How Toronto-Dominion Bank Is Set to Save $400 Million in 2016
One of the biggest concerns for Toronto-Dominion Bank (TSX:TD)(NYSE:TD) (and Canadian banks in general) over the past several years has been expense control and cost inflation. The reason why is simple—banks are facing a challenging revenue-growth environment that’s largely pressured by a weakening macro environment (a major source of growth for banks) combined with increased competition.
There are multiple reasons for a slow revenue-growth environment. The majority of bank earnings come from net interest income (58% for TD), and a combination of slow economic growth in Canada, record-high consumer debt levels, and falling interest rates means revenue growth should slow for banks.
As a result, each of the Canadian banks took a series of restructuring charges over the course of 2016. These are basically investments that banks make to reduce the overall expense base as well as slow the rate of expense growth over time to fit within a lower revenue-growth rate. TD has excelled on this front, and shareholders should be rewarded with enhanced earnings growth.
TD took $686 million in 2015 restructuring charges
TD took two restructuring charges in 2015—a $337 million charge in Q2 and a $349 million charge in Q4. What do these charges accomplish?
Over the past decade or so, TD has seen excellent growth, which has occurred both organically and through a string of acquisitions. As a result, TD now sees opportunity to both better integrate these acquisitions in terms of people, processes, and technology, as well improve and streamline processes throughout the entire institution.
The charges also related heavily to real estate optimization. Consumers are increasingly using the digital channel to do their banking and, as a result, more transactions are taking place online and less are taking place in the branch (TD sees branch transactions dropping by 7% a year in the U.S.). As a result, these charges will go towards TD closing branches, merging other branches, and attempting smaller branch formats.
The end result? TD estimates that these restructuring charges will lead to $600 million in annual non-interest expense savings by 2017. This is significant—TD’s restructuring charges were by far the largest of the Big Banks (as a percent of non-interest expenses), and the cost savings are as well. $600 million in savings equates to about 3.5% of the bank’s 2015 non-interest expenses, which is above the approximate 2% savings expected by TD’s peers.
These savings are a tailwind to earnings
TD sees the majority of the $600 million being realized in 2016. The bank estimates about $100 million of the savings was realized in 2015, $400 will be realized in 2016, and another $100 will be realized in 2017.
How does this fall to the bottom line? In 2015 TD had cash based non-interest expenses of $17 billion with adjusted revenues of $29.2 billion. This gives TD an efficiency ratio (or expenses as a percentage of costs) of 58.1%. Analysts at RBC see TD growing revenue by about 10% in 2016 (to $32.2 billion), and if the efficiency ratio stays the same, TD will see expenses of $18.7 billion, a 10% expense growth over 2015.
The bank can be expected to see expense growth annually as wages increase and the business grows, and the $400 million in expected savings in 2016 should reduce this growth. A $400 million reduction would reduce expenses to $18.3 billion, resulting in an efficiency ratio of 56.8% and expense growth of 7.6%.
As a result, this works out to a potential $0.16 per share uplift for shareholders in 2016 over the $4.72 earnings per share that would have been expected if expenses stayed at $18.7 billion. While this does assume all of the savings fall to the bottom line (TD plans to re-invest some to drive future growth and improve competitiveness), investors will definitely see some on the bottom line, and this is an excellent reason to consider adding TD to your portfolio.
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Fool contributor Adam Mancini has no position in any stocks mentioned.
One of the biggest concerns for Toronto-Dominion Bank (TSX:TD)(NYSE:TD) (and Canadian banks in general) over the past several years has been expense control and cost inflation. The reason why is simple?banks are facing a challenging revenue-growth environment that’s largely pressured by a weakening macro environment (a major source of growth for banks) combined with increased competition.
There are multiple reasons for a slow revenue-growth environment. The majority of bank earnings come from net interest income (58% for TD), and a combination of slow economic growth in Canada, record-high consumer debt levels, and falling interest rates means revenue growth should slow…