For Canada’s TD Bank, the US has become more rags than riches

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Boring but steady US retail banking was once TD Bank’s prized possession, helping justify a nice premium for the stock. The same business will now do the reverse.

Canada’s second-largest bank this week agreed to pay $3.09bn in fines to the US government and pleaded guilty to charges that it failed to prevent money laundering. The fine is the largest ever levied under the US Bank Secrecy Act and represents about a third of TD’s net income last year. Worse still, regulators imposed a cap on TD’s ability to take on new US deposits.

The punishments are severe. But then again, so were the failings. Prosecutors said TD failed to monitor more than 90 per cent of the transactions on its network. Employees openly joked on the company’s instant messaging platform that the bank’s motto — “America’s Most Convenient Bank” — was marketed towards criminals. One customer, who bribed bank employees with more than $57,000 in gift cards, used TD to launder more than $470mn in drug proceeds.

An asset cap is going to hurt. Just ask Wells Fargo. The Federal Reserve capped the latter’s assets at $1.95tn in February 2018 and has yet to lift the restriction. While deposits at US commercial banks have jumped by more than $4tn since the start of 2020, according to Fed data, Wells has had to stay on the sidelines. The $77.2bn of revenue it pulled in last year is about 10 per cent lower than in 2017.

TD Bank’s asset cap differs from Wells Fargo’s in one major way. It applies only to TD’s two US retail banking subsidiaries, rather than the entire company. Those assets — at about $434bn — account for more than a fifth of the company’s overall balance sheet and generate about 30 per cent of total overall earnings, according to BMO Markets.

True, the cap will not affect TD’s US capital markets, Canadian or other operations. It could mitigate some of the impact by restructuring its balance sheet. A plan to reduce US assets by about 10 per cent and sell as much as $50bn of lower-yielding investment securities to reinvest the proceeds is a good start.

Near term, however, TD’s earnings will take a hit — with ongoing investments required to improve compliance. The share price, which has trailed most of its peers over the past year, reflects this.

On a price-to-forward-earnings basis, TD has historically traded at a premium to its Canadian rivals. But the ratio, now at 10.2 times, puts it at the bottom of the pack. Expect that gap to persist.

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