DBRS, Inc. (DBRS) upgraded the long-term ratings of The Toronto-Dominion Bank (TD or the Bank) and its related entities, including TD’s Long-Term Issuer Rating to AA (high) from AA. The Bank’s Short-Term Issuer Rating is confirmed at R-1 (high). The trend on all ratings is now 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 by DBRS). The SA2 designation results in a one-notch uplift to the Long-Term Issuer Rating. Under the new Canadian Bank Recapitalization Regime, DBRS expects to eventually remove the uplift from systemic support once the Bank has issued a sufficient level of bail-inable senior debt, which would thereby provide an adequate buffer for non-bail-inable obligations and is then expected to offset the removal of systemic support.
KEY RATING CONSIDERATIONS
The upgrade of TD’s long-term ratings recognizes the Bank’s improving fundamentals and franchise, including a growing level of earnings in the United States and ongoing strong performance in Canada, as the Bank continues to execute on its lower-risk strategy. DBRS views TD as consistently outperforming most global banks, and the Bank’s upgraded IA is now in line with a few highly regarded U.S. peers. The U.S. retail bank now represents over one-third of the Group’s earnings, which contributes to TD’s geographic diversity. Indeed, the Canadian and U.S. retail operations generate more than 80% of TD’s adjusted net income, providing considerable earnings stability, which is a key factor underpinning the ratings. DBRS notes that the performance of the U.S. franchise has vastly improved as the Bank has built its asset generation capabilities, and it has realized the benefit from margin expansion and lower corporate taxes following U.S. tax reform. However, while historically a source of lower credit risk, TD’s focus on retail lending in Canada, where the consumer is highly levered, makes it somewhat more exposed to a potential downturn in Canada. At present, TD is less exposed (as a percentage of earnings) to capital markets businesses compared with the other large Canadian banks. However, TD is investing to build out its capital markets capabilities, particularly in the United States, which could potentially expose the Bank to greater earnings volatility.
Given TD’s recent rating upgrade and high rating level, upward ratings momentum is unlikely. Negative ratings pressure could arise if there is a perceived increase in risk appetite or a sustained deterioration in asset quality, especially from deficiencies in risk management. Additionally, a sustained weakening of profitability metrics could also result in negative ratings pressure.
TD operates a significant North American franchise, including a top-tier retail banking platform in Canada and the largest foreign-owned bank in the United States. In addition, TD’s U.S. retail bank, which has a branch footprint along the U.S. east coast from Maine to Florida, ranks in the top ten nationally by deposits. This very strong franchise contributes to high levels of profitability through highly diversified revenue streams.
TD reported strong earnings and returns for H1 2019, with net income increasing a solid 6% (4% on an adjusted basis) year over year (YOY). The increase reflected revenue growth, derived from both net interest income and non-interest income, partially offset by higher non-interest expenses, higher insurance claims and a higher provision for credit losses (PCL). On an adjusted basis by segment, net income growth included solid growth in Canadian Retail, the Bank’s largest segment, which increased 4% YOY, while the U.S. Retail segment saw a robust 30% YOY increase in earnings. Conversely, Wholesale Banking earnings decreased 63% following difficult market conditions in Q1 2019.
Credit quality remains strong with the level of gross impaired loans (GIL) relatively stable. However, the H1 2019 PCL increased by 22%, or $234 million, YOY. The increase reflected volume growth, seasoning and mix shift in the U.S. credit card portfolios and higher provisions in U.S. commercial. DBRS expects that asset quality at current levels is likely unsustainable and expects GILs and PCLs to revert to more normalized and higher levels over time.
DBRS remains concerned over the combination of Canadian household indebtedness and elevated housing prices, particularly in and around Vancouver and Toronto, and the potential impact of a housing downturn to the Canadian economy as well as to other consumer-related loan portfolios. Nonetheless, TD’s residential-secured portfolio, like all the large Canadian banks, appears conservatively underwritten, with 33% of TD’s Canadian residential-secured portfolio insured. The average loan-to-value ratio of the uninsured portfolio is a very conservative 54%, providing a substantial buffer for a decline in housing prices.
DBRS views TD as having the best funding profile of the large Canadian banks, underpinned by a very strong deposit franchise in both Canada and the United States. TD enjoys ready access to diversified wholesale funding sources, which augments its ample deposit funding. The Bank’s liquidity remains strong with a Liquidity Coverage Ratio of 135% in Q2 2019, which remains well above regulatory minimums.
TD’s Q2 2019 CET1 ratio increased 20 basis points YOY to 12.0% primarily due to strong earnings generation. However, DBRS expects the Bank will manage capital lower from this level. TD is viewed as a very strong capital generator, although absolute capital levels remain at the low-end of some global peers. The Bank has begun issuing bail-inable senior debt as part of the Canadian bail-in regime. It is expected that the Bank will exceed the requirement as it replaces maturing legacy senior debt.
The Grid Summary Grades for TD are as follows: Franchise Strength – Very Strong; Earnings Power – Very Strong/Strong; Risk Profile – Very Strong/Strong; Funding & Liquidity – Very Strong/Strong; Capitalisation – Very Strong/Strong.
DBRS notes that the above press release was amended on August 28, 2019, to add a disclosure necessary for European Union endorsement under the Notes section. The amendment was minor and would not impact the understanding of the reader.
All figures are in Canadian dollars unless otherwise noted.
The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (July 2018) and DBRS Criteria: Guarantees and Other Forms of Support (January 2019), which can be found on our website under Methodologies & Criteria.
The primary sources of information used for this rating include company documents (and other sources such as bank regulators etc.). DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:
Each of the principal methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision. Specifically, the “Global Methodology for Rating Banks and Banking Organisations” was utilized to evaluate the Issuer, while the “DBRS Criteria: Guarantees and Other Forms of Support” was used to rate subsidiary debt issuances guaranteed by the Issuer.
The last rating action on this issuer took place on June 27, 2018, when the Bank’s ratings were confirmed, and the trend was revised to Positive.
For further information on DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.
Lead Analyst: John Mackerey, Senior Vice President, Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global FIG
Initial Rating Date: 19 December 2005
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