Toronto-Dominion Bank: A Small Deal That Shows The Bank's Strengths

| About: Toronto-Dominion Bank (TD)

Summary

A few days ago TD agreed to purchase Albert Fried & Company.

On the surface it's a relatively small deal, you might have even missed it.

But it shows pretty clearly how TD goes about growing its business.

Toronto-Dominion Bank (NYSE:TD) is one of Canada's largest banks. It's also been expanding into the United States via acquisition and organic growth. The recent agreement to buy Albert Fried & Company is a great example of the bank's approach.

North of the boarder
One of the reasons I like TD Bank is that it's large and insulated from being acquired. This is a big issue in banking because smaller players frequently get gobbled up by larger ones. That said, even large U.S. banks aren't immune from being gobbled up or merged out of existence. Corporate actions like that can change the company you bought into one you don't want to own, which goes against one of my key investment questions: Would I want my wife to own this stock if I were to die?

If I can't be reasonably sure that a company will remain on a good course, I can't answer yes to that question and a takeover clearly changes everything. Which is why I didn't buy a U.S. bank. Canada, on the other hand, has pretty much created a system in which a small handful of large banks, TD being one of them, run the show. And Canada likes it that way, putting in place rules to stop foreign takeovers and literally standing in the way of mergers between the country's own big banks.

So it's a fight for market share in Canada for TD and its Canadian banking peers, but TD isn't likely to change because another bank takes it over. Yet what about growth? For TD that has been helped along by its move into the U.S. market, something its Canadian peers have been doing too.

But TD didn't move in a giant leap. Instead it looked for banks that shared its service oriented culture and gave it access to markets it thought desirable. The start of the process was in 2005 with the purchase of 51% of Banknorth, with the purchase of Commerce Bank a few years later in 2008. It used that platform to expand largely via new bank branch openings.

The interesting thing about this is that TD started with a toehold and then used an industry downturn to opportunistically add to its position. That created the foundation for growth. It's the type of contrarian, long-range thinking shareholders should like to see.

A little deal
Which is where the bank's recent agreement to purchase Albert Fried & Company comes in. Albert Fried is a U.S. financial company that offers what are known as prime brokerage services. Toronto-Dominion Bank does this already in Canada, so it knows the business. And buying Albert Fried gives it the ability to expand into the U.S. market.

Now prime brokerage services sound exciting, but they aren't. Essentially, it means that TD is the middle man helping to coordinate certain aspects of trading for large investors like hedge funds and pensions. Thinking about it in simplistic terms, prime brokers allow hedge funds and the like to outsource some of the mundane tasks that would otherwise require them to hire a full staff of employees. It's not really exciting at all, which is right up TD Bank's alley!

So TD Bank is taking a business it knows and buying its way into the U.S. market. Via a company with a nearly 100 year history that's currently building a new technology platform to support long-term growth. That's the kicker... Toronto-Dominion plans to finish up the tech work Albert Fried started and then put the system to work in early 2017. The new system allows TD to move past regulatory issues that might plague the purchase of a company working with legacy systems.

In other words, TD has opportunistically bought a foundation with plans to start building a U.S. prime brokerage business next year. This is exactly the type of take-it-slow approach that I hoped for when I bought into Toronto-Dominion Bank on a price drop not too long ago.

Pleasing to behold
Mergers and acquisitions always worry me because they have a habit of not working out as planned. TD buying Albert Fried is no slam dunk on that score, it comes with execution risk in the development of the new platform, integration risk, and a payoff that won't come until at lest 2017. And maybe the prime brokerage business won't turn out to be as desirable as hoped.

However, based on Toronto-Dominion's history of successful acquisitions in the United States, the relatively small size of the current deal, and the take-it-slow approach being extolled, I'm quite pleased with the bank's move to expand further into the U.S. market. You should be too if you own TD Bank. And don't forget to watch the earnings releases for updates on the new U.S. prime brokerage unit.

Disclosure: I am/we are long TD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.