DBRS, Inc. (DBRS Morningstar) confirmed the ratings of 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). All trends are 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 Morningstar). The SA2 designation results in a one-notch uplift to the Long-Term Issuer Rating. Under the Canadian Bank Recapitalization Regime, DBRS Morningstar expects to remove the uplift from systemic support once the Bank has issued a sufficient level of bail-inable senior debt. This would thereby provide an adequate buffer for non-bail-inable obligations and likely offset the removal of systemic support.
KEY RATING CONSIDERATIONS
The rating confirmations and Stable trends recognize the Bank’s strong fundamentals and strong Canadian franchise. Additionally, the U.S. retail bank typically accounts for about one-third of the Group’s earnings, which contributes to TD’s geographic diversity. The Canadian and U.S. retail operations generate more than 80% of TD’s net income, providing considerable earnings stability, which is a key factor underpinning the ratings. DBRS Morningstar notes that the performance of the U.S. franchise has improved as the Bank has built its asset-generation capabilities. Although historically a source of lower credit risk, TD’s focus on retail lending makes the Bank somewhat more exposed to a consumer-driven downturn. At present, TD is less exposed (as a percentage of earnings) to capital markets businesses compared with the other large Canadian banks; however, TD has invested in building out its capital markets capabilities, particularly in the U.S., which could potentially expose the Bank to greater earnings volatility. The ratings also reflect the likely impact of the wide and growing scale of the economic disruption caused by the Coronavirus Disease (COVID-19) pandemic. DBRS Morningstar notes that governments and regulators around the globe have put unprecedented support measures, which will mitigate some of the negative impacts of this crisis. DBRS Morningstar will continue to monitor this developing situation and potential impact on the Bank's revenue, earnings, and asset quality.
Given TD’s high rating level and the current economic environment, an upgrade of the ratings is unlikely. Ratings would be downgraded if there is a prolonged adverse impact from the coronavirus pandemic resulting in a sustained deterioration in asset quality, especially due to deficiencies in risk management. Additionally, a sustained weakening of profitability metrics would also result in a downgrade of ratings.
TD operates a significant North American franchise, including a top-tier retail banking platform in Canada and the largest foreign-owned bank in the U.S. 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 10 nationally by deposits. TD entered the current, more challenging operating environment from a position of strength, with a high-quality balance sheet, strong liquidity levels, and a sound capital position. Additionally, TD’s franchise generates high levels of income before provisions and taxes through well-diversified revenue streams.
TD reported a sharp drop in earnings for Q2 2020 as it built reserves to reflect weakening economic conditions, with net income roughly half of a typical quarter for TD. Positively, expenses were lower while revenue modestly declined sequentially as volume growth helped to offset net interest margin pressure caused by the low rate environment. Additionally, capital markets revenue was robust with strong trading-related revenue and higher debt underwriting activity. DBRS Morningstar expects revenue to remain pressured while credit costs remain elevated in the current economic environment, which will negatively affect TD’s earnings for the remainder of F2020.
While current credit quality metrics remains relatively stable, DBRS Morningstar remains concerned over the potential impact of a housing downturn on 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 to be conservatively underwritten, with 29% of TD’s Canadian residential-secured portfolio insured. On the uninsured mortgage portfolio, the average loan-to-value ratio was very conservative at 54%, thereby providing a substantial buffer to a decline in housing prices.
DBRS Morningstar views TD as having the strongest funding profile of the large Canadian banks, underpinned by a very strong deposit franchise in both Canada and the U.S. Augmenting its ample deposit funding, TD enjoys ready access to diversified wholesale funding sources. The Bank’s liquidity remains strong with a Liquidity Coverage Ratio of 135% in Q2 2020, which remains well above regulatory minimums. Additionally, TD held $260 billion in high-quality liquid assets, representing over 16% of total assets at quarter end.
TD’s Q2 2020 CET1 ratio decreased 69 basis points from the linked quarter to 11.0%, primarily reflecting growth in risk-weighted assets. TD has historically generated strong internal capital; however, capital generation may be lower as earnings remain under pressure in the current environment. On March 13, 2020, the Office of the Superintendent of Financial Institutions (OSFI) lowered the Domestic Stability Buffer (DSB) requirement for Domestic Systemically Important Banks (D-SIBs) to 1.0%, which effectively reduces the CET1 regulatory minimum to 9.0% for D-SIBs. As the DSB was intended, OSFI is providing the D-SIBs with more flexibility to extend loans to their customers during the coronavirus pandemic. Simultaneously, OSFI announced that it expects all D-SIBs to halt any new common share dividend increases and buyback activity.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
The Grid Summary Grades for The Toronto-Dominion Bank are as follows: Franchise Strength – Very Strong; Earnings Power – Very Strong/Strong; Risk Profile – Strong; Funding & Liquidity – Very Strong/Strong; Capitalization – Very Strong/Strong.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are the Global Methodology for Rating Banks and Banking Organisations (June 11, 2019) https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020) https://www.dbrsmorningstar.com/research/355780/dbrs-morningstar-criteria-guarantees-and-other-forms-of-support.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
The primary source of information used for this rating includes Company Documents. DBRS Morningstar 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 Morningstar 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 (DBRS Morningstar) for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:
Each of the principal methodologies/principal asset class 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” (June 11, 2019) was utilized to evaluate the Issuer, while the “DBRS Morningstar Criteria: Guarantees and Other Forms of Support” (January 22, 2020) was used to rate subsidiary debt issuances guaranteed by the Issuer.
The last rating action on this issuer took place on May 30, 2019, when the Bank’s ratings were upgraded.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.
For further information on DBRS Morningstar 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
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG
Initial Rating Date: December 19, 2005
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
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