Earnings Call Transcript
TORONTO DOMINION BANK (TD)
Earnings Call Transcript - TD Q3 2022
Operator, Operator
Good afternoon, everyone, and welcome to the TD Bank Group Q3 2022 Earnings Conference Call. I would now like to turn the meeting over to Ms. Brooke Hales. Please go ahead, Ms. Hales.
Brooke Hales, Investor Relations
Thank you, Operator. Good afternoon, and welcome to TD Bank Group's Third Quarter 2022 Investor Presentation. We will begin today's presentation with remarks from Bharat Masrani, the bank's CEO, after which Kelvin Tran, the bank's CFO, will present our third quarter operating results. Ajai Bambawale, Chief Risk Officer, will then offer comments on credit quality, after which we will invite questions from pre-qualified analysts and investors on the phone. Also present today to answer your questions are Michael Rhodes, Group Head, Canadian Personal Banking; Paul Douglas, Group Head, Canadian Business Banking; Raymond Chun, Group Head, Wealth Management and Insurance; Leo Salom, President and CEO, TD Bank, America's Most Convenient Bank; and Riaz Ahmed, Group Head, Hotel Banking. Please turn to Slide 2. At this time, I would like to caution our listeners that this presentation contains forward-looking statements that there are risks that actual results could differ materially from what is discussed and that certain material factors or assumptions were applied in making these forward-looking statements. Any forward-looking statements contained in this presentation represent the views of management and are presented for the purpose of assisting the bank's shareholders and analysts in understanding the bank's financial position, objectives and priorities, and anticipated financial performance. Forward-looking statements may not be appropriate for other purposes. I would also like to remind listeners that the bank uses non-GAAP financial measures such as adjusted results, to assess each of its businesses and to measure overall bank performance. The bank believes that adjusted results provide readers with a better understanding of how management views the bank's performance. Bharat will be referring to adjusted results in his remarks. Additional information on items of note, the bank's use of non-GAAP and other financial measures, the bank's reported results and factors and assumptions related to forward-looking information are all available in our Q3 2022 report to shareholders. With that, let me turn the presentation over to Bharat.
Bharat Masrani, CEO
Thank you, Brooke, and thank you everyone for joining us today. Q3 was a good quarter for TD, earnings increased 5% to $3.8 billion, and EPS rose 6% to $2.09. Revenue grew 8% year-over-year, reflecting increased customer activity and the benefits of our deposit-rich franchise. Credit quality remained sound and we continue to build a bank of the future with investments in frontline colleagues and data and mobile capabilities. The bank's common equity Tier 1 ratio ended the quarter at 14.9%, reflecting robust organic capital generation and the activation of the DRIP discount last quarter. A long track record of delivering consistent earnings growth has positioned TD to close two strategic acquisitions, First Horizon and Cowen, while remaining strongly capitalized. We expect TD's common equity Tier 1 ratio to be comfortably above 11% post-closing of both transactions. Overall, I'm pleased with our results this quarter. They reflect the benefits of our diversified business mix and North American scale, while maintaining our risk discipline. Let me now turn to each of our businesses and review some highlights from Q3. Our Canadian retail segment earned $2.3 billion with record revenue of $7 billion in the quarter. The personal bank performed well. We saw industry-leading market share gains in non-term deposits, contributing to 8% growth in personal deposits year-over-year. In our real estate-secured lending business, volumes were up 3% from Q2, a second quarter of very good sequential loan growth demonstrating momentum from our investments across frontline sales channels, operations and account management. We remain confident in the quality and mix of our real estate secured lending book supported by prudent underwriting practices. Our cards business continued its strong run with loan volume up 10% year-over-year on record spending. Last quarter we spoke about the Next Evolution of Work, or NEW for short. The NEW model enables us to deliver innovations faster, deploy technology more efficiently and continue to meet and exceed the rapidly evolving expectations of our customers. The Canadian Personal Bank delivered several key initiatives this quarter leveraging the NEW model, including migrating its flagship mobile application entirely to the public cloud, enabling our teams to drive customer-centric innovations at the speed of the market. The Next Evolution of Work also powered enhancements for our new to Canada customers, where we delivered our strongest quarter to date in new account acquisition. In Business Banking, TD again achieved double-digit loan growth driven by strength across Canada in verticals including commercial real estate, agriculture, middle market, dealer financing, and small business banking, demonstrating our commitment to grow with our clients over the long-term. In our Wealth business, TD Asset Management, already the number one Canadian institutional asset manager, grew its market share and remained focused on delivering for its clients with 90% of managed funds AUM ranked in the first or second quartile in three-year performance. And TD Direct Investing was recognized as the number one online broker in Canada in MoneySense magazine's 2022 review. In our insurance business, we opened a 24th location of our best-in-class auto centers, further extending our ability to provide superior customer experiences through a one-stop-shop while managing claims costs in the face of inflationary pressures. Turning to the U.S., our U.S. Retail Bank had record earnings of USD 913 million for the quarter. Commercial loan volumes, excluding PPP runoff, accelerated their momentum, increasing 3% quarter-over-quarter, reflecting growth in middle market and specialty lending. We saw robust personal loan growth of 8% year-over-year driven by increased customer activity and moderating paydowns. Retail deposits also grew 8% year-over-year, as customers continue to entrust TD Bank, America's Most Convenient Bank with their business. To further enhance the customer experience, this quarter the U.S. Retail Bank launched TD Workshop, which combines a fully functional store with space designed for researching, collaborating and bringing the community together. The information collected at TD Workshop will help inform how TD evolves its interaction, store format and the financial services offered to our customers. Our retail card services business established financing partnerships with home furnishings brand RH, formerly Restoration Hardware, and jewelry retailer Blue Nile, to launch private label credit card programs. In addition, for the third year in a row, TD Auto Finance received the highest ranking in the J.D. Power U.S. Dealer Finance Satisfaction Study. With the contribution from our investment in Schwab of USD 226 million, segment earnings were USD 1.1 billion this quarter. Before we leave the U.S. Retail segment, I want to provide an update on our acquisition of First Horizon. We were pleased that our commitment to the communities we serve was reflected in the support we heard for the transaction at the joint public meeting held by the Federal Reserve and the OCC on August 18th. We are excited about the benefits that our combined banks will deliver for all of our stakeholders and continue to expect the transaction to close in the first fiscal quarter of 2023. Turning to our wholesale banking business, net income for the quarter was $271 million, a decrease of 18% compared to the third quarter last year reflecting continued investments in our U.S. dollar strategy, including the hiring of banking, sales and trading and technology professionals. Revenue was roughly flat year-over-year, as the impact of weaker underwriting environment was offset by strength in other parts of our business, including higher trading and net interest income, again reflecting the benefits of our diversified business model. This quarter, TD Securities was named the Canadian FX Service Quality Leader for Corporates in 2022 by the Coalition Greenwich Study for the third consecutive year as the wholesale bank continues to lead in the Canadian market. As I said on our call earlier this month, the acquisition of Cowen will build TD Securities’ strong foundation. This combination will further accelerate our growth in the U.S. and position TD Securities as an integrated North American dealer with global reach. We're incredibly excited about this opportunity and we have heard from many TD Securities and Cowen clients and colleagues that they are equally excited about the combined offering, added scale and capabilities. We are delighted with the enthusiastic support for this strategic transaction and have already started work on our integration plans, ahead of the anticipated closing in the first calendar quarter of 2023. Three quarters into fiscal 2022, we have made significant strategic progress and seeing positive momentum in our businesses. As we enter the final quarter of the year, we continue to navigate heightened uncertainty in a volatile environment. We will maintain our prudent approach and focus on building our business for the future and delivering long-term value for our shareholders, united by our purpose to enrich the lives of our customers, colleagues and communities. That purpose comes to life in our business and in how we engage with all of our stakeholders. We continue to strengthen our brand as an employer of choice, attracting fantastic talent to the bank. This quarter, TD Bank, America's Most Convenient Bank was recognized by Forbes as one of America's best employers for women. And in partnership with the Black Professionals in Tech Network, TD recently announced the launch of Obsidi Academy and Engineering Bootcamp for black individuals to help them build careers in technology. We will hire program graduates in cohorts over the next three years. We have also committed $1 million to organizations working here and overseas to assist refugees to help them settle in Canada. In addition to this financial commitment, TD is hiring arriving Ukrainians for roles at the bank, helping to provide meaningful employment and stability upon arrival in Canada. TD colleagues are committed to the communities in which we live and work. Recently, our digital and research teams volunteered their skills in customer experience and design to help the WellSpring Cancer Support Foundation create a Virtual Platform for families dealing with cancer. TD supported Wellspring for 30 years and now we are helping guide them through their digital transformation. TD Securities’ Underwriting Hope Campaign is another long-standing example of our commitment, celebrating its 25th anniversary this year. Colleagues raised almost $2 million in support of children's charities in June, bringing the total raised since inception to nearly $25 million. At TD, we are privileged to serve more than 27 million customers around the globe. This month, we launched TD Thanks You, our signature annual North American program that recognizes and celebrates TD customers, spotlighting their contributions and helping them continue to make an impact. I encourage you to follow these inspiring stories online. To wrap up, I would like to thank all of our TD bankers who are living our shared commitments every day. I'm very proud of what we have accomplished together, and I look forward to a strong finish to the year. With that, I'll turn things over to Kelvin.
Kelvin Tran, CFO
Thank you, Bharat. Good afternoon, everyone. Please turn to Slide 11. This quarter, the bank reported earnings of $3.2 billion and earnings per share of $1.75, both down 9%. Reported earnings include the net loss from the mitigation of interest rate volatility to closing capital on First Horizon acquisition. Adjusted earnings were $3.8 billion and adjusted EPS was $2.09, up 5% and 6%, respectively. Reported and adjusted revenue increased 2% and 8% year-over-year, respectively, reflecting margin and volume growth in the Personal and Commercial Banking businesses. Reported revenue also includes the net loss from mitigation of interest rate volatility to closing capital on First Horizon acquisition. Provision for credit losses was $351 million. Reported expenses increased 9% year-over-year, reflecting higher employee-related expenses and higher spend supporting business growth. Adjusted expenses increased 8%. Absent the retailer partners’ net share of the profits from the U.S. strategic card portfolio, adjusted expense growth was 9.9% year-over-year or 8.7% ex FX. Consistent with prior quarters, Slide 26 shows how we calculate total bank PTPP and operating leverage removing the impact of the U.S. strategic card portfolio, along with the impact of foreign currency translation and the insurance fair value charge. Reported total bank PTPP was down 5% year-over-year before these modifications and adjusted PTPP was up 6% after this modification. Please turn to Slide 12. Canadian Retail net income for the quarter was $2.3 billion, up 6% year-over-year. Revenue increased 7%, reflecting volume and margin growth, higher fee-based revenue in the banking business and higher insurance volumes partially offset by lower transaction and fee-based revenue in the wealth business. Average loan volumes rose 9%, reflecting 8% growth in personal volumes and 15% growth in business volume. Average deposits rose 7%, reflecting 8% growth in personal deposits, 4% growth in business deposits and 8% growth in wealth deposits. Wealth assets decreased 3%, reflecting market depreciation, partially offset by net asset growth. Net interest margin was 2.7%, up 8 basis points compared to the prior quarter, primarily due to higher deposit margins, reflecting the rising interest rate environment, partially offset by lower loan margins. Total PCL of $170 million increased $110 million sequentially. Total PCL as an annualized percentage of credit volume was 0.13%, up 8 basis points sequentially. Insurance claims decreased 1% year-over-year, reflecting favorable prior year claims development and the impact of a higher discount rate, resulting in a similar decrease in fair value of investments supporting claims liabilities reported in non-interest income, partially offset by higher current year claims. Non-interest expenses increased 8% year-over-year, reflecting higher spend supporting business growth, including technology and employee-related expenses. Please turn to Slide 13. U.S. retail segment reported net income for the quarter was USD 1.1 billion, up 7% year-over-year. Adjusted net income was USD 1.1 billion, up 8% year-over-year. U.S. Retail Bank reported net income was USD 898 million, up 1% and reflecting higher revenue, partially offset by higher PCL and non-interest expenses. U.S. Retail Bank adjusted net income was USD 913 million, up 2%. Revenue increased 11% year-over-year, reflecting higher deposit margins and volumes, partially offset by lower income from PPP and lower loan margin. Average loan volumes were flat year-over-year, reflecting an 8% increase in personal loans and a 7% decline in business loans. Business loans increased 2%, excluding PPP loans due to strong origination, new customer growth, higher commercial line utilization and increased customer activity. Average deposit volumes excluding sweep deposits were up 5% year-over-year. Personal deposits were up 8% and business deposits were up 2%. Net interest margin was 2.62%, up 41 basis points sequentially as higher deposit margins, reflecting the rising interest rate environment and positive balance sheet mix were partially offset by lower PPP loan forgiveness and lower loan margins. On Slide 30, we've continued our disclosure on the impact of the PPP program. This quarter, PPP revenue contributed approximately USD 16 million to net interest income and 2 basis points to NIM. Total PCL was USD 83 million, an increase of $98 million sequentially. The U.S. retail net PCL ratio, including only the bank's share of PCL for the U.S. strategic cards portfolio as an annualized percentage of credit volume was 0.2%, higher by 24 basis points sequentially. Reported expenses increased 8% year-over-year, reflecting higher employee-related expenses and business investments, and acquisition and integration-related charges for the First Horizon acquisition, partially offset by productivity savings. Adjusted expenses were up 6% year-over-year. The contribution from TD's investment in Schwab was USD 226 million, up 40% from a year ago, reflecting higher net interest income, partially offset by lower trading revenue. Please turn to Slide 14. Wholesale Bank net income for the quarter was $271 million, a decrease of 18% year-over-year, reflecting higher non-interest expenses and PCL. Revenue was $1.1 billion, down 1% year-over-year reflecting lower underwriting fees and markdowns in certain loan underwriting commitments from widening credit spreads, partially offset by higher trading-related and global transaction banking revenue. PCL for the quarter was $25 million compared with the recovery of $9 million in the prior quarter. Expenses increased 9% year-over-year primarily reflecting the continued investments in Wholesale Banking U.S. dollar strategy, including the hiring of banking, sales and trading and technology professionals, partially offset by lower variable compensation. Please turn to Slide 15. The corporate segment reported a net loss of $752 million in the quarter compared with reported net loss of $205 million in the third quarter last year. The year-over-year increase primarily reflects the net loss from mitigation of interest rate volatility to closing capital on First Horizon acquisition, higher net corporate expenses and a lower contribution from other items. Adjusted net loss for the quarter was $175 million compared with an adjusted net loss of $122 million in the third quarter last year. Please turn to Slide 16. The common equity Tier 1 ratio ended the quarter at 14.9%, up 22 basis points sequentially. We had strong organic capital generation this quarter, which added 42 basis points to CET1 capital, excluding the net loss from the mitigation of interest rate volatility to closing capital on the First Horizon acquisition, which decreased CET1 by 10 basis points. We also saw a 12 basis point increase in CET1 related to the issuance of common shares under our dividend reinvestment plan. These additions were partially offset by an increase in RWA. RWA increased 1.4% quarter-over-quarter, reflecting higher credit risk and market risk RWA. Credit risk RWA increased $5.1 billion or 1%, mainly reflecting higher volumes in all of our businesses, partially offset by a decrease in equities. Market risk RWA increased $1.1 billion or 5%, reflecting widening credit spreads. The leverage ratio was 4.3% this quarter and the LCR ratio was 121%, both well above the regulatory minimum. Please turn to Slide 17. As we mentioned on our call relating to the Cowen acquisition earlier this month as part of our ongoing capital management activities and in light of heightened volatility in interest rates, reduction in our net interest income sensitivity with rising rates and continued uncertainty in the macroeconomic environment, during the third quarter we established a strategy to mitigate the CET1 ratio impact of further rate changes on goodwill in connection with the First Horizon acquisition. The bank already has a large portfolio of U.S. investment securities, many of which are hedged using interest rate swaps. As a result, TD was able to implement a strategy to mitigate interest rate volatility without entering into any new transaction. Now as interest rates change, certain interest rate swaps, which were de-designated from their previous hedge accounting relationships against TD's existing U.S. investments will mark-to-market through P&L, and mitigate the capital volatility due to interest rate changes and goodwill amount for the First Horizon acquisition. We recorded an item of note of $505 million after tax, which primarily reflected the mark-to-market loss of these swaps as of July 31. If quarter end was yesterday, given the change in rates, you will no longer see a loss, but actually a gain. So that shows the extent of interest rate volatility during this time. The sensitivity will also change over time as a result of a number of factors, including First Horizon's interest rate risk management and balance sheet composition, as well as macroeconomic factors like the degree of the rate change and the shape of the interest rate curve. Based on changes in interest rates, we expect that the amount allocated to goodwill and intangibles will increase by USD 1.5 billion upon close. I will now turn the call over to Ajai.
Ajai Bambawale, CRO
Thank you, Kelvin, and good afternoon, everyone. Please turn to Slide 18. Gross impaired loan formations were 12 basis points, stable quarter-over-quarter. Please turn to Slide 19. Gross impaired loans decreased 2 basis points quarter-over-quarter to a new cyclical low of 28 basis points, reflecting reductions in both the Canadian and U.S. Retail segments. Please turn to Slide 20. Recall that our presentation reports PCL ratios both gross and net of the partner share of the U.S. strategic card PCLs. We remind you that PCLs recorded in the corporate segment are fully absorbed by our partners and do not impact the bank's net income. The bank's PCL was $351 million or 17 basis points, increasing $324 million quarter-over-quarter, largely related to a prior quarter performing allowance release, coupled with nominal performing provisions in the current quarter. Please turn to Slide 21. The bank's impaired PCL was $340 million, increasing by $26 million quarter-over-quarter, driven by a modest increase in the U.S. consumer lending portfolios. Overall, impaired provisions remained at cyclically low levels. Performing PCL was $11 million compared to a recovery of $287 million last quarter. The current quarter performing provision reflects a nominal increase to the allowance for credit losses. Please turn to Slide 22. The allowance for credit losses was stable quarter-over-quarter at $6.9 billion as the impact from deterioration in our economics forecast was largely offset by the release of overlays previously set aside for economic uncertainty. The bank's allowance coverage remains elevated to account for ongoing uncertainty that could affect the economic trajectory and credit performance. In summary, the bank continued to exhibit strong credit performance this quarter as evidenced by continued low gross impaired loan formations, gross impaired loans and PCLs. While these key credit metrics are at or near cyclical low levels, economic risks remain elevated, reflective of persistent inflation and rising interest rates and the increasing risk of a recession. TD, however, remains well positioned, given we are adequately provisioned, we have a strong capital position, and we have a business that is broadly diversified across products and geographies. With that, operator, we are now ready to begin the Q&A session.
Operator, Operator
First question is from Ebrahim Poonawala from Bank of America.
Ebrahim Poonawala, Analyst
I guess maybe just to start out, Kelvin, if you can just follow up, I just want to make sure we understand you correctly on the interest rate swaps. So you had existing swaps against the fixed income book, you de-designated them towards the goodwill to mitigate that impact. Where does that leave the fixed income book? Do we see AOCI hit, that impacts capital or no?
Kelvin Tran, CFO
No. So the fixed income is not going through OCI and does not impact capital. So you don't mark-to-market the fixed income.
Ebrahim Poonawala, Analyst
And is that because the fixed income is held in held-to-maturity?
Kelvin Tran, CFO
Yes, it's held to collect. Correct.
Ebrahim Poonawala, Analyst
Understood. Okay. So that's clear. And I guess two other questions. One, Bharat, just around the deal you mentioned, you all went through the public earnings last week. It seems like you still feel comfortable in terms of the timing of the close. Is there any risk like in terms of deal delay and then the U.S. regulators have been fairly vocal in terms of thinking about liquidity requirements around TLAC within the U.S. subs for the larger regional banks? Give us a sense of your comfort around that? Like, do you see any changes you might need to do in terms of your funding to get through the deal over the finish line?
Bharat Masrani, CEO
No, we don't, Ebrahim. Just to clarify, and maybe Leo will comment on the public meeting we just had because quite happy with how that turned out, consistent with TD's commitment to the communities in which we live and work. Just on your point, there is a lot of speculation on what might be the requirements to get approvals. Our deal continues to progress in the normal course; there is nothing out there to suggest that, that is different this time around. A lot of discussions on TLAC, yes, without a doubt. But just to clarify that point, and who knows what the ultimate requirement will be or will not be. TD, we've been compliant on OSFI’s mandated TLAC requirements since the date of inception of that requirement. And as the G-SIB, TD’s U.S. Intermediate Holding Company is already subject to internal TLAC requirements with or without First Horizon with the compliance date of January 1st, 2023, and we expect to meet that requirement on that day. So I just wanted to clarify that because I know I’d heard this morning there was a lot of discussion on what does this mean for TD. Well, I just told you as a G-SIB, our intermediate holding company in the U.S. is subject to internal TLAC as of January, and we expect to meet it.
Ebrahim Poonawala, Analyst
That's helpful. And just one last one, Kelvin. In terms of the NIM expansion both in Canada and the U.S., should we expect a similar or greater expansion in the fourth quarter compared to what you saw in the third? Thank you.
Kelvin Tran, CFO
Hi. It's Kelvin. As you know, with NIM, there are a lot of moving parts, but everything remaining equal. If the forward rates are realized, then we expect margins to continue to expand.
Operator, Operator
Next question is from Doug Young from Desjardins Capital Markets. Please go ahead.
Doug Young, Analyst
Good afternoon. Just have a few hedge questions as well. Just the mechanics of the first rise in hedge, is that similar to others and in that you view swaps that obviously rise in value as interest rates increase and give a portfolio of matched duration U.S. treasuries? Do I have the mechanics correct or is there a different structure you've used?
Kelvin Tran, CFO
Yes, you have the structure correct. So the way I would look at it is that, you could do this in two steps or you do it in one step. The two-step would be, you raise funding, buy the investment portfolio and then match it with a swap, and then the swap mark-to-market would offset in the opposite direction of the impact of goodwill. So you do it in two steps, right, buy that matched portfolio and then having the swap mark-to-market. But because we already have a portfolio in place, we don't need to do the first step; we do the second one, so it would be the same. That's correct.
Doug Young, Analyst
Have you hedged more of the interest rate sensitivity for your U.S. business compared to last quarter? I'm asking this because I noticed that your interest rate sensitivities for the U.S. division have significantly decreased according to your disclosure. Is this a typical occurrence, or is there something more to it?
Kelvin Tran, CFO
Yes, it doesn't affect NIIS in the same way that the previous transaction does. It relates to variations in data over time. As you're aware, the sensitivity reflects the difference between the earnings on increasing rates and the rates passed on to customers. With rising rates, as we anticipate the next 100 basis point movement, the beta increases, which explains why the sensitivity is lower.
Doug Young, Analyst
Okay, so there's no collection. Can you explain why you decided to implement the hedge? When you announced the deal, you didn't mention it, and I know the Cowen transaction came later. I'm curious about your reasoning for choosing this path.
Kelvin Tran, CFO
Yes. It's a great question. So first, as you recall, we have significant sensitivity to interest rates. So in a way, we have a natural offset. As rates rise, we will earn more through net interest income. But what we just talked about is actually relevant because as rates rise the next 100 basis points, we would be less sensitive. So if you think back into Q1, our NIIS was $2 billion, 400 basis point move. And when the first 100 basis points already moved, the next 100 basis point will be lower then you think Q2, it declined to 1.5. And then rates rise again, so the next 100 basis point is lower. And so now, the NIIS is lower. So, as rates continue to rise, the natural hedge of the net interest income sensitivity becomes less effective. And then secondly, interest rate has been much more volatile since we made the announcement. And like what I just said earlier, just even between July 31 and yesterday, rates have moved so much that the swap was in a loss position to now a small gain. So the combination of those factors will lead us to put on this hedge.
Operator, Operator
Next question is from Gabriel Dechaine, National Bank Financial.
Gabriel Dechaine, Analyst
Just that slide showing the structure of the hedge there. It looked like when you put on the hedge, the goodwill tied to the acquisition is up by $1.5 billion. That's just going to sit on the balance sheet and then probably around another 20 basis points, a capital hit from the acquisition. It's not classified as a credit mark or anything like that; it’s just pure goodwill, right?
Kelvin Tran, CFO
Rates have risen since we announced the transaction, resulting in a decline in the fair value of the fixed rate loans. Consequently, on an after-tax basis, we need to retain an additional $1.5 billion in capital. This adjustment, which can be considered a fair value mark, will revert to income over the lifespan of the loans as increased net interest income once the transaction is finalized.
Gabriel Dechaine, Analyst
That $1.5 billion increase in goodwill will come back into income over time.
Kelvin Tran, CFO
Correct. So that's what we said is a timing issue. So on closing, we have to hold more capital because of higher goodwill, but then we earn more earnings over time, and so we're building more. So it all comes back as higher capital over time over the life of the loan.
Gabriel Dechaine, Analyst
You mentioned the 20 basis points impact at closing, but then it seems like you'll be back to a better position over a duration of two to three years, is that correct?
Kelvin Tran, CFO
It's a little bit higher than that. And the loans are about four to five years.
Gabriel Dechaine, Analyst
I'm curious about your strategy regarding liquidity investment, especially in light of the current flat or inverted yield curve. Have you adjusted the duration of your liquidity management?
Kelvin Tran, CFO
No, materially, we haven't changed. I mean, our strategy is still the same. We look at the permanence of the deposits. And as we feel comfortable with the permanence of the deposit, we would put the tractors on.
Gabriel Dechaine, Analyst
I'll ask a broad question. With significant net interest margin expansion this quarter, both in the U.S. and Canada, could you share whether this trend is likely to continue into Q4 and beyond? I'm considering factors like deposit betas and when they might begin to impact net interest margin expansion. Additionally, I understand you raised a considerable amount of wholesale funding recently; will this start to affect the margin or dilute the gains we experienced this quarter? What was the reasoning behind raising all that wholesale funding? Are you pre-funding for anticipated rate increases? I apologize for the numerous questions; I'll keep this my last.
Kelvin Tran, CFO
And a lot of questions for Kelvin, I want to make sure that somebody else can get the answer as well. Sure. I can share my perspective on this before passing it to Michael and Leo for their insights. We have a robust deposit base, and as anticipated, our net interest income sensitivity indicates that with increasing rates, our margin will expand. As mentioned earlier, when rates rise by the next 100 basis points, we should expect beta to increase, which may limit the extent of the expansion, but an expansion will still occur. This is a crucial point to consider. Eventually, the beta may plateau, but we haven't reached that stage yet. In the U.S. and Canada, the conditions are somewhat different. In the U.S., we have a surplus of deposits, so as we increase loan growth, we don’t require additional funding. We are substituting lower-yielding securities with higher-yielding loans, which will also contribute to the expansion of our net interest margin. Conversely, in Canada, we do not have a surplus of deposits over loans. Therefore, as we expand the residential portfolio and other assets, we will need to secure funding. We constantly assess our balance sheet to determine the most effective way to optimize funding, whether through wholesale channels or our deposit franchise. Michael, would you like to add anything before we turn it to Leo?
Michael Rhodes, Group Head, Canadian Personal Banking
We have a couple of points to discuss. First, regarding our core depository accounts, the betas remain consistent with our historical trends, indicating stability. Our core checking account balances are still on the rise, and our acquisition efforts are very strong. There are some minor shifts in the mix, but overall, we are pleased with the performance of our core checking accounts, both in terms of balances and new account acquisition, which is showing solid growth year-over-year and aligns with pre-pandemic levels. The second point affecting our net interest margin (NIM) is somewhat more nuanced. You may have noticed a significant year-over-year growth in our card balances, which have increased by 10% or $1 billion sequentially. However, the revolving mix remains relatively low compared to historical standards. As a result, the income from this increase in card usage is not reflected in NIM; instead, it is contributing to fee income. Our fee income has been robust, driven by a combination of transaction net spreads, foreign exchange fees, and other factors. This summarizes the situation for our Canadian Retail bank.
Leo Salom, President and CEO, TD Bank, America's Most Convenient Bank
And maybe turning to the U.S., Gabriel, obviously a very good quarter from a NIM perspective. NIM came in at 262 and that was up 46 basis points year-on-year. If you look at the drivers, obviously higher deposit margins drove the bulk of it, but we also saw improvements as a result of balance sheet mix, higher asset growth and improved treasury investment returns. So it was a good solid quarter. To your point around sustainability, we haven't yet seen the full impact of the third quarter rate increase, and so that will flow through in the fourth quarter. And likewise, to the point that Kelvin raised earlier, if forward rates do realize we will see some sort of increase associated with that. So I would expect NIMs to continue to drift upwards as we look to the fourth quarter and early into next year. I do want to stress though Kelvin's point that we do expect net interest income sensitivity to wane a little bit. But we haven't seen any significant price sensitivity in the book yet. Retail deposits on a quarter-on-quarter basis were essentially flat. But I do expect that we're going to see that. Just the amount of the increase we've seen in short-term rates will mean that we will see some movement to either CDs or other money market solutions and or other investment wealth products over time. So we're really pleased with the performance. I think our book is performing the way we would expect and the way you'd expect TD to perform in this environment. And I think we can sustain some of the NIM expansion that we've seen this quarter.
Gabriel Dechaine, Analyst
All right. Well, enjoy the rest of your summer.
Operator, Operator
Thank you. Next question is from Meny Grauman from Scotiabank. Please go ahead.
Meny Grauman, Analyst
Hi. Good afternoon. I want to stick with margin and just focusing on the Canadian PNC margin, which for you was up 7 basis points sequentially. When I compare it to the peer group so far, it’s at the bottom end of the peer group. That’s not a ranking I would have expected, given your deposit balances. So Michael, you talked about business mix, is that all it is? And furthermore, if I compare the sequential margin expansion in Q3, it was actually a little bit lower than what we saw in Q2. So I'm trying to figure out if there is anything offsetting some of that margin expansion that's maybe going to go away, anything beyond business mix here?
Michael Rhodes, Group Head, Canadian Personal Banking
I believe the situation is influenced by a mix of our business areas. The card business is experiencing growth at a rate that surpasses our deposits. There are some competitive pricing factors to consider, but I don't want to overstate their impact. It's important to recognize that while our card loans are growing, they aren't generating the same net interest income we would typically expect from such growth. Those revolving balances usually yield significant returns. However, as Leo mentioned, we remain optimistic about our position. I'm confident in the performance of our Canadian Personal division and believe it will continue to improve going forward.
Meny Grauman, Analyst
Just on the card side, the revolvers, do you have any sense like early in Q4 can you start to see those revolvers picking up? What's the timeline that you are thinking from that perspective?
Michael Rhodes, Group Head, Canadian Personal Banking
The dynamic we're seeing in our book and everyone's portfolio is probably going to be a little different, but we have a very heavy mix of transactors, particularly the affluent travel. And so, we're seeing spend levels on a year-over-year basis, which are quite attractive. We are up about 23% on a year-over-year basis for spend levels. And so, we are still seeing consistent high transaction activity and less borrowing activity. And I don't think we have seen that shift happen yet.
Operator, Operator
Thank you. Next question is from Paul Holden from CIBC. Please go ahead.
Paul Holden, Analyst
Couple of questions for Riaz to start. Just first one is with respect to the growth in the wholesale lending book. I believe the slide deck says it was up by 21% year-over-year, so really good growth there and highlighted growth, particularly in the U.S. So maybe we can talk a little bit about which sectors that’s coming from? And if there is any sort of read-through in terms of lending capacity and appetite in terms of how it might flow through to the Cowen transaction when that does close?
Riaz Ahmed, Group Head, Hotel Banking
That growth, as you outlined, is principally in the U.S., and it is in areas where we have traditional strength in communication, media technology of fairly wide variety of diversified industries, as well as in power and utility areas. And so it's actually been a fairly attractive area for us to continue to increase in our client base and deepen client relationships as we just continue to pursue our long-held U.S. dollar strategy. I think as we look forward to welcoming our colleagues from Cowen to the TD Securities family, as you know, their areas of strength are in healthcare, wide their sectors in the healthcare side, which will bolster onto our healthcare practice as well as on the technology side, and they have a fair bit of diversified coverage as well. So I think that there is a very good fit there and should mold well not only to continue to add to our client base, but also to serve them with a wider set of products and services.
Paul Holden, Analyst
And then second question for Riaz. I mean, it was also highlighted that as you continue to make investments in the U.S. wholesale business, the hiring of banking, sales and trading technology professionals, I'm just a little bit maybe surprised you’re ramping up organically, that aggressively ahead of the Cowen acquisition. Maybe you can kind of talk through the logic of that, the capacity to grow organically plus through acquisition?
Riaz Ahmed, Group Head, Hotel Banking
I think, Paul, you should really just sort of look at that more in a timing context. The growth in the U.S. dollar strategies started some nine years ago and has been picking up momentum as we grew up their corporate lending and then the treasury products, fixed income, commodities and currency side of the business. And if you look at our FTEs, you'll see that in the last year we added about 350 FTEs and fairly broadly across the platform in global market and corporate and investment banking, in technology and business operations. And so with the addition of 1,700 colleagues from Cowen, I expect that some of our organic additions will slow here a little bit in the next two years as we look at the integration. So it's mostly, I would say, Paul, in the timing of how the organic add came together with the acquisition opportunity with Cowen.
Paul Holden, Analyst
I'm looking at the expenses, specifically the professional advisory and outside services line, which increased by 40% this quarter and is also up around 40% year-to-date. This is a significant amount, highlighting an additional 446 million in spending so far this year. Could you elaborate on the factors driving this increase? Are there specific projects tied to this spending, and is any of it related to mergers and acquisitions? Thank you.
Kelvin Tran, CFO
Hi, it's Kelvin. As we’ve discussed previously, our approach to managing expenses isn’t based on short-term quarterly fluctuations but rather on a few key principles. We prioritize essential operational spend, engage in longer-term investments, and allocate a portion of our budget to discretionary spending while utilizing outside professional services. This flexibility allows us to adjust our resources based on emerging opportunities. Currently, we see promising chances to invest in technology. For example, we are re-platforming our contact center and utilizing AI capabilities to enhance our customer service in the insurance sector. Additionally, we are working on implementing a platform for our commercial banking business in Canada, similar to what we have already accomplished in the U.S. These initiatives present great opportunities for optimizing our spending while enhancing customer service. We are able to see the benefits in real time, and I’ll now hand it over to Ray to discuss the contact center for insurance in more detail.
Raymond Chun, Group Head, Wealth Management and Insurance
Thanks, Kelvin. I mean, what we've done in the last quarter is actually launched the new state-of-the-art telephony system that'll be leveraged across all of TD Bank, but we started in TD Insurance. And we are launching new capabilities, things like for example, using AI being able to actually identify the client, what they hold, using our data and getting that client to the right advisor with the right skills the first time to actually be able to fulfill those capabilities. Also, we're introducing now with the new platform omnichannel capabilities, where we can help customers through those who are starting digitally, that actually then need assistance through a chat capability. And so in the buying moment, where you can actually help our clients, and when needed to, they can also then click to speak with a phone representative to support them through the process. These are all capabilities that we're starting with within TD Insurance, but will be expanded to across all of our contact centers across all of our businesses in the coming years. And so significant investment on behalf of TD, but the benefits will certainly pay off.
Operator, Operator
Next question is from Lemar Persaud from Cormark Securities.
Lemar Persaud, Analyst
Just before I start off here, I kind of dropped off a little bit during the Q&A. So if my questions have been asked and answered, feel free to let me know. I just want to come back to the de-designation of the hedging. So I understand there's just no such thing as a free lunch. What did TD give up to reallocate these hedges to mitigating the impact of the interest rate changes on First Horizon? Does that mean you're now just going to strain these larger losses on the fixed income portfolio at maturity? Is that the right way to look at it?
Kelvin Tran, CFO
No. So let me just go back and let's look at what we're hedging. So the risk that we're hedging is not an economic risk. It's a capital timing risk. If you recall, when you close on the transaction, the accounting rules require you to fair value the balance sheet of the target, in this case, First Horizon, and allocate the purchase price to these assets and liabilities. And if interest rates rise, you would have to mark these loans to a discount. And that difference would cause higher goodwill where you would have to hold capital. But that is just a timing issue. It's not like it's not a real loss because these loans, as you hold them to maturity, they would be accreting back to par. So you earn that, and as it gets earned through income, it flows through retained earnings, it becomes your book capital, so you earn that capital over time. So it's just the timing of you holding the capital on closing and you earn that back over four or five years. And so because there's no economic risk, you would not want to just put a swap on because if you just put a swap on, you're now actually creating economic risk. And so what you're trying to do is find a match portfolio that already exists or you can build the match portfolio and enable the accounting - timing of the accounting to help you offset that goodwill so that you - if rates rise, you have a gain on the swap, which would give you capital to offset the goodwill hit, and then over time, that swap kind of unwinds because you have a package, the whole cash flow, you still have that package there. You're not - you don't have any changes to the cash flow; it's just the timing of the recognition of the P&L is different. I lost a lot there, but happy to take your questions off-line as well.
Lemar Persaud, Analyst
I think I understand it, but if I don't, I'll circle back on that one. And then on my next question, just switching gears here. Some pickup in business loan growth in the U.S. after a number of quarters had kind of softer results. Personal loan growth also looks pretty good sequentially. Can you talk to us about what's driving the turnaround this quarter? And looking ahead, would it be fair to suggest that TD could be closing the performance gap relative to your U.S. peers?
Leo Salom, President and CEO, TD Bank, America's Most Convenient Bank
Thank you, Lamar, for the question. Let me break it down. In commercial lending, we were pleased with the quarter's performance, with commercial loans, excluding PPP, increasing by 2.8%. The mid-market trend we observed last quarter continued, and this quarter we had broader participation. Many of our specialty businesses, such as healthcare, municipal education, and not-for-profit segments, also experienced momentum, and there was a slight increase in our institutional CRE business. This broader performance contributed to our growth. However, we still see some sluggishness in the small business and community segment, where originations were solid but paydowns were elevated, indicating that clients are being more defensive amid market uncertainties. Additionally, we witnessed momentum not just in commercial lending but also in retail. For instance, mortgage balances increased overall by 14%, and card sales rose by 10%, leading to a 7% growth in our balance sheet. In the auto segment, which faced pricing challenges recently, we saw some stabilization and managed a portfolio growth of 5.8%. Overall, it was a strong, broad-based lending performance for our U.S. business, and we believe this momentum is sustainable as we approach the fourth quarter.
Operator, Operator
Our next question is from Nigel D’Souza from Veritas Investment Research.
Nigel D'Souza, Analyst
I wanted to circle back on your allowances this quarter, and you mentioned that the release have overlay offset the situation in your macroeconomic outlook. I wonder if you could size the impact of Federal related release? Any sense of what your provision performing loans would have been if it wasn't for that overlay offset?
Ajai Bambawale, CRO
Yes, let me explain what is happening. We were cautious about releasing our reserves because we noticed changes in the environment. Currently, we are relatively well positioned for a moderate recession, holding $1.6 billion in reserves above pre-COVID levels. This quarter, you will see that there was significant change in the macroeconomic landscape. Economic growth projections for Canada and the United States have decreased, and employment growth numbers for 2022 are also lower. We anticipate higher unemployment rates in both countries for 2023, driven by elevated interest rates, which have notably affected the housing market, especially in Canada. Our downside case now includes a recession scenario, which led to an increase in our projections. However, we had preemptively incorporated this uncertainty into our allowance process with overlays, and we have since adjusted those overlays. At this point, approximately 90% of our allowance is based on models, leaving only a small portion based on judgmental overlays.
Nigel D'Souza, Analyst
I would summarize that by saying that the uncertainty you previously accounted for due to COVID-19 has now integrated the uncertainty from rising interest rates and inflation. Therefore, it's reasonable to conclude that there is a decreased likelihood of significant increases in provisions for performing loans, given that you have carried over the excess reserves from the pandemic.
Ajai Bambawale, CRO
That's a fair remark. We don't expect to build any more reserves or significant amounts, but much depends on the macroeconomic situation. If the macroeconomic conditions worsen significantly, we will need to reassess. However, the key point is that we didn't rush to release our reserves for good reason. We are well reserved and positioned to handle a moderate recession as a bank.
Nigel D'Souza, Analyst
Okay. I need some clarification on how First Horizon affects this loan. I understand you have a day one provision, but I assume there wouldn't be the additional reserves you have with the existing loans, or at least the provisions on performing loans would be higher.
Ajai Bambawale, CRO
Yes. That will be a legal day one activity. There is no First Horizon included in these numbers. However, we will share more details at the appropriate time. We did indicate what type of credit mark we took at the beginning. As the time approaches, we will keep you updated.
Operator, Operator
Next question is from Jo Ho Kim from Credit Suisse.
Jo Ho Kim, Analyst
I want to revisit the U.S. business. We're hearing reports that the U.S. housing market is cooling off early in the cycle, with some originations facing significant pressure. However, looking at your mortgage growth, it didn't appear that way last quarter. Is your mortgage business possibly outperforming in other regions? What gives you confidence that this growth can continue moving forward?
Leo Salom, President and CEO, TD Bank, America's Most Convenient Bank
Let me explain that for you. It's related to both originations and significantly lower paydown activity. On the origination side, two main factors are driving some of the growth we observed. First, we implemented a new mortgage origination model in our retail stores, which establishes a direct connection to our mortgage origination unit. This model offers considerable support to the stores and enables us to capture a larger portion of retail flow. Secondly, we experienced strong correspondent originations this quarter, which were substantially higher than last year and came from high-quality, high net worth, and mass affluent clients. This contributed to the growth in originations. However, the key point is that we are seeing much lower paydown activity. As interest rates have increased, there is a notable decline in refinance demand, meaning more of what we are originating is actually aiding in balance growth. Looking ahead at the mortgage market, we expect some moderation in mortgage activity due to rising rates in the U.S. Nonetheless, I believe we have opportunities based on the commercial strategies we are implementing to perform well and achieve positive growth in the portfolio.
Jo Ho Kim, Analyst
Great. And just last one for me. Just on expenses. When I look at it at the all-bank level, it was up about, I think, 9% this quarter, and I did hear the commentary about higher employee cost and tech expenses across the segment. So just wondering how you're thinking about the pace of investments in the near term and could either stabilize from here or accelerate and what that means for expense growth from your perspective as you look at it?
Kelvin Tran, CFO
It's Kelvin. I'll take that question. We don't manage expenses on a quarterly basis. Currently, we see great opportunities to invest in our distribution channel, which is why we're increasing full-time equivalent positions in the contact center, supporting insurance and wealth. We're also investing in technology and other frontline client support roles. Our focus and goal are to achieve positive operating leverage in the medium term, and we will adjust our strategy as the environment evolves. For now, we plan to continue investing.
Operator, Operator
Our next question is from Darko Mihelic from RBC Capital Markets.
Darko Mihelic, Analyst
I have two quick questions. First, how should I think about or have you thought about the Credit Card Competition Act in the U.S.?
Leo Salom, President and CEO, TD Bank, America's Most Convenient Bank
I'll take this one. Darko, good to hear from you. As you know, Darko, let me just talk a little bit about our cards business for a moment in terms of the things that we're focused on. We've got a proprietary bank card business and a retail card services book, both of which are a major area of focus for us in terms of growth going forward. We feel quite comfortable with that business. We continue to think about expanded value proposition, expansions to be able to support our growth in that segment. We also have two very important co-branded relationships which have been a source historically, a very good growth. From an overall competitive position, I don't believe at this point that, that act is going to be a significant change to our existing cards base, but it's something that we continue to monitor and we'll certainly evaluate in terms of what the impact could be for fees and for other considerations.
Darko Mihelic, Analyst
Okay. And does it affect anything that you do with First Horizon at all either? Or like, I realize it has nothing to do to target margin?
Leo Salom, President and CEO, TD Bank, America's Most Convenient Bank
So Darko, very quickly on First Horizon. So First Horizon has about 1 million retail clients, but they have a very small cards book. So as we talked about, I think, last quarter, when we think about synergies, one of the obvious synergies for us on First Horizon is actually bringing our cards capability to bear to First Horizon. And that's going to be one of the things that we'll do early on in terms of the union between the two institutions. From our standpoint, we see that as a growth opportunity; we don't really see a great deal of headwind there.
Operator, Operator
Next question is from Mike Rizvanovic from KBW Research.
Mike Rizvanovic, Analyst
I want to revisit the margins in Canada. Regarding Meny's point, TD's performance this quarter has been somewhat disappointing compared to its peers. I'm curious about Michael's reference to competitive dynamics. Could this relate to the RESL portfolio? I understand that you have been losing market share for some time, but it seemed to improve last quarter. I assume that you might have continued this positive trend into Q3. How significant has this been for the margins? More importantly, as you strive to regain the lost market share in RESL, how will that affect your margins in Canada moving forward?
Michael Rhodes, Group Head, Canadian Personal Banking
Good question. You're correct in noting the recent positive trajectory and momentum in our RESL business. If you examine our sequential growth in the mortgage sector, combining mortgage and HELOC, this past third quarter was our strongest performance since 2010. We're optimistic about this progress. I want to emphasize that our growth is not due to underpricing in the market, but rather through enhancing customer relationships and improving our operational efficiency. We're not gaining market share by lowering prices. Consequently, as our mortgage business expands more rapidly than our deposit business, it will influence our overall reported NIM.
Mike Rizvanovic, Analyst
Okay, I just need some clarification on a numbers question. When I look at a couple of your peers with a similar structure in Canadian variable rate mortgages, they both reported over 35-year amortizations making up over 20 percent of their portfolio as of Q3. However, your disclosure indicates that you have basically 0. I assume you might be calculating this differently. I find it hard to believe that it wouldn't increase given the significant rate hikes, especially since you would likely be extending that aim for many of your recent originations. Can you provide any insights on this?
Michael Rhodes, Group Head, Canadian Personal Banking
Yes. I will begin by explaining how our product functions and how it is represented in our disclosures. Our variable rate contracts require customers to adhere to their initial amortization schedule upon renewal. Therefore, if interest rates rise and the portion of the payment allocated to the principal decreases, customers must adjust to maintain the original schedule at renewal, which typically results in a higher payment. Table 21 in the Report to Shareholder illustrates this situation, showing that our variable rate contracts require customers to keep the original amortization schedule.
Mike Rizvanovic, Analyst
Okay. So I guess that means when it comes to TD's trigger, you actually push a higher payment. It is a fixed payment, but if the interest portion exceeds the original payment, then that small incremental amount gets added to the payments. You're adjusting it incrementally instead of all at the end when it comes time for renewal. Is that a fair way to look at it?
Michael Rhodes, Group Head, Canadian Personal Banking
Not exactly. The way to think about this is that if a customer reaches a point where they are no longer paying down the principal, we will reach out to them and provide options. These options include increasing their payment, doing nothing, or making a lump-sum payment, among others. If they choose to do nothing, their amortization will deviate from the original schedule. When the loan comes up for renewal in one, two, or three years, we will adjust the payment to reflect the remaining amortization at that time.
Operator, Operator
Our next question is from Scott Chan, Canaccord Genuity.
Scott Chan, Analyst
Switching over to asset management. In your opening remarks, you talked about 90% of your AUM in the top two quartiles over the past three years, which is a lot higher, I think, the last time I ran with the industry. And Bharat, you gave some points on retail and institutional. But I was wondering if you can elaborate on both those client platforms year-to-date and the potential outlook on the improved performance.
Bharat Masrani, CEO
I think, Ray will provide good perspective on that. Ray?
Raymond Chun, Group Head, Wealth Management and Insurance
Thanks for the question, Scott. I'll begin by discussing the mutual fund industry as a whole. It's clear that there have been net outflows from mutual funds, totaling around $21 billion for the quarter. We’re noticing that funds are being redirected to our various GICs and cash products due to market volatility. This trend of rebalancing isn’t new. The positive news for us is that year-to-date, we've achieved the largest net inflow in mutual fund sales among the top five banks, which reflects the strong performance of our mutual funds. Over the past three years, our performance stands at 90%, and it’s about 92-93% over four years. During these volatile times, clients seem to prefer quality, and as the largest asset manager, we are providing just that. On the institutional side, we continue to hold the top position in asset management and are gaining market share. TD Asset Management has had a notably strong year with significant positive inflows, largely due to our past acquisition of Greystone, which has made alternative investments more appealing. Institutional clients are especially interested in these alternative investments, showcasing our strength in this area. Overall, whether catering to retail or institutional investors, TD Asset Management is performing well.
Operator, Operator
Thank you. We have no further questions registered at this time. So Mr. Masrani, I'll turn the meeting back over to you.
Bharat Masrani, CEO
Thanks, operator, and thank you all for joining us today. Great questions, great engagement. I know Kelvin is going to take a lot of offline calls on working out the accounting around the First Horizon acquisition, which is terrific. And as you heard, there is no economic impact to the bank, and that is the key part, but I'm sure Kelvin will explain all the ins and outs on that for folks who need further clarification on that. Once again, very happy with how the quarter has turned out and I'd like to take this opportunity to thank our bankers around the world. They do a great job for all of our stakeholders, including our shareholders. So thanks for that, and we will see you again 90 days from now. Thank you.
Operator, Operator
Thank you. Your conference has now ended. Please disconnect your lines at this time. We thank you for your participation.