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Fitch Ratings has announced that it:

has affirmed The Toronto-Dominion Bank’s (TD) Long-Term Issuer Default Rating (IDR) at ‘AA-‘ and Short-Term IDR at ‘F1+’. The Rating Outlook has been revised to Negative from Stable. Fitch has also affirmed the ratings of TD’s subsidiaries, TD Bank US Holding Company and TD Bank, N.A.

KEY RATING DRIVERS
The affirmations reflect TD’s resilient financial profile, including consistent and prudent underwriting, benign asset quality, diversified business mix, strong capitalization and robust liquidity. Under Fitch’s macroeconomic base case, conditions for continued financial and credit performance at TD’s current rating level are adequate.

The Negative Outlook reflects the uncertainty regarding the ultimate impact on the bank’s franchise, earnings and risk profiles from the various investigations by regulators on the deficiencies of TD’s anti-money laundering (AML) practices in the U.S. The outcomes of these investigations could have both monetary and non-monetary penalties, including, in Fitch’s opinion, an inability to engage in further M&A in the U.S. Furthermore, Fitch believes management’s focus on remediating shortcomings in risk controls may divert from ongoing operations, and with the costs of remediation, manifest in a weaker financial profile and franchise.

Regulatory Probe into BSA/AML: Fitch has changed its Business Profile factor outlook for TD to Negative from Stable. On April 30, TD announced that it took an initial provision of USD$450 million in connection with discussions with one of its U.S. regulators related to investigations of TD’s U.S. Bank Secrecy Act (BSA) / anti-money laundering (AML) program. The bank’s regulatory and law enforcement discussions with three U.S. regulators (including the regulator referenced in the preceding sentence) and the Department of Justice are ongoing.

TD has stated that its AML program was insufficient to effectively monitor, detect, report, and respond to suspicious activity. In 2023, TD terminated its agreement to acquire First Horizon Corporation (FHN), little more than a year after the announced merger, due to uncertainty when and if regulatory approvals could be obtained. The bank has invested approximately $500 million in program remediation and platform enhancements, and the work is well underway to enhance the bank’s risk controls.

Risk Management Shortcomings: Fitch has lowered the Risk Profile score to ‘a+’ from ‘aa-‘ and changed the factor outlook to Negative from Stable. TD has exhibited a strong track record of well-monitored and conservative risk appetite despite its moderately higher structural interest rate sensitivity, which is commensurate with its retail focus and deposit-rich balance sheet. However, Fitch expects the regulatory findings regarding TD’s AML practices to continue to garner a great deal of regulatory, political and potential legal attention, both in Canada and the U.S. over the near term.

The timetable of the investigation and implementation of remediation recommendations is unclear. Meanwhile, TD is undergoing a comprehensive overhaul of its U.S. and global AML program. TD has hired recognized AML executives from across the private and public sectors, onboarded hundreds of new AML professionals with expertise in program design, oversight and execution. The bank has also deployed new enterprise-wide training and onboarding programs, and made investments in new technology, processes and controls to enhance oversight across the enterprise.

Asset Quality Normalization: As with peers, TD’s credit quality measures are normalizing from unusually benign levels. The extent and duration of benign credit quality from 2020 to 2023 were not incorporated into the ratings because they were temporary. Similarly, Fitch does not expect to take rating actions on credit quality normalization, except if the velocity and scale of deterioration were to suggest sustained credit losses outside historical norms. Credit normalization started to pick up pace at the end of FY 2023. TD guided in 2Q24 that provisions would likely finish the year between 40bps-50bps of net loans, in line with 2019 levels (45bps). As of 2Q24, the provision ratio was 47bps.

Remediation and Regulatory Costs 2024: Fitch has changed the Earnings Profile factor outlook to Negative from Stable. TD’s core earnings power has been relatively stable over time, supported by its diversified business model. However, since the start of its AML issues, TD has thus far earmarked approximately $1.8 billion in extra costs according to Fitch’s calculations, including penalties, provisions, remediation efforts and the cost of the termination of the FHN acquisition. These costs could increase as the regulators announce their findings.

At the end of FY 2023 TD announced a restructuring program to reduce its cost base and achieve greater efficiency. Thus far, it has spent $819 million (pre-tax) and is expected to achieve savings of $400 million (pre-tax) in 2024 going up to run rate savings of approximately $725 million (pre-tax) thereafter. Management believes this will help achieve TD’s positive operating leverage target over the medium term.

Potential Capital Pressure: TD had built up its common equity Tier 1 (CET1) ratio to 15.2% prior to the FHN acquisition. The ratio has declined to 13.4% as of 2Q24, as TD deployed the unused capital and returned some it to shareholders through share buy-backs. Still at the highest level among peers, Fitch believes that a larger capital buffer is appropriate at this juncture to allow TD to provision for potential regulatory penalties.

Stable Funding and Liquidity Profile: TD’s funding and liquidity profile is stable and in line with peers. However, contraction in wealth management and U.S. retail deposits over the last couple of years, a trend seen industry wide, TD’s loans-to-deposits ratio deteriorated to 117% in 2Q24 (as per Fitch’s calculations), at the top end of Canadian peers. Meanwhile at 126%, TDS’s LCR ratio sits in the middle of the Canadian peer range.

RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
–Fitch could downgrade TD’s ratings if the current regulatory issues translate into a material loss of franchise strength, or if it becomes likely that the bank will incur fines that would result in structurally lower profitability that pressures existing capital levels.
–If TD’s Long-Term IDR is downgraded the Short-Term IDR would be downgraded as well.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
–Conversely, the Outlook may be revised to Stable if the monetary and non-monetary penalties form the regulatory findings are manageable for TD and do not significantly impact its growth prospects and earnings.

Affected issues are TD.PF.A, TD.PF.B, TD.PF.C, TD.PF.D, TD.PF.E, TD.PF.I, TD.PF.J and TD.PF.M.

This entry was posted on Tuesday, May 28th, 2024 at 9:57 pm and is filed under Issue Comments. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.