted relative to U.S. major banks (see our April 29, 2013 report Canadian Banks Short Interest Ratio Higher Than Prior to Lehman Collapse), based on the most recent data, August 30, by the TSX and NYSE.

Implications

• Canadian banks short interest ratio declined modestly in August to 9.4 trading days compared to 10.6 trading days in July. U.S. major banks short interest ratio remained flat at 1.2 trading days, well below the short interest levels of the Canadian banks.

• CM had the highest short interest ratio in the bank group at 11.8 days, followed by BMO at 10.7 days.

Recommendation

• Following the strong earnings beat from the Canadian banks in Q3/13, including dividend increases and new share repurchases, the short interest ratio declined a modest 0.3 trading days versus our last update (data as at August 15, 2013).

• Earnings could continue to surprise on the upside, especially if the net interest margin continues to stabilize and perhaps increase.

• Positive earnings momentum, housing market resilience and the high cost of carry is not expected to be short interest friendly.

• Maintain Overweight recommendation versus TSX, although we continue to recommend Overweight U.S. major banks (select and less aggressive) relative to Canadian banks.

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Preview of Banks' Q3 2013 Earnings

Scotia Capital, 19 August 2013

Banks begin reporting third quarter earnings on August 27. We expect underlying operating earnings to increase 4% YOY and 3% QoQ. Our earnings estimates are in line with consensus. ROE 17.0% (18.0% excluding TD), RRWA at 2.25% (2.31% excluding TD).

Implications

• We expect Wholesale earnings to remain strong, up slightly both sequentially and YoY. Domestic/Retail Banking earnings are expected to remain resilient although growth is slowing, with Wealth Management earnings expected to be strong, aided by AUM growth. Wholesale is expected to be benefit from solid fixed income underwriting, strong equity underwriting, and continued strength in corporate lending.

• We expect TD, BNS, RY, and BMO to increase their dividends 4%, 3%, 3%, and 2%, respectively.

• Bank P/E multiples, we believe, are very attractive at 11.2x and 10.2x our 2013E and 2014E EPS. We believe housing concerns and short interest are muting bank valuations and P/E expansion. We expect Canadian bank P/E multiples to hit 15x trailing in 2015 as systemic risk continues to decline, housing concerns moderate, and investors chase banks' high dividend yields.

Recommendation

• We maintain our overweight Canadian banks versus the TSX and our overweight U.S. banks versus Canadian banks recommendations.

• We maintain CM as our FS; an SO rating on RY; SP ratings on TD, BNS, NA, CWB and LB; and SU rating on BMO.

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Why Canada Can Avoid Banking Crises & the US Can’t

The Wall Street Journal, Victoria McGrane, 9 April 2013

Since 1790, the United States has suffered 16 banking crises. Canada has experienced zero — not even during the Great Depression.

It turns out Canada can thank the French for their stable system, according to a paper by Columbia University’s Charles Calomiris, presented at the Atlanta Fed’s 2013 Financial Markets Conference.

When it became a British colony, the majority of Canada’s population was of French origin — and the French inhabitants hated the British government.

So to keep the colony firmly within the Empire, British policymakers steered toward a government structure that would limit the power of the French-majority while also giving Canada more and more self-government. The eventual result was a highly-centralized federal government which controlled economic policy making and had built-in buffers for banker interests against populist forces, the paper argues.

That anti-populist political system — known in political science as liberal constitutionalism or liberal democracy — is a key ingredient in Canada’s stable banking track record, Mr. Calomiris contends in his paper, which is a summary of a much longer book he’s written with Stephen Haber due out in September. That’s because this kind of political system makes it difficult for political majorities to gain control of the banking system for their own purposes, the authors contend.

Populist democracies like the U.S., on the other hand, tend to create dysfunctional banking systems because a majority of citizens gain control over banking regulation that steers credit to themselves and to their friends at the expense of the citizens that are excluded from the banking system, he said.

The contrast between the U.S. and Canada was part of Mr. Calomiris broader argument that dysfunctional banking systems — which are by far the norm rather than the exception around the world — are the result of political factors.

“Whether societies have dysfunctional banking systems is really not a technical issue at all. It’s a political issue,” Mr. Calomiris said at the conference, introducing his premise as “we do know how to avoid dysfunctional banking but that we make political choices – you might even say consciously” not to have functional banking systems for most of the modern era in most countries of the world.

The history of the U.S. banking system is one in which the government forms partnerships with different interest groups at different points in history, and those coalitions jointly influenced the way the banking system was regulated, Mr. Calomiris argues.

“In populist democracies, such as the United States, the regulation of banking is used as a political tool to favor some parties over others. It is not that the dominant political coalition in charge of banking policy desires instability, per se, but rather, that it is willing to tolerate instability as the price for obtaining the benefits that it extracts from controlling banking regulation,” he writes in his paper.

Backing up their argument: Only six countries – including Canada — have been crisis-free and at the same time have banking systems that provide abundant credit. Three of these – Singapore, Malta and Hong Kong – are small, island-bound city-states where the homogeneity of the population makes it politically difficult to create losers. The other three – Canada, Australia and New Zealand – all share histories of liberal democracy.

Mr. Calomiris argues that in the U.S., a coalition that emerged in the 1990s of government, big banks and activist consumer groups came helped fuel the housing crisis. Regulatory changes opened the door to a wave of mergers and acquisitions that created today’s megabanks. But banks still had to get approval – usually from the Federal Reserve – to complete those mergers and outside groups were able to weigh in on the wisdom of the deal as part of the Fed’s decision-making process.

Community groups, with the Clinton administration’s encouragement, used the Fed’s approval process to extract binding concessions from banks to loosen underwriting standards for poor, urban communities – concessions to which the Fed agreed, Mr. Calomiris argues. The banks had to apply the looser standards to everyone. That helped fuel an explosion in poorly underwritten mortgages that contributed to the depth and severity of the housing crisis, he contends.

All in all, Mr. Calomiris’ theory is a bleak one for the ability of financial reform efforts to make much of a difference.

“Smart economists with their regulatory ideas are sort of dead on arrival,” he said. “Political coalitions will decide — not whether you’ve got the right VAR model — [but] whether a banking system is going to be set up with rules that will lead it to be stable and have abundant credit or not.”

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TD Bank’s US Expansion Hasn’t Come Cheap

The Globe and Mail, Scott Barlow, 5 April 2013

The impending ascension of Bharat Masrani to the CEO chair at Toronto-Dominion Bank underscores the strategic importance of U.S. operations for the company as a whole, and provides an excellent opportunity to assess just how well TD Bank’s $17-billion (U.S.) foray into foreign territory is going.

The bottom line: It still faces considerable challenges. While U.S. expansion provides the bank with a useful counterbalance to its Canadian base, the venture is – for now – still a work in progress.

One question: can TD Bank maintain loyalty among its U.S. consumers? The Wall Street Journal recently published a brief report highlighting increasing customer dissatisfaction at its U.S.-based branches.

Meanwhile, return on equity (ROE), the most widely used measure of a bank’s profitability, has been running at about eight per cent per year on the company’s approximately $17-billion in U.S. acquisitions since 2004. This pales in comparison to TD Bank’s overall ROE of 14.8.

To be fair, the consumer data highlighted by the Journal is anecdotal and an ROE of eight per cent is perfectly acceptable for a relatively new expansion. But what does seem clear, with the benefit of hindsight, is that TD Bank paid a generous price for its primary U.S. assets.

The broader U.S. banking sector currently trades at an average price-to-book value of 1.2 times, according to Bloomberg data. TD Bank’s two major acquisitions south of the border, Banknorth Group Inc. in 2004 and Commerce Bancorp Inc. in 2007, were completed at far higher book value multiples of 2.6 and 2.8 times, respectively.

TD Bank spokespeople emphasize that the bank’s U.S. acquisition strategy is part of a long term initiative and that it was not trying to time the market when it made its U.S. purchases. Nonetheless, management can’t be thrilled with the evolution of U.S. book value multiples.

According to Brad Smith, analyst and head of research at Stonecap Securities, TD Bank’s U.S. operations have also required considerable financial support from the Canadian parent company. He estimates that TD Bank, N.A., the U.S. based holding company under which the bank’s U.S. operations legally sit, have required approximately $8.6-billion in loans – one assumes on favourable terms – from Toronto.

Mr. Smith also notes that the U.S. regulatory environment is likely to change. Foreign-owned bank holding companies south of the border are currently exempted from the U.S. regulatory system. But under the Collins Amendment, part of the Dodd Frank Financial reform bill, this exemption will end in 2015.

TD Bank spokespeople are correct in pointing out that rule changes will not be certain until the legislation is fully implemented. But under the Collins Amendment, TD Bank, N.A. would have to double its level of tier 1 capital to be considered “well capitalized” by U.S. regulators.

Mr. Masrani, who has been group head of U.S. personal and commercial banking, is well aware of all these issues, and he’s backed by a deep management team that has proven remarkably adept at running the bank’s Canadian operations.

Barring another financial-sector catastrophe, TD Bank N.A.’s balance sheet and its profitability are likely to improve as trust in the U.S. financial system is restored. The question is how high the upside is for the bank’s U.S. arm. To date, blind faith in the bank’s ability to repeat its domestic success in the U.S. appears misplaced.

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TD Bank Faces Loss of Luster

The Wall Street Journal, Suzanne Kapner, 3 April 2013

For two decades, Joanny Campbell of South Philadelphia was satisfied with her bank.

Then her lender, New Jersey's Commerce Bank, was acquired by TD Bank NA, a unit of Toronto-Dominion Bank of Canada. The parent company had no U.S. locations as recently as 2000 but now operates the ninth-largest U.S. bank by assets, a major player in large cities including New York and Boston.

Unhappy with customer service, Ms. Campbell closed her TD account late last year.

"The Commerce employees called me by name," said the 38-year-old Ms. Campbell. "The TD employees didn't know me, and they didn't care to know me."

A TD Bank representative declined to comment on specific interactions with customers.

Ms. Campbell's decision to find a new bank highlights the challenges facing TD as it looks to build on an expansion nearly unmatched in the banking industry, at a time of slow economic growth, profit-crunching low interest rates and intense competition.

The company bills itself as America's Most Convenient Bank, with unusually long hours and many branches open every day except New Year's Day, Easter, Thanksgiving and Christmas. Its branch count has surged 23% in the past five years, a time in which many other large lenders have retrenched.

Toronto-Dominion said Wednesday that the architect of its U.S. expansion, Chief Executive Ed Clark, will retire next year and be succeeded by Bharat Masrani, TD's U.S. head of personal and commercial banking, who has pledged to keep the company expanding.

"If there are three banks on each corner of an intersection and the fourth corner is unoccupied, we would love to have that corner," Mr. Masrani told The Wall Street Journal in January.

But TD's profitability has lagged behind that of many of its peers, and the company's once-sterling reputation for customer service has declined since the 2008 purchase of Commerce.

Although TD Bank NA's net income increased 14% in 2012, to $775 million, compared with $681 million earned the prior year, 90% of its peer group earned more, according to the Federal Deposit Insurance Corp. TD says the numbers reflect in part its low-risk strategy.

Toronto-Dominion avoided getting hit in the U.S. mortgage meltdown, thanks to its conservative lending practices. But some analysts say competition has intensified now that large U.S. rivals have recovered from the crisis.

"It was easier to take share away when competitors were struggling," said Brian Klock, an analyst with Keefe, Bruyette & Woods. "Now, the competition has woken up, and it's going to be a tougher fight."

Mr. Masrani said he is satisfied with TD's performance relative to other banks. "I feel as long as we grow our franchise in the U.S., the returns will take care of themselves," he said Wednesday.

Both Commerce and TD were known for their attention to customers. TD retained some popular Commerce practices, operating coin counters known as Penny Arcades and giving customers pens, dog biscuits and lollipops.

But the products and pricing changed. TD increased minimum-balance requirements on some accounts and started charging for out-of-network ATM use. And it made no apologies about aggressively peddling mortgage and credit-card loans to account holders, a practice known as cross selling that Commerce eschewed.

Some customers have taken to websites Consumeraffairs.com and MyBanktracker.com to complain, using the word "hate" to describe their feelings about what TD has done to Commerce.

TD executives say then-and-now comparisons are unfair given that the environment in which Commerce once operated differed from the low-margin banking world of today.

"With margins compressed, you have to do something," said Linda Verba, TD's executive vice president of retail operations and service programs. Rather than being annoyed by TD's attempts to cross sell, Ms. Verba said, "customers want us to tell them what we have to offer."

TD ranked at the top of its class in customer satisfaction surveys compiled by J.D. Power & Associates, a West Lake Village, Calif., research firm, for four straight years in the 2000s. But TD hasn't held the honor since 2009.

Mr. Masrani acknowledged that TD made mistakes in its $8.5 billion purchase of Commerce, including a botched attempt to transfer data that prevented customers from checking their account information online for two days.

"When you bring banks together, there are cultural things that you have to overcome," Mr. Masrani said in January. A TD spokeswoman added Wednesday that the bank has retained the vast majority of customers it inherited from Commerce.

TD recently opened its 100th branch in New York City, making it the sixth-largest lender in the Big Apple by retail outlets and the fifth by a measure of retail deposits known as capped deposits. TD has plans to open 50 more branches in New York City and become No. 3 in capped deposits by 2015. Similar expansions are planned for parts of Florida and Boston.

Mr. Masrani said in January he isn't worried by the competition: "When they are closed, we'll be open."

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CIBC’s Stay-at-Home-Strategy Could Prove Costly

The Globe and Mail, Sean Silcoff, 3 April 2013

With Toronto-Dominion Bank CEO Ed Clark announcing his impending retirement, it’s too early to declare TD’s big bold foray into U.S. retail banking a success – returns are still low and it has yet to prove it can increase its relatively weak loan business. But looking ahead, few would doubt the wisdom of diversifying out of Canada, at a time when a long runup in the growth of household debt appears to be peaking.

If a solid Canadian economy and ever-growing borrowing by Canadians has lifted all Big Five banks for years, a receding one will split them into two groups: TD, Bank of Nova Scotia and Bank of Montreal, which are more heavily exposed to growing retail banking operations in the U.S., Latin America and Asia and poised to do better; and Royal Bank of Canada and Canadian Imperial Bank of Canada, which are much more exposed to Canada.

But among the second tier, CIBC would likely stand alone as the clear underperformer in the Canadian recession scenario. Poor CIBC earned a reputation last decade as the bank most likely to run into sharp objects. Then CEO Gerald McCaughey committed to make it the most risk-averse bank of the Big Five by retreating largely to its home market.

Unfortunately, CIBC might have to dust off the Kick-Me sign once again. The low-risk strategy seems destined to put CIBC at the greatest risk among its peers of suffering the worst effects of a drifting Canadian economy, should that happen. Fully 66 per cent of CIBC’s estimated earnings for 2014 will come from the Canadian personal and commercial banking sector – the next highest is Royal at 52 per cent, TD and BMO in the low 40s and Scotia at 29 per cent, according to National Bank Financial analyst Peter Routledge. About half of CIBC’s total assets are loans to households, compared to about one-third or less for other banks.

The biggest risk is CIBC’s credit card portfolio, which stood at $14.8-billion as of Jan. 31. That only amounts to about 6 per cent of the bank’s outstanding loan book, but that is much higher than other banks and accounts for more than 15 per cent of its profits, Mr. Routledge estimates. Typical credit card losses in the 3 to 4 per cent range could easily double in bad times, taking a big bite out of profits. Commercial loans would also likely take a relatively bigger hit than other Canadian banks.

Fear not, this wouldn’t be a crisis situation: CIBC’s earnings growth rate would flag but its capital situation wouldn’t be threatened. Even the worst of the Canadian banks is still a solid performer by many standards. The difference is that three of them have figured out strategies to grow beyond Canada and create substantial long-term value by deploying their capital adventurously. RBC won’t be far behind. At some point, CIBC will have to have to find ways to do the same. The head-in-the-sand strategy worked for a while; perhaps a Canadian recession will prompt CIBC to take a second chance at becoming a first-tier bank again.

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BMO Q1 2013 Earnings

Scotiabank, Global Banking and Markets, 27 February 2013

Event

BMO cash operating EPS increased 7% YoY to $1.52, beating street expectations. The $1.52 includes $0.06 per share related to recoveries on M&I purchased credit impaired loans versus $0.13 per share in the previous quarter and $0.13 per share last year. BMO also announced a 3% annual dividend increase to $2.96 per share from $2.88 per share.

Implications

• Earnings growth was driven by strong U.S. P&C results as credit losses declined; continued strong Wholesale banking earnings driven by solid trading revenue and very strong underwriting and advisory fees, and solid performance in PCG. Lower PCLs in P&C Canada also contributed to earnings growth.

• Wholesale Earnings remained strong, declining a modest 2% from the strong Q4/12, and increasing 38% YOY. P&C Canada earnings increased 4% as solid volume growth of 9% YOY and lower PCLs, helped offset margin compression, with NIM declining by 27 bps YOY and 3 bps QOQ.

• Operating ROE: 14.8%, RRWA: 1.86%, CET1: 9.4%.

Recommendation

• Our 2013E and 2014E EPS are unchanged at $6.20 and $6.60 per share, respectively. We are increasing our one-year target price slightly to $70 from $66 supported by higher dividend. Maintain Sector Underperform based on high relative P/E multiple given its low relative profitability.

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Moody's Downgrades 5 Canadian Banks by One Notch

Scotiabank, Global Banking and Markets, 29 January 2013

Event

• Moody's downgraded the credit ratings of BMO, BNS, CM, NA and TD by 1-notch. The outlook for the banks was set to Stable.

• The downgrades were expected as Moody's had placed the five banks on review for downgrade on October 26th 2012.

Implications

• Moody's highlighted the increase in house prices in Canada, high consumer indebtedness, downside risks to the Canadian economy, and risks inherent in capital markets activity as factors for the downgrades.

• However, Moody's acknowledged the credit strength of Canadian banks, supported by the strength and stability of the earnings generated by their domestic retail banking franchises.

• Despite the downgrades, Canadian banks remain amongst the highest rated banks globally.

Recommendation

• The downgrades are a continuation of the trend by credit rating agencies in downgrading the global banking sector, with RY previously downgraded by Moody's in June 2012.

• We view the downgrades as mildly negative, with no impact on cost of funds and bank share prices. The concerns highlighted by Moody's have been the cause of headline risk for Canadian banks and, we believe, have been fully reflected in bank valuations.

• Maintain Overweight recommendation.

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TD Bank Makes Big Money Off Real Estate Banking

The Globe and Mail, Tim Kiladze, 10 December 2012

The hot real estate market is boosting the fortunes of Toronto-Dominion Bank.

More than any other Canadian bank, TD has tied itself to the real estate market, ramping up corporate lending to the sector and cashing in on a flurry of equity offerings for real estate investment trusts.

As of early December, the bank’s capital markets arm ranks third in the overall equity league tables, according to Bloomberg, but has the highest share of real estate equity deals, topping even league table leader RBC Dominion Securities. In calendar 2012, TD’s share of equity offerings – after splitting co-lead status amongst all bookrunners – is about $1.6-billion. RBC’s share, which is the second highest, is just north of $1.4-billion.

The same story played out last year, as real estate underwriting helped drive TD to the top of the equity league tables.

TD can thank the Dundee family of REITs for its success. Nearly two-thirds of TD’s $1.6-billion share of real estate deals came out of Dundee REIT, Dundee International REIT and Dundee Industrial REIT.

But the bank is also heavily weighted to real estate in its corporate lending book. As of fiscal year end, TD had about $33-billion in loans outstanding to real estate companies, comprising 31 per cent of its total corporate and government loan book. That’s the highest total and percentage in the Big Five. Bank of Nova Scotia’s loans are more heavily skewed to financial services and retail, while Bank of Montreal’s are more heavily weighted toward service industries and manufacturing.

RBC – TD’s biggest rival – currently has about $21-billion of loans outstanding to real estate companies, comprising about 23 per cent of its corporate lending book.

The question now is how much longer the strength will last. While the real estate sector in Canada has been incredibly hot and retail investors still can’t get enough of their REITs, every sector has its ebbs and flows. Nothing stays hot forever. Just look at the dearth of mining deals for proof.

However, on the corporate lending side, about 30 per cent of TD’s real estate loans are to U.S. companies. Expanding that business could pay off if the U.S. real estate recovery takes shape the way so many people expect it to.

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Behind Scotiabank's Global Push

The Wall Street Journal, Caroline Van Hasselt, 5 December 2012

Canadian bankers haven't been shy about seizing on the global financial crisis, snapping up assets from U.S. and European peers scrambling to raise cash. None have done so as aggressively as Rick Waugh, chief executive of Bank of Nova Scotia.

The bank is Canada's third-largest by assets, often overshadowed by its bigger and better-known competitors, Royal Bank of Canada and Toronto-Dominion Bank. RBC is pushing to build a world-class investment-banking franchise, while TD Bank has focused on US growth.

But in recent years, Scotiabank has quietly bought up an international portfolio of personal- and commercial-banking assets far surpassing those competitors, while bolstering its retail presence in Canada. Over the past five years, Mr. Waugh has clinched 30 acquisitions, valued at more than $15 billion, by the bank's estimates.

The buying binge puts Scotiabank at No. 2 in the world, behind U.S. Bancorp, in the number of banking deals since 2007, according to Dealogic. It ranks No. 5 for the period, by value, counting only disclosed deals.

"They have really said, 'We are going to be an international bank and be in a position to take advantage of the growth of emerging markets,'" said Paul Cantor, the former chief of National Trust Co., a Canadian lender that Scotiabank bought in 1997.

The overseas acquisitions have helped boost revenue and profit at a time when Scotiabank — which reports quarterly results Friday — and its Canadian peers have struggled to offset weak capital-markets and wealth-management profits. Domestic, retail-banking profits have been strong, but after several years of low interest rates here, Canadians have loaded up on debt. Many economists say they are now tapped out, with lending recently shrinking. Banks have looked abroad for new growth.

Revenue from Scotiabank's international personal and commercial banking surpassed its Canadian banking revenues last quarter for the second quarter in a row, though the domestic unit remains more profitable. The international unit accounted for 26% of the bank's net income last quarter. Overseas profits have grown 46% since 2007, outstripping the domestic retail division's 30% profit growth over the same period.

Mr. Waugh closed his biggest deal — the 3.1 billion Canadian dollar ($3.16 billion) purchase of ING Groep NV's Canadian unit—just a few weeks after elevating a longtime Scotiabank executive as president. That lieutenant is now widely tipped to take over as CEO in as little as a year's time.

Nearing the end of his tenure, the 64-year-old Mr. Waugh (who turns 65 later in December) has more than doubled the bank's assets to some $700 billion since taking over in 2003. Most of that increase has come in the years following the economic crisis.

Mr. Waugh, in an interview, says his push is an extension of the bank's longtime overseas-focused strategy, based on conservative and local personal and commercial businesses.

"It's very straightforward and conservative, but underpinning it is diversification," he said. "It's having the right risk appetite and staying to your fundamental business."

Mr. Waugh has tended to pick off assets in countries from the Caribbean, where the bank has long had a foothold, to emerging markets from Mexico and Brazil to Vietnam and Thailand. His purchases have come from the likes of BNP Paribas SA, Royal Bank of Scotland Group PLC, and Commerzbank AG, as those banks sought to shore up capital or repay government bailouts.

Scotiabank has also moved aggressively into China, agreeing last year to purchase a 20% stake in Bank of Guangzhou. And the bank already has an 18.1% stake in Xi'an City Commercial Bank and owns a 33% stake in a joint-venture fund-management company with Bank of Beijing Co.

But the strategy also carries risks, tethering the bank's fortunes more than many of its peers to the developing world. "It remains to be seen whether by going into all these different countries, whether that's going to pay off well," said Stephen Jarislowsky, chief executive of Jarislowsky Fraser Ltd., one of Scotiabank's largest investors.

After Mr. Waugh's first job as a Scotiabank teller in a strip mall in his hometown of Winnipeg, he quickly rose up the ladder. He moved to Scotiabank headquarters in Toronto, and then around the bank in several, increasingly senior positions — a way the bank's top management has long tested rising stars.

After taking over international and wealth management in 1998, he impressed then-CEO Peter Godsoe by focusing his energies looking for overseas expansion potential, instead of the domestic market. Mr. Waugh is known to preside over marathon meetings, debating and poring over details of potential deals. He's also notorious for mangling names and phrases and mixing metaphors, malapropisms that have come to be known inside the bank as "Rick-isms."

Despite his push to set Scotiabank up for the future, Mr. Waugh holds on to some of the 180-year-old's bank old-world traditions. He marks up documents in red — a carry-over from a Scotiabank tradition of identifying senior managers' input in paper work by the color of their pencils. His expected successor—Brian Porter, who took on Mr. Waugh's title as president on November 1 — uses brown.

Scotiabank was set up in Halifax, the capital of the Canadian province of Nova Scotia, almost two centuries ago. It financed trade in sugar, rum and fish between the West Indies, the U.K. and Canada. It opened an office in Kingston, Jamaica, in 1889, eight years before opening a branch in Toronto. It now operates more branches overseas than in Canada.

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