With the CEO Gone, is TD out of the Penalty Box?
On Friday, TD announced CEO Bharat Masrani would be stepping down two months earlier than originally communicated to make way for incoming CEO Raymond Chun.
The bank also announced a number of cuts to executive compensation, due to the money laundering scandal linked to fentanyl distribution that has weighed on shares.
The stock was up 4% on the news and 10% in 2025, making it the best performing Canadian bank stock YTD. With shares trading at a discount to the other Canadian banks, does TD have room to move higher? Or will its AML-related headwinds be sticky?
Using Wells Fargo to estimate impact
The fines are known ($3.1B), but what remains unclear is how TD will navigate the other burdens placed on the business, including an asset cap ($434B) on its U.S. retail business, increased compliance costs, and reputational damage. Thankfully, TD isn’t the first bank to royally screw up like this, so we have some precedents to pull from.
The U.S. Retail segment has grown net income almost 14% annually from 2012-2023 into a significant portion of TD’s book of business.
TD has already committed to reducing its U.S. asset base by ~10% to have a buffer against the asset cap. The assets (loans) it sheds will be lower yielding and could be replaced by more attractive investments to keep the business from shrinking, but it certainly won’t be growing, and we don’t know for how long.
To put some context around this, Wells Fargo was fined in 2016 for its fake account scandal and an asset cap was placed on it in 2018. Given it was unable to grow its asset base and incurred higher costs from beefing up its compliance program, net income hasn’t budged since the restrictions were put in place.
The cap could be lifted from Wells Fargo this year, 7 years after it was initially instated, and until recently its share price appreciation matched WFC’s profits - flat to down.
TD could face a similar jump in its efficiency ratio (non-interest expense divided by revenue) as it works through higher compliance costs. But will the stock suffer the same fate?
We expect fiscal 2025 expense growth to be in the 5% to 7% range, reflecting investments in our risk and control infrastructure, and investments supporting business growth…
Lost growth could be tough to replace
If there’s an upside case to TD shares from here, it lies within the bank’s ability to make up for some of the lost growth in the U.S. by allocating that capital to its higher return segments.
When I look at the momentum that we have in these businesses… as we revisit how to reallocate our capital as a part of our strategic review, I think you should expect that we are going to accelerate our momentum and continue to outperform our peers as we move forward.
Since 2020, TD has seen loan growth in its Canadian Personal and Commercial segment average over 7% and the bank could look to ramp up its efforts domestically, specifically in mortgages.
So I look forward to an active season. But our goal is to make sure that we are growing profitably and continuing to take market share as we go forward.
With TD’s acquisition of Cowen finalized in 2023, the wholesale banking segment could also pick up some of the slack if the markets remain volatile (good for trading) and deal making activity picks up. Whether it can grow this business profitably is another question.
Verdict? Patience pays
While the valuation gap looks attractive at face value, it’s there for a reason.
With management guidance pulled until the back half of 2025, limited clarity around the strategy for replacing foregone growth in the U.S., and new leadership coming in February, patience may be the best approach for investors thinking about sizing up.