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The Toronto-Dominion Bank (NYSE:TD) and Bank of Montreal (NYSE:BMO) are both in the process of doing large U.S. acquisitions. In December of 2021, BMO announced that it would purchase Bank of the West from BNP Paribas (OTCQX:BNPQF) for US$13.4 billion. A few months later, TD Bank announced a deal of its own. In a press release dated February 28, TD announced that it would be buying First Horizon (FHN) for US$13.4 billion–the exact same amount that BMO offered for Bank of the West.
The response to both deals was mixed. BMO received praise for its Bank of the West deal, but later took criticism from community groups for alleged discriminatory practices. TD’s FHN deal was immediately greeted with concerns about valuation, and later received criticism from a group of senators who alleged that TD was guilty of abusive practices.
Public opposition notwithstanding, U.S. expansion is very important to both TD and BMO. Canada’s financial services market is saturated by six big banks, leaving little room for domestic growth. For this reason, Canadian banks generally look to the U.S. for expansion. So far, TD has been the most successful of its peer group in pushing into the U.S.; it earns a full 36% of its net income from U.S. retail. However, BMO isn’t too far behind, with approximately 29% of adjusted net income coming from its U.S. segment. In fact, BMO has an even higher percentage of income coming from the U.S. on a reported basis, though that’s mainly due to the sale of a subsidiary. TD has more U.S.-source income than BMO on a normalized basis.
Expansion into the U.S. is very important for Canadian banks. The U.S. is a massive market in which banks have a lot of room to grow. It’s also more fragmented than the Canadian market, giving an edge to banks that consolidate market share. So it makes a lot of sense for TD and BMO to expand there.
The question is, which of the two banks is better positioned to grow in the U.S. going forward? TD has the bigger U.S. business for now, but BMO’s deal gives it more U.S.-based assets. It appears, then, that the latter is better positioned for U.S. growth, assuming we’re looking at just the value of the banks’ deals, and none of the other factors. However, the other factors are definitely worth exploring, as I’ll demonstrate in the ensuing paragraphs. Ultimately, I conclude that TD and BMO are both great stocks, but that TD’s deal is slightly more attractive than BMO’s.
BMO – the Existing Business
Before looking at BMO’s M&A deal, we need to look at the business as a whole. BMO already has a large presence in the U.S., so we need to understand how Bank of the West will add to that presence.
The Bank of Montreal is Canada’s third biggest bank. It is the second most “American” Canadian bank after TD, with 29% of adjusted earnings coming from the USA. Overall, BMO boasts:
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US$810 billion in total assets.
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C$17 billion in year-to-date revenue.
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C$7.6 billion in year-to-date net income.
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C$4.7 billion in year-to-date adjusted net income.
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US$9.4 billion in trailing 12-month net income.
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C$50 million in provisions for credit losses (“PCL”), down from $60 million.
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A 16% CET1 ratio, up from 13%.
From these metrics, we can calculate a 0.9% return on assets (trailing 12-month) and 27.6% adjusted net margin (year to date). These metrics are both very strong. The profit margin is high by the standards of any industry, while the 0.9% return on assets is higher than TD’s 0.81%. The CET1 ratio is more than double what regulations require, and is rising over time. So, BMO is a pretty solid bank financially speaking.
One possible area of weakness here is the PCLs. At $50 million, they’re only 2.9% of 12-month revenue. This year, Canadian housing is in a freefall, with sales down 47%, and prices down 20% from February. In the meantime, the Bank of Canada is raising interest rates, so homeowners with variable rate mortgages are paying more interest on increasingly less valuable homes. It seems like this situation could lead to a lot of defaults, but BMO is expecting only 2.9%. Perhaps, then, its business is vulnerable in a scenario where Canada’s housing market crashes further.
As far as valuation goes, BMO is pretty cheap. Trading at just 9 times GAAP earnings, 7 times adjusted earnings, and 1.4 times book value, it’s a real bargain. Banks are generally cheap, but even Bank of America (BAC) has a double-digit P/E ratio. So, if you’re looking for cheap, high-yielding stocks, BMO has what you’re looking for.
BMO – Bank of the West Deal
Having looked at BMO’s total business, it’s time to turn to the bank’s upcoming deal. As we’ve seen, BMO is pretty cheap at today’s prices, and has a solid balance sheet. Those are good things, but they won’t be as good in the future if BMO overpays for its acquisition. So, we have to look at that deal in detail.
BMO is paying $13.4 billion for Bank of the West. For that sum, it’s getting:
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US$105 billion in assets.
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1.8 million customers.
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US$974 million in annual earnings power.
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A strategic position in the California market.
At $13.4 billion, BMO is paying $13.75 for every dollar of earnings Bank of the West generated in 2021. It could be that earnings have grown since 2021, as the COVID-19 crisis was still negatively impacting bank earnings in the first quarter of that year. However, BNP Paribas’ first half earnings release doesn’t list Bank of the West’s earnings separately from the rest of the company, so 2021 earnings are what we have to go on. Therefore, we’ll estimate that the “deal P/E ratio” for BMO’s Bank of the West deal is 13.75–not insanely high, but higher than average for a bank.
The amount being paid for the assets looks more enticing. With a $13.4 billion purchase price, BMO is paying $0.127 for every dollar in assets it’s getting from this deal. That’s higher than the same ratio for BMO’s own stock (about $0.081) but it compares favourably to the price TD is paying for First Horizon’s assets, as I’ll show momentarily.
TD Bank – the Existing Business
TD Bank is Canada’s second-biggest bank by market cap, and the largest by total assets. It’s the most American Canadian bank, with 36% of earnings coming from the United States, and a huge equity stake in Charles Schwab (SCHW). As of this writing, TD boasted:
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US$1.4 trillion in assets.
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US$34 billion in revenue.
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US$19 billion in net interest income.
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US$11.5 billion in net income.
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US$60 million in PCLs.
On the whole, this is a pretty similar picture to BMO. The 0.82% return on assets is lower than for BMO, as is the CET1 ratio. However, TD gets a higher ‘profitability’ grade than BMO in Seeking Alpha Quant, because it has positive cash from operations (BMO does not).
TD also scores pretty well on valuation. It has a 10 P/E ratio, and a 1.5 price to book ratio. These are higher than the same multiples for BMO, but BMO’s most recent earnings were inflated by the sale of a subsidiary–it isn’t as cheap going by adjusted earnings as by GAAP earnings.
On the whole, TD and BMO are pretty comparable going by profitability and valuation. To really break the tie between these two stocks, then, we’ll have to look at TD’s First Horizon deal in detail.
TD Bank – First Horizon Deal
TD is paying $13.4 billion for First Horizon. This is the same price BMO says it’s paying for Bank of the West, although BMO is netting the $16.3 billion purchase price against excess capital owned by Bank of the West. In TD’s case, the $13.4 billion fully reflects what will be paid out to FHN shareholders, it isn’t being netted against anything gained in the transaction.
What’s TD getting for its $13.4 billion?
According to the deal’s press release, it’s getting:
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US$89 billion in assets.
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A 10% boost to 2023 earnings.
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An increased presence in the South, which has faster population growth than the U.S. average.
Additionally, we can turn to Seeking Alpha Quant to get FHN’s 12-month EPS. That turns out to be US$1.50, so TD is valuing FHN at a 16.6 P/E ratio. That’s very high for a bank, but TD says it will boost FHN’s earnings via US$610 million worth of “pre-tax synergies.” I covered these synergies in a past article. Basically, TD can reduce FHN’s costs via economies of scale. It can move FHN’s cloud servers to its own cloud, and give FHN the benefit of bulk pricing. FHN will save some money this way, but TD’s $610 million estimate seems a little bit adventurous. FHN’s entire EBT for the last 12 months was $1 billion, so TD thinks that it can boost pre-tax earnings by 60%. I don’t think that’s realistic, though certainly some savings will be achieved: the bigger the company, the more power it has to negotiate lower prices on bulk purchases.
So, which deal is better, TD’s FHN deal or BMO’s Bank of the West deal?
Based on the claimed purchase prices, BMO is paying less than TD is. The BMO deal is for 0.13 times assets and 13.75 times earnings, TD’s is for 0.15 times assets and 16.6 times earnings. It seems like BMO is paying less, but keep in mind that the purchase prices for these deals are different: TD is calling the amount paid the “purchase price,” BMO is subtracting excess capital from price. If we use $16.3 billion–the amount actually being paid out–as BMO’s price, then suddenly the deal P/E ratio swells to 16.7, which is actually pricier than TD’s deal. So these two deals are more similar than they appear.
Final Verdict
Taking into account the value of TD and BMO’s respective deals, I find both stocks to be worth investing in. However, I slightly prefer TD Bank. BMO’s deal looks better on the surface, but you have to remember that BMO is subtracting some of Bank of the West’s assets from the purchase price. TD’s press release gives a much more straightforward purchase price: literally the amount it will pay FHN shareholders. First Horizon, like Bank of the West, has some excess capital, but TD doesn’t subtract the amount like BMO does. When we compare TD and BMO’s deals on an “apples to apples” basis (that is, the amount of money actually changing hands), we see that TD is paying slightly less than BMO is. So, TD is getting a better value overall.
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