TD investors concerned with lack of details about U.S. regulatory probe after bank sets aside US$450-million provision for penalties

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Toronto-Dominion Bank TD-T investors are concerned with the lack of details about a probe by U.S. regulators into the bank’s anti-money-laundering practices that threatens to stunt growth after the lender disclosed it is setting aside US$450-million to cover penalties.

TD said late Tuesday it is booking the provision as it awaits further penalties resulting from investigations by several U.S. regulatory and law enforcement agencies that scuttled the bank’s takeover of Tennessee-based First Horizon Corp. a year ago. With the probe continuing into its second year, analysts and large shareholders are warning the issue could strike a blow to the bank’s outlook.

“From a pure stock and market perspective, clarity and one-time nature items tend to get looked through,” said Dan Rohinton, iA Global Asset Management vice-president and portfolio manager, in an interview. “Having it drag on is definitely not in their best interest. The bread crumb strategy just compounds anxiety as opposed to getting it over and done with,” he said.

“This is neutral, with a bit of disappointment that hopefully it would be all wrapped up by now.” But ultimately, Mr. Rohinton said, TD is limited in what it can disclose from conversations with regulators.

TD said it is continuing discussions with three U.S. regulators and the Department of Justice, and that it anticipates additional monetary penalties. The US$450-million the bank is setting aside does not reflect the final amount of those penalties.

The bank said it is unable to estimate the full extent of the penalties at this time. Some analysts have estimated they could range as high as US$2-billion.

“On the one hand, additional fines could push the total above investors’ expectations for a total charge of (about) US$1-billion, and potential non-monetary penalties related to TD’s US growth would be a concern,” Keefe, Bruyette & Woods analyst Mike Rizvanovic said in a note to clients. “On the other hand, this initial provision does suggest some progress toward resolution with regulators, which remains an important catalyst for TD and should lend support to its share price.”

While TD did not disclose the agencies involved, banking regulators in the United States include the Office of Comptroller of the Currency (OCC), the Federal Reserve Board and the Financial Crimes Enforcement Network.

One of the biggest penalties handed out by U.S. regulators involving anti-money-laundering and sanctions violations was imposed on Britain-based HSBC Holdings PLC and its U.S. subsidiary in 2012. The Department of Justice ordered the bank to pay a penalty of US$1.3-billion, while the OCC levied a penalty of US$500-million and the Federal Reserve Board imposed a penalty of US$165-million.

But TD investors are more concerned about the threat of non-monetary penalties. Regulators could implement regular monitoring of TD’s remediation efforts to clean up its anti-money-laundering practices, which would be costly for the bank. The agencies could also limit the lender’s asset growth, or bar it from striking takeovers – which would significantly stunt TD’s growth ambitions in the U.S. market.

The bank could manage increased monitoring through other measures, including reducing the cost of its operations. Without acquisition opportunities, the bank could continue to grow in the U.S. by investing in its business. But a cap on asset growth – which limits a bank’s ability to expand its balance sheet, a key factor in how lenders make money – would be the worst-case outcome as it could prompt a bank to reduce its activity in certain businesses.

“That’s where it limits your ability to grow and deploy capital organically, which is the single best use of capital that the banks can do at any given point in time,” Mr. Rohinton said.

Time is also a major concern for the bank. These types of issues often take years of work to meet regulatory expectations. In the case of HSBC, the Federal Reserve lifted its almost decade-long enforcement order on the bank in 2022.

The anti-money-laundering issues have weighed on TD’s share price as its stock trades at a discount to its forward price-to-earnings ratio – a common metric used when assessing a stock’s valuation – compared with its peers, according RBC analyst Darko Mihelic.

“We view this announcement as negative because it does not provide clarity on all of our concerns but certainly suggests that the minimum cost of the problem is higher than the minimum estimated range,” Mr. Mihelic said.

He added that an asset cap would be the worst-case scenario, but that he does not expect regulators to impose this restriction.

“Nevertheless, as long as our worst-case scenario is averted, we see significant upside potential for the stock relative to its peers once the full cost of the fine and non-monetary penalties are revealed.”