A cloud of uncertainty has been lifted from Toronto-Dominion Bank’s (TSX:TD) stock in October following resolutions of longstanding anti-money laundering (AML) issues with U.S. regulatory bodies. The US$3.1 billion (C$4.3 billion) fine the bank was slapped with was largely provided for and may have minimal impact on future earnings. However, the sixth-largest North American bank isn’t off the hook yet and there is more for TD Bank stock investors to be concerned with over the next year.
What’s impacting TD Bank stock in October?
TD Bank announced on October 10 the resolution of its anti-money laundering issues with U.S. regulators. The bank acknowledged and took full responsibility for U.S. AML program failures. It was slapped with a US$3.1 billion (C$4.3 billion) regulatory fine, which was slightly higher than its US$3.05 billion provision in a recent earnings report.
The bank was also hit by an asset cap of US$434 billion (C$600.2 billion). The asset cap wasn’t yet priced into the stock, resulting in a nearly 8% decline in TD stock price during two trading sessions following the announcement. The bank may not grow total assets at its two U.S. banking subsidiaries beyond this limit until concerned regulatory monitors are satisfied with remediation progress.
Asset size is a critical operating factor in the banking business. All else equal, the larger its asset base, the higher the operating earnings a bank can generate. The asset cap limits how big TD Bank’s operations and profits can grow in the United States.
Furthermore, TD Bank will be subjected to “more stringent approval processes for new bank products, services, markets, and stores.”
Implications for TD Bank stock’s future profitability and valuation
TD Bank is going to incur higher operating costs going forward as it invests in human capital, engages in training sessions, and installs new stringent safeguards to avoid future AML lapses. There’s a risk that the bank’s management could become overly cautious in everything it approves, and some level of paranoia may creep into the business, potentially slowing the bank’s pace in making money for investors.
Moreover, the asset cap may cripple TD Bank stock’s earnings growth capacity, constrain its return on equity (ROE), and weigh on its future valuation metrics like price-to-book (P/B) multiples for the foreseeable future. The bank’s U.S. retail banking operations contributed 39% of TD’s earnings before tax (EBT) during the fiscal year 2023, before corporate charges.
Given the precedent set by Wells Fargo & Co, which faced similar issues and suffered a US$2 trillion asset-cap consequence six years ago, TD Bank investors may have to endure the impact on U.S. assets for an unknown duration. Wells Fargo isn’t off the hook yet since the Federal Reserve last publicly commented on the asset cap in 2021, and its stock performance has suffered due to a contraction in valuation multiples, especially its P/B multiple versus peers.
Limited damage?
However, TD Bank stock may suffer limited damage. The asset cap is significantly smaller than what was imposed on Wells Fargo, both in absolute terms and on a relative basis. TD’s U.S. retail banking assets comprised around 28.5% of its total assets in July, and the limitation does not apply to TD Securities and the bank’s vibrant Canadian operations.
The bank may continue to grow its Canadian business, which contributed 58.4% to its total revenue during the past 12 months. As seen recently, the bank’s earnings diversity, as evidenced through impressive contributions from a Charles Schwab equity investment, could help its earnings performance going forward.
Where will TD Bank stock be in a year’s time?
Regulatory issues can be significantly unpredictable, and considerable time and expense may go into salvaging relationships with U.S. monitoring institutions and the increasingly watchful authorities in other financial jurisdictions. Potential shareholder lawsuits may follow and distract management’s focus from creating new value for investors. TD Bank stock may underperform other top Canadian bank stocks.
That said, financial analysts currently expect TD Bank to grow its revenue by 4.1% over the next year and its normalized earnings per share (EPS) by 1.5% year-over-year in 2025.
Most noteworthy, income-oriented investors will continue to receive their quarterly dividends, and analysts project a 5.8% dividend bump for the next year. The bank’s dividend currently yields 5.2% annually and remains well covered by recurring earnings.
The average analyst price target of $87 implies a potential 9.9% capital gain on TD Bank stock over the next year.
