Toronto-Dominion Bank's expensive foray into the U.S. was supposed to supercharge its growth. Instead, it's become a drag on profitability and badly dented the lender's reputation.
A busted $13.4 billion takeover of First Horizon, a money-laundering probe into its U.S. branches and anemic returns across its stateside operation have investors turning sour on Canada's second-largest bank. Despite some positive momentum in recent weeks, its stock has underperformed all other major Canadian banks.
Those once-prized U.S. assets, which include more than 10 million customers, accounted for about 23% of net income and 25% of revenue in the most recent quarter. Those operations used to deliver a nice valuation premium for the stock. Now, some investors believe they aren't delivering on their promise.
"The U.S. is a tougher market to operate in. It's not as profitable, it's more competitive. And the relationship with the regulator is less friendly," said Brian Madden, chief investment officer at Toronto-based First Avenue Investment Counsel, said. While he applauded Toronto-Dominion's attempt to seek U.S. growth, he now counts his firm as a "frustrated shareholder."
All eyes will be on Toronto-Dominion's U.S. results and strategy when it kicks off Canadian bank earnings season on Thursday. The lender faces the threat of billions of dollars in fines and — maybe worse — the prospect that regulators will impose limits on future U.S. growth. A spokesperson declined to comment, citing a quiet period ahead of its earnings release.
"Once again, TD heads into reporting season in a unique position as anti-money laundering issues at the bank overshadow quarterly results," Scotiabank analyst Meny Grauman wrote in a report to clients.
Grauman said he sees Toronto-Dominion as a value opportunity, considering "the market is now ascribing negative value to its U.S. business."
Investors seem to have a one-way view: signs of weakness are "likely to be severely punished," while strong results aren't likely to cause a rally in the share prices because investors are still waiting for a resolution to the anti-money-laundering problem, he said.
Toronto-Dominion executives have said they remain confident in the U.S. business, notwithstanding the regulatory woes. Chief Executive Officer Bharat Masrani told investors last year the division still has "substantial growth potential — there are three times as many customers in our U.S. footprint as there are in all of Canada."
'Go Big or Stay Home'
Toronto-Dominion has struck deals worth just over $25 billion in the U.S. over 20 years, according to data compiled by Bloomberg, thanks to an acquisition spree kickstarted by former CEO Ed Clark.
While Canada has one of the most stable and profitable banking sectors in the world, it's almost completely carved up by its six largest lenders, leaving them fighting over scraps of market share.
"You need to go big or stay home," Clark told Bloomberg in 2011, after Toronto-Dominion spent about $6.3 billion to acquire auto lender Chrysler Financial. "You don't want to be stuck in this mid-sized space."
That deal was one of four major stateside acquisitions announced since 2004. Others included the $8.5 billion takeover of New Jersey's Commerce Bancorp in 2008; a roughly $7 billion purchase of Banknorth Group, which was completed in two steps by 2007; and the $1.3 billion acquisition of brokerage Cowen, which closed in 2023.
Then came its pact in 2022 to buy First Horizon, a regional player in the southeastern U.S., in what would have been its largest-ever deal. The parties walked away in May 2023, saying it was unclear regulators would ever greenlight the deal.
The collapse was a blow to the credibility of Masrani, who led the U.S. business during Clark's expansionary days.
Soon after, Toronto-Dominion had to acknowledge that it was receiving inquiries from the U.S. Department of Justice, in addition to financial regulators and the Treasury Department. The core allegations are that it failed to catch money laundering and other financial crimes at several U.S. branches. Analysts have speculated that penalties may run into the billions and that the bank may face curbs on its business, similar to how Wells Fargo & Co. was punished in a fake accounts scandal.
In the fallout, Toronto-Dominion has replaced about 10 senior leaders in compliance and legal roles — and fired about a dozen customer-facing employees — and has already spent 500 million Canadian dollars ($367 million) to bulk up its anti-money-laundering defenses.
'Subsidized' Returns
As ugly as that is, some investors find something else even more problematic at Toronto-Dominion: it just doesn't earn attractive returns in the U.S.
Nigel D'Souza, senior investment analyst at Veritas Investment Research, estimates the U.S. retail bank's return on equity was just 8.5% in fiscal 2023, according to his analysis. That compared with a 36.8% return in its Canadian personal and commercial banking business. Return on equity is a critically important metric of bank profitability, measuring how much shareholders get for each dollar of equity capital.
Toronto-Dominion's disclosures make the U.S. business seem rosier, D'Souza said, because "they have returns that are subsidized," with some treasury and corporate expenses allocated to the bank's general corporate segment, including significant investments in strengthening risk controls.
"The major U.S. banks generate higher profit margins and most outperform TD," D'Souza said. "My argument to my clients is if you want exposure to U.S. banking, just buy a well-run U.S. bank instead."
There are signs investors are doing just that. Toronto-Dominion shares have fallen 3.6% over the past 12 months; its five biggest rivals have gained an average of 17%.
That underperformance, coupled with negative headlines on the money-laundering probes, have also put a target on the back of Masrani, who has been CEO for almost 10 years.
"Having a different leader could change sentiment around the stock," D'Souza said. "But it is not going to improve the ROE of the U.S. banking franchise. It's not going to make the industry any less competitive."
