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Toronto-Dominion Bank (TSX: TD) has become the centre of a lot of unwanted attention recently.
In early May, Canada’s second-largest bank provided further details about the major failure of the Anti-Money Laundering (AML) controls at its U.S. operations. We’ve learned that this was a critical issue in the derailment of TD’s attempted takeover of Tennessee-based First Horizon Corp. last year. And we’re finding out more about the potential size of the financial penalties that may be imposed as a result.
The whole mess is a blow to TD’s reputation. But, from an investors’ viewpoint, most of the damage to the share price seems to already be reflected in the stock’s lacklustre performance over the past 18 months.
TD’s CEO Bharat Masrani and senior executives have reportedly conducted a tour of meetings with top executives at the bank to reassure them about concerns of TD’s AML failures arising from the probe by U.S. law enforcement agencies.
“We will continue our discussions with all U.S. authorities and the Department of Justice in the U.S., and I’m hoping we can resolve this as soon as possible,” Mr. Masrani said at a town hall meeting with employees on May 6. “We’re looking at a global resolution.”
In an internal memo, Mr. Masrani said TD is overhauling its AML program by hiring new leaders and hundreds of employees, redesigning existing controls, and building new ones, deploying new technology, and implementing improved training. The bank has invested more than half a billion dollars in remediating its AML procedures.
Mr. Masrani admitted in the memo that “we did not meet our expectations or our regulatory obligations to monitor, detect, report, or respond to suspicious activity. As a result, criminals broke through our defenses, and used the bank to launder money.”
He went on to say, “This is absolutely unacceptable and while our systems stopped a lot of activity, there were serious instances where we failed to stop these criminals.”
TD announced at the end of April it has set aside US$450 million to cover penalties arising from an investigation, adding the provision does not reflect the final amount of the monetary penalties or any nonmonetary penalties.
A U.S. Department of Justice report on a money laundering and drug trafficking operation involving sums estimated to be in excess of US$650 million “utilized a variety of financial institutions and methods.” Investigators tracked the chief defendant making multiple transactions at branches of a single financial institution, which has been identified as TD.
U.S. TD head Leo Salom told employees, “This story, in particular, raised a lot of concerns because it linked the TD name to the illicit drug trade.” In a notable example of understatement, Mr. Salom said, “This is not a headline any institution would want, and for TD it is truly sobering,” He added, “I can assure you we are co-operating and working hard to resolve these matters.”
While undoubtedly a major black eye for TD’s reputation, and a blow to its hard-earned record of effective expansion over the last two decades, it appears likely that the worst of the damage to the share price has already been inflicted. With the break fee for the First Horizon deal not closing and the US$450 million minimum penalty for the AML breaches, TD’s earnings have already taken a hit.
Some pessimistic estimates point out that this is only a fine from one regulator, and that the total amounts could be nearer US$1 billion. Furthermore, nonmonetary penalties could include consent decrees that limit TD’s growth until the breaches are fixed, while the cost of doing so drives up TD’s expense ratio.
With the shares down 11.5% year to date, National Bank analyst Gabriel Dechaine warned, “We believe that TD could not only face a larger than expected fine, but regulator-imposed limitations on its (US) business activities.”
While TD stock has gone from trading at a 4% premium to its Canadian bank peer group to a 6% discount, Mr. Dechaine cautioned investors from expecting a rebound back to a premium “and put a greater weight on worst-case scenarios for the stock.”
It will undoubtedly take some time for TD to regain its momentum, especially until the eventual size of the penalties is known. But it should be reiterated that TD is the second-largest Canadian bank and an historically extremely profitable business. It dominates its domestic markets in an oligopoly with the other Big Six chartered banks.
To put things in perspective, in the year to Oct. 31, 2023, despite provisions for credit losses (PCLs) for potential and actual bad debts tripling to $2.9 billion, TD still had net earnings of $10.8 billion, although this was below the $11.7 billion in 2018. Non-interest income from its extensive wealth management and investment banking activities was $23 billion in 2023.
Penalties for its AML breaches, even if they end up being double the base case estimate of $1 billion, are effectively less than one quarter’s earnings.
TD now trades at about 12 times depressed earnings. The dividend yield is 5.4%, the highest since the financial crisis of 2008-09.
TD remains a banking sector favorite, especially as there is the potential for new management to come in and reassure investors as to the bank’s future direction. As always, consult your financial adviser before making an investment to ensure it fits your financial objectives and risk tolerance.
Gavin Graham is a veteran financial analyst, money manager, formerly Chief Investment Officer of BMO Financial, and a specialist in international investing, with over 35 years’ experience in global investment management.
Notes and Disclaimer
Content © 2024 by Gavin Graham. This article first appeared in The Internet Wealth Builder newsletter. Used with permission.
The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
Image: iStock.com/alfexe
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