has today downgraded the long-term ratings and assessments of The Toronto-Dominion Bank (TD), including its Baseline Credit Assessment (BCA) to a2 from a1, its long-term Counterparty Risk Ratings to Aa2 from Aa1 and the bank’s long-term Counterparty Risk Assessment to Aa3(cr) from Aa2(cr). Concurrent with this rating action, we downgraded the long-term issuer rating to A3 from A2 of TD Group US Holdings LLC (TD GUS), the US Intermediate Holding Company (IHC) of TD Bank US Holding Company, which in turn is the direct parent of TD Bank, N.A. (collectively, “TD US”).
The rating outlooks for the long-term deposits, issuer ratings, senior unsecured and junior senior unsecured debt ratings at TD as well as the outlook for the long-term issuer rating at TD GUS included in today’s rating action were changed to stable from negative.
The rating action follows TD’s announcement [1] on 10 October that it has resolved its civil and criminal investigations into its US Bank Secrecy Act (BSA)/anti-money laundering (AML) program by US prudential regulators, the Financial Crimes Enforcement Network and the US Department of Justice. The total financial penalties of US$3.09 billion was largely covered by the bank’s previous provisions of US$3.05 billion.
“The downgrade of TD’s BCA reflects the scale and severity of the bank’s risk management failures as evidenced by its BSA/AML settlement with the Department of Justice and regulators, which has changed our view of the effectiveness of TD’s governance” said Robert Colangelo, Moody’s Ratings Vice President – Senior Credit Officer. “Next year will be a transitional year for the bank’s US operations as it continues to invest in its US BSA/AML remediation program and undertakes its balance sheet restructuring to comply with the asset cap that was imposed on its US bank subsidiaries,” Mr. Colangelo added.
A full list of affected ratings can be found at the end of this press release.
RATINGS RATIONALE
The ratings downgrade reflects the severity of TD’s risk management failures, which are no longer consistent with an a1 BCA, and change our view of TD’s long-established culture of low risk tolerance. TD and two US banking subsidiaries – TD Bank, N.A. and TD Bank USA, N.A. (collectively TD Bank US) – have consented to orders with the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board, and the Financial Crimes Enforcement Network (FinCEN), with the OCC imposing an asset cap on TD Bank US whereby the total assets of TD Bank US cannot exceed US$434 billion (total assets as of 30 September 2024). In addition, TD Bank, N.A. and its parent company TD Bank US Holding Company pled guilty to conspiring to fail to maintain an AML program that complies with the BSA, fail to file accurate Currency Transaction Reports, and launder money.
We regard TD’s weaknesses in corporate governance and risk management as a governance risk under our General Principles for Assessing Environmental, Social and Governance Risks (ESG), given its implications for financial strategy and risk management, management credibility and track record, and compliance and reporting. We reflect such governance deficiencies in TD and TD GUS’s high risk Governance Issuer Profile Score (G-4). As a result, we changed TD and TD GUS’s ESG Credit Impact Score to CIS-4 from CIS-2, indicating that ESG considerations have a discernible impact on the current ratings. We have added a one-notch downward adjustment for corporate behavior into TD’s rating construct.
While the financial penalties imposed on TD are largely covered by the provisions the bank has already booked, we expect that profitability will remain challenged over the medium term given the extensive US remediation program being implemented and the expected costs that will be incurred from the bank’s strategy to comply with the asset cap that includes an asset reduction and investment portfolio repositioning. TD’s remediation program will require ongoing monitoring of its progress through the appointment of a compliance monitor, which we believe will restrict the strategic and financial flexibility associated with its US activities. However, we expect these planned actions to provide capacity for TD to serve its US clients while allowing the bank to protect its US franchise through the remediation period.
TD’s capitalization remains comfortably above regulatory minimums, with the bank reporting a common equity tier 1 (CET1) capital ratio of 12.8% as of 31 July 2024. The bank’s proforma CET1 ratio is approximately 13.0% reflecting the 54 basis points (bps) impact from the sale of 40.5 million shares of common stock of The Charles Schwab Corporation (Schwab, A2 stable), which will offset the negative 35 bps impact from higher operational risk due to the provision.
In addition, capital levels at TD US remain very strong underpinning a still relatively favorable BCA. We expect TD US to maintain capitalization levels well in excess of regulatory minimums, particularly as it navigates through its remediation period. We note that the OCC consent order includes the requirement for board certification for any dividend distributions from TD’s two US subsidiaries to the parent to help ensure that the bank continues to prioritize the AML remediation. However, this does not affect the parent’s ability to pay common share dividends.
The downgrade of TD GUS’s adjusted BCA and long-term ratings was driven by our downgrade of the long-term ratings and assessments of TD, TD GUS’s parent, which provides affiliate support. There remains a very high likelihood that TD would provide support to TD US, if needed, given its size and strategic importance to TD, including that TD US is the principal source of growth and diversification for TD outside Canada.
We utilize advanced Loss Given Failure (LGF) analysis for the bank’s creditors and believe that TD’s long-term deposits and senior unsecured debt are likely to face extremely low loss given failure, due to loss absorption provided by more junior obligations and to the high volume of deposits in its liability structure. Our current ratings expect the volume of TD’s junior senior unsecured debt outstanding will reduce over the course of 2024 and 2025 given the 2024 termination of the First Horizon Corporation acquisition, lowering the loss absorption provided by those more junior obligations.
The stable outlooks reflect our expectation that TD and TD GUS’s financial profiles will remain largely unchanged despite the significant BSA/AML remediation efforts underway, due primarily to the enduring strength of TD’s Canadian franchise. We also expect the entities to maintain strong capitalization, with TD’s CET1 ratio expected to remain comfortably above the regulatory minimum.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
TD
An upgrade of TD’s BCA would be contingent upon the bank successfully managing the asset cap imposed on its US bank subsidiaries with no further risk management issues becoming apparent; and with TD demonstrating material improvements in the strength and stability of profitability while maintaining a conservative risk appetite, and stronger capital, liquidity and funding.
TD’s BCA could be downgraded should significant new risk management failures become apparent or if the nonfinancial penalties imposed on its US activities restrict its strategic decision-making and financial flexibility, resulting in a deterioration of its US franchise strength. Downward rating pressure could also emerge if the bank were to experience a material worsening of asset quality or a decrease in its tangible common equity to risk-weighted assets ratio below 12% for a sustained period, or should the bank significantly increase its reliance on capital markets activities. A lower BCA would likely lead to a ratings downgrade. The long-term deposits and senior unsecured debt ratings could also be downgraded due to a reduction in our assumptions regarding the expected issuance volume of junior senior unsecured debt, resulting in lower protection for the bank’s creditors.
TD GUS
An upgrade of TD Bank, N.A.’s BCA would be contingent upon the bank successfully managing its asset cap and with no further risk management issues becoming apparent; and with a material and sustained improvement in its profitability and funding profile, with its capital, liquidity and asset quality remaining strong. However, a higher BCA is unlikely to lead to an upgrade in TD US’s ratings, absent an upgrade of TD’s BCA.
TD Bank, N.A.’s BCA could be downgraded should significant new risk management failures become apparent or should its nonfinancial penalties significantly restrict its financial flexibility, resulting in a material worsening of TD US’s profitability or erosion of its franchise strength. Downward rating pressure could also emerge if TD US were to experience a sustained deterioration in asset quality, a significant decrease in capitalization, a sustained weakening in its funding and liquidity profile, or a heightened risk appetite. However, a downgrade of TD Bank, N.A.’s BCA might not result in a downgrade of its adjusted BCA or ratings, since we might incorporate a further notch of affiliate support into its rating construct. A downgrade of TD’s BCA would likely lead to TD US’s ratings being downgraded.
Affected issues are TD.PF.A, TD.PF.C, TD.PF.D, TD.PF.E, TD.PF.I and TD.PF.J.