DBRS Limited (Morningstar DBRS) confirmed its credit ratings on The Toronto-Dominion Bank (TD or the Bank) and its related entities, including TD's Long-Term Issuer Rating of AA (high) and Short-Term Issuer Rating of R-1 (high).
The trend on all credit ratings is Stable. TD's Long-Term Issuer Rating is composed of an Intrinsic Assessment (IA) of AA and a Support Assessment (SA) of SA2, which reflects the expectation of timely systemic support from the Government of Canada (rated AAA with a Stable trend). As a result of the SA2 designation, the Bank's Long-Term Issuer Rating benefits from a one-notch uplift to the Bank's IA.
KEY CREDIT RATING CONSIDERATIONS
TD's credit ratings and Stable trends are underpinned by its strong banking franchise and diversified business mix and earnings, including its top-tier Canadian retail franchise. Additionally, the Bank has a large U.S. banking franchise operating primarily along the Eastern Seaboard, contributing to earnings diversity. Moreover, the Wholesale Banking segment (includes more volatile capital markets and investment banking revenues) comprised only 5% of F2023 reported net income (compared with 8% in F2022), excluding the Corporate segment, providing more predictable earnings. Although credit and market risk are well managed, TD has acknowledged failures in its anti-money laundering (AML) program, controls, and risk management practices. U.S. regulatory and law enforcement investigations of TD's U.S. Bank Secrecy Act/AML program resulted in the Bank disclosing an initial provision of U.S. $450 million on April 30, 2024. Further, the Bank expects continued discussions with U.S. regulators and the Department of Justice to result in additional fines and/or nonmonetary penalties. This was preceded by the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), Canada's financial crimes regulator, fining TD approximately $9.2 million for faulty AML controls on April 9, 2024. Nonetheless, Morningstar DBRS believes the Bank has ample liquidity and sufficient capital to undertake the required remediation work related to its AML program deficiencies while absorbing any subsequent and potentially substantial fines.
The credit ratings also consider the challenging macroeconomic and geopolitical environments, which could lead to an adverse impact on profitability and asset quality. Morningstar DBRS remains concerned about the commercial real estate (CRE) market, particularly the U.S. office sector, along with the combination of highly leveraged Canadian consumers, elevated home prices (particularly in the greater Toronto and Vancouver areas), persistent inflation, and materially higher borrowing costs that are eating into consumers' disposable income. Morningstar DBRS believes that the CRE office sector and housing prices remain somewhat vulnerable and, as a result, views TD, like its Canadian bank peers, as susceptible to any material adverse changes in these markets. Positively, TD has maintained its prudent underwriting standards, reflecting the Bank's strong credit risk culture.
CREDIT RATING DRIVERS
Given TD's high credit rating level and current risk profile, a credit ratings upgrade is unlikely. A credit ratings downgrade would occur if the Bank were to fail to execute on its action plan to strengthen its AML controls and risk management practices, leading to heightened operational risk or a weaker franchise. Additionally, a sustained deterioration in earnings or asset quality would also lead to a downgrade of the credit ratings.
CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Very Strong
As measured by assets, TD currently ranks as the second-largest bank in Canada, the sixth-largest in North America, and the 10th-largest U.S. bank (including being the largest foreign-owned bank). TD maintains a top-tier retail banking platform in Canada where it is ranked first or second across most retail products. In the U.S., TD's existing footprint along the U.S. East Coast from Maine to Florida includes retail, small business, and commercial banking operations in four of the top 10 metropolitan statistical areas and six of the 10 wealthiest states. TD ranks second in total deposits in Canada and sixth in North America. The Bank benefits from its wide distribution channels and strong brand, which continue to provide growth opportunities in the U.S. through an expanding Wholesale business and an organic growth strategy.
Earnings Combined Building Block (BB) Assessment: Strong/Good
TD generates solid underlying earnings through its well-diversified and predictable retail revenue streams, contributing to the Bank's ability to absorb credit losses. In F2023, adjusted net income (as reported) decreased 1.8% year-over-year (YOY) to $15.1 billion, as higher net interest income and noninterest income were more than offset by higher provisions for credit losses (PCL) and noninterest expenses. TD had Q1 2024 adjusted net income (as reported) of $3.6 billion, a quarter-over-quarter (QOQ) increase of 4.4% as higher revenues were only partly offset by higher PCLs and noninterest expenses. As at Q1 2024, the net interest margin (NIM) in Canada expanded QOQ and YOY while the U.S. had NIM contraction QOQ and YOY as a result of higher funding costs.
Risk Combined Building Block (BB) Assessment: Strong
Morningstar DBRS views TD's credit risk profile as conservative and well managed, exhibited by its solid asset quality with a manageable level of PCLs and impaired loans that have moved to within normalized levels. In Q1 2024, the total PCL ratio increased 5 basis points (bps) QOQ to 44 bps, while allowance coverage remained stable QOQ at 89 bps but higher compared with pre-Coronavirus Disease pandemic levels. TD's real estate secured lending (RESL) portfolio represents nearly half of total gross loans and acceptances (GL&A), toward the higher end of the peer range. The Bank's RESL portfolio, like that of all large Canadian banks, appears to be conservatively underwritten with an uninsured average credit bureau score of 792 and an uninsured current loan-to-value ratio of 52%, which provides a substantial buffer. On a positive note, negatively amortizing mortgages (13% of the mortgage portfolio) and amortization periods greater than 30 years (19%) in Canada continued their downward trend in Q1 2024. Meanwhile, CRE office sector exposure represents a manageable 11% of total CRE loans and 1% of GL&A and is well diversified across geographies and sub-segments. Morningstar DBRS will monitor TD's ongoing efforts to strengthen its AML program and controls.
Funding and Liquidity Combined Building Block (BB) Assessment: Strong
Morningstar DBRS views TD as having one of the strongest funding profiles of all the large Canadian banks, underpinned by a strong deposit franchise in both Canada and the U.S. that is diversified and broad-based, reflecting the Bank's expansive network of deposit-gathering branches. With interest rates appearing to have peaked, the deposit mix shift from demand to higher-cost term deposits is moderating. Augmenting its ample deposit funding, TD also enjoys ready access to diversified wholesale funding sources. TD's liquidity profile remains strong as at January 31, 2024, with a liquidity coverage ratio (LCR) of 133% and a net stable funding ratio (NSFR) of 114%, both comfortably exceeding regulatory minimum thresholds.
Capitalization Combined Building Block (BB) Assessment: Strong
Morningstar DBRS views the Bank's capitalization as strong, supported by significant internal capital generation. TD's CET1 ratio of 13.9% at Q1 2024 was the second highest among large Canadian bank peers and well above the 11.0% regulatory requirement. With the closing of a competitor's acquisition in Q2 2024, TD will likely have the highest CET1 ratio. Following the termination of TD's acquisition of First Horizon Corporation, TD has been utilizing a portion of its excess capital toward an accelerated share buyback program and organic U.S. growth strategy. As of January 31, 2024, the Bank's risk-based total loss-absorbing capacity ratio was 30.8% and its leverage ratio was 4.39%, both well above the regulatory minimums and in line with its Canadian bank peers.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/432323
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Governance (G) Factors
Morningstar DBRS finds the corporate/transaction governance ESG factor is relevant to the credit rating but does not change the assigned credit ratings or trends. The Bank is actively working on remediation efforts to enhance its AML program, which has been insufficient in providing adequate surveillance, reporting, and responses to suspicious activity. On April 30, 2024, TD announced that it has taken an initial USD 450 million provision in connection with one of its U.S. regulators, related to previously disclosed Department of Justice and regulatory investigations. Discussions with law enforcement and regulatory agencies remain ongoing, and the Bank expects additional monetary and/or nonmonetary penalties. This was preceded by a fine of about $9.2 million on April 9, 2024, from FINTRAC in Canada related to the Bank's AML program. As a result, this factor is incorporated into TD's Risk Profile grid grades. This factor is new and was not present in the prior credit rating disclosure and reflects the material development following the previous credit review.
There were no Environmental or Social factors that had a significant or relevant effect on the credit analysis.
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030
Notes:
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (April 15, 2024) https://dbrs.morningstar.com/research/431155. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.
The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.
The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at dbrs.morningstar.com
The credit rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the credit rating process for this credit rating action.
Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.
This is a solicited credit rating.
These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed credit ratings:
The last credit rating action on this issuer took place on May 4, 2023, when Morningstar DBRS confirmed the Bank's credit ratings.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.
For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.
Lead Analyst: Carl De Souza, Senior Vice President, Sector Lead, North American Financial Institution Ratings
Rating Committee Chair: Michael Driscoll, Managing Director, North American Financial Institution Ratings
Initial Rating Date: November 30, 1980
For more information on this credit or on this industry, visit dbrs.morningstar.com.
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THE TORONTO-DOMINION BANK 
