Morningstar DBRS Changes Trends on The Toronto-Dominion Bank's Credit Ratings to Negative from Stable, Confirms Long-Term Issuer Rating at AA (high) and Short-Term Issuer Rating at R-1 (high)

DBRS Limited (Morningstar DBRS) changed the trends on all long-term credit ratings of The Toronto-Dominion Bank (TD or the Bank), and its related entities, to Negative from Stable and confirmed all credit ratings, including TD's Long-Term Issuer Rating at AA (high). At the same time, Morningstar DBRS confirmed all short-term credit ratings, including TD's Short-Term Issuer Rating of R-1 (high), with Stable trends, with the exception of TD Bank, N.A. and TD Bank US Holding Company whose short-term credit rating trends were changed to Negative from 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). 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 CREDIT RATING CONSIDERATIONS
The trend change to Negative from Stable reflects the significant failures in corporate governance related to antimoney laundering (AML) at TD's U.S. retail operations and what Morningstar DBRS views as the heightened risk of discovering additional past transgressions or new missteps, including the potential for not remediating identified regulatory issues in a timely, effective manner. Moreover, Morningstar DBRS believes that profitability may be negatively affected for a prolonged period, which could lead to further negative credit rating pressure.

Certain U.S. subsidiaries of TD pleaded guilty to multiple criminal charges, including conspiracy to commit money laundering, as part of a global resolution to its AML investigations with the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board, the Financial Crimes Enforcement Network, and the U.S. Department of Justice. Total fines of USD 3.09 billion were substantial and the largest ever imposed on a bank for AML-related matters, although Morningstar DBRS notes the USD 3.05 billion in provisions the Bank had already put aside. In addition, the OCC Consent Order included an asset cap on TD's two U.S. banking subsidiaries (TD Bank USA, N.A. and TD Bank, N.A.) of approximately USD 434 billion. Morningstar DBRS considers this to be the outcome from multiple corporate governance failures at the Bank and expects the asset cap, combined with ongoing AML remediation efforts necessary to address TD's material shortcomings, to reduce the Bank's earnings power over the intermediate term. TD estimates its pretax U.S. governance and control costs to be USD 350 million in F2024 and USD 500 million in F2025. The extent of the AML resolution's medium to long-term impact, including the asset cap, on TD's reputation and earnings power remains uncertain. Further, TD's AML remediation efforts will be a multiyear undertaking that will require a significant time commitment from the Bank's revamped senior executive team if TD is to avoid any missteps, which could have further asset cap implications.

TD has some flexibility and levers to mitigate a prolonged and adverse impact to earnings. While the asset cap will hamper U.S. growth, Morningstar DBRS estimates the Bank is operating with a roughly USD 40 billion to USD 50 billion surplus in U.S. assets that can be redeployed to create loan capacity to support existing or new U.S. customer relationships. With U.S. assets representing 28.5% of total Bank assets at Q3 2024 and U.S. revenue comprising approximately 25% of total Bank revenue, Morningstar DBRS also views the Bank as having the ability to pivot its growth focus toward Canada and TD Securities to minimize the impact on earnings. TD has leading market positions in Canada in both retail and commercial, along with a large, integrated wealth management franchise. TD Securities, which is not affected by the asset cap, has a top two market share position in Canada and the integration of TD Cowen has notably increased its U.S. capital markets business while expanding the wholesale bank's capabilities and product set, providing additional opportunities for growth in the U.S.

Finally, TD currently has an elevated liquidity position. At Q3 2024, the liquidity coverage ratio was 129%, representing a surplus of $75 billion over the published regulatory minimum. The Bank also currently has a solid capital position, with a healthy CET1 position of 12.8% in Q3 2024, which Morningstar DBRS expects to rise to 13% going forward. Both are expected to remain well above their respective regulatory minimum thresholds and remain supportive of the current credit ratings.

CREDIT RATING DRIVERS
Given the Negative trends, credit rating upgrades are unlikely. Morningstar DBRS would change the trends back to Stable if TD demonstrates substantial progress in its AML remediation efforts while demonstrating a credible path to return to profitability metrics commensurate with its credit rating category.

A credit ratings downgrade would occur if the Bank experienced any additional missteps or failures, including in its AML remediation efforts. Additionally, the credit ratings would be downgraded if profitability is negatively affected for a prolonged period, there is notable deterioration in franchise strength, or there is a sustained deterioration in asset quality.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Very Strong

Earnings Combined Building Block (BB) Assessment: Strong/Good

Risk Combined Building Block (BB) Assessment: Strong

Funding and Liquidity Combined Building Block (BB) Assessment: Strong

Capitalization Combined Building Block (BB) Assessment: Strong

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/441267.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Governance (G) Factors
Morningstar DBRS finds the corporate/transaction governance ESG factor is significant to the credit ratings and could affect the credit ratings or trends assigned to the Bank. This factor has been changed from the prior credit rating disclosure, moving to significant from relevant, reflecting the details of the global resolution to TD's AML investigations. On October 10, 2024, certain U.S. subsidiaries of TD pleaded guilty to multiple criminal charges, including conspiracy to commit money laundering. The settlement included total fines of USD 3.09 billion, along with a USD 434 billion asset cap on TD's two U.S. subsidiaries (TD Bank USA, N.A. and TD Bank, N.A.). Morningstar DBRS considers this to be a significant corporate governance failure for the Bank, related to its AML program and controls, including insufficient surveillance, reporting, and responses to suspicious activity. This factor is incorporated into TD's Franchise and Earnings and Risk Profile grid grades.

There were no Environmental or Social factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 4, 2024), https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.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 https://dbrs.morningstar.com.

The credit ratings were initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

These credit ratings are 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 credit ratings:

The last credit rating action on this issuer took place on May 3, 2024, when Morningstar DBRS confirmed the Bank's credit ratings.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS 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, Sector Lead, North American Financial Institution Ratings
Rating Committee Chair: Elisabeth Rudman, Managing Director, Global Financial Institution Ratings
Initial Rating Date: November 30, 1980

For more information on this credit or on this industry, visit https://dbrs.morningstar.com.

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