How to Improve Commerce Bank's Income

DealBook asks today whether Toronto-Dominion Bank is overpaying for Commerce Bank. They're both customer-serviced, says RBC analyst Gerard Cassidy, but they have very different profit margins:

The difference, Mr. Cassidy told The Times, is that Toronto-Dominion, which operates in a much less competitive market, pampers its customers at a much lower cost. The Canadian bank, Mr. Cassidy calculates, spends about 50 cents for every dollar it generates. That amount is 74 cents at Commerce.

It's true that Commerce's home base of New York and New Jersey is less competitive than, say, Toronto. But I'm not entirely sure what Cassidy is talking about when he refers to dollars "generated". If he means loan income, then he's not really talking about the cost of pampering customers, he's talking instead about ability to generate loans. Here's what Murray wrote in the comments to my last blog entry:

CBH is great at attracting depositors. But it's terrible at putting those assets to work: it hates lending - at 36% its loans to deposit ratio is among the lowest (TD's is 65%). So it put majority of deposits in a securities portfolio that it's been losing money on here and there for the last 2 years. Not clever.

In other words, if Commerce's costs remain the same, but it increases its loan-to-deposit ratio from 36% to 54%, then – presto – its cost-to-income ratio will fall from 74% to Toronto-Dominion's 50%. And if TD can loan out the same proportion of Commerce's deposits that it does at the rest of its banks, then Commerce's cost-to-income ratio would fall (assuming costs stay the same) all the way to 41%.

Now, it's certainly possible that there's some deep connection between Commerce Bank's customer service, on the one hand, and the fact that it makes very few loans, on the other. Maybe it's good at being nice to its customers because it owes its customers money, rather than the other way around.

But banks buy and sell loans to and from each other every day: if Commerce didn't want to lend money to its customers, it could just buy loans from the bank next door instead, and let that bank have the bad customer relationship. Loan-to-deposit ratios are easy to increase.

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