October 17, 2024 | An astute reader of The Institutional Risk Analyst asked a while back if Toronto-Dominion Bank (TD) was not taking the place of Wells Fargo (WFC) in the penalty box for big dumb banks. The short answer to that question is “Yes.” WFC is not even out of dodge yet, but TD has cut off several of the fingers of one hand in yakuza style and is now headed for years of misery at the hands of US regulators, the Department of Justice and FinCEN.
Q: Is it time for TD to reassess its US strategy for going big in retail banking?
Call us old fashioned value investors, but TD management deserve the torments of the damned for their business strategy in the US. They have risked a stable, low-beta banking and investment management business in Canada by pouring capital into a group of mediocre US retail banks over the past two decades. And they have sold their stakes in valuable investment advisory businesses.
TD Bank reminds us of PepsiCo when it got into the retail restaurant business decades ago, beginning twenty years of intense value destruction. As long as PepsiCo invested in more Taco Bell restaurants, it looked great in terms of EPS growth. But ultimately the investments in retail restaurants were consuming capital and PepsiCo spun off the restaurant business in 1997 in an act of self preservation.
In fact, the TD retail bank in the US is destroying value with both hands (minus some fingers of course). And the real crime is that other banks in Canada are following TD’s bad example of buying underperforming US retail banks on the way to shareholder value hell. Click the link below to see a history of institutions acquired by TD going back in time to the successor of Penobscot Savings Bank in 1869.
TD Bank US Holdings Acquisitions
Because its undermanaged US retail bank was totally unprepared for a deliberate assault by organized crime organizations, TD must pay a total of $3.1 billion in penalties to resolve its latest management fiasco. This includes $1.9 billion to the Department of Justice in the single largest fine ever imposed under the Bank Secrecy Act. What was the sleepy appendage of an inoffensive Canadian bank doing with branches all over the eastern half of the US? Almost 200 branches in New Jersey alone? Getting targeted by professional criminals for a classic scam.
You could write a great case study of TD about how not to manage KYC/AML risk. In one example, TD reportedly was dupped by drug traffickers who purchased millions of dollars worth of gift cards via a branch in Southern New Jersey over a period of years. Are you shocked? All told, the bank “enabled three money laundering networks to collectively transfer more than $670 million through TD Bank between 2019 and 2023,” says the DOJ.
We’ve long argued that Canadian banks as a group have utterly failed in their attempts to successfully acquire and grow retail banks in the US. There is not a single example going back fifty years where a Canadian bank made a profitable investment in a US retail bank. If we've missed one, please email: info@rcwhalen.com.
Not only is the financial performance of TD’s US units below-average, but the operational risk created by the half trillion asset “retail” bank is off the scale and destroying any value to TD shareholders. TD and the other Canadian banks should stick with retail banking north of the border and global asset management. The chart below shows the ROA of the US unit of TD vs JPMorgan, WFC and Peer Group 1.
Source: FFIEC
Regulators are actually compelling TD to create an entirely new unit to conduct triage and recovery for the US operation when it comes to the two acronyms from the infernal reaches of bank regulation: Know-your-customer (KYC) and anti-money laundering (AML). US authorities have imposed an asset cap on TD’s US operations, a sanction that may actually be a blessing in disguise.
Rather than fighting to remove the asset cap imposed by US authorities, TD should instead take a hint from Wells Fargo and begin to downsize its US operations and shed most of the 1,200 branches and 10 million loss-leading US retail customers. Unlike WFC, which continues to report profits even after seven years in regulatory purgatory, we doubt that TD will ever generate consistent profits from the US bank unit. WFC, of note, has made a virtue of its own asset cap and dramatically downsized, exiting third-party correspondent mortgage.
The chart below shows the efficiency ratio for TD Group US Holdings. Not only does the bank holding company have the highest operating costs of the group, but the variance in this metric is worrisome. Say what you want about the studied mediocrity of Bank of America (BAC), but the results are consistent and reasonably stable. And of course JPM has the lowest cost of revenue in the industry in the low 50s.
Source: FFIEC
How much more capital will Canadian banks shovel into the furnace before institutional shareholders scream? TD recently sold part of its stake in Charles Schwab (SCHW), a disastrous decision for TD shareholders who now face years of sanctions by US regulators without the benefit of the SCHW investment. The fact that TD actually sold some of its stake in SCHW to pay the US fines illustrates a certain lack of clarity on the part of CEO Bharat Masrani and the TD Board of Directors when it comes to shareholder value.
TD Bank US Holdings
Source: FFIEC
TD’s leaders have been talking for years about building a business in the US, but all that they seem to have done is create a vast about of reputation risk for the bank. The US unit now accounts for one quarter of TD revenue, but the operating results for the $540 billion asset TD Bank US Holdings are abysmal. We’ve said on X several times, TD ought to downsize or sell its entire US retail banking operation and throw the proceeds back into SCHW. Why?
First, doubling down on SCHW as an investment is going to be a better risk than buying also ran US retail banks. The list of dreadful crap that has been acquired by TD over the past 20 years is appalling. If we calculate the return on invested capital for TD equity only, the results are in low single-digits. If we also include the cost of the corporate debt, then the numbers get really small. TD could get better risk-adjusted returns on T-bills.
How could the managers of TD ignore the published historical data for US banks showing negative risk-adjusted returns in many years for half of the industry? Buy T-bills or Ginnie Mae pass throughs if you must, but why buy US retail banks at a premium to book value? TD Group US Holdings has $16 billion in goodwill and other intangibles out of $56 billion in total capital.
Second, a significant stake in SCHW gives TD a possible option to buy the whole business, particularly if they stop wasting money on US retail banking. The retail banks that are worth buying are too expensive, but that does not mean we ought to buy crap.
At present, SCHW is worth more than the larger TD Bank and has far more AUM. TD has less than $400 billion in AUM vs over $7 trillion in advisor assets for Charles Schwab. But SCHW’s total balance sheet assets are just shy of $500 billion vs $1.4 trillion for TD.
Source: Google Finance (10/16/24)
TD is in for a long grind to get through the US regulatory sanctions. In the meantime, we think the Board of TD Bank needs to do some serious soul searching about the nature of shareholder value, especially adjusted for risk, based upon a US retail banking franchise. Given the huge focus on a retail consumer risk model, if TD were not being tormented for KYC/AML violations, it would be something else. Consumer risk in retail banking and mortgage lending is toxic. Investment management is lower risk and better returns. And SCHW is not the only large bank with a focus on investment advisory business in the US.
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