Toronto-Dominion Bank Earnings Call NUGGETS: Litigation Risk, Mix Impact on Mortgages

On Thursday, Toronto-Dominion Bank (NYSE:TD) reported its third quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Litigation Risk

Michael Goldberg – Desjardins Securities: I always get cut off with one question, so I am going to give you a two-parter. To what – Michael Goldberg, DesJardins Securities. To what extent is a make versus buy decision shake the U.S. Bank acquisition decisions and I guess there’s a couple of situations recently where that question might be addressed. And secondly, with your litigation experience and the recent Samsung decision in the U.S., how do you feel about litigation risk going forward?

W. Edmund Clark – Group President and CEO: We’re always happy, to give you Michael two shots here. So I would say the make versus buy really haven’t – we haven’t really moved up the paradigm. I think we’ve after we got the Commerce deal and then I think supplemented by the South deal and the FDIC deals, we believe we got our U.S. platform to a strategically viable size and that we weren’t endangered. And as you know, my view has always been to go in the United States, you definitely have to get to a certain size in order to say competitive, and having got that with the platform, and the second component of that is also to run the bank like a North American bank rather than a Canadian bank that happens to own a U.S. bank, so that you will see that in our card strategy, you’ll see that in our auto loan strategy, you’ll see that in our direct bank strategy where we’re really spreading the class of investment across a retail earnings bases that’s the largest retail earning base in Canada by a significant margin. So, I think we don’t believe we’re strategically challenged for size. Obviously, if we want to continue to grow and deepen the franchise, but we really look at acquisitions and say, what’s the cost of growing by buying and what’s the cost of growing by building? And if we can’t – buying is not cheaper than building, I think if anything we’d have a preference to build rather to buy because you know exactly what you’re building when you’re building whereas when you’re buying, you get a lot of other things that you wouldn’t have built, and so I think that’s how we tend to look at it without (indiscernible) specific, we have an active corporate development group that looks at everything. It certainly turns down at least nine things for everyone that it does probably in the numbers 90 for every 95 for every 100 that it looks at. So, they are very, very disciplined and so we obviously decided to pass on the acquisitions that happened, it’s not like everybody wasn’t aware of all these acquisitions, and so from our point of view, they just didn’t make sense. In terms of the litigation atmosphere in United States, I think when you go into the United States, you’ve got a regulatory environment that’s different than you would feel in Canada and the litigation environment that’s different than you would feel in Canada. And if you’re not up to that environment, then you probably should get out of the kitchen, and so I think there’s an element in you just have to accept that there is an environment where you may have the better part of the law which won’t necessarily – you’re going to pay a price if you don’t in fact deal with that. So you’re trying to get the right balance in what cases to try and what cases not to try and so when we look at our situation, we’re not – we don’t find it at this stage an overwhelming burden, but it’s obviously an irritation to us to have these kinds of litigation charges.

John Reucassel – BMO Capital Markets: John Reucassel, from BMO Capital Markets. Question for earlier Colleen or maybe Tim and Bharat, but I think we’re four years now into the very low interest rate environments that central banks have talked about. So, is the NIM pressure greater today than it has been or is it about the same, and if it’s the same, it seems you’re being more cautious on NIMs today than you have been in the past? Could you just explain why the pressure is greater today than has been in the past?

Tim Hockey – Group Head, Canadian Banking and TD Auto Finance; President and CEO, TD Canada Trust: So, why don’t I start from the Canadian perspective. I’m not sure that the NIM pressure is any greater. The competitive environment depends on the product and on the day and the month and the competitor goes up and down. I think what we’d be seeing today is even though we’ve gone through four years of low interest rates the outlook for when that might turnaround continues to lengthen out and so we’ve – it’s not that we’ve lost faith. We’re suggesting that it’s probably not right to hope for a higher interest rate environment in the next level also when we see an outlook, it’s pretty clear that as we said earlier revenue is going to continue to be at low rates, not just because of margin pressure, but because we’re also seeing the asset growth slowdown at the same time so we better plan for that and bring our expenses down accordingly. But it sure feels like NIMs in Canada will continue to drop down by ones and twos per quarter over the foreseeable future.

W. Edmund Clark – Group President and CEO: I agree completely with that, but I think if you want to get a sense of how we see the world. I think the core way is to look at the five-year either U.S. Treasury rate or five-year Canadian rate. And the reality is five year rate today is significantly lower than it was a year ago. If there has been a sea change in the last couple of years, by four years. The European crisis has clearly changed interest rate environment for negative and I think, if you have a view that the European crisis isn’t going away quickly which I would subscribe to that just push across the world a pretty heavy downward pressure on interest rates. So rates have actually fallen significantly in the last 18 months. I think if you want to watch our mood watch that rate.

Mark Chauvin – Group Head and Chief Risk Officer: Just to add, there is a lot of focus on the volatility in the NIM numbers out of the U.S. and to some extent that is to be expected there is acquired loan accounting. So there is always noise in that number as Ed said and Tim said on the deposit side obviously you feel this effect of lower rates and we’ve been saying that that isn’t a real effect. The good thing is on the asset side, I think it’s hanging in there in the U.S. and in our case as you know we’ve been growing our loans faster than deposits. So from a fundamental perspective, I feel good about that and have also noted for many quarters now that because of the noise and the way we’re repositioning our business from a loan perspective you should expect the range to be somewhere (350 and 375). John, I think we’ve talked about this in the past. I think that continues to be applicable, but you continue to see noise in the number, but the pressure from a low interest environment on the deposits side is there.

Mix Impact on Mortgages

Gabriel Dechaine – Credit Suisse: Just on the – well we’re talking about NIM in the U.S. there. So 15 basis points down quarter-over-quarter, I guess than over half of that’s from related to acquisition accounting, but the other half. If you can kind of break it down into what’s coming from the competitive pricing environment, what’s coming from the change in your mix and how much of that’s coming from your securities portfolio? Then just on the mortgages in the U.S. as well, you are one of the few banks or maybe few is an exaggeration, but one of the banks that is actually keeping the mortgages on balance sheet rather than selling them. Can you explain to me in your very simple terms how you’re managing the interest rate risk if you are growing U.S. mortgage book?

W. Edmund Clark – Group President and CEO: First on the margin, yes I think for the most part, I think directionally your numbers are correct. Mix does impact a lot and mortgages come in at a lower spread than commercial loans do. So depending on what kind of generation we had in one quarter you are going to see volatility around that, investment portfolio obviously, some of those investments as they roll, they’re rolling at a lower rate, so there would be some noise on that as well, but as I indicated earlier — and our hope is that we are rolling less of those investment portfolio of components as we continue to grow our core loan business and I think you’ve seen that in the U.S., so those are the moving parts and that’s why I said to focus on that number is right, but to try and get a level of precision is very difficult. There is also somewhat of an offset in the non-interest income as we’ve talked before, we have lot of optimization initiatives in the U.S. to increase our free income in response to Durbin, and Reg E, as well as the low interest rate environment because as you’ve seen with many banks that the amount of minimum deposits you have to hold before you start to charge fees has gone up, so those are industry trends that the system is adjusting to offset some of this pressures. On the second part of your question.

Gabriel Dechaine – Credit Suisse: Before we move on to that the range you gave is fairly wide, the 350 to 375. What would cause (it to shrink) that much and should we think of it more in the low-end of that range for next little while or is it just going to bounce around a lot?

Mark Chauvin – Group Head and Chief Risk Officer: I think it will bounce around a lot. Last quarter I think people were realistic that the margin had gone up by 10 basis points or whatever, so it will bounce around a lot. Acquired loan accounting is a factor in that and this time it’s about half and sometimes it’s higher and sometimes it’s lower, but I think trying to stay within that range is the appropriate way to do, but it will bounce around, but I’m comfortable that the range is an appropriate range given what we know today. On the second part, we have talked about why we are benefiting and why we are one of the few banks that is benefiting from the refi boom. With the lower rates there is a huge refi wave going on. As I’ve said before, we did not have in the U.S. any meaningful mortgage business through the legacy acquisitions. We build out a new platform. We have many, many customers that love the wealth service, that love our offering, and as they refi their mortgages which are elsewhere, they would like to give a shot to TD and they’re happy with the service and the products we have and the servicing we provide. So overall, we’ve been a big beneficiary of that as most of the refis that are happening — are not happening in our book. We’re benefiting from other banks refinancing activities. So that’s the reason why mortgages are going up. In our product offerings, we work very hard to focus on products that carry less interest rate risk. So, for example, lot of our originations come in 15-year product, instead of the 30-year product. There is a large demand as well for variable rate mortgages as well. So, that’s a benefit from an interest rate risk perspective. Thirdly, if you look at our overall balance sheet in the U.S. and more importantly for the TD Bank Group balance sheet, the amount of this mortgages we are keeping on balance sheet and the level of risk in that is manageable. In fact, there are offsetting parts within our own balance sheet that helps us to mitigate some of the risks that might come through this particular type of risk. So again, like you said in simple terms that would be the answer. If you do want to have more detailed and technical discussion, we can set up an offline call with you. But overall, feel very comfortable that this is still a relatively small part of our balance sheet. If it becomes meaningful, then obviously you may see a different form of strategy from TD in managing this book.