Why Toronto-Dominion Bank Investors Should Pay Attention to its Latest Wave of Layoffs

Toronto-Dominion Bank (TSX:TD)(NYSE:TD) recently confirmed another large round of layoffs. For investors, it may be reason for cautious optimism.

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For the second time this year, Toronto-Dominion Bank (TSX:TD)(NYSE:TD) is announcing a wave of layoffs as a part of their ongoing productivity review. For investors, this story is far bigger than a set of layoffs—both the layoffs and the productivity review are a part of the bank’s effort to adjust to a new, slower-growth, more digital, and more competitive operating environment.

In the first half of the year, TD announced a $228 million restructuring charge as the first part of this review—which involved branch closures, mergers, and the streamlining of processes, as well as a round of layoffs at all levels of the bank.

The bank is now in the midst of the second part of the review; some are expecting several hundred layoffs. Here’s what investors need to know about TD’s latest move and why it may be cause for optimism.

Why TD is laying off staff

TD’s CEO Bharat Masrani recently stated that the company’s ongoing productivity review—including the layoffs—are all a by-product of the new slower-growth world that banks need to operate in. This is true, and TD faces slower earnings and revenue growth going forward.

Canadian banks averaged earnings growth of about 11% annually for the past 20 years, with TD growing by 15% in 2014. TD is expecting earnings growth of about 7% in 2015, and analysts are expecting growth between 4-7% for 2016 and 2017.

There are plenty of reasons for the slower-growth forecast. Firstly, a weak economic picture in Canada (where TD earns 70% of its revenue) will pressure returns. Bank-loan growth is driven by GDP growth as well as employment. While employment is decent, Canada is expecting GDP growth of only 1% in 2015 compared to a 2.2% average.

In addition, the Canadian consumer is extremely overleveraged with a debt-to-income ratio of 164% (one of the highest in the world), and this should put pressure on loan growth for banks as well. This will not be helped by the fact that housing starts in Canada are expected to decline.

TD is also facing a far more competitive environment going forward from new “FinTech” start-ups. A recent report by McKinsey suggested that 60% of global bank profits are at risk from new start-ups that offer a more accessible customer experience with lower fees. At the very least, these firms will put pressure on margins as banks will need to remain competitive on pricing.

At worst, they will steal bank market share as customers opt to use FinTech firms for their day-to-day borrowing, payments, and wealth management needs, relegating the banks to their traditional regulated business of taking deposits and making larger loans.

It is clear that TD needs to reduce both its cost base and expense growth to adjust to this new banking environment.

The recent cost-cutting measures will allow TD to compete

The productivity review and recent string of layoffs should lead to some tangible benefits. TD estimates that the current initiatives will lead to a 2% reduction in their overall cost base by 2017.

Even more importantly, however, is the fact that the recent restructuring will reduce TD’s rate of expense growth. This is important because if TD’s revenue declines, but its expense growth remains the same, the bank will see a decline in its overall profitability. By lowering its expense growth, TD will be able to increase its profitability as revenue grows.

Analysts at RBC see the banks non-interest expense growth declining from 8% annually in 2015 to 6% by 2017, which will successfully protect the bank’s profitability in a slower revenue-growth world.

TD’s latest wave of layoffs and cost reductions are also helping the bank adjust to customer’s increasing preference for digital banking. TD estimates that transactions in branches are declining by 6-7% per year. At the same time, digital transactions are growing by 12% annually.

As a result, TD is closing branches, merging branches, and implementing smaller, more advice-based branches. TD is then taking the savings that emerge from these changes, and re-investing it in the online and mobile channels.

Since mobile and online banking are much cheaper to run than branches, TD’s cost-cutting measures are simultaneously reducing costs, while improving digital and online competitiveness.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Adam Mancini has no position in any stocks mentioned.

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