Did TD Overpay for Chrysler Financial?

Trying to reverse engineer the economics of today’s announced acquisition of Chrysler Financial by TD Bank, it is unclear whether TD overpaid for the auto finance company — but it appears possible it did.

You can look at the purchase from two directions: as a portfolio acquisition or as a purchase of Chrysler Financial as a company. Let’s start with the purchase as a portfolio acquisition. The $6.3 billion purchase price includes a portfolio of $7.5 billion of auto loans. Taking that $7.5 billion number, TD paid $0.84 on the dollar for the portfolio. Now, TD is betting that new originations will not just sustain Chrysler’s portfolio, but grow it. The bank cites expected growth of $200 billion in auto finance over the next three years, and that’s a number I won’t quibble with. However, Chrysler Financial hasn’t even been originating much over the last year or so and its portfolio today is vastly reduced from the estimated $20 billion Chrysler Financial had on its books at yearend 2009.

Will Chrysler truly grow its portfolio and not see its new originations offset by continuing erosion in its current book of loans? Consider this: of the $7.5 billion in Chrysler Financial’s current portfolio, TD classifies $5.9 billion as “fair value,” meaning that fair value is but 79% of the portfolio’s face value. In other words, the default rate in Chrysler Financial’s portfolio appears to be hovering at 21%.  Remember, versus fair value, TD is paying greater than par. Yes, Chrysler can overcome such an offset, but that’s no slamdunk.

Considering the acquisition as a multiple to earnings is a lot more difficult. TD said the acquisition “is expected to add about $100 million to Toronto-Dominion’s earnings by 2012,” but elsewhere said, that TD “expects U.S. earnings to top its target of $1.6 billion a year in three years with the Chrysler Financial purchase … [compared] with a profit of about $1 billion in the year that ended Oct. 31.” I’ll be charitable and use the $600 million number as earnings from Chrysler Financial, otherwise this will be the worst deal in history. We discount the $600 million a bit to $550 million and it appears as though TD is paying more than 11 times going-forward earnings. That’s a high, high price. TD argues that the $7.5 billion portfolio is going to reach $20 billion in three years, and that will throw off maybe $1.4 billion of cash annually, but there’s ample risk in that estimate, and there is little doubt in my mind that Chrysler Financial earned nothing close to that over the last 12 months.

I wrote earlier that the BMO acquisition of Marshall & Ilslay Corp. last week was a sign of the newfound financial power of Canadian banks. This deal amounts to yet another sign.