Toronto-Dominion Bank

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Generating a wow factor, handing out dog biscuits to customers’ pets, penny arcades. These are some of Commerce Bancorp’s gimmicks for keeping its “fans” happy. But it was the bank’s investors who had the most fun on Tuesday: Toronto-Dominion Bank’s $8.5bn offer for their company works out at a 22.5 times forecast earnings.

This is a risky move for TD. It is earnings dilutive to start, which, though an imperfect measure of the economics, is widely noted by investors. It is also an exciting move. First, there is a good cultural fit. This is key because Commerce’s impressive track record in deposit-gathering relies on a particular culture that could easily be broken by a knife-wielding, cost-cutting takeover.

But TD cannot just rely on deposit growth to make the deal stack up. Its initial return on capital will be an underwhelming 7 per cent. To hit the more impressive internal rate of return of 15 per cent later on, TD surely has to improve on Commerce’s net interest margins. There are several ways of doing this, and the most obvious way is to be more aggressive with Commerce’s deposits. Currently, Commerce has an unusually low ratio of loans-to-deposits. It invests some of the deposits in securities, which in the current yield environment is hard going. In fact, it will lead to a large charge in Commerce’s third quarter, as disclosed on Tuesday amid the news of the takeover. If TD puts more of Commerce’s deposits to work as loans, and comes up with more products that customers pay fees for, it should be able to boost margins.

TD should also, of course, be able to cut costs, though the branch culture will probably be left alone. Still, that leaves a lot of non-branch costs to be trimmed. There are not many banks, for instance, that boast a 65,000 sq ft university to train staff.

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