DBRS Limited (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). The trend on all 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 by DBRS Morningstar). As a result of the SA2 designation, the Bank’s Long-Term Issuer Rating benefits from a one-notch uplift.
KEY RATING CONSIDERATIONS
TD’s ratings and Stable trends are underpinned by its strong banking franchise and diversified business mix and earnings, including its leading Canadian retail franchise. Additionally, the Bank has a solid U.S. banking franchise operating primarily across the Eastern Seaboard, contributing to earnings diversity. Indeed, the Canadian Retail and U.S. Retail business lines comprise approximately 90% of TD’s net income, providing considerable earnings stability.
The ratings also consider that government support measures have largely mitigated the negative economic impacts of the Coronavirus Disease (COVID-19) pandemic. Positively, economic performance has rebounded, and the labour market is essentially at full capacity; however, headwinds persist from a potential aggressive interest rate tightening cycle to combat inflation, geopolitical tensions related to the Russia-Ukraine conflict, supply chain disruptions, and the pandemic. Furthermore, DBRS Morningstar remains concerned about the combination of Canadian household debt levels that have reached an all-time high and elevated home prices that have been driven by housing market imbalances and robust demand during the pandemic (particularly in the greater Toronto and Vancouver areas). Housing prices remain vulnerable and, as a result, TD and its Canadian peers remain susceptible to adverse changes in the Canadian real estate market. DBRS Morningstar views TD’s retail exposure as manageable given its conservative underwriting and strong risk culture. Historically, the Bank’s focus on retail lending has been a source of lower credit risk and positions the Bank for growth as the economy improves and interest rates rise.
DBRS Morningstar views TD as well placed in its rating category. Given TD’s high rating level and current risk profile, a ratings upgrade is unlikely. Ratings would be downgraded if there were a sustained deterioration in asset quality, especially caused by deficiencies in risk management. Additionally, a prolonged decline in profitability metrics would also result in a ratings downgrade.
Franchise Combined Building Block (BB) Assessment: Very Strong
TD currently ranks as the largest bank in Canada and the fifth-largest in North American as measured by total assets. TD maintains a top-tier retail banking platform in Canada with a complete product set (ranked #1 or #2 for 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 seven of the 10 wealthiest states. TD’s U.S. retail footprint includes a larger branch network than the Bank’s Canadian operations, and TD ranks in the top 10 nationally by deposits. The Bank benefits from its wide distribution channels and strong brand which continue to provide growth opportunities, particularly in the U.S.. DBRS Morningstar notes that TD’s announced U.S. $13.4 billion acquisition of First Horizon Corporation (First Horizon) will strengthen the Bank’s size and scale, positioning it as the sixth largest bank in the U.S. First Horizon will extend TD’s U.S. footprint into the fast-growing and adjacent U.S. Southeast, providing immediate scale in new markets (Memphis, Nashville, Knoxville, and Chattanooga in Tennessee, and Lafayette and New Orleans in Louisiana), increasing the Bank’s presence in Florida and the Carolinas, and providing an entry point into the Texas and Georgia markets.
Earnings Combined Building Block (BB) Assessment: Strong
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 F2021, adjusted net income (excluding the F2020 net gain on the sale of its investment in TD Ameritrade) increased 47% year over year to $14.6 billion, as earnings were boosted by provision for credit loss (PCL) reversals based on strong credit performance and an improved macroeconomic outlook. TD reported Q1 2022 net income of $3.7 billion, a modest sequential quarterly decline of 1.3% driven by higher PCL and insurance claims, partly offset by revenue growth. Unprecedented support measures put in place through monetary and fiscal stimulus have mitigated some of the negative impacts of the pandemic, although TD has been disproportionately affected by the pandemic and related lockdowns as a result of its heavier dependency on its retail branch network. While near-term challenges remain given the scale of the aforementioned headwinds, TD is the most interest-rate-sensitive bank among large Canadian banks and should benefit from the current interest rate tightening cycle.
Risk Combined Building Block (BB) Assessment: Strong
DBRS Morningstar views TD’s risk profile as conservative and well managed, exhibited by its strong asset quality with manageable level of PCLs and impaired loans that remain well below pre-pandemic levels. TD, like others in the banking industry, benefitted in F2021 from PCL reversals on performing loans that resulted in a total PCL of -$224 million and a total PCL ratio of -3 basis points (bps). PCL in Q1 2022 showed some modest deterioration quarter over quarter with total PCL of $72 million compared with -$123 million in Q4 2021, although total PCL ratio at 4 bps remains well below historical levels. Moreover, gross impaired loans remained low in Q1 2022 at a manageable 0.33% of gross loans and acceptances. Additionally, the Bank’s exposure to sectors affected by the pandemic was highly manageable at 5.4% of total gross loans and acceptances.
DBRS expects continued modest deterioration in asset quality metrics from unsustainably low levels as credit conditions normalize and the magnitude of PCL reversals slows. DBRS Morningstar remains concerned about the high household debt levels and the potential impact of a housing downturn the Canadian economy and consumer-related loan portfolios, and TD has a greater loan portfolio concentration in Ontario and a larger percentage of consumer loans than many of its Canadian bank peers. However, TD’s real-estate secured lending portfolio, like that of all large Canadian banks, appears to be conservatively underwritten with 22% of these loans being insured and an uninsured loan-to-value ratio of 49%, thereby providing a substantial buffer.
Funding and Liquidity Combined Building Block (BB) Assessment: Strong
DBRS Morningstar views TD as having the strongest funding profile of all the large Canadian banks, underpinned by a strong deposit franchise in both Canada and the U.S., reflecting the Bank’s expansive network of deposit-gathering branches. Augmenting its ample deposit funding, TD enjoys ready access to diversified wholesale funding sources. TD's liquidity profile remains strong as at January 31, 2022, with a liquidity coverage ratio (LCR) of 124% and a net stable funding ratio (NSFR) of 124%. The NSFR, unlike the LCR, looks at funding resilience over the medium to longer term and both the LCR and NSFR comfortably exceed regulatory minimum thresholds.
Capitalization Combined Building Block (BB) Assessment: Strong
DBRS Morningstar views the Bank’s capitalization as strong, supported by significant internal capital generation. TD currently has the highest CET1 ratio among large Canadian bank peers. In Q1 2022, TD’s CET1 ratio was 15.2% (flat quarter over quarter), well above the 10.5% regulatory requirement. Internal capital generation offset common share repurchases, growth in risk-weighted assets (RWA), and a decrease in the Office of the Superintendent of Financial Institutions’ transitional Expected Credit Loss arrangements. At this CET1 level, the Bank maintained a sizable cushion of $22.1 billion. TD will be deploying this excess capital when the First Horizon acquisition closes in Q1 2023, reducing the CET1 ratio by approximately 400 bps, although expected to remain above 11% at closing. Following the close of the acquisition, DBRS Morningstar expects the Bank to partially rebuild its CET1 ratio buffer via internal capital generation. As of January 31, 2022, the Bank's total loss-absorbing capacity as a percentage of RWA was 28.6%, well above the regulatory minimum of 24.0%. The Bank reported a leverage ratio of 4.4% in Q1 2022, above the regulatory minimum of 3% and in line with its Canadian bank peers. DBRS Morningstar notes that this metric remains somewhat weaker than many global peers.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/396531.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are the Global Methodology for Rating Banks and Banking Organizations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022; https://www.dbrsmorningstar.com/research/394683). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).
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 www.dbrsmorningstar.com.
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 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 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 (July 19, 2021) was used to evaluate the Issuer, while the DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022) was used to rate subsidiary debt issuances guaranteed by the Issuer, and DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021) was used to assess ESG factors.
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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
Lead Analyst: Carl De Souza, Senior Vice President
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG
Initial Rating Date: December 19, 2005
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