"TD Bank, America's Most Convenient Bank"
Thank you, Wendy. It’s a pleasure to be here at Rotman; I appreciate the opportunity to share my thoughts on the state of the U.S. Banking System and some of the factors contributing to the recent financial crisis.
So what are my key themes for you today?
- The U.S. Banking System is fundamentally sound and on the mend.
- There is still some uncertainty regarding the regulatory environment for banks in the U.S. and globally.
- The TD Bank Group - through TD Bank, America’s Most Convenient Bank - is well positioned to continue its growth in the United States.
TD Bank Group and TD Bank, America’s Most Convenient Bank
Let me share an overview of both TD Bank Group and the bank I run in the U.S. – TD Bank, America’s Most Convenient Bank.
TD has a proud 156 year history in Canada.
We are a top 10 North American bank with more than $600 billion in assets, $438 billion in deposits and a market cap of more than CAN $75 billion.
In 2010, we posted adjusted profits of more than CAN $5 billion.
We continued our growth and last week closed on the acquisition of Chrysler Financial, creating a top 5 bank-owned auto lender in North America.
TD is one of the few banks in the world rated Aaa by Moody’s and the only one in Canada.
Globally, we employ more than 81,000 incredibly talented employees – including many here this morning - each of whom is committed to meeting the financial service needs of our Customers.
And we are the first truly North American bank with significant operations in both Canada and the U.S. In fact, you might be surprised to learn that we now have more stores – as we call them - in the U.S. than we have branches in Canada.
I am incredibly proud of our position in the U.S. and the franchise we have built. We are the 10th largest bank in the country with nearly 1,300 stores along the East Coast from Maine to Florida when just 6 years ago we had none.
We have more than $175 billion in assets, $143 billion in deposits, and over 25,000 dedicated employees.
Our brand promise - centered on WOWing our Customers with legendary service and unparalleled convenience - is unique in U.S. banking circles and cannot be easily replicated.
And through the Great Recession, while other financial institutions collectively lost billions or failed outright, we continued to grow and last year earned over $1 billion in adjusted earnings in the U.S.
Lastly, we continue to invest in our people, our franchise and our brand. In fact, if you haven’t had an opportunity to visit New York recently, I would encourage you to do so and look for the TD shield all across Manhattan. It’s something to behold and, as a Canadian, something to be extremely proud of as well.
The U.S. Banking System
Let me now turn my attention to today’s topic – the state of the U.S. banking system.
Over the past several years, the industry has gone through massive disruption – I will talk more about that in a moment – but overall has weathered the storm.
We are now in what I would consider a normal “healing phase” given the depths of both the financial crisis and the recession.
The economy in the U.S. is growing again. And although there are risks going forward – the debt crisis in Europe, instability in the Middle East and North Africa, the recent tragic disaster in Japan, the federal deficit to name a few - policymakers are committed to doing everything they can, to sustain - and accelerate - the growth in the economy.
Consumers are starting to delever their balance sheets and the savings rate seems to be on the rise.
Credit losses are moderating.
Banks are rebuilding their balance sheets and credit is generally available to credit-worthy customers.
So from where I sit, while there are still issues to be resolved – such as what the Federal government should do with Fannie Mae and Freddie Mac -- the U.S. banking system is sound and on the mend.
Looking back, to truly understand where we are today, you need to understand how we got here.
To say that the last few years have been extremely challenging for banks in the U.S. and around the globe would be an understatement. I have been involved in banking for nearly a quarter of a century – sounds like a long time – and I can say that I’ve never seen anything like it in my career.
Think back to 2008. The excesses of the preceding few years were beginning to unravel. The housing bubble started to burst. Mortgages in the U.S., which had been considered an extremely stable asset class, began to see an alarming rise in defaults.
Losses, both on subprime mortgages and on complex derivatives, began to mount. I’ll talk more about that in a minute
Unemployment – which had consistently remained below 5% in the 2 years prior to the crisis - peaked at just over 10% and has remained stubbornly high.
Storied firms in the U.S. began to fail with increasing speed and the contagion quickly spread. Bear Stearns and Merrill Lynch sold at steep discounts. Fannie Mae and Freddie Mac effectively placed into receivership. Lehman Brothers filed for Chapter 11 bankruptcy. WaMu and Wachovia, gone in an instant.
The dislocation and transformation of the U.S. banking industry during this period was both unprecedented and really quite remarkable.
Anatomy of a Financial Crisis
So what happened to cause the financial crisis? Scholars will likely debate that for years to come – and I am not a scholar – but let me share my perspective.
From where I sat, the financial crisis was influenced by a confluence of factors including: excessive leverage, greed and a lack of oversight – all compounded by a fundamental misunderstanding of the risk-reward tradeoff inherent both in investing and lending. Let me explain.
Let’s start with leverage. The basic principle of leverage is that you use borrowed money to increase your economic return. Leverage can be a good thing; but too much leverage can be devastating and can cripple both a company’s and an individual’s balance sheet.
In banking, a good rule of thumb is that for every dollar of capital you have, you can lend up to $12 - $18. And when you lend out that money, it is always with the expectation that you will not only be repaid, but you’ll make a reasonable return on your loan. Not an unreasonable paradigm, especially for bankers!
In traditional banking, such transactions are clearly shown on your balance sheet and the risk is managed through sound underwriting and ongoing credit monitoring.
In the 1990s, in an effort to generate liquidity for banks and spread both the credit risk and interest rate risk inherent in certain products and instruments like 30 year, fixed rate mortgages - which are common in the U.S. - Wall Street took these loans, securitized them, and sold them to investors in the form of Mortgage Backed Securities.
This had the beneficial effect of spreading the credit risk and interest rate risk associated with these underlying loans while providing banks with additional liquidity which they could then use to make even more loans.
Properly used, Mortgage Backed Securities are useful financial instruments. Improperly used, however, they can be -- as we witnessed – toxic. In fact, they should probably come with some kind of warning label – handle with care!
As demand for these securities rose, Wall Street got even more creative and figured out how to take these underlying loans, slice and dice them and re-package them in various synthetic instruments with exotic names like CDOs and CDOs squared and, in so doing, significantly increased the use of leverage.
These instruments were then sold to investors around the globe and in many instances, held in off balance sheet investment vehicles which made it difficult, if not impossible, for regulators and investors to understand the true risk of the companies they were either regulating or investing in. So excessive leverage played a key role leading up to the financial crisis.
Leverage, meet greed. In the immortal words of Michael Douglas’ character, Gordon Gekko, in the movie “Wall Street,” – “Greed is good.” I’m not here to debate that proposition – I’ll leave that to the philosophers and humanists – but I am convinced that for better or worse greed often drives human behavior.
Normally in banking, consumer demand for financial products drives supply. Companies innovate to meet an underlying need for credit or deposit products. The greater consumer demand, the more willing banks are to meet those needs.
In the years prior to the Financial Crisis, the normal forces of supply and demand were turned on their head and we ended up in a supply-push environment. How so?
Investors, in search of higher yields, were being told that they could invest in triple “A” rated securities – equivalent to the rating of U.S. Treasuries – yet with a substantially higher yield. This led to an increased – almost insatiable – demand for these financial instruments around the globe.
As a result, Wall Street needed an increasing supply of mortgage loans in order to package them into securities to sell to these investors. As has been widely reported in the financial press, an almost factory, production-like mentality ensued.
Certain companies who shall remain nameless – not TD, mind you - invented exotic ways to make more and more mortgage loans to meet Wall Street’s needs. At first, the products were arguably “creative,” but manageable - involving perhaps a low down payment or interest only for a few years, but with a fixed rate thereafter.
Then greed reared its ugly head again and we started seeing things like the negative amortization loan – essentially a way to lower your monthly payment whereby rather than a portion of your mortgage payment going to reduce your principal, a certain amount actually gets added to your mortgage so that it grows over time - hence the negative amortization!
And, in some cases, these loans were reportedly being made to borrowers who weren’t required to document they even had the ability to repay. We saw the evolution of what were called low doc and no doc loans and ultimately, if you can believe this, the “ninja” loan – no income, no job, no assets and you could still get a mortgage to buy a $750,000 home! It was like free money and who wouldn’t want that?
So in hindsight, what we saw was that the desire for an increased supply of mortgages which could then be securitized, effectively led to - and drove - the underlying demand. This is backwards from how supply and demand normally works in financial services and, I believe, contributed to the financial crisis.
Lack of Oversight
At the same time, there was also a reported lack of oversight at the corporate level by management and Boards of Directors. There can be no rounding the corner on that. Companies simply took their eye off the ball and failed to ask basic questions such as:
What would happen to the value of these securities if housing prices stopped rising at double digit rates or in fact declined?
Would borrowers be able to afford their mortgage payment when teaser rates reset or if interest rates rose?
And from a regulatory perspective, the subprime meltdown highlighted the patch quilt nature of financial regulation in the U.S. whereby certain unregulated players in the mortgage industry were allowed to lever up their balance sheets and make loans that regulated players, such as federally and state-chartered banks, would never consider – or be allowed to make.
So taken as a whole leverage, the reliance in the U.S. on products such as 30 year fixed rate mortgages not held on banks’ balance sheets, leverage, greed and a lack of oversight contributed significantly to the current financial crisis.
At the same time, many of the players involved simply forgot or ignored the basic tradeoff of risk/reward. It is an axiom of investing that the greater the risk, the greater the reward and vice versa.
One of the things that in hindsight is so baffling about the financial crisis - while at the same time being so apparent - is that highly sophisticated investors around the world invested in securities that were rated by various debt rating agencies the same as U.S. Treasuries while paying 200 – 300 basis points more.
How does that make sense? It doesn’t take a degree from the Rotman School to know it doesn’t – although that might have helped!
One of two things must be true. Either there is more risk inherent in those investments or they were paying too much. I think we now know which was true.
The TD Experience
So how did TD fare through the crisis? Extremely well.
At TD Bank Group we avoided the subprime mess and were one of the few major banks in the world to do so. How?
Several years ago, we decided to exit the structured products business at the height of the market. This was a contrarian move at the time. Most other financial institutions were rushing to get in and we were criticized – even vilified - by some, for our decision to exit the business. Although it cost us in short term profitability, it was the right thing to do.
To us, the securities were not transparent and the risk reward relationship was not obvious. These were instruments valued by mathematical models which few people on the planet understood and it wasn’t clear to us that the business model was sustainable. So when everyone else was getting in, we got out.
Thankfully, we’ve benefited from our decision by largely avoiding the subprime meltdown altogether. Having said that, it doesn’t mean we haven’t been impacted by the current economic downturn. Like others, we have. But the impact is considerably less than it would have been otherwise and has provided us with significant flexibility to continue to grow both in the U.S. and Canada.
The Government Response
So what was the government response around the globe? In short, it was coordinated, swift, and massive.
In many instances, governments chose to rescue their banks, rather than let them fail.
In addition, many adopted fiscal stimulus policies to replace private sector spending and central bankers used all of the monetary policy tools at their disposal to lower both short and long term rates to help stimulate the economy.
In the U.S. the Fed reduced short term rates to near zero where they remain today.
The combination of fiscal and monetary policy, appears to be working and the Great Recession is officially over.
Having said that, we are not out of the woods yet. The pace of the recovery is not nearly as robust as anyone would like. Unemployment in the U.S. has remained stubbornly high, just shy of 9%, and it is unlikely to fall materially anytime soon.
Although firms are hiring, they are doing so cautiously, and it will take some time to replace the nearly 8.8 million jobs lost during the recession.
Housing continues to be a drag on the economy in many parts of the country. In our footprint – largely up and down the East Coast - we have seen signs of stabilization. But it will likely take some time for housing prices in the U.S. to stabilize.
Other risks include geopolitical uncertainty, the current crisis in the Middle East and the resulting impact on oil prices, the potential for the sovereign debt crisis in Europe to widen, the interruption in the global supply chain caused by the disaster in Japan, how the Fed will unwind its stimulative monetary policies and the political will of Congress to address the country’s fiscal challenges.
On the positive, one bright sign in the U.S. is in manufacturing. The relatively weak dollar, low inventory levels and global demand, particularly from emerging markets, have led to an increase in manufacturing which is a positive development.
And one should not underestimate the inherent resiliency of the U.S. economy and the fundamental optimism of the American consumer. The U.S. economy always bounces back and I am confident it will do so coming out of the Great Recession.
TD Economics’ forecast is for the economy in the United States to grow in the 3% range for the next couple of years. So on balance while the American economy is on the mend, the pace of the recovery is not as fast as we would like.
The Regulatory Environment
Let me turn my attention to the regulatory response to the financial crisis, both in the U.S. and globally.
The world’s banking regulators meet in Basel Switzerland regularly and recently published a new set of proposals known as Basel III – the goal of which is to prevent a repeat of the global financial meltdown.
Among other things, the Basel III regulations increase capital and liquidity requirements and will be phased in over a number of years. From TD’s perspective, we are well positioned to meet the new requirements.
If I have any concerns, they are around: 1) the doctrine of unintended consequences and the possibility that the new rules could lead to a possible tightening of credit for businesses and consumers by some institutions – not TD, mind you; and 2) the timing of the implementation of the proposed liquidity rules which are not scheduled to be implemented for some time.
Turning to the U.S, major financial reform came in the form of the Dodd-Frank Act, named for the heads of the banking committees in the U.S. Senate and House, Senator Chris Dodd and Congressman Barney Frank.
Passed in July of last year, the legislation represents the most sweeping changes to the nation’s banking laws since the Great Depression and will have a significant impact on the U.S. financial system.
The Act is more than 2,300 pages long; let me read just a few pages. Just kidding, I wouldn’t do that to you.
From my perspective - while many commentators like to criticize regulation - not all of the changes are bad. Should non-banks that provide mortgages to American consumers be subject to the same laws and regulations as banks like TD Bank? Absolutely.
Was the regulatory framework in the U.S. which allowed banks to pick and choose the most lenient regulator in need of overhaul? It was.
Do I think that the industry should adapt and become less reliant on overdraft revenue to fund basic banking services for the nation’s consumers and eventually look more like the Canadian system? I do.
The Act is critically important and could play a significant role in re-shaping the U.S. banking system.
The legislation is comprehensive and taken as a whole, requires nearly 100 studies to be undertaken and 240 rules to be promulgated in the coming years.
Again, my only concern is with the doctrine of unintended consequences. Given the comprehensive nature of the legislation and the number of rules that need to be promulgated, my hope is that U.S. regulators will carefully consider the impact of any proposed changes to ensure that proposed solutions address the underlying cause of the problem and that unintended consequences are minimized.
Outlook for U.S. Banking System
So what do I see for the U.S. Banking System in the coming years?
There are a number of forces at work which could re-shape the industry.
First, as I mentioned earlier, the regulatory environment will continue to put pressure on banks and this will force them to adjust their business models.
On this point, I am confident banks will be able to do so, but it will take some time.
Second, the industry will continue to consolidate: sometimes voluntarily; at times involuntarily.
Consider this. In 2000, on a combined basis, the top 10 U.S. banks had $3.4 trillion in assets. A decade later, the top 10 banks had assets of more than $9 trillion.
Twenty years ago, in 1990, there were 15,000 banks and thrifts in the U.S. Today there are approximately half that number and in the coming years it is not inconceivable for the number to be substantially reduced even further.
Third, consumer demand for innovative products which can be delivered seamlessly across multiple channels including in store, ATMs, online and increasingly mobile – and the costs associated with providing these services – will drive further consolidation.
So the U.S. banking industry will continue to consolidate and evolve and, at TD, we intend to involve with it.
Let me leave you with these thoughts:
Despite what you may read in some of the popular press, banking is still a noble profession and I am extremely proud to be a TD banker.
TD is one of the few Aaa rated banks left in the world – and the only Canadian bank.
We are the first truly North American bank with a substantial presence in both Canada and the U.S.
The state of the U.S. banking system is sound and the industry is on the mend, although there are issues which still need to be addressed.
And while the economy is improving there are risks to the economic growth we are experiencing.
Similarly, while the regulatory environment is becoming more clear, there is still some uncertainty regarding the rules going forward.
Lastly, at TD Bank, America’s Most Convenient Bank, we are well positioned to take full advantage of the opportunities in the U.S. to continue our growth and we intend to do so.
Thank you for this opportunity to share my thoughts with you.