Analysts Question Why TD Bank Lags Behind Canadian Peers

Bloomberg, Doug Alexander, 28 August 2016

Foreign investors betting against Canadian bank stocks continue to swell in numbers while stock prices in the sector grind higher. The result, for now, is considerable financial pain for the doomsayers.

Toronto-Dominion Bank’s own analyst is wondering why the lender is becoming a laggard in Canadian banking, underscoring concerns that prompted two stock downgrades.

"We’re all collectively scratching our heads on why this premium domestic retail bank isn’t keeping up with its peers," TD analyst Mario Mendonca asked Teri Currie, the head of Canadian personal banking, on a conference call Thursday after the company reported quarterly results.

Profit from Canadian banking rose 1.4 per cent in the third quarter, less than half the pace of the country’s largest lender, Royal Bank of Canada, and a quarter that of Canadian Imperial Bank of Commerce.

TD Bank posted a 4-per-cent increase in quarterly profit from a year earlier as gains from its U.S. bank and capital-markets business offset declining domestic retail operations.

Ms. Currie told Mr. Mendonca, who rates the shares a buy, that lower interest rates, competitive pricing and the cost of funds for mortgages were to blame, along with repricing on fee-based products.

Other analysts are highlighting TD Bank’s problems at home.

CIBC Capital Markets’ Robert Sedran downgraded the stock of the Toronto-based company to the equivalent of hold from buy on Thursday.

“As much as we’re heartened by the stronger U.S. performance, we expect and need better from the Canadian business relative to its peers,” Mr. Sedran said in a note to clients.

Canaccord Genuity Group Inc.’s Gabriel Dechaine also cut the stock to hold, saying the Canadian personal and commercial-banking business “is falling short of peer results and the bank’s own targets.”

TD Bank has a medium-term objective of 7-per-cent growth for its Canadian banking division, a goal Ms. Currie reiterated Thursday.

The division is the bank’s largest and generates about half the company’s profit.

Weak margins – with low rates, competition and lower mortgage-backed securities funding – along with a higher tax rate and provisions “are likely to drive below-average domestic banking earnings next quarter,” Mr. Mendonca wrote Friday in a note.

On Friday, TD Bank shares closed down 0.2 per cent to $57.29, on pace for a second day of declines.

TD Bank has nine buy recommendations, eight holds and one sell, according to data compiled by Bloomberg.

Analysts including Bank of Nova Scotia’s Sumit Malhotra and Barclays PLC’s John Aiken have suggested the bank may be easing up on Canadian growth on purpose, given concerns about sluggish economic growth and overheated housing prices.

“They’re putting the brakes on domestic growth,” said Mr. Aiken, who rates TD Bank stock a sell, in an interview.

“They’re consciously growing slower than peers because they’re worried about what’s going on with the economy.”

Canaccord’s Mr. Dechaine also noted the discrepancy, despite his downgrade.

“To be fair, it seems odd to criticize TD for its low growth in Canadian retail banking at a time when market concerns over consumer indebtedness and late-cycle credit growth in certain segments (e.g. housing in overheated markets) are elevated,” Mr. Dechaine said in his note.

“However, we also believe it is fair to compare TD’s actual performance to targets it communicated to the Street.”

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Why Are Hedge Funds Shorting Canadian Bank Stocks So Confident?

The Globe and Mail, Scott Barlow, 26 August 2016

Foreign investors betting against Canadian bank stocks continue to swell in numbers while stock prices in the sector grind higher. The result, for now, is considerable financial pain for the doomsayers.

The short positions on Canadian banks have almost uniformly resulted in losses and this had me all ready to write a “foreigners don’t understand the Canadian banking system” column. But I’m worried I’m missing something now.

The early year concern for domestic bank stocks focused on energy industry exposure. The banks repeatedly stated, however, that potential losses were minimal as a percentage of total business operations and wouldn’t affect earnings too much. With help from a partial recovery in the oil price, this has proven correct.

If oil losses were the main reason for the short positions, we’d expect the number of bearish bets on bank stocks to have decreased as the oil price recovered. This has not been the case.

Profits for Canadian banks have also been more reliant on capital markets activity – trading and investment banking operations – and in industry terms this is what’s called a “lumpy” source of profits. Capital markets profits are inconsistent on even a quarter-over-quarter basis and can double or dry up with little notice. Perhaps part of the short thesis is that this profits generator will fade, but on its own such a scenario doesn’t seem a big enough reason to short a bank.

One U.S. hedge fund manager I contacted who holds a short position on Canadian banks believes that transaction activity is about to decline significantly. They believe that corporate and household clients will repay loans early, thanks to low rates, and growth in new loans will be extremely slow. In this scenario, profits from the banks’ basic business of lending will fall.

We’ve covered the energy sector, capital markets and credit demand, which leaves the domestic housing markets. National Bank economist Warren Lovely wrote in a report released on Tuesday that real estate markets have been 'surprisingly sturdy' in recent years, but that 'cracks in the foundation are nonetheless visible,' notably in regions dependent on oil revenue. Vancouver housing sales, viewed as unstoppable until very recently, have cooled considerably as the Vancouver Sun reported that sales in the metro area have 'frozen solid.'

It has been fashionable for domestic pundits, including me, to write that foreign managers’ short positions on Canadian banks were a negligent mistake because they did not understand the Canadian Mortgage and Housing Corp.’s role in protecting major banks from losses on mortgage defaults.

But too much time has passed for that to be the case, at least in general. The U.S. hedge fund companies that hold the bulk of the short positions have analysts looking deeply into every trade and I refuse to believe they don’t understand the CMHC’s role at this point. In the majority of cases, they make too much money to be that dense.

I’ve written at least three bullish columns on Canadian banks in recent months and still lean that way. But it’s a bad idea for any investor to get so locked into a market view that they consider anyone betting the other way as stupid or uninformed. I won’t be as comfortably bullish on domestic bank stocks until I have a clearer idea what the hedge funds are thinking.

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