A TD Bank branch in Toronto’s Financial District, Sept. 24. On Thursday, TD pleaded guilty to felony crimes in the U.S. and agreed to pay US$3.09-billion in penalties stemming from major, widespread failures in its anti-money-laundering programs.Fred Lum/The Globe and Mail
Toronto-Dominion Bank TD-T is facing years of constrained growth and pressure on profits, a worst-case scenario that will force the bank to shift its strategy to try to keep up with rivals after regulators put a straitjacket on key parts of TD’s U.S. business.
On Thursday, TD pleaded guilty to felony crimes in the U.S. and agreed to pay US$3.09-billion in penalties stemming from major, widespread failures in its anti-money-laundering programs. The more damaging blow to TD was U.S. officials’ decision to place an indefinite cap on the assets in TD’s U.S. retail banking subsidiaries as of Sept. 30, which are now limited to US$434-billion.
Other restrictions imposed by U.S. regulators will make it harder for TD to launch new products or open new branches. To stay onside with regulators, TD will slash its U.S. retail assets by 10 per cent to create a buffer with the asset cap, and hold more cash on hand.
But with its U.S. retail arm boxed in, the bank will be forced to put more capital to work in Canada – where it already has a large share of a saturated market – and in its U.S. wholesale bank, which is growing but not yet a major contender. Investors are relieved that TD’s Canadian operations and U.S. investment dealer were excluded from the asset cap.
“This is a difficult chapter for TD,” said Raymond Chun, who will take over as chief executive officer in April when current CEO Bharat Masrani retires, but “TD has the scale and resilience to deliver.”
What remains to be seen is how long this chapter drags on.
Starting Wednesday evening, senior TD leaders have held calls and meetings with staff that continued Thursday, as well as an all-staff town hall in the U.S. on Friday. They sought to strike a balance between owning up to the bank’s failures while bolstering morale.
As the gravity of the sanctions against the bank set in, employees expressed embarrassment, sadness and anger over all that went wrong for a decade, and TD executives in Canada said their teams were in a state of shock. Employees questioned how a compliance system that flags the most mundane issues could miss money laundering by U.S. drug dealers for years.
One source said staff are struggling to square Mr. Masrani’s constant reminders about compliance and doing things the right way with the way some U.S. employees behaved. The Globe is not naming the source because they are not authorized to speak publicly.
At the same time, TD has already begun to pivot its focus toward corporate clients, the source said. Mr. Masrani, Mr. Chun and other TD leaders have told investment bankers at TD Securities and corporate lenders that the bank plans to put more capital behind their businesses and expects them to win additional clients and do more work for existing business customers.
The onus to prove that TD can stabilize its earnings, find ways to grow and restore its tarnished reputation rests heavily on Mr. Chun. He is launching into a six-month apprenticeship before he leads TD into an uncertain future after barely three years of experience on TD’s top executive team. He made his reputation at TD in part by fixing divisions with performance problems, including the bank’s insurance business, and is known for his intense focus on improving operations by cutting costs and streamlining management.
“Management’s credibility and reputation have been harmed, in our view, and will likely be reflected in a discounted valuation versus its peers for years to come,” Darko Mihelic, an analyst at RBC Dominion Securities Inc., said in a note to clients. Mr. Mihelic downgraded his rating on TD and lowered its price target for the shares from $88 to $82 on Friday.
TD will also have to fight to retain talent. In recent years a number of highly respected leaders have left the bank, while executive search professionals and leaders of rival banks predict TD will continue to lose experienced leaders to rivals as the bank undertakes a restructuring of its U.S. business in the wake of Thursday’s penalties.
The U.S. Department of Justice disclosed that TD has withheld or clawed back about US$2-million in compensation from executives, including a $1-million cut to Mr. Masrani’s bonus pay last year, and US$201,000 from Leo Salom, the head of TD’s U.S. business. Justice officials said TD expects to claw back a further US$5.5-million in pay.
TD’s failures at detecting and stopping money laundering have already cost the bank dearly. Its stock has lost the premium it used to enjoy and now trades at a 12-per-cent discount to the average for its peers. TD’s market capitalization is $143-billion, more than $93-billion behind Royal Bank of Canada’s $236.2-billion. Less than two years ago, the gap in market cap between the two banks was only $20-billion.
TD’s share price fell 4 per cent to $78.48 on Friday, after it dropped more than 6 per cent on Thursday.
Mr. Salom said Thursday that the bank’s leaders are thinking of 2025 “as a transition year,” when earnings are likely to take a modest hit, costs to fix its AML systems will rise to US$500-million from US$350-million this year and revenue and income from interest will suffer from the cuts to U.S. assets. After that, he expects profits to stabilize.
Even so, the asset cap on the U.S. retail business “will restrain TD’s growth efforts in the U.S. for a long time to come,” Mr. Mihelic said. “This is a significant reduction in future potential earnings power.”
He speculated that the asset cap will remain in place on TD’s U.S. retail business for a minimum of five years, while other analysts said that timeline could be too optimistic. Analysts at Scotia Capital Inc. compared the Canadian bank’s situation with what has played out at Wells Fargo & Co., which is still under an asset cap imposed in 2018 over a sales-practices scandal, as well as seven other corporate scandals, including Volkswagen Group’s fraudulent emissions reporting in 2015.
While the valuations of companies that have been penalized for scandals sometimes recovered within four to five years, severe issues can “have significant longevity in investors’ minds, if not continued erosional effects on valuation versus peers,” said the analysts, Meny Grauman and Patrick Bryden.
Though investors’ alarm has focused mostly on TD’s U.S. assets, its vaunted deposit book – which Mr. Chun described as “second to none” on Thursday – could also come under pressure. TD plans to manage its risks in part by holding more liquidity, the cash and other assets that can quickly be turned to cash to meet the bank’s obligations, for the next while. The bank will keep its liquidity coverage at 150 per cent of regulatory minimums, compared with 129 per cent in the latest quarter – not only in U.S. retail banking, but across its Canadian retail and TD Securities divisions. That suggests some concern at TD that some deposits, and perhaps the customers who made them, could leave.
TD has work to do “to steward our conversations with our clients and give them the confidence that TD will continue to service them as we have for the last two decades,” Mr. Salom said Thursday. “We’re not taking that lightly. We have deep relationships with our clients but this is a significant event.”