Toronto-Dominion Bank's (TD) CEO Bharat Masrani on Q4 2014 Results - Earnings Call Transcript

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The Toronto-Dominion Bank (NYSE:TD) Q4 2014 Earnings Conference Call December 4, 2014 3:00 PM ET

Executives

Rudy Sankovic - SVP, IR

Bharat Masrani - CEO

Colleen Johnston - CFO

Mark Chauvin - Chief Risk Officer

Tim Hockey - Group Head, Canadian Banking, Auto Finance and Wealth Management

Mike Pedersen - Group Head, U.S. Banking

Bob Dorrance - Group Head, Wholesale Banking

Riaz Ahmed - Group Head, Insurance, Credit Cards and Enterprise Strategy

Analysts

Jason Bilodeau - Macquarie

John Aiken - Barclays

Steve Theriault - Bank of America Merrill Lynch

Gabriel Dechaine - Canaccord Genuity

Sumit Malhotra - Scotiabank

Robert Sedran - CIBC

Peter Routledge - National Bank Financial

Meny Grauman - Cormark Securities

Mario Mendonca - TD Securities

Darko Mihelic - RBC Capital Markets

Rudy Sankovic

Good afternoon, and welcome to TD Bank Group's Fourth Quarter 2014 Investor Presentation. My name is Rudy Sankovic. I'm the Head of Investor Relations for the Bank. We will begin today's presentation with remarks from Bharat Masrani, our CEO; after which Colleen Johnston, the Bank's CFO will present our fourth quarter operating results. Mark Chauvin, Chief Risk Officer, will then offer comments on credit quality; after which we will entertain questions from those in the room and from pre-qualified analysts and investors on the phone.

Also present today to answer your questions are Tim Hockey, Group Head - Canadian Banking, Auto Finance and Wealth Management; Mike Pedersen, Group Head - U.S. Banking; Bob Dorrance, Group Head - Wholesale Banking; Riaz Ahmed, Group Head - Insurance, Credit Cards and Enterprise Strategy. Riaz is also responsible for the capital and treasury activities at the Bank.

Please turn to Slide 2. At this time, I would like to caution our listeners that this presentation contains forward-looking statements. There are risks that actual results could differ materially from what is discussed, and that certain material factors or assumptions were applied in making these forward-looking statements.

Any forward-looking statements contained in this presentation represent the views of management and are presented for the purpose of assisting the Bank's shareholders and analysts in understanding the Bank's financial position, objectives and priorities, and anticipated financial performance. Forward-looking statements may not be appropriate for other purposes.

I'd also like to remind listeners that the Bank uses non-GAAP financial measures to arrive at adjusted results to assess each of its businesses and to measure the overall Bank performance. The Bank believes that adjusted results provide readers with a better understanding of how management views the Bank's performance. Bharat will be referring to adjusted results in his remarks.

Additional information on items of note, the Bank's reported results and factors and assumptions related to forward-looking information are all available in our Q4 2014 report to shareholders.

With that, let me turn the presentation over to Bharat.

Bharat Masrani

Thank you, Rudy, and welcome everyone. Thank you for joining us this afternoon. Colleen will be up shortly to discuss our fourth quarter results in detail, but let me start by sharing my thoughts on the quarter and the year as a whole.

Our fourth quarter was a solid quarter for TD. Earnings and EPS were up 3% year-over-year to $1.9 billion and $0.98 respectively. While the headline numbers appear to be a bit soft, the shortfall was due to several factors which Colleen will discuss.

Looking beyond these items, the fundamentals of our business remain strong, with healthy loan and deposit volumes, good growth in fee income, and lower credit losses offset by higher enterprise expenses and the margin pressure we signaled last quarter.

Turning to the full-year 2014, I'm very pleased with our performance. Total bank earnings exceeded $8 billion, up 8% from a year-ago, after adding back the insurance charge we took in 2013. And EPS rose 8% on the same basis to $4.27. Our Basel III capital position ended the year at a healthy 9.4%, and we delivered a 14% increase in dividends paid per share as well as a 20% total shareholder return for the fiscal year. These strong results were driven by great execution in all of our businesses.

Canadian retail performed very well in 2014, with earnings up 8% after adding back last year's insurance charge. In our personal and commercial banking business, loan and deposit volumes were strong and credit quality was excellent. Our wealth businesses had a banner year with direct investing maintaining its industry leadership position and our advice and asset management businesses achieving record levels of long-term fund sales in assets under management.

Insurance continued it's recovery from a tough year in 2013, and we achieved the number one ranking in credit card market share with the acquisition of exclusive Aeroplan Visa mass marketing rights and half of the Aeroplan Visa portfolio. I'm equally proud of the recognition we received for continuing to deliver legendary customer experiences from industry providers like J.D. Power and IPSOS, as well as customers in the broader public through their overwhelming response to our TD Thanks to You and more recent Make Today Matter campaigns.

Our U.S. retail bank also delivered good results in a challenging environment. U.S. personal and commercial banking net income reached nearly US$1.7 billion in fiscal 2014, up 5% from the previous year, an impressive performance given continued pressure on loan margins and US$234 million less in security gains relative to last year. These results were driven by strong loan and deposit growth, a continued contribution from Epoch and Target, significant declines in credit losses, and disciplined expense management.

Together with a strong year at TD Ameritrade, where earnings from our ownership stake rose by 17%, this drove a 7% increase in net income in our U.S. retail segment and a 14% increase in Canadian dollar terms reflecting the stronger U.S. dollar.

Our wholesale bank turned in a great performance in 2014, with earnings up 25% and ROE at 18% for the year. Revenue growth was strong in our trading and origination businesses and TD Securities led some of the year's largest equity and debt transactions, including PrairieSky Royalty's $1.7 billion IPO and the Nalcor Energy- Muskrat Falls project, a bond placement that demonstrated our ability to leverage capabilities and partnerships across the entire bank.

On the expense front, total bank expenses, excluding variable compensation, acquisitions and FX rose 3.7% in fiscal 2014. This growth included investments to position ourselves for future success, including strengthening our digital capabilities, opening new stores and ensuring that we are equipped to meet significant new regulatory requirements. As we've often said, it's important that we make the investments necessary to keep TD strong today and in the future.

Let me now turn to the year ahead. We will continue to focus on organic growth, leveraging the investments we've made to expand our businesses and capabilities over the last decade, and we will keep looking for ways to deliver legendary customer experiences across all of our businesses, including digital channels. We have great opportunities to drive stronger growth by being true to these core attributes of our brand. At the same time we face several headwinds. The operating environment remains difficult. With interest rates still low, a global recovery that is only gradually taking hold and increased competition from traditional and nontraditional players.

In addition, credit, and a stronger U.S. dollar were tailwinds this year. We do not expect either to make the same contribution to earnings growth in 2015.

Our reflected tax rate is likely to rise, and expense pressures will persist as we continue to invest in our technology platform, our distribution network, our regulatory infrastructure, and productivity initiatives. That's why I'm determined we will re-double our efforts to increase efficiency and streamline our cost base. This will be an important area of focus in 2015.

What does this mean for earnings growth? We continue to aspire to deliver 7% to 10% EPS growth or the medium term. In the current environment, it is difficult to see how we will get into that range next year, given the headwinds I've just outlined, but this should not obscure the strong fundamentals of our franchise businesses.

In Canadian retail, personal loan and deposit volumes are accelerating. Business lending is strong, and TD Canada Trust has enhanced its product offerings to support this growth. Our cards business is performing well. The fundamentals of our insurance business continues to strengthen, and our wealth franchise goes from strength-to-strength with direct investing platform that is on par with global players like TD Ameritrade and an advice business that is partnering evermore closely with TD CT to drive new client relationships.

Our U.S. retail franchise is well positioned to benefit from a stronger U.S. economy, one of the few OECD economies currently experiencing a genuine recovery. While low rates and intense competition persist, we continue to take share and outperform our peers. We're also evolving our distribution strategy, deepening customer relationships, and improving our productivity.

We will keep investing in all of these areas next year, including opening 23 new stores. We expect continued good performance in our wholesale business, though the recent drop in oil prices may affect our momentum in the energy space. We will build on the signature deals we led in Canada this year to strengthen our profile with clients and extend our franchise model in the United States.

In closing, as I reflect on the year just ended, and look ahead to my first full quarter as CEO of this great institution I'm optimistic about the opportunities we have and confident about our strong track record of executing on our goals.

I want to thank you, members of my senior management team, and our incredible colleagues here at TD, who now number over 85,000, for your hard work, dedication, and ability to rise to any challenge. I know that together we will achieve great things as we build an even better bank.

Thank you very much, and now, I will pass it on to Colleen.

Colleen Johnston

Thanks very much, Bharat, and good afternoon everyone. Let me take you through our results. Before we review the fourth quarter in detail, let's start with a brief overview of 2014.

For the full-year, total adjusted net income was 8.1 billion, a new record, up 14% from 2013 and adjusted EPS of 427 was up 15%. Our 2013 results included additional losses in our insurance business related to claims resulting from severe weather-related events and increased general insurance claims. After adding back this impact, adjusted earnings and EPS grew 8% compared with last year.

Our retail businesses had a great year, contributing 90% of total earnings. Canadian retail grew 17% or 8% after adding back the insurance charges I just mentioned. This record performance was driven by good growth in loans deposits and wealth assets, strong credit performance, positive operating leverage, and the addition of the widely recognized Aeroplan program.

U.S. retail grew 14%, another new record, supported by good operating performance and currency translation. In a tough operating and regulatory environment, the fundamentals remained very good for our U.S. business. Strong loan and deposit growth and excellent credit performance helped the business earn through a significant decline in security gains, and we benefited from the acquisitions of the Target credit card portfolio and Epoch Investment Partners.

Wholesale banking delivered an impressive year with earnings growth of 25%. Very strong top line growth, lower PCL, and good expense management all contributed to a great year. We finish the year with a CET 1 ratio of 9.4%. Overall, we were very pleased with our 2014 performance.

Please turn to Slide 5. Turning to Q4, we delivered adjusted net income of 1.9 billion and adjusted EPS of $0.98, both up 3% year-over-year. The quarter reflected good earnings contributions from our operating segments partly offset by higher corporate segment loss. Retail adjusted earnings of 1.9 billion were up 7% over last year, driven by good loan and deposit growth on both sides of the border as well as lower overall PCL and currency translation.

Wholesale net income of a 160 million was up 31% from a week quarter last year. The corporate segment posted a loss of a 165 million. Overall, a solid result for the bank this quarter.

Please turn to Slide 6. This slide presents our reported and adjusted earnings this quarter with a difference due to two items of note both of which you've seen before. I'd like to highlight that the MBNA conversion is now successfully completed and we do not expect any further items of note related to the MBNA integration.

Please turn to Slide 7. Canadian retail delivered a good quarter with adjusted net income of 1.4 billion, up 7% year-over-year. The increase was driven by good loan and deposit and wealth asset growth and the addition of Aeroplan partly offset by higher expenses. Loan and deposit growth was good this quarter. Total loan growth was 6% year-over-year with real-estate secured lending volume up by 4% and business lending up a strong 10%.

Card growth was strong at 21% due mainly to the addition of Aeroplan, while auto lending volumes increased by 11%. Personal and business deposits increased by 4% due to strong growth in core savings and checking accounts, up a 11%, partially offset by lower term deposit volume. Margin was down six basis points sequentially in line with our guidance from last quarter, primarily due to the low rate environment, competitive pricing and seasonality.

We expect margins to bump around, but remain relatively stable for the next few quarters depending on product mix, seasonality of the competitive environment, and rate moves. Credit performance continues to be favorable with PCL and personal banking up by 8 million from last year due to the addition of Aeroplan balances.

Business banking PCL was up by 18 million, driven mainly by higher prior year recoveries. Adjusted expenses were up 8% year-over-year due to higher employee-related cost, including variable compensation mainly in wealth, volume growth, initiatives to grow the business, and the addition of Aeroplan. These increases were partially offset by productivity gains.

We continue to disclose the Canadian wealth and insurance businesses, which are included in the Canadian retail segment. The wealth business made a strong contribution with 10% earnings growth. Assets under management grew 23 billion or 11%. The insurance business had solid results, roughly in line with Q4 of last year; overall, good performance for Canadian retail.

Please turn to Slide 8. U.S. retail, excluding TD Ameritrade had earnings of U.S. 385 million flat to Q4 of last year. Results for the quarter reflected strong organic growth, favorable credit, and good expense management offset by margin compression and lower security gains. Revenue decreased by 2% year-over-year, as volume growth was offset by lower gains on sales of securities and lower margins driven mainly by lower accretion and also heightened competition.

Average loans were up 8% year-over-year with a 3% increase in personal loans and a 14% in business loans. Average deposits increased by 5%. Margin was down 11 basis points quarter-over-quarter, in line with our guidance from Q3, reflecting lower accretion as well as some core compression due to heightened competition and mix. We are starting to see signs of margin stabilization from the Q4 level as competitive pressures are abating.

PCL decreased 29% due primarily to improvements in credit quality, particularly in auto loans and lower net charge-offs in business lending. Expenses were down versus last year. Permanent expense reductions were offset by higher employee costs to support business growth.

Expenses related to Target revenue share declined versus last year. Earnings from our ownership stake in TD Ameritrade in U.S. dollars were up 5% year-over-year due to increased TD Ameritrade earnings which rose 6% versus last year; all-in, a solid performance in the U.S.

Please turn to Slide 9. Net income for wholesale of a $160 million was up by 31% compared to a weak fourth quarter last year. The increase was due to lower expenses. Revenue was flat versus Q4 last year as higher equity and debt underwriting and M&A fees were offset by lower trading-related revenues. During Q4 we implemented a funding valuation adjustment related to non-collateralized derivatives which amounted to $65 million pretax. The introduction of this reserve reflects evolving industry practice. This item reduced trading-related revenue.

Non-interest expenses were down 10% compared to an elevated Q4 of 2013, which included expenses related to a commercial dispute. ROE this quarter was 13% below what has been our range due to the FVA charge.

Please turn to Slide 10. The corporate segment posted an adjusted loss of $165 million in the quarter. As expected, the elevated loss was primarily driven by continued investments in enterprise projects and initiatives and a lower contribution from favorable tax items. We expect corporate segment losses to increase next year, reflecting the non-recurrence of gains from the sale of TD Ameritrade shares recognized in 2014, higher expenses and a reduced level of favorable tax items in 2015.

Please turn to Slide 11. Core expenses for the quarter, which exclude the impact of FX and acquisitions were up 5.5% year-over-year. Excluding higher variable compensation, core expenses grew by 5%. On a full-year basis, core expenses grew by 4.9% or 3.7% when the variable compensation is excluded. As anticipated, operating leverage for the fourth quarter and 2014 was negative. Growth in core expenses for both the quarter and the full-year was driven by a combination of higher investment in regulatory and growth initiatives and employee costs.

On a full-year basis close to 2% of our expense growth reflected higher project and initiative spend, investments in the future including digital regulatory and infrastructure build. Base growth was partially offset by productivity savings.

Please turn to Slide 12. Our Basel III common equity Tier 1 ratio was 9.4% in the fourth quarter, up approximately 10 basis points versus Q4, due mainly to solid organic capital generation. Overall, we continue to remain well positioned for the evolving regulatory and capital environment.

With that, I'll turn things over to Mark, and turn to slide 13.

Mark Chauvin

Thank you, Colleen, and good afternoon everyone. This has been a strong year from a credit quality perspective. Performance across the loan portfolios remained very solid with full-year PCL of 34 basis points, a four basis better than what we experienced in 2013.

The positive trend continues with loss rates remaining at cyclically lower levels during the fourth quarter. The increase noted in U.S. personal impaired loans during the quarter is attributed to full implementation of continuing regulatory guidance on troubled debt restructuring, related primarily to our home equity line of credit portfolio, the continued mortgage foreclosure backlog in the courts of Massachusetts, New York, and New Jersey, and a weakening Canadian dollar. Notwithstanding their impaired status, roughly one-third of the mortgage and HELOC impaired balances are current with their payments. We remain satisfied with the credit quality of the U.S. real estate secured portfolio.

Looking forward, current economic forecasts suggest that credit quality will remain strong in 2015, although volume growth is expected to result in a moderate increase in total credit losses.

Lastly, given the focus on current oil prices, I would like to briefly comment on our exposure in near to mid-term outlook. The information provided in appendix slides number 31 and 33 has been expanded to provide additional information on our oil and gas credit exposure.

Our oil and gas loan portfolio consists of a well-diversified mix of global and North American oil and gas companies. The majority of non-investment grade loans are subject to a secured borrowing base using discounted oil and gas prices, risk-based independent engineer reports and semi-annual re-determinations. We also stress each borrower to a conservative level which is well below current prices.

At present we would not expect to see any material loan impairment or losses in an environment, where oil dropped to $60 for an extended period. Historically our experience with this sector has been very good. For context, we incurred no credit losses in the 2008-'09 financial crisis during a period in which oil prices touched $35.

Now, I'll turn the presentation back to Rudy.

Rudy Sankovic

Thank you, Mark. We'll now open it up for questions. To give everyone a chance to participate, please keep to one question and re-queue if there is time. For those participating in the room, can I ask you to identify your name and firm before asking your question? Before ending the call today I'll ask Bharat to offer some final remarks. So why don't we get started in the room, Jason?

Question-and-Answer Session

Q - Jason Bilodeau

Yes. Maybe I'll pick up on …

Rudy Sankovic

Jason Bilodeau from Macquarie Capital.

Jason Bilodeau

Jason Bilodeau from Macquarie Capital. Just picking up on that issue about energy. Mark, you addressed this from a credit perspective. I don't know who on the Board wants to talk to what does it mean from a growth perspective so what does the corporate and commercial loan book look like in a $60 oil environment and what does the investment banking activity look like in a $60 oil environment?

Mark Chauvin

You start, Bob.

Bob Dorrance

Sure, I can do it from the investment corporate banking perspective. The energy business, upstream/midstream pipeline utilities et cetera has been approximately 5% to 10% of our revenue over the last number of years. With the current activity going on in oil pricing certainly is impacting activity levels in the business. And so, things have slow down, and we would expect that until oil starts to establish a range wherein businesses can plan around what their activities would be, it will probably remain slow until that time.

As Mark alluded to, it's not something that hasn't happened before. There is a cyclicality in the business and hence the 5% to 10% range of what it represents to our overall capital markets revenues. So I think what we'll have to do is look to other areas to augment revenue growth and not be reliant on the energy or especially the oil part of the patch, companies like Midstream and utility part can remain relatively active, but it's the equity raising on the oil and gas part that will be I think slow for a while, for the industry.

Jason Bilodeau

And then, in sort of smaller books like in small business or commercial type lending, is there any weight you'd expect in that part of the …

Tim Hockey

No, as you can imagine we've both stressed that book often and obviously frequently recently. Not too much to add to what Mark and Bob would offer other than if you look at piece of Canadian economic picture overall as a result of this, given it's -- our economics team would say it sort of a net negative for the Canadian economy overall, but it would probably be at these low rates are one or two quarter period of time until the supply side starts to equilibrate.

So for example, if you look at the housing market in Calgary, which has been one of our three hottest markets across the company, then the expectation is it is that would start to moderate over time, but the overall economic impact on Canada is relative needed, probably 25-50 basis points even over a sustained multi-quarter low oil shock and as far as our commercial and commercial management accounts book that we are actually quite comfortable with our clients and their exposure even at low levels.

Rudy Sankovic

Thanks, J. Next question, John?

John Aiken

John Aiken with Barclays. Bharat, you framed your outlook for 2015 in your opening comments; couple of things that I'm stuck at for me is obviously that to paraphrase your challenge to hit your medium term guidance in terms of 7% to 10%. You also have a stressed organic growth being part of the process. Would be very interested to see if you could frame this around the outlook for dividends and what conversations the Board has been having around that? The increase that you took in the first quarter was obviously to break out of that pattern of every second quarter. But are we now looking at TD falling into a pattern of an annual dividend increase and what that may mean for the outlook?

Bharat Masrani

Yes, John; on the dividends we did signal at the time as you rightly point out that we don't want to make this an autopilot way of doing it. Our current plan is to look at our dividends like we did last year. At the same time and we will do so. And what pattern we follow, we will let you know, but it should not surprise you that we will do declare dividends when we think it is appropriate for the bank to do so, based on where we are in our thinking on where earnings are going, and secondly where we are in the range as well, and both those issues are important to us, but for now you should assume that we will stick to the timeline we did that we outline, last time we talked about this.

Rudy Sankovic

Good, thank you. Anything else in the room? Okay, operator, why don't we go to the phones, please?

Operator

Our first question comes from the line of Steve Theriault at Bank of America Merrill Lynch.

Steve Theriault

Thanks very much. Question for Tim Hockey. So balances have been flat at the last several quarters in US in direct auto but showed some nice growth in Q4. I know you've been optimizing dealer relationships dealing with some issues and a little bit of restructuring. So does this signal that you're back in growth mode? The rightsizing and restructuring is past? Maybe a bit of an update there, please?

Tim Hockey

Sure. Actually, we're quite pleased with the level of growth. As you know we have been restructuring the mark [ph], the industry overall was pressured by margins. So we took significant cost out of the business and we have been skewing more to the prime and the actually super prime end of the spectrum. So as a result, we're quite confident, as Mark pointed out, our credit losses have dropped in that particular business. So we're -- because of the very high fixed to variable cost base of putting on additional prime and super prime, it's a business that we actually like. So yes, we're quite pleased with both our risk profile as well as the increased growth on that book.

Steve Theriault

So you'd expect to be able to report some relatively consistent growth through next year?

Tim Hockey

Yes, we can.

Steve Theriault

Thank you.

Rudy Sankovic

Thank you, Steve. Next question, please?

Operator

Our next question comes from the line of Gabriel Dechaine at Canaccord Genuity. Please go ahead.

Gabriel Dechaine

Hi, I just want to ask about the earnings outlook for the US business. Considering your revenue outlook, margin trajectory and maybe some uptick in PCLs because we had a bit of a low point in PCLs in Q2 and Q3 this year?

Mike Pedersen

Yes. So we did say in Q3 that the earnings would be down a bit in Q4 as you saw. We had strong fundamentals in Q4 and growth continued to outpace the industry. In fact, I'd say we accelerated in Q4, which was nice to see. Our NIAT was flat the last year because of lower securities gains and margin compression which Colleen alluded to. We also had a few tax and expense items related to the year end, but I'd point out that our expenses were nevertheless lower than they were in Q4 last year.

So I think about growth for next year in terms of modest growth over the full 2014 year. So in '14, we're up 5.3%, bit better than we expected. We outperformed our U.S. peers across most metrics as we built the franchise. I'd share that the full-year loans were up 10.2%, deposits up 7% year-over-year, much better than our peer and we also outperformed in checking accounts and household acquisitions. Expenses for the full-year grew 1.4%, that's ex-acquisitions and that's even as we continued to invest in the business, including 34 new stores for the year.

In terms of the modest NIAT growth outlook for 2014, I do expect that we'll continue to grow the business very strongly still. There are really three issues that make it a bit tough next year. One is margins, this is as you know always hard to predict, but based on everything I see now, in terms of rates and mix and competition and accretion trends and so on, I'd expect that our 2015 margin will be relatively stable from the fourth quarter, although it may jump around a bit during the year. But nevertheless, even though we expect it to be relatively stable from the fourth quarter, the full-year margin will be down from 2014, because the margin declined during 2014.

The second, so the headwind is that we haven't planned for much in the way of securities gains in 2015 and we have 61 million in 2015, and then the last one is PCL's and you asked about that, we had a very good better than expected year on PCLs in 2015; low charge offs, some strong recoveries. We do think we're near the end of that, although we may be wrong again, but we're expecting as we talk about modest growth that PCL growth will normalize along with loan growth. So just to be clear, all of what I've just said assumes no rate increases and given this outlook we're obviously also very, very focused on expenses for 2015.

Gabriel Dechaine

I call that a thorough response would be an understatement. Thanks for that, Mike.

Mike Pedersen

It was a wide ranging thorough question.

Gabriel Dechaine

Actually I lost my question list, but anyway, thanks.

Rudy Sankovic

Thanks, Gabriel. Next question, please?

Operator

Our next question comes from the line of Sumit Malhotra at Scotiabank. Please go ahead.

Sumit Malhotra

Thanks, good afternoon. Let's stay with you, Mike and to go back specifically on the revenue outlook. I know security gains have played a role but you've obviously had on a constant currency basis a tougher comparison for revenue in the last couple quarters in the second half of this year. When I hear you talk about net interest margin when you've got -- you're talking about no interest rate increase assumption in your outlook. Bond yields have obviously moved a lot lower and looking at some of your regional bank counterparts in the US, they seem to be talking about continued NIM compression in a pretty significant way, at least for the first half of 2015. So is it something to do with accounting or the accretion that TD has had that leads you to make that statement? Or maybe you can give me some visibility as to why you think you can buck the trend on margins?

Mike Pedersen

Yes, I think a few things. So first of all, on loan margins; we are starting to see the pressure moderate a little bit, and I think you've heard that from other banks as well, in particular on commercial corporate banking, but also in auto finance. So it feels a little better than it did. We expect our deposit margins to be stable to up during 2015. We've been able to do some things on the treasury side as rates have evolved that make that the likelihood. And the acquired loan portfolio was obviously smaller and smaller, but we expect the impact on the margin to be lower this year than it's been in the last year. It was pretty significant in 2014, you saw form Q4, 25 basis point decline year-over-year and over 2/3rds of that was accretion. So those would be the kinds of things we thought through as we tell you that.

Sumit Malhotra

Is it your view that positive operating leverage is a realistic goal, again on a constant currency basis for this segment in 2015?

Mike Pedersen

Yes. So we obviously have a much smaller securities gains issue that we did and that's what made it difficult in 2014. We're very focused on expenses. As I said, 1.4% ex-acquisitions was a good result for this year. We are hoping to repeat that sort of performance roughly. And so, I think a positive operating leverage, I would say that we are targeting it, but not necessarily predicting it. It's a difficult environment that's hard to predict anything in.

Sumit Malhotra

Thanks for your time.

Rudy Sankovic

Yes. Thanks, Sumit. The next question, please?

Operator

Our next question comes from the line of Robert Sedran at CIBC. Please go ahead.

Robert Sedran

Hi, good afternoon. So Mike you're on a bit of a roll so I guess I'll stick with you. I want to ask you about the personal loan growth. The outlook both for the industry in general and then also for TD, and maybe you can touch on Target and some of the other initiatives in so doing. And I know you're not banking on any interest rate increases but what you think any interest rate increases might do to that loan demand on through your footprint?

Mike Pedersen

Okay, I'll try. It's tough in the personal loan space right now. It improved a little bit in Q4 across most of the categories, but especially auto. Let me try to comment on each of them. I mean, mortgages, we're still way down from where we've been, our year-over-year growth was 2%, last quarter was 1%. So you could say it's on an annualized basis increasing a little bit, but frankly there is just very little trend or hard indicators to hang your head on.

In the fourth quarter we saw a re-fi spike for about 10 days until rates went back up. So I'd say cautious expectation that 2015 will be a bit better on mortgages. Home sales are rising, stated intentions to buy are up, house values are improving, but really I think we need wages and incomes to rise. I think the key thing for me is that household incomes are still nowhere near recovered from pre-crisis, and if you think about how that feels from a personal point of view, it doesn't really matter what other statistics are that makes it a little tough. So that's why I'm cautious about predicting much growth in the mortgage space.

When and if it starts to happen, I think we're well positioned where we got very low penetration, we're growing our mortgage sales force, we got our store network, which is very strong and have also invested now in digital mortgage origination. So I think we're well positioned.

On home equity lending, I'm a little puzzled as to why that isn't growing better, given what's happened with employment in housing, but I think the industry was down like 4% or 5% in the last numbers I saw. We've been flat, so we can feel good about that, but it doesn't feel very good. Again, I think this all come, but again I think it's related more to wages and income than to anything else. Tim talked about autos, so I won't repeat that, I agree with what he said.

On cards, Target is the large part of our existing portfolio and it's still down from a year ago, but continuing to recover. So sales and new account growth is now back to where it was before the pre-breach levels. The non-Target TD card portfolio is showing strong growth, but it's a small base in the context of Target being included.

So you don't really see that show up, but to give you a data point, a year ago, 9.6% of our households had a TD credit card. Today, it's 12.8%. So it's a big focus for us. Deepening customer relationships in general's a big focus for us, and we'll be even more so going forward. Another data point and then I'll quit. A year ago, we had 3.8 products and services for customer, today it's 4.2; that's a really good progress, I'm really happy with that. There's more opportunity because we got upside there compared to other banks.

Robert Sedran

And just a quick follow-up because that was another detailed answer, just a quick follow-up on that credit card answer; is it a question of is the goal credit card volume, is the goal credit card balances, what are you looking to grow in terms of the credit card business?

Mike Pedersen

Well, the goal is credit card profitability, and customer profitability, and customer attention, but cards are a very attractive product set in today's capital environment. And Riaz runs that business very effectively and we're delighted with what we're seeing from a U.S. perspective. And we got lots of plans to grow that business. Riaz, I will invite you to jump in to the extent you want.

Riaz Ahmed

No, that's great. We're hoping to grow both.

Rudy Sankovic

Thanks, Robert. Next question, please?

Operator

Our next question comes from the line of Peter Routledge at National Bank Financial. Please go ahead.

Peter Routledge

Hi, thanks. I just want to go back to an issue Tim referenced in his answer and it just relates to the price of oil and what that might mean for his household book. I think Mark you said you've stress tested your commercial portfolio for oil at $60 for an extended period of time and you didn't view credit as a major issue. What would that do to household PCLs if you had $60 oil for an extended period of time?

Mark Chauvin

Shorter and serious, I have no idea. I don't think we've actually tried to take a look at that particular item.

Tim Hockey

I mean we have look at the economic forecast. And it's very early in the process, so I wouldn't have an answer to the question. But it would look to increase unemployment by 5% or 10% from what the base would have been. So that would have some impact on PCL but you not in the scope of a material large one in our view. But we're going to spend more time looking at that over the next couple of months.

Peter Routledge

Okay. And then for Tim or Bharat, you think about your personal commercial bank in Canada. Its been on let's call it a great 15 to 20 year growth run and I'm sure there are, I'm sure the platform is still somewhat geared towards growth mode. If you decided to get very aggressive, could you still grow earnings at 5% a year even if you did have flat revenues because of slowing loan growth and higher PCLs and what have you?

Tim Hockey

Yes.

Bharat Masrani

I was going to say that. Since Tim said that I will reiterate that the answer is yes. In fact we would be disappointed with that.

Tim Hockey

I wasn't going to say that but I guess my boss just chimed in, but okay.

Peter Routledge

I mean how quickly could you act if all of a sudden the Canadian environment shifted and you really were worried about falling earnings? How ready are you for that?

Tim Hockey

It's depends on what you say in terms of shifting. On the one hand we are a large organization; on the other hand if I look at some of the investments we've made in 2014 and the momentum that we're already seeing in the business and actually feeling pretty good about the 2015 outlook relative to our growth. We've had an uptick in our linked quarter growth in lending. We've got products coming on-stream; we have new services that we've offered. There is a -- I think a sense of momentum here that we've got going forward in to 2015 notwithstanding low interest rate et cetera.

So if you're asking if things went so quickly you'll have to illustrate the scenario but I'm quite confident about our growth aspect going forward and as many have said we've made investments in 2014 and we will continue to make some investments in 2015 going forward but we will be also focused on positive operating leverage.

Peter Routledge

Let me reframe it then. A year from today oil is $60. What sort of efficiency initiatives would you be ready to go with?

Tim Hockey

Well, we've explained this, the way we approach it in Canada and many of the other parts of the business. We have an ongoing productivity focus in all of our businesses; and that is we expect our businesses to operate under a pretty simple paradigm, which is they get to grow their expenses inside their growth revenue. And to do that, to be ready for a shift in revenue outlook then they have to be constantly be investing in productivity gains and then if the revenue warrants it then the expenses can grow in new initiatives. So we've been on this program for three or four years. Our operating leverage for example in Canadian retail in 2014 was exactly the same as it was in 2013 at about 150 basis points.

So if you're saying that all of a sudden revenue growth falls off a cliff then we would have to severely curtail our investments in future in order to bank, if you will, the productivity gains, that would be a tough choice to make given that we don't like expense fire drills but it's one we would make.

Peter Routledge

Okay, thank you very much.

Bharat Masrani

The only thing I would add Peter is that we -- our franchise is national as you know, so if there is a problem with oil, I'm sure it will be a more of a regional story then perhaps as big a national story. And given the size of our business, the diversity of our business you would think there would be offsets elsewhere in our business. We do this stress testing as you would expect and would make sure that we adapt to the environment we find ourselves in.

Peter Routledge

Okay, thanks.

Rudy Sankovic

Thanks Peter. Next question, please?

Operator

Our next question comes from the line of Meny Grauman at Cormark Securities. Please go ahead.

Meny Grauman

Hi, good afternoon. Bharat, in your opening remarks you referenced non-traditional players as being a source of competition and increased competition. I'm wondering whether you could just flush that out a little more and just talk about what you're talking about and specifically in the non-traditional side.

Bharat Masrani

Great question. I'd say one example would be, obviously you've heard as I have there is intense interest in the payment system for example. You have potential entrants that are not banks in that space and that's an important business for TD, for the Canadian banks and we got to figure out ways to how we compete with those players, how can we be as agile, as flexible as them. So what it takes is and banks have generally been pretty good. I can talk about TD. We take those issues very seriously and so we will make the right investments to make sure that if and when that were to happen that we are prepared for it and are able to effectively complete.

So that's just one example. I mean you hear of a lot of other non-traditional type of threats, the shadow banks, as regulation is changing in various jurisdictions where we operator and those are all the issues that we think about as to how we can effectively compete especially in our core businesses that are very important to us. So that will be one example of many.

Meny Grauman

Thank you.

Rudy Sankovic

Thanks, Meny. Next question, please?

Operator

Our next question comes from the line of Mario Mendonca at TD Securities. Please go ahead.

Mario Mendonca

Good afternoon. Colleen and Bharat, if we could go to the capital question. So the Basel III common equity Tier 1 ratio 9.4% on a relative to global peers I'm sure it's fine but among the big five Canadian banks, not so much. What I'm struggling with is, is this actually a meaningful disadvantage or should we expect TD to be able to manage RWAs and to get that ratio through 10% relatively quickly?

Bharat Masrani

Riaz, do you want to take it first as to what's going on with the ratio and then perhaps I can follow-up on the first part of his question, on whether this is a disadvantage or not?

Riaz Ahmed

Sure, hi, Mario. If you look at the quarterly capital development for us, you saw that in the first quarter we were down a bit, second quarter, we grew quite a bit and then Q3 and 4 we grew by about 10 basis points each quarter. So our overall organic capital generation, net of dividends and net of risk weighted asset growth is about 20 basis points is how you should think about it. And in the first quarter we took a CVA charge, second quarter you saw that capital growth and then in Q3 and Q4 some small things were undertaken. We completed our buyback program in Q3 and then in Q4 we had the pension valuation go against us.

So I am not overall worried about the rate of capital generation and I think we are quite optimally placed in terms of where we would like to be and in the organic growth strategy that we are looking at in '15. I don't see it as being something that I worry about.

Mario Mendonca

But Riaz, do you think 20 is still a good number to use for organic capital generation quarterly?

Riaz Ahmed

Yes.

Mario Mendonca

Okay.

Bharat Masrani

The only thing I would add, I think Riaz covered it up. No, Mario we would not consider our self to be strategically challenged from a capital perspective. That's not how I think about it. In fact we would consider our self to be well capitalized and have whatever flexibility we need to make sure we remain within our strategy.

Mario Mendonca

Are buybacks still part of the outlook?

Bharat Masrani

Well you know, we have talked about this more generally. I look at buybacks overall, within our overall capital deployment framework where we look at you know what's the amount we are going to require to meet our organic growth aspirations. Those are important, those are our core businesses. We also look at, is there any strategic or capability gap within our franchises and you have seen, we have taken advantage of opportunities when they have emerged, Epic comes to mind where we thought, it provides capability that would enhance where we were already. So we'd use our capital for that.

We have also said that if an appropriate smallish tuck-in acquisition appeared in Mike's business, especially in certain part of the geography we would seriously look at that. And so this is kind of the hierarchy we go through and at the end, if all of them turn out then, yes, we still have too much capital; we don't have any need based on what I just said, of course we will look at buybacks at that point. But that's how we think about it, Mario rather than targeting a particular date.

Mario Mendonca

Then really quickly, Colleen and I think Bharat, you both referred to the tax rate being a bit higher next year. Not so much into the details as to why but more what numbers are we talking about, 100 basis points, 200 basis points?

Colleen Johnston

I think Mario you got it right on. I would say versus and taking as a base the effective adjusted tax rate for 2014, I would say we're probably about a point to two points higher in 2015.

Mario Mendonca

Thank you.

Rudy Sankovic

I think we have time for one last question, please, operator.

Operator

Our next question comes from the line of Darko Mihelic at RBC Capital Markets.

Darko Mihelic

Thank you for letting me squeeze in here; just -- my question is actually on capital as well, but I wanted to ask it in a different way, and what I'm really looking at is the U.S. retail segment.

Riaz Ahmed

What are you asking, Darko?

Darko Mihelic

When I look at the capital there, it seems that the capital base is growing a touch faster than RWAs. We also know that you're going to have to comply I guess with U.S. regulatory demand in the next couple of years, so the question is, should we expect to see the capital build continue even though you have modest earnings expectations such that we get a low return in this business in the next two, three years, and I guess turning that on its head, if we do have low return expectations on this capital, question over to Colleen; is there anything that we have to think about with respect to goodwill write-downs and so on?

Riaz Ahmed

Darko, it's Riaz. So I think it's been a while; I can't remember exactly when, but three or four quarters ago, I had highlighted that as the U.S. rules continue to develop and the Basel III rules continue to develop. In our business, we're seeing a convergence between the amount of capital that the U.S. regulators are requiring and the amount of capital we're holding for the same risks at the consolidated level. So I don't think you should necessarily assume that as we go through and meet the rest of the Dodd-Frank requirements that our capital requirement are automatically rising, that is not the correct way to look at it. Right now, in fact I would say that we're experiencing a high level of convergence between the two.

Colleen Johnston

And Darko, it's Colleen. So we obviously have to go through an annual process of testing our goodwill evaluation, and we've gone through that process, and I think it's safe to say we have a generous buffer in that calculation. So I don't have any concerns whatsoever concerning goodwill.

Mike Pedersen

Darko, it's Mike. I was asked earlier about upside, and I didn't answer it. Needless to say the modest language is with respect to the short-term outlook 2015. I think there is lots of growth opportunity in the U.S. business beyond 2015, we have productivity upsides, we have cross-sell upsides, we have lots of growth upside not even factoring in the fact that as rates rise obviously we stand to benefit somewhat from that, and the headwinds we face in 2015 are largely temporary in nature.

Darko Mihelic

Okay, great. Thank you very much.

A - Rudy Sankovic

Okay. Thank you, Darko. I'll ask Bharat for final remarks.

Bharat Masrani

Thanks, Rudy. In typical TD style, we give you all the headwinds that we think that are going to be out there in '15, but notwithstanding that we have a fantastic business model, we have a brand that is second to none. Our mix of businesses is to die for, and we have a great team. And so, as long as we execute I feel very, very good about the Bank's long-term prospects as to what we can do together, and in case if I don't see you folks before the end of the year, wish you happy holidays, and thank you very much.

Rudy Sankovic

So with that, we will end the meeting; and thank you everybody for joining us. Thank you.

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