DBRS Limited (DBRS Morningstar) confirmed its 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 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 reflect 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 to the Bank’s IA.
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 large U.S. banking franchise operating primarily along 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. However, U.S. regional banks have been in focus with the volatility and deposit outflows that have resulted since the initial U.S. bank failures in March 2023. In addition to being the largest foreign-owned bank in the U.S. and having a 12% ownership interest in the Charles Schwab Corporation, TD has further increased its U.S. exposure with the USD 1.3 billion acquisition of Cowen Inc. that closed on March 1, 2023. On May 4, 2023, however, it was announced that TD and First Horizon Corporation (First Horizon) mutually agreed to terminate their previously announced USD 13.4 billion merger amid uncertainty around receiving the required regulatory approvals.
The ratings also consider the challenging macroeconomic and geopolitical environment, which could lead to an adverse impact on profitability and asset quality. DBRS Morningstar remains concerned about the combination of highly leveraged Canadian consumers; elevated home prices, particularly in the greater Toronto and Vancouver areas; and materially higher borrowing costs and inflation levels that are eating into consumers’ disposable income. DBRS Morningstar believes that housing prices remain somewhat vulnerable and, as a result, views TD, like its Canadian bank peers, as susceptible to any adverse changes in the Canadian real estate market. Positively, DBRS Morningstar views TD’s residential real estate portfolio as conservatively underwritten, reflecting the Bank's strong risk culture and, historically, the Bank’s focus on retail lending has been a source of lower credit risk.
Given TD's high rating level and current risk profile, a ratings upgrade is unlikely. DBRS Morningstar would downgrade the ratings if there were a sustained deterioration in asset quality, especially caused by deficiencies in risk management. Additionally, material deposit outflows or 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 second-largest bank in Canada and the sixth-largest in North America as measured by total assets. 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 seven of the 10 wealthiest states. TD ranks first in deposits in Canada and fifth in North America. The Bank benefits from its wide distribution channels and strong brand, which continue to provide growth opportunities, particularly in the U.S. where size and scale remain critical to competing.
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 F2022, adjusted net income increased 5.3% year over year to $15.4 billion, primarily driven by higher net interest income that was partly offset by higher provisions for credit losses (PCL) and noninterest expenses. TD reported adjusted Q1 2023 net income of $4.2 billion, a modest sequential quarterly increase of 2.2%. TD has benefitted from the recent aggressive interest rate tightening cycle in the form of net interest margin (NIM) expansion. With interest rates stabilizing and funding costs expected to increase, however, NIM is expected to moderate in the remainder of F2023.
Risk Combined Building Block (BB) Assessment: Very Strong/Strong
DBRS Morningstar views TD’s risk profile as conservative and well managed, exhibited by its strong asset quality with a manageable level of PCLs and impaired loans that remain at cyclically low levels. In Q1 2023, the total PCL ratio increased 3 basis points (bps) QOQ to 32 bps as credit performance continues to normalize, while allowance coverage remained stable QOQ at 86 bps but higher compared with pre-Coronavirus Disease (COVID-19) pandemic levels. TD’s real estate secured lending (RESL) portfolio represents approximately 48% of total gross loans and acceptances (GL&A), with Canadian large bank peers ranging between roughly 36% and 54%. The Bank’s RESL portfolio in particular, like that of all large Canadian banks, appears to be conservatively underwritten with an uninsured current loan-to-value ratio of 51% and an uninsured average credit bureau score of 793, thereby providing a substantial buffer. However, amortization periods greater than 30 years in Canada have materially increased since Q2 2022 (29% for TD at Q1 2023), illustrating the impact of higher interest rates on variable interest rate mortgages with fixed payments. We will continue to monitor the impact rising interest rates will have on variable rate mortgages, including the ability of Canadian consumers to handle higher payments once their mortgages reset. Meanwhile, CRE exposure represents a manageable 10% of GL&A and is well diversified across geographies and sub-segments, including some portfolios that benefit from CMHC insurance.
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. that is diversified and broad-based, reflecting the Bank’s expansive network of deposit-gathering branches. In recent periods, however, the deposit mix has been notably shifting from demand to higher-cost term deposits as clients search for yield. 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, 2023, with a liquidity coverage ratio (LCR) of 141% and a net stable funding ratio (NSFR) of 125%. 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’s CET1 ratio of 15.5% at Q1 2023 was the second highest among large Canadian bank peers and well above the 11.0% regulatory requirement. Unrealized losses on TD’s amortized cost portfolio would have a negative impact of 180 bps on the CET1 ratio. With the cancellation of TD’s acquisition of First Horizon, TD will maintain excess capital and have the highest CET1 level among its large Canadian bank peers. DBRS Morningstar expects the Bank to deploy some of its excess capital toward another potential acquisition, organic growth, share buybacks, and/or dividend increases. As of January 31, 2023, the Bank's total loss-absorbing capacity as a percentage of RWA was 36.6% and its leverage ratio was 4.75%, 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/413500.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.
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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organizations (https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations; June 23, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.
The following methodologies have also been applied
-- DBRS Morningstar Criteria: Guarantees and Other Forms of Support, https://www.dbrsmorningstar.com/research/411694/dbrs-morningstar-global-criteria-guarantees-and-other-forms-of-support (March 28, 2023)
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.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 www.dbrsmorningstar.com.
The rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the rating process for this rating action.
DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This is a solicited credit rating.
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:
The last rating action on this issuer took place on May 6, 2022, when DBRS Morningstar confirmed the Bank’s ratings.
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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.
For further information on DBRS Morningstar 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, North American Financial Institutions Group
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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