DBRS Confirms The Toronto-Dominion Bank at AA; Trend Changed to Stable from Negative

DBRS, Inc. (DBRS) has today confirmed the ratings of The Toronto-Dominion Bank (TD or the Bank) and its related entities, including TD’s Long-Term Issuer Rating at AA and Short-Term Issuer Rating at R-1 (high). TD’s Long-Term Issuer Rating is composed of an Intrinsic Assessment (IA) of AA (low) and a Support Assessment (SA) of SA2, reflecting 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. The trends on TD’s short-term ratings, as well as the Long-Term Issuer Rating, Long-Term Senior Debt, Long-Term Deposits and older-style subordinated debt, have been revised to Stable from Negative, while other capital instruments whose ratings are notched down from the Bank’s IA remain Stable.

The revision of the trends to Stable reflects DBRS’s view that TD’s long-tenured track record of improving fundamentals points to an improving IA, which may offset the anticipated regulatory reform support-related downward pressure on the rating. Therefore, the expectation of a ratings downgrade following the removal of support is less likely.

TD’s ratings reflect its strong North American franchise. TD ranks as the largest bank in Canada and the fifth-largest bank in North America by assets ($1.25 trillion as of April 30, 2017). The Bank offers a largely complete set of banking products and services, with top-tier market positions in most retail products domestically. In addition, TD’s U.S. retail bank ranks in the top ten nationally by deposits, with a branch network larger than its Canadian operations and locations throughout the east coast, from Maine to Florida. Its U.S. Retail segment is material, representing over one-third of the Group’s total H1 2017 earnings and contributes to the geographic diversity of the organization. Indeed, more than 80% of TD’s adjusted net income is generated from its Canadian and U.S. retail operations, providing considerable stability to earnings, a key underpinning to its ratings. However, while historically a source of lower credit risk, TD’s focus on retail lending in Canada makes it more exposed to a potential downturn in that sector. TD’s ratings also consider the challenging operating environment that is constrained by sluggish global growth, low interest rates, heightened regulatory and compliance expense burdens and the potential for a housing downturn in Canada.

DBRS continues to view that changes in Canadian banking legislation and regulation point to a declining potential for timely support for Canada’s systemically important banks. Eventually, this decline is expected to result in a change in DBRS’s SA to SA3 from SA2. Currently, for these banks, the SA2 results in an uplift of one notch above their IAs. This regime primarily affects the six big Canadian banks that have been designated as domestic systemically important banks (D-SIBs). While this bail-in regime is expected to come into force in H1 2018, the proposed new bail-inable debt will only begin to be issued by D-SIBs at that time and no existing debt will be subject to bail-in retroactively. Thus, DBRS considers that there would not be sufficient bail-inable debt initially to reduce the likelihood of systemic support from its current level in Canada. DBRS expects to maintain the current notch of support until the D-SIBs build up sufficient new bail-inable senior debt such that the likelihood of systemic support has declined to a level at which this uplift is no longer warranted. The timing of such action depends on the finalization of the bail-in regime and the extent to which the D-SIBs build up their bail-inable senior debt. Two factors pressuring the D-SIBs to issue new bail-inable senior debt are the maturing of their existing senior debt and their need to meet the newly established requirements for total loss absorbing capacity (TLAC) by November 1, 2021. DBRS continues to evaluate the impact of the proposed regulations and will comment further as the proposals are finalized. For more detail, please see “DBRS Comments on Proposed Implementation of Bail-in Regime in Canada; Bank Negative Trends Unchanged” published July 11, 2017, on dbrs.com.

TD reported $5.1 billion in adjusted earnings for H1 2017, up a solid 13% year over year (YoY). Loan and deposit growth in both the Canadian and U.S. Retail segments, higher fee and trading related income, a lower provision for credit losses and lower claims and related expenses were partially offset by an increase in non-interest expenses, lower insurance premiums and the shorter-day count in the current period. All segments reported an increase in net income with a lower loss in the Corporate segment also providing some lift. Net income in Canadian Retail, the Bank’s largest segment, increased 5%, while U.S. Retail and Wholesale Banking net income increased a solid 12% and 36%, respectively.

Credit quality remains strong with gross impaired loans lower YoY with improvements in all business segment with a large drop in the wholesale bank reflecting improvements in the oil and gas sector. Likewise, the H1 2017 provision for credit losses (PCL) decreased by 8% or $93 million YoY. Improvements in oil and gas losses versus the previous year including recoveries in the specific provision were offset by higher provisions for auto loans and credit cards in the U.S. DBRS expects that asset quality at current levels is likely not sustainable and expects gross impaired loans and PCLs to revert to more normalized and higher levels over time.

DBRS remains concerned over the significant appreciation seen in 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 real estate-secured portfolio, like all of the large Canadian banks, appears conservatively underwritten or is insured. Specifically, 47% of TD’s Canadian residential real estate-secured portfolio is insured, while the loan-to-value ratio of the uninsured portion is a very conservative 49%. Meanwhile, loss rates have remained stable and very low at just one basis point.

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 averaging 122% for Q2 2017. DBRS notes that the net stable funding ratio will now not go into effect until January 1, 2019, but expects that the Bank is well positioned to adhere to the rule.

The CET1 ratio increased 70 basis points YoY to 10.8% with earnings retention offset by common stock repurchases and growth in risk-weighted assets. DBRS views TD as a very strong capital generator although absolute capital levels are at the low-end of some global peers.

With $1.25 trillion in assets as of April 30, 2017, TD is the largest Canadian bank by assets.

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 – Strong; Capitalization – Very Strong/Strong.

RATING DRIVERS
When support is removed, TD’s ratings could remain at their current levels reflecting an improving IA offsetting the removal of the uplift currently derived from support. On an intrinsic basis, if TD continues to successfully build and strengthen the performance of its U.S. banking franchise, while maintaining its current commanding position and solid performance in Canada, it could lead to positive rating implications. Conversely, missteps in the U.S., a material increase in risk appetite, a significant deterioration in asset quality or a sustained downturn in the Canadian housing market leading to a sustained and significant decline in earnings could lead to negative rating implications.

Notes:
All figures are in Canadian dollars unless otherwise noted.

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.dbrs.com.

The principal methodologies are the Global Methodology for Rating Banks and Banking Organisations (May 2017) and DBRS Criteria: Guarantees and Other Forms of Support (February 2017), which can be found on dbrs.com under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: John Mackerey
Rating Committee Chair: Lisa Kwasnowski
Initial Rating Date: 30 November 1980
Most Recent Rating Update: 28 July 2016

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.