Am I good to go? Okay. Good morning, everybody. My name's Darko Mihelic. For those of you who haven't met me, I'm the Research Analyst in Toronto. I cover the Canadian banks and the Canadian life insurers. Welcome to the session. We're excited to have Kelvin Tran, the CFO of TD Bank here.
Good morning.
For those of you who follow Canadian banks, we reported earnings just last week, so this is going to be a bit of a, I don't know, like a second kind of earnings call, maybe with some follow-ups in there, a few longer-term questions I'm going to throw in too just for some added spice. Before we begin, I've been asked to tell you that Kelvin's comments today may include forward-looking statements. Actual results could differ materially from forecasts, projections, or conclusions in these statements. Listeners can find additional details in the public filings of TD Bank Group. Kelvin, with that out of the way, thank you for joining us this morning.
Thank you for having me.
Last week, just before the call, I got some news through the FHN filings, and I'd appreciate we probably, unless anything's changed, we're probably not going to talk too much about the process there. I did have a couple of follow-up questions that I thought would be useful. One of the things that I get the benefit of is my colleague John Armstrong covers First Horizon, so I get to flop that in my model, throw in some expense synergies, and call it a day. Stuff must have changed, and now potentially this deal could go much further into the future than in the past.
Is there anything you could tell us about and if you don't want to tell us numbers, that's cool, but maybe talk about some of the things that might be changing with respect to the original expense synergies or any other assumption that may be interesting for us with respect to First Horizon?
Sure. Good morning, everyone. It's great to be here. Like you said, I think the main benefits continue to be there. We're very excited about the deal. When you see some of the moving parts, you would have seen it in the recent results from First Horizon. They continue to benefit from the rate hike. You see expanding margins, higher NII. As expected, when rates rise, you have a negative impact on other businesses like the mortgage warehousing business. You see that as kind of an offset, but that's expected on a diversified business. There are some puts and takes there. In terms of the expense synergy, the number is still the same, but it gets delayed a little bit. Also, I would say that what we keep our eyes very closely on is the impact on goodwill.
We talked about that on the purchase price equation, where with rising rates, we would have to have a bigger fair value decrement on the loans that we booked on closing. That would have an impact on goodwill, but that accretes back over time in benefiting the P&L. Those are all the different moving parts that we're looking at.
That brings to mind the hedge, right? You've implemented a hedge, but presumably there would have been, I don't know, some time horizons, some duration stuff on the hedge. Is there anything changing there with respect to the hedge, especially if this deal was delayed significantly?
Well, what we do is we continue to monitor the book of First Horizon and refine, modify, and extend as appropriate. I know there are questions on the call, even with the investors, say, "Well, what happens to the hedge if we don't need it?" I would say it's very similar when we don't need the hedge, whether on close or not. What happens with that is that when we don't need the hedge, we unwind the hedge at that point in time, and we put on a new hedge. At the end of the day, it's just a timing difference, right? Overall, cash-cash, cash-to-cash is net neutral for the portfolio. Assuming rates continue to stay at this level or have risen, then the gains that you would have seen book-like today would be there.
With the swap coming in at a higher rate, you would have a negative carry over time, effectively unwinding that cash. It's really a timing difference from a hedge perspective.
There isn't really any difficulty in managing this hedge over time with an uncertain time horizon?
Correct. We just continue to roll that. We have a lot of smart people, and some of them are in this room.
Okay, great. Maybe they can pipe in. Of course, it brings about the other question, which is the other side of this, which is, what if the deal doesn't close? You're carrying a lot of excess capital. What's plan B? Is there a plan B? I'm sure there is, but I'm not sure that you're willing to talk about it. What can you tell investors who are thinking about the possibility that First Horizon doesn't actually close?
Well, we're very committed to the transaction, very focused on that, and we're working really hard to get the deal closing as soon as we can.
Okay. We don't want to talk about the possibility of $13 billion or whatever price. I think price is changing. What about that mechanism for the price to increase past May 27th?
What do you mean?
The role of the as we got past February, I think you renegotiated to the end of May 27th. Once again, when you think of the purchase price of FHN, is there a running meter that would cause a rise in the price to purchase FHN if it was December?
Well, we have the what do you call it? ticking fee, right?
Ticking fee. That's $0.65.
Sorry, I'm looking for it. $0.65 on an annualized basis that discloses in our filing. That's something that we look at. Every month that passes by, we continue to add to our book value as well.
Okay. All right. Well, we'll pull the audience later for questions, but hopefully that kind of gets that sort of out of the way. Now we can talk a little bit more about what the quarter was like because I felt like it was a good quarter, maybe a little overshadowed by all the FHN stuff.
We're very pleased with the quarter.
Maybe first, I wanted to chat a little bit about risk-weighted assets. There's a bit of an increase. You talked about some of the things in there. One of the things that I've had a lot of questions from folks is the possibility of negative migration happening in as we perceive maybe a mild slowdown coming here in North America economically. People talk to me about the threat of RWA migration. Can you give me a touch on that, and what are your views on RWA, possible migration? I have a bit of a follow-up, maybe a tag-end to the quarter on the Stanford litigation because one of the things that the Stanford litigation cost does under the newer rules is it creates higher operational risk. Not sure if that's material or not.
Maybe you can weave in RWA migration and then talk about the potential for higher operational risk going forward.
Yeah, yeah. Sure. The credit risk migration is really dependent on the economy and how your exposure plays out. We've taken that into account in our forecast. The comments that we've made last week have built in into our forecast, credit risk migration. I would say we are confident that our allowance for credit losses is adequately reserved. When you talked about what was your other question? The Stanford. That is already also taken into account. In Q2, when we implement operational risk and credit risk under Basel III, the net effect is very small either way, positive or negative. A negative on the operational risk side and then positive on the credit risk.
Okay. That was included in the overall discussion, fair enough?
Correct.
Okay, great. Moving quickly on to some of the other fundamentals in the quarter, I wanted to talk about loan growth in Canada. One of the things that we noticed with respect to TD is slightly less growth than peers. Certainly, we've been noticing that with mortgages for some time. There was a bit of a pickup, and now it's sort of peeled back a little bit. Maybe you could talk a little bit about loan growth and touch on all important loan categories. First, let's kick off with mortgages at the start.
Sure, sure. I mean, there was a slowdown in RESL in the quarter, and that was a cautious business decision that we made given the margins that we've seen in certain segments. We've made some business decisions close to the end of last year, and obviously, that would have impacted funding throughout this time, including Q1. If you look at Q1 spot year-over-year, spot to spot, we were about third in terms of relative peer comparison for RESL. We continue to see a good pipeline there. We're happy with it. In terms of other loan categories, we continue to see good spending on credit cards. Paydown rates are still high but normalizing, and so we expect that to continue to grow and also add to not just the volume and margin as well because they are higher margin business.
Business banking loans continue to hit double-digit growth year-over-year, and that's something that we're monitoring given the economy, given the need to invest in inventory. The cost is high now for people to make a decision on, "Okay, well, do they want to stack up more on inventory because of potential supply chain disruption?" Rates are higher, so it costs more. Businesses are thinking about that.
Now flipping to the U.S. quick on the loan growth side, you had some PPP loans in the commercial. Can you talk a little bit about that outlook as well with respect to the U.S. business?
I mean, the PPP loans were really important for our customers. We wanted to be there for them in their times of need, and being able to support them is really important to continue to build that franchise relationship. We were, I would say, over-indexed a little bit compared to our peers on PPP loans. When you compare the year-over-year changes, that would have been the impact. What you've seen our peers do is that they're more indexed in C&I loans and middle market. That category was significantly impacted by the pandemic. You actually see a bigger retrenchment and then a bigger pickup, whereas us were more a gradual decline and now picking up as well. If you look at over the last few quarters, we've been picking up momentum, seeing good credit utilization, and continuing to acquire new customers.
It begs the question with your as I hear that, it begs the question of what is your longer-term strategy with C&I, and does that become a bigger focus point for TD Bank Kelvin ?
Yes, it absolutely is. It becomes a bigger focus point for us. We don't swing for the fences. We do things gradually. We invest, acquire core customers, and we're definitely seeing the middle market and C&I loans growing as a proportion of our total loans. With the acquisition and closing of Cowen, they are also in that space, and so we see synergies and potential there as well.
Switching to deposits, we just had Comerica here in the session just before this one. We spoke about deposit beta. I wanted to talk a little bit about your deposits in the U.S. because you have a significant chunk of sweep deposits from the Schwab arrangement, plus you have very good core deposit base in the U.S. Maybe you can talk a little bit about your margin outlook with respect to the strong funding source that you have and your view on deposit beta in the U.S. and maybe how your NIM will evolve in the U.S. for the rest of the year.
Sure, sure. I mean, we have a strong deposit franchise business, as you mentioned. because of the customer convenience and our distribution channel, we don't need to lead with pricing. we're obviously very conscious about the dynamics, competitive dynamics in the industry, higher beta that you see. we want to make sure that we're competitive as well to our customers. what we're seeing is that we continue to acquire new customers, so adding new customers, volume to our franchise, and then be conscious about the pricing. we're seeing customers also very similar to the industry migrating from non-interest bearing deposit to interest bearing deposit and from non-term to term. that's what we're seeing as well. the dynamic is slightly different from personal versus business. A lot of our business owners are also clients of our wealth business because they have succession planning needs.
They have other financial planning needs. We're working very closely with our partners in wealth to make sure that we retain those customers within the TD franchise.
Are you talking both sides of the board there or specifically?
Well, I was more focusing on the U.S. When we look forward, deposits ex-s weep is how we look at it. It's kind of, I would say, flat quarter-over-quarter. We're seeing more a shift from non-interest bearing to interest bearing.
Is that shift faster in the U.S., or is it faster in Canada?
Well, I think the timing differs. What do you see in terms of beta historically and as it plays out in this cycle as well is that when rates rise, the beta in Canada was earlier to react, right? The Canadian dynamics is they're earlier to react, but they are more gradual over time, whereas the U.S. data, there's a lag, and then there's a bigger shift. I think that's what you're seeing in the dynamics in the U.S. right now is that there was a period of lag, and now you see a bigger shift in the U.S. Obviously, something we're monitoring very closely. We're introducing new products to make sure that we remain competitive in the market.
With respect to that sort of dynamic on the deposit side and sort of therefore, one of the discussions we had in the call was your NIM and with respect to, well, what can we expect for future NIM expansion? I think you guys touched on your securities book and your tractoring. Maybe you can just go over that a little bit because I think some other Canadian banks do things a little differently. Maybe we can chat a little bit about weaving in your tractoring and how that should still support some NIM expansion despite the changing deposit beta dynamic.
Right. Sure, sure. If you look at our deposit base, a lot of it is savings deposits that are more float-type exposure. Because of that, we invest that excess cash into float-rate investment. That's why when you saw over the last year 75 basis point increase or 50 basis point increase, you see a rapid rise in margin. Rightly so, the question now is if the next few moves are either a pause potentially in Canada or smaller increases, I guess it depends on what Powell says right now, that you would expect slower margin expansion. I would note that when you look at the margin, it's a total encompassing margin, right? You should also have loan pricing competition there as well.
Over the last few quarters, while deposit margin has been expanding, there continued to be competition on the loan side, and loan margins have depressed a little bit. That was an offset. Then you'd also expect that as products like deposit migrate from savings account to term deposit, and term deposits are lower-margin products. That would have an impact. I'll talk about it more in the near- term. In the near- term, you would expect the margins to bounce around a little bit because of some of these dynamics. In the, I would say, the remainder of 2023, if you look at a little bit longer-term horizon, that's where our tractors come into play. Tractors, for us, means a laddered bond portfolio, right? These are stickier deposits for a longer- term.
What we do is we invest into them, into either a five-year investment in Canada or swaps equivalent or seven years in the U.S., and then they reprice. As the investments or swaps mature, the rates that we invested in back five or seven years ago are lower than the rate that we would put on today. As they reprice, even if rates remain the same, it would still be supportive to margin expansion but much more gradual, right, because they're much smaller over a five or seven-year term horizon, and that would continue to support margin.
It's fair to say over a five-year horizon, every month, 1/60th of the book is more or less repriced. Is that tightly structured, or?
It's fairly tight.
Okay. All right. Oh, of course. Maybe then just moving on to because I'm very mindful of the time. I wanted to talk on a few other things here. Of course, when you want technology to work, it's not going to help you.
Well, do you have a note that said, "Cowen, you look great today. Bye." Feel free to elaborate.
I wanted to jump back to. I apologize. This is something that's sort of come up more recently with respect to the mortgage scenario in Canada. I wanted to sort of come back to mortgages. I apologize for bouncing around a little bit because this is something that's just recently come up. Essentially, what we're seeing in Canada, as we all know in the room, Canadian mortgages are structured a little bit differently. Interest rates went up pretty quickly. We now have some mortgages that are variable rate and significant variable rate mortgages that were put on books by all Canadian banks in 2021, 2022, and now we've had a very big increase in rates. We're now in a spot where some of these mortgages are negatively amortizing. I believe one bank has put out some information on that.
I can't imagine for a minute it's just one bank. Let's think about the industry as a whole and think about TD within this industry, a very large mortgage provider in Canada. Presumably, you two would have negative amort mortgages on the books. I don't know if you're willing to disclose how much or where we're at, but can you talk a little bit about that phenomenon and why or why not it should be concerning to investors?
Yeah. We monitor that very closely as our peer banks. The credit quality is strong. In Canada, the qualifying rates, our regulators have made sure that there's a stress testing buffer from that perspective when these consumers qualify for the mortgages initially. I think that's a good buffer there. Also, less than 1% of our RESL portfolio is uninsured, have a bureau score of less than 650, and a loan-to-value ratio of more than 75%. What we consider higher risk is contained. Also, we work very closely with our customers. We proactively reach out to them with the rising rate environment and work out and say, "Hey, what options do they have?" Provide guidance, and we're encouraged to see that they are taking action, whether it's they're putting a lump sum payment, they're changing their payment schedule.
Also, we continue to do stress testing and scenarios, and that gives us comfort that it is manageable.
What is the most I mean, presumably, you're having these conversations. What is the most likely scenario? What is the customer telling you more often than not, "Yeah, you know what? I'll put more money down," or, "I'll change my I'll agree to a higher mortgage payment"? What is the most likely and most often kind of reaction from your customers who are paying?
It really varies. It depends on the consumer and their personal situation. We take comfort in our stress testing and our reserve methodology, and we take that into account in our allowance for credit losses. I mean, our allowance today, as you would know, is 12 basis points higher than pre-pandemic. We're adequately reserved.
Is there a potential that it, I mean, if rates stay high, there's also the fixed book, and there's the variable book? There's the fixed book, which will presumably 2025, 2026 start to kind of roll and face potentially significantly higher interest rates. Are we just putting off a potential problem, or is this also something that's built to, I mean, because I think five years out, your ACL would really not have a lot of migration for stuff that's that far into the future? I think the concern will be is, okay, there's nothing imminent this year. Is there an issue three, four years down the line if rates stay high?
Well, we've always said the way to not get into trouble is to not get into trouble in the first place. We have robust underwriting standard through the cycle. We don't swing for the fences just because it's bull market, and we don't step back just because it's a bear market. That is the best protection that you have, is to make sure that you are lending to quality borrowers. The best indication continues to be unemployment rate, and people in that market continues to unemployment continues labor market continues to be very tight. We'll continue to work with our customers and monitor portfolio very closely.
Okay. I'm going to poll the audience. If there's any questions that anybody wants to lob up here, there's a hand up right there.
Thank you. I think you and your peers have talked about the ongoing remix from checking and savings product into term and that being one of the bigger drags on that long-term NIM grind-up that you and peers will experience. I just wonder if you could talk about the limits of that and kind of what. Of the process. You can't buy a gig twice, I suppose, with the same dollar. Thank you.
Yeah. Well, I think what our focus is making sure that we provide the right advice and the product for our customers and that our pricing remains competitive. We expect to see that migration over time because rates continue to rise. You could see that migration also occur. We just manage it appropriately, and we'll adapt to the situation at that moment.
Okay. No other hands in the audience. I wanted to get back to capital, which was a big discussion on the conference call. You'd mentioned that you're guiding towards or working towards a 12% Common Equity Tier 1 ratio. I think you'd mentioned midway through next year. I think that was the view? The question sort of jumps up, why 12, right? Minimum's now 11. Most of the time, banks operate at 50 basis points above that. What is it that's driving you to go to 12?
I don't want to speculate on the regulatory requirements. I think 12 is a good number. Given what we're seeing in terms of the environment, we continue to forecast conservatively. As we talked about on the call, we have strong internal capital generation. Every quarter that passes by, we would add to our capital ratios. On top of that, we have flexibility. We have levers. We've shown that we could deploy that, right, whether it was reintroducing the DRIP discount, whether it was selling investments that are high RWA consumption that are not impacting our core franchise, whether they are risk transfer trades. For the Cowen acquisition, we sold down some Schwab shares to fund that. We have a lot we generate strong internal capital, and then we have flexibility.
We feel very good and comfortable with that given the outlook.
It begs the question because the one thing that's been on my mind ever since the regulator increased the DSB buffer all the way up to a maximum of 4%. In my mind, I think to myself, if a regulator pushes that out to 4%, eventually, they're going to get you to 4%. How do you think about that from a longer-term perspective of managing the bank? Do you think that it's reasonable to assume that if the economy doesn't really slow down, we somehow manage a soft landing, Goldilocks kind of environment, that we're eventually going to go all the way up to the 4% DSB, and that's just going to push you even higher?
Well, the regulator has said publicly that this is not dead capital, right? We take comfort in that. Like any organization, we would adapt. We manage our bank with enough flexibility that we can adapt with changing environments.
Okay. Any last questions before we got three minutes left. Cowen, you've been ripping through my questions really quickly. Is there any other questions before I sort of wrap it up here to the crowd? No. You're satisfied this morning, Cowen, so it's great. The last question, I guess, I have for you.
I thought that was the last question.
Oh, no. Sorry. I meant.
Oh, okay. Oh, okay.
I meant one last question, one from the crowd. Sorry. When we sit back and we think about TD's overall North American strategy, you're clearly acquiring First Horizon. You're committed to the deal. That very much is clear. I mean, once you actually close the FHN acquisition, the question then becomes, sure, we've got a couple of years of integration work. I'm sure you all were prepared for that. It begs the question of the longer- terms for the strategy beyond First Horizon, which is wealth. Where do you stand on the wealth buildout, so to speak, in the U.S., knowing that you have a shareholding in Schwab, but beyond that? How do you view I mean, is it simply that what we do in Canada is what we want to do in the U.S., or is it a little more nuanced than that?
Well, we like the wealth business a lot. It generates consistent, high ROE returns. Right now, we're building that organically, but we're always open to opportunities if they arise. It's a great business to be in.
Okay. All right. Well, with that, we've got the screen turning a different color on me, and we'll wrap it up here. Cowen, thank you so much for being part of the conference.
Yeah. Thank you.
Appreciate it.
Yeah.