The $6 Billion Bet Against TD Bank

What is it about Canada that the rest of the world always seems to misunderstand?

We don’t all play hockey; our land isn’t covered in a blanket of ice and snow; our health care is not free; and we do not all communicate saying “oot”, “aboot”, and “eh”.

In April, Canada’s TD Bank became the world’s most heavily shorted bank stock. A short sale is a bet the share price will go down. Over $6 billion is betting against the stock. To put that into context, the bank’s market capitalization is $111 billion as of May 4, 2023.

The short position follows a month of banking turmoil south of the border.

Briefly, here’s what happened. Bonds prices go up and down just like stock prices. The ones that have a longer maturity date than those that mature in the next few months are more volatile as interest rates move up or down. There’s an inverse direction with bond prices and interest rates, so when rates go up, bond prices go down (much more so for bonds with a duration rate further out into the future). Regional banks in the United States hold a lot of long-term debt, which lost a fortune in value as rates went up. This brought down several banking institutions, starting with SVB (Silicon Valley Bank) in March.

It’s understandable why TD Bank was the target. It has a huge U.S. presence. Most Americans, including their 10 million U.S. customers, probably don’t know what the “T” stands for in the bank that has 1100 locations. Royal Bank and BMO also have a large U.S. presence too.

The Canadian banking system is very different from the U.S. We have just over thirty Schedule 1 banks here at home with the lion’s share of the market controlled by six players. This compares to almost five thousand commercially insured banks south of the border, only 10% of which are publicly traded. To compare Canada’s oligopoly to the U.S.’s branch-based system is apples of oranges.

Earlier this week, TD Bank walked away from its plan to acquire First Horizon, a U.S. regional bank based out of Memphis, TN. That was a good move. Regional banks will face more regulations and a troubled loan book because of the troubled commercial loans presently sitting on the Balance Sheet.

Beyond U.S. banking concerns, the Canadian housing market has been a worry for well over a decade. Canadians are more heavily indebted than our peers to the south. When fixed rate borrowers renew their mortgage after 5 years, the repayment schedule may be too much for many to stomach. However, many will extend their amortization if that’s what is required.

This isn’t the first time that global investors have sought to bet against the Canadian banks. In 2015, all of the Canadian banks became a target for short sellers. With the dividends included, you could have bought any of the large Canadian banks in 2015 and made out like a bandit.

Right now, the market is pricing in with a 100% probability that the U.S. cuts their rates by the end of this year. Canada, which has already paused their hikes, usually follows suit. That will ease the pressure on Canadian mortgagees and squeeze the short sellers betting against TD Bank’s stock.

Just like in 2015, shorting TD Bank’s stock won’t be a profitable one over the long term.