Toronto-Dominion Bank Earnings: $2.6B Fine Erases All Profit (NYSE:TD)

Toronto-Dominion Bank Overview

The Toronto-Dominion Bank (NYSE:TD, TSX:TD:CA) just released its fiscal third quarter earnings and largely missed analyst expectations. The headline metrics were C$14.1 billion in revenue, up 9.7% (beat by C$1.4) and $-0.14 in reported EPS, down from $1.53. Although revenue was far ahead of estimates, it was overshadowed by the completely unexpected negative GAAP earnings figure. The earnings were negative, primarily due to a $2.6 billion provision for fines related to the Department of Justice’s (DoJ) ongoing anti-money laundering investigation into TD.

Unfortunately, actual details about the investigation were rather lacking in the release. The matter received only a brief mention, primarily announcing an increase in the provisions by $2.6 billion. TD had booked $460 million in charges for expected fines several months ago. Total provisions now sit at approximately $3.06 billion. There was no mention of what the DoJ expected from TD Bank, when their investigation would conclude, or whether there was potential for “expected fines” to increase further. The CEO did say on the earnings call that he expected resolution by year’s end.

The ultimate amount of fines TD will face is a key factor in how much its stock is worth. Fines take a bite from net income and can at times single-handedly reduce a year’s profit to zero. Analysts have estimated that TD will take between $2 billion and $4 billion in fines related to the AML investigation. As I’ll show in a later section on valuation, the stock is quite cheap if the fines stop at $2 billion and fairly valued if they go all the way to $4 billion.

The odds of truly thesis breaking fines is low; however, it’s not zero percent. The extreme “worst-case scenarios” here, going by the biggest banking fines in history, are very bad. JPMorgan Chase (JPM) once paid out $13 billion in a single fine, and Bank of America (BAC) took a staggering $30 billion in fines related to the SMC scandal over a period of about a decade. If TD Bank takes fines like these, then anybody buying the stock today will have to wait a very long time to get their investment back in dividends.

I consider TD taking fines comparable to the most severe in the history of banking very unlikely. The JPM and BAC fines mentioned above came about during the Great Financial Crisis, when public outrage toward banks was at an all-time high. Regulators likely felt the need to give the public a sense that “justice had been served.” TD does not face this kind of pressure currently. However, if more drug money laundering is found at more TD branches across the country and media outlets start writing about this and its connection to overdose deaths and cartel activity, then such pressure could emerge. Plenty of pieces would have to fall in place for this scenario to actually materialize, which is why I consider it low-probability. But it’s certainly possible for it to play out.

It’s partially for this reason that I’m maintaining my TD rating at “hold,” unchanged from my previous TD article. This is even though I, personally, hold the stock at a very high portfolio weighting and considered today’s earnings release in some ways a good one. Investors have different levels of risk aversion, and to the most risk-averse, the large AML fines are a major problem–a problem that today’s release didn’t rectify. Additionally, some ESG portfolio managers include “health and safety” as a factor they consider in their investments. They probably would want to see that TD has new AML protocols in place before investing in the stock, as the “ML” in question pertains to a major public health crisis (opioid drugs).

TD Bank Q3 Earnings Recap

TD’s fiscal third quarter earnings release broadly missed analyst estimates. Some highlight metrics included:

• Revenue: C$14.1B, up 10% year over year (beat by $1.4 billion).

• Adjusted net income: C$3.6B, flat year over year.

• Reported net income: C$-181 million, down from $2.8 billion.

• Adjusted EPS: C$2.05, flat year over year (miss by C$0.03).

• GAAP EPS:C$-0.15, down from $1.53 (miss by C$1.7).

• Return on equity (“ROE”): 14.1% based on adjusted earnings.

• CET1 ratio: 12.8.

As you can see, TD’s top-line growth was pretty good. In an overlapping period, Bank of America (BAC) grew its revenue 1% and Wells Fargo (WFC) grew its revenue at near-zero percent. So TD’s top-line performance was better than many other large banks in the most recent reported quarter. Furthermore, some individual segments did well: Canadian retail earnings were up 13% and wholesale banking earnings were up 14%.

The problem was the fine. Coming in at $2.6 billion, it erased the bottom-line impact of the positives mentioned above, resulting in negative net income! Adjusted net income was a fairly healthy $3.6 billion, but this figure excluded the fine. You have to wonder whether this is a valid adjustment, when the bank said in the earnings call that it wasn’t sure whether fines had reached their maximum amount yet. CEO Bharat Masrani did say on the call that he expected to have the matter resolved by the end of the year, but did not clarify whether “resolution” would include another increase to the expected fines.

TD Stock Valuation

Having discussed TD Bank’s earnings release and the ambiguity surrounding more fines, we can turn to the matter of valuation.

Going by Seeking Alpha Quant’s numbers, TD Bank is cheap, trading at:

• 10.3 times adjusted earnings.

• 13.7 times GAAP earnings.

• 2.87 times sales.

• 1.35 times book.

The problem is that these numbers will worsen when they are updated for the impact of the fine taken in Q3. In its press release, TD admitted that its GAAP P/E had gone to 19, which is very high for a bank. If the fines continue to increase, then the ratio will go even higher. So the cheap valuation I mentioned in my last article on TD may not be a reality for much longer.

Risks

The main risk facing TD right now is the one alluded to throughout this article:

AML fines.

The amount of expected fines is rising, and if the matter resolves by the end of the year like TD expects, then there’s room for the fines to rise further still. TD does about $11 billion in net income in a good year. If TD books another $2.6 billion in fine provisions, then the total rises $5.66 billion–roughly half of a year’s profit! So these fines are proving to be a serious near term risk factor.

Other risks impacting TD Bank include those that impact all Canadian banks, such as:

• Canada’s housing market. Sales are starting to fall in major markets, leading some to worry about price declines. Canadian mortgages are usually variable rate, which means that Canadian borrowers have seen their total cost of housing, including financing, rise since the start of 2022. The potential for defaults is very real.

• A relatively sluggish economy. Canada’s GDP growth has been slow and barely positive in recent quarters. For example, Q1 growth was just 0.4%. If this trend persists, then there may be layoffs, reduced demand for loans, and other developments that are not favorable to banks.

The Bottom Line

The bottom line on The Toronto-Dominion Bank right now is that it’s a tough sell at the current price. Although I continue holding my position, I accumulated most of it at the year’s lows. I’m not enthusiastic about buying more today. If we see $74 again, there may be an opportunity.