DBRS Morningstar Confirms The Toronto-Dominion Bank at AA (high) With a Stable Trend

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). 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). The SA2 designation results in a one-notch uplift to the Bank’s Long-Term Issuer Rating.

KEY RATING CONSIDERATIONS
The ratings confirmations and Stable trends recognize TD’s strong banking franchise, including its leading Canadian retail franchise. Additionally, the Bank’s large and growing U.S. retail bank contributes to TD’s geographic and earnings diversity. Indeed, the Canadian and U.S. retail operations generate more than 75% of TD’s net income, providing considerable earnings stability, which is a key factor underpinning the ratings. DBRS Morningstar notes that the financial performance of the U.S. franchise has improved, reflecting the asset generation capabilities the Bank has built over the last few years. However, while historically it is a source of lower credit risk, TD’s focus on retail lending makes it somewhat more exposed to a consumer-driven downturn. The sale of the Bank’s stake in TD Ameritrade has resulted in a new ownership stake in The Charles Schwab Corporation, providing another avenue for earnings growth as synergies are realized. The ratings also reflect the economic disruption caused by the Coronavirus Disease (COVID-19) pandemic. However, TD has weathered this downturn with only a modest impact on its earnings as the unprecedented support measures put in place by governments and regulators around the globe have mitigated much of the negative effects of this crisis.

RATING DRIVERS
Given TD’s high rating level, an upgrade of the ratings is unlikely. Ratings would be downgraded if there were a sustained deterioration in asset quality, especially if it were related to deficiencies in risk management. Additionally, a sustained weakening of profitability metrics would also result in a downgrade of ratings.

RATING RATIONALE
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’s strong balance sheet, ample liquidity levels, and a sound capital position provided a source of strength during this challenging economic period. Overall, TD’s franchise generates high levels of income before provision and taxes through its well-diversified revenue streams.

TD reported Q1 2021 net income of $3.3 billion, a decline of 36% quarter-over-quarter (QOQ), driven by the prior quarter gain from the sale of its stake in TD Ameritrade. Adjusting for this gain, net income increased 14% sequentially, reflecting lower provision for credit losses (PCL) as well as strong growth in the Canadian Retail and U.S. Retail segments. Conversely, Wholesale Banking earnings were down 10% QOQ as a modest increase in revenue was more than offset by higher variable compensation. The U.S. Retail segment had elevated expenses related to its branch optimization strategy, which included the planned closure of 82 branch locations.

As at January 31, 2021, TD's payment deferral programs have largely wound down, with only a modest balance of loans remaining under deferral. While delinquency rates on loans with expired deferrals are higher than the broader loan book, they remain low in absolute terms because of continued government support programs. Additionally, total PCL declined to well below pre-pandemic levels, decreasing a substantial 66% QOQ to $313 million. TD recorded a recovery of PCL on performing loans of $153 million, driven by the impact of an improving economic outlook on its U.S. commercial and consumer lending portfolios. This was partially offset by an increase in PCL on impaired loans. As a result, the total PCL ratio declined sequentially to 17 basis points (bps), its lowest level in the last 15 years. Moreover, gross impaired loans (GIL) remained stable in Q1 2021, representing a manageable 0.42% of gross loans and acceptances. In addition, the Bank's exposure to sectors directly affected by the pandemic was highly manageable at 6.2% of total loans.

While current credit quality metrics are relatively stable, DBRS Morningstar remains concerned about the potential impact of a housing downturn on the Canadian economy as well as the negative effect this may have on its other consumer-related loan portfolios. Nonetheless, TD’s real estate-secured lending (RESL) portfolio, like that of all the large Canadian banks, appears to be conservatively underwritten, with 26% of these loans being insured. On the uninsured mortgage portfolio, the average loan-to-value ratio was very conservative at 52%, thereby providing a substantial buffer to a decline in housing prices.

DBRS Morningstar views TD as having the strongest funding profile of all 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. TD's liquidity profile remains strong, with a liquidity coverage ratio (LCR) of 139% as at January 31, 2021. The Canadian domestic systemically important banks (D-SIBs) are now required to disclose their net stable funding ratio (NSFR), which, unlike the LCR, looks at funding resilience over the medium to longer term. TD's NSFR was 128%, which comfortably exceeds the regulatory minimum of 100%.

TD's Q1 2021 CET1 ratio increased 50 bps from the prior quarter to 13.6%, largely driven by strong internal capital generation. At this level, the Bank has a sizable capital cushion of $21.5 billion above the regulatory minimum. DBRS Morningstar expects capital levels will continue to build until the Office of the Superintendent of Financial Institutions (OSFI) relaxes its restrictions on capital management activities for the D-SIBs. Furthermore, the Bank's total loss-absorbing capacity as a percentage of risk-weighted assets increased 190 bps to 23.8%, above the current minimum of 22.5% (21.5% plus 1.0% Domestic Stability Buffer) set by OSFI, with compliance required by November 1, 2021.

ESG CONSIDERATIONS
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.

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; Capitalisation – Very Strong/Strong.

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

The principal methodologies are the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020; https://www.dbrsmorningstar.com/research/362170) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 14, 2021; https://www.dbrsmorningstar.com/research/372344). 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).

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 sources of information used for this rating include 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 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 (June 8, 2020) was used to evaluate the Issuer, while the DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 14, 2021) 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.

The last rating action on this Issuer took place on May 29, 2020, when the Bank’s ratings were confirmed.

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: 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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