Fitch Ratings has affirmed The Toronto-Dominion Bank's (TD) Long and Short-term Issuer Default Ratings (IDRs) at 'AA-' and 'F1+' respectively. The Rating Outlook is Stable.
This rating action follows a periodic review of the Canadian Banking sector. Fitch will publish the main findings of this review in a report 'Canadian Banks: Nearing a Tipping Point' available at www.fitchratings.com
KEY RATING DRIVERS - IDRS, VR's, AND SENIOR DEBT
The affirmation reflects TD's solid franchise in Canada and the U.S., strong asset quality, continued earnings stability, strong funding and liquidity position, sound capital position, and favorable metrics relative to international peers. These strengths help support TD's already high ratings, which are at the top of Fitch's global rating universe for financial institutions.
However, Fitch believes that all Canadian banks, including TD, are vulnerable to credit deterioration in their domestic loan portfolios given high levels of consumer indebtedness in Canada, combined with Fitch's view of some overvaluation in the Canadian housing market. This limits housing affordability and makes consumers particularly susceptible to negative shocks to their income levels. Should the rapid decline in global oil prices cause an economic slowdown in Canada that impacts employment levels, this could hasten potential credit deterioration. Either way, Fitch believes provision expenses will be a growing headwind to earnings over the medium-term.
Canadian Mortgage and Housing Corporation (CMHC) insurance plays an important role in supporting the balance sheets of all Canadian banks, although the availability of mortgage insurance is expected to continue to decline. TD is currently at the high end of the peer group, in terms of mortgage insurance, with over 69% of its residential mortgage portfolio being insured at YE14 and uninsured mortgages had a loan-to-value ratio of 70%. Fitch believes this profile will help to insulate the bank from material disruptions in housing prices or marked deterioration in the consumer leverage profile, on a relative basis.
Additionally, Fitch continues to expect that earnings growth in consumer banking and lending in Canada will be challenged, given the maturity of the market and the increasingly strained consumer. As a result, banks will need to focus on growth in wealth management; an increasingly competitive business, and be keenly focused on cost controls in order to meet earnings targets over the medium-term. TD's adjusted efficiency ratio ticked-up modestly in 2014, given investments in strategic initiatives and the impact from recent acquisitions. Fitch does not expect material efficiency improvements in 2015, as the bank continues to spend money on growth initiatives.
From a capital perspective, TD's position is sound for the rating category. At Oct. 31, 2014, the bank's Basel III Tier I common equity ratio (CET1) was 9.4%, on an all-in basis, which is below the peer average, but above minimum regulatory requirements. The CET1 ratio rose 40 bps during 2014 as a 14.7% increase in risk-weighted assets, was more than offset by growth in retained earnings and an increase in accumulated other comprehensive income. On a relative basis, TD's capital position is impacted by a higher risk weighting on its residential mortgage portfolio, as it uses the standardized approach for a portion of the loan book.
RATING SENSITIVITIES - IDRS, VR's, and SENIOR DEBT
Given its already high rating levels and the Negative Sector Outlook on Canadian banks, Fitch does not expect any upside to TD's ratings over the medium-term.
However, negative rating actions could be driven by significant deterioration in earnings and/or credit performance, particularly if it differs materially from that of other large Canadian banks, as the housing market eventually slows and consumer leverage profiles remain at high levels. Fitch believes TD may be more susceptible to consumer stress, as it is now the largest credit card issuer in Canada. While some credit normalization is expected, Fitch notes that this could be hastened or potentially more severe due largely to exogenous macroeconomic risks such as continued pressure in the global oil and gas markets, unexpected increases in interest rates, which impact consumers ability to service debt obligations, as well as macroeconomic weakness in China or Europe that flows through to adversely impact the Canadian economy. An alternation of the bank's risk appetite, a weakening liquidity profile, and/or reduced buffers on regulatory capital minimums could also yield negative rating momentum.
KEY RATING DRIVERS - SUPPORT RATINGS AND SUPPORT RATING FLOORS
The affirmation of the TD's SRs and SRFs reflect Fitch's expectation that there remains an extremely high probability of support from the Canadian government ('AAA'; Outlook Stable) if required. This expectation reflects Canada's extremely high ability to support its banks especially given its financial flexibility, though propensity is becoming less certain.
Specific to TD, our view of support likelihood is based mostly on their systemic importance in Canada, significant concentration overall Canadian banking assets amongst the institutions noted above, which account for over 90% of banking assets, the large size of the banking system with banking assets at 2.1 times Canada's GDP, and the Canadian banks' position as key providers of financial services to the Canadian economy. TD's IDRs and senior debt ratings do not benefit from support because their VRs are all currently above their SRFs.
However, in Fitch's view, there is a clear intention to reduce support for D-SIFI's in Canada, as demonstrated by commentary and actions from Canadian banking regulators seeking to protect tax payers from the risk of a large financial institution failing. This is further supported by the proposed issuance of non-viability contingent capital (NVCC) instruments, resolution powers given regulatory authorities under the CDIC Act, and other initiatives that demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward. Fitch believes this increases the likelihood of NVCC and potential senior debt losses if one or more of the Canadian Banks run afoul of solvency assessments.
RATING SENSITIVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR
Fitch is classifying Canada as a Path 2 country as defined in its September 2013 report, Bank Support: Likely Rating Paths, and given the factors noted above, Fitch expects there to be some level of support for the TD going forward, and as such does not expect the SR to be impacted.
The SRF ratings are more likely to be impacted and are sensitive to progress made in completing NVCC issuances and any additional regulatory initiatives that may be imposed on the Canadian D-SIFIs. Fitch's assessment of continuing support for Canadian D-SIFI's has to some extent relied upon resolution powers granted regulators under the CDIC ACT as well as the potential size, structure, and feasibility of NVCC implementation.
Fitch expects that the continued regulatory action to ensure sufficient contingent capital will be implemented for all Canadian banks in the near term, but regardless of its finalization, Fitch believes that sufficient regulatory progress continues to be made over the ratings time horizon. Therefore, Fitch expects to revise TD's SRFs to 'BBB-' at some point over the next twelve months.
Absent a material change in economic conditions or the companies' stand-alone credit profiles, a revision of the SRFs to 'BBB-' would mean no change to TD's Long-term IDR and debt ratings because its viability rating is above the SRF.
KEY RATING DRIVERS - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other hybrid capital issued by the banks and by various issuing vehicles are all notched down from the banks' (or bank subsidiaries') VRs in accordance with Fitch's assessment of each instrument's respective nonperformance and relative loss severity risk profiles. Their ratings are primarily sensitive to any change in the VR of TD.
KEY RATING SENSITIVITIES - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The subordinated debt ratings are primarily sensitive to any change in the VR of the parent bank.
The preferred securities ratings of TD, TD Capital Trust III and IV, and Northgroup Preferred Capital Corporation reflect the ability of management and regulatory authorities to suspend dividends, which results in the rating being five notches from TD's VR.
KEY RATING DRIVERS & SENSITIVITIES - LONG- AND SHORT-TERM DEPOSIT RATINGS
TD Bank, NA's uninsured long-term deposit ratings are rated one notch higher than the company's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.
The ratings of long and short-term deposits issued by TD Bank, NA are primarily sensitive to any change in TD Bank NA's IDR.
KEY RATING DRIVERS - SUBSIDIARY AND AFFILIATED COMPANY RATINGS
All of the subsidiaries and affiliated companies reviewed as part of the Canadian bank peer review factor in a high probability of support from parent institutions to the subsidiaries. This reflects the fact that performing parent banks have very rarely allowed subsidiaries to default. It also considers the high level of integration, brand, management, financial and reputational incentives to avoid subsidiary defaults.
KEY RATING SENSITIVITIES - SUBSIDIARY AND AFFILIATED COMPANY RATINGS
The subsidiary and affiliated company ratings are primarily sensitive to any change in the VRs of the ultimate parent, Toronto Dominion Bank.
Fitch has affirmed the following ratings:
Toronto-Dominion Bank
--Long-term IDR at 'AA-'; Outlook Stable;
--Short-term IDR at 'F1+';
--Short-term debt at 'F1+';
--Viability Rating at 'aa-';
--Senior debt at 'AA-';
--Subordinated debt at 'A+';
--Preferred at 'BBB';
--Support Rating at '1';
--Support Floor at 'A-'.
TD Bank U.S. Holding Company
--Long-term IDR at 'AA-'; Outlook Stable;
--Short-term IDR at 'F1+';
--Support Rating at '1'.
TD Bank, NA
--Long-term IDR at 'AA-'; Outlook Stable;
--Short-term IDR at 'F1+';
--Viability Rating at 'a';
--Long-term deposits at 'AA';
--Short-term deposits at 'F1+';
--Senior debt at 'AA-';
--Support Rating at '1'.
TD Capital Trust III, IV
Northgroup Preferred Capital Corporation
--Preferred at 'BBB'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Global Financial Institutions Rating Criteria' (January 2014);
--'Assessing and Rating Bank Subordinated and Hybrid Securities' (January 2014);
--'Rating FI Subsidiaries and Holdings Companies' (August 2012);
--'The Evolving Dynamics of Support for Banks' (September 2013);
--'Bank Support: Likely Rating Paths' (September 2013); and
--'2015 Outlook: Canadian Banks' (December 2014)
Applicable Criteria and Related Research:
Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397
Assessing and Rating Bank Subordinated and Hybrid Securities Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732137
Rating FI Subsidiaries and Holding Companies
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=679209
The Evolving Dynamics of Support for Banks
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715000
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=978296
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