The banking crisis has been raging since it began, sweeping across Europe, dragging down bank stocks of all shapes and sizes. Now, one of Canada’s largest banks has found itself in the crosshairs of investors.
Toronto-Dominion Bank (Td 1.74%), often referred to as TD Bank, has a very large presence in the United States and is now the smallest bank stock among its peers. Traders took $3.7 billion worth of bets against the bank
With roughly $1.26 trillion in assets, TD Bank must be considered too big to fail, and many believe that big banks will benefit from this latest banking crisis because they can be seen as a safe place to move funds. Let’s take a look at why shorts are betting against TD Bank and whether their arguments have merit.
Linkage with other banks
Unlike US banks that collapsed because of bank runs and because they were sitting on huge unrealized bond losses, TD Bank’s securities portfolio had hardly any unrealized losses. Additionally, the bank has an incredibly diverse deposit base when you consider its global scale, whether in the US or Canada, so deposit runs are less likely.
Image source: Getty Images.
However, TD Bank has some other bank exposures that investors are watching closely. one Charles Schwab (Black 0.39%)Whereas TD Bank acquired a 13.4% stake when it sold Ameritrade to Schwab.
Schwab shares have come under a lot of pressure since the banking crisis began and have fallen 36% in the past month. The big reason is that Schwab is sitting on enough unrealized bond losses that could wipe out most of the company’s real common equity if it ever had to sell them to cover deposit outflows.
Still, Schwab has more than $7 trillion in client assets, access to tons of liquidity and more than 80% of deposits insured by the Federal Deposit Insurance Corporation (FDIC), so a bank is run and forced to sell securities. Trading at a loss is highly unlikely. I expect Schwab’s earnings to struggle in the near term as customers move their money into higher-yielding bank products.
Another bank has ties to TD Bank, a US regional bank first horizon (MFA -0.23%). TD Bank announced plans to acquire First Horizon in February 2022 Since then, it had to extend its merger agreement in February this year and recently announced that it will need to extend the deal again before it expires in May. Regulators have gotten tougher on approving bank mergers since the Biden administration took office, and many investors are now worried it won’t go through.
However, I don’t see the outcome of this acquisition as a huge problem for TD Bank. If it cannot complete the merger, it may be required to pay a termination fee under certain circumstances. This is not ideal, but TD Bank will have additional capital flexibility and can repurchase its own stock at an attractive price.
It could buy another US regional bank for a cheaper price. If TD Bank completes the acquisition, it gains a presence in the attractive Southeast region of the United States, which is experiencing some of the fastest population growth in the country.
Real estate exposure
TD Bank is also under pressure as investors worry about the slowdown in the Canadian housing market. A recent report by TD Bank economists said housing prices in Canada are expected to continue to decline. They gained 47% early in the pandemic, and economists expect average home prices to fall 21% at the bottom of the market.
Furthermore, many Canadians took out variable-rate mortgages at the start of the pandemic when interest rates were at all-time lows. Since then, they have seen their mortgage payments increase as Bank of Canada interest rates rise.
A home is a large part of a household’s or individual’s wealth, so if home prices drop too much or mortgage delinquencies and defaults rise, it could hurt the Canadian economy, and TD Bank would clearly be affected. However, at the end of TD Bank’s first quarter of 2023, which is the three months that ended Jan. 31, gross impaired loans made up just 0.07% of the bank’s roughly $180.8 billion mortgage portfolio, and borrowers have strong equity in their homes. We will be.
Since the onset of the banking crisis, investors have renewed focus on commercial real estate (CRE), particularly sectors such as office space, retail and multifamily loans. TD Bank has an approximately $66 billion loan CRE portfolio, with 29% multifamily, 18% retail, and 10% office.
But the total CRE exposure as a percentage of the bank’s core capital is about 106%. While this may sound like a lot, US regulators will not be too concerned about a bank’s CRE exposure unless it exceeds 300% of core capital. TD Bank’s common equity Tier 1 capital ratio, which expresses a bank’s core capital as a percentage of its risk-weighted assets, stood at 15.5%, higher than most major U.S. banks.
TD Bank investors should be worried
Obviously, growing short interest on a stock is never great, but TD Bank isn’t facing a liquidity problem. I’m not too concerned about exposure to Schwab, which I don’t believe poses any systemic risk.
While the pending acquisition of First Horizon is uncertain, I don’t believe either outcome will be too difficult for TD Bank to overcome. The bank will undoubtedly see loan losses as credit conditions normalize and the economy begins to struggle further, but TD Bank is extremely well capitalized and loans appear to be much better underwritten today than they were during the Great Depression.
TD Bank currently trades at about 178% of its real book value, a low seen at the very beginning of the pandemic. Since 2003 the bank has averaged about 314% turnover, so I think many of the fears regarding the current environment are priced in.