DBRS Changes Trend on The Toronto-Dominion Bank to Positive from Stable

DBRS, Inc. (DBRS) changed the trends on all long-term ratings of The Toronto-Dominion Bank (TD or the Bank) and its related entities to Positive from Stable. DBRS also confirmed all the ratings of TD, including its Long-Term Issuer Rating of AA and Short-Term Issuer Rating of R-1 (high). The short-term ratings of the Bank remain Stable. TD’s Intrinsic Assessment (IA) and Support Assessment continue to be AA (low) and SA2, respectively, 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 one notch of uplift from the IA to the Long-Term Issuer Rating. However, following the finalization of the Canadian Bank Recapitalization Regime, DBRS eventually expects to remove the uplift from systemic support. This will be actioned once a sufficient level of bail-inable senior debt is issued, thereby providing an adequate buffer for non-bail-inable obligations, which is then expected to offset the removal of systemic support (see the press release “DBRS Takes Rating Actions on Six Canadian Banking Groups after Finalization of Bail-In Regime” dated April 19, 2018).

KEY RATING CONSIDERATIONS
TD’s ratings reflect its strong and significant North American franchise. With $1.28 trillion in assets as of April 30, 2018, TD ranks as the largest bank in Canada and the fifth largest in North America. The Bank offers a largely complete set of banking products and services, with top-tier market positions in most retail products in Canada. 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, with a larger branch network than TD’s Canadian operations. TD’s U.S. Retail segment is material, representing about 30% of the Bank’s earnings, and contributes to the geographic diversity of the Bank. 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 factor that underpins TD’s ratings. However, while historically a source of lower credit risk, TD’s focus on retail lending in Canada makes it somewhat more exposed to a potential downturn in the consumer segment in Canada. In addition, the ratings also consider the longevity of the current credit cycle. U.S. tax reform and higher interest rates in both the United States and Canada should also help boost earnings going forward.

The Positive trends reflect DBRS’s view that TD’s long-tenured track record of improving its fundamentals and franchise points to an improving IA.

RATING DRIVERS
If TD continues to show strong credit fundamentals, an improved level of earnings in the United States and better-than-peer performance in Canada, the ratings would likely be upgraded. DBRS does not see any near-term negative rating pressure, but sustained negative operating leverage could pressure the ratings. Additionally, a severe downturn in the economy that leads to a sustained deterioration in asset quality, especially from deficiencies in risk management or underwriting, could have negative rating implications.

RATING RATIONALE
TD reported $5.3 billion in earnings for H1 2018, up a solid 5% year over year (YOY). The increase reflected higher earnings in all business segments, partially offset by a higher provision for credit losses (PCL), reflecting the adoption of International Financial Reporting Standards (IFRS) 9. In addition, the prior year had a lower effective tax rate in Wholesale Banking, reflecting a change in business mix. The Bank also reported a higher net loss in the Corporate segment. On an adjusted basis, net income rose a strong 17% for H1 2018. Positively, net income growth was broad based, with all three business segments reporting strong growth. Specifically, net income in Canadian Retail, the Bank’s largest segment, increased by 14%; U.S. Retail increased by 17%; and Wholesale Banking increased by 6%.

Credit quality remains strong, with gross impaired loans (GIL) lower YOY, with improvements in all business segments. In addition, new GIL formations remain low and were stable compared with last year. However, the H1 2018 PCL increased by 10%, or $116 million, YOY. The increase largely reflected the implementation of IFRS 9 and the impact on the consumer portfolio. DBRS expects that asset quality at current levels is likely unsustainable and expects the GIL and PCL 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 on the Canadian economy as well as on other consumer-related loan portfolios, especially given the level of Canadian household indebtedness. Nonetheless, TD’s residential-secured portfolio, like all the large Canadian banks, appears conservatively underwritten, with 39% of TD’s Canadian residential-secured portfolio insured. The average loan-to-value ratio of the uninsured portfolio is a very conservative 52%.

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 123% for Q2 2018.

TD’s Q2 2018 Common Equity Tier 1 ratio increased 100 basis points YOY to 11.8%, primarily due to the elimination of the Basel I floor. DBRS expects the Bank will manage capital lower from this level. TD is viewed as a very strong capital generator, although absolute capital levels are at the low end of some global peers.

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; and Capitalisation – Very Strong/Strong.

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 applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (May 2017) and DBRS Criteria: Guarantees and Other Forms of Support (January 2018), 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 to be of satisfactory quality.

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

Lead Analyst: John Mackerey, Vice President, Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global FIG
Initial Rating Date: 30 November 1980
Most Recent Rating Update: 19 April 2018

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.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.