Uncovering the Mystery: Why is Toronto-Dominion (TD), Canada’s Second Largest Bank, the Most Shorted Bank in the World?

Last month, the US banking sector experienced a significant blow when Silicon Valley Bank (SVB), Signature Bank, and Silvergate collapsed due to bank runs, fueling concerns about a banking sector meltdown.

Then came the collapse of Switzerland's second-largest bank, Credit Suisse, which sent shockwaves through financial markets and damaged the country's reputation. However, UBS, Switzerland's largest bank, later purchased Credit Suisse for $3.2 billion in a government-backed, cut-price deal.

Unfortunately, the global banking and financial system may not have seen the worst yet. Canada's second-largest bank has now entered the spotlight amidst the ongoing financial crisis, adding to the growing list of banking failures.

Toronto-Dominion Bank, commonly known as TD Bank, has been targeted by short sellers who have increased their bets against the bank to $3.7 billion. This has resulted in TD being the most bearish bank among all financial institutions in the world, according to S3 Partners.

The share price of TD (TSE: TD) is down over 15% from its 2023 high in mid-Feb and almost 9.5% year-to-date (YTD). From its all-time high (ATH) in Feb. 2022, TD share prices are down more than 25%. And as of writing, TD shares are trading at CAD 79.41, a level last seen in early 2021.

First, let's see what TD Bank is.

Toronto-Dominion (TD)

Toronto-Dominion Bank is a leading Canadian multinational bank that provides a wide range of financial products and services to over 27 million customers worldwide. The bank was formed in 1955 through the merger of The Bank of Toronto and The Dominion Bank, and its headquarters is located in Toronto, Canada.

TD Bank operates in three main business segments: Canadian Retail Banking, US Retail Banking, Wholesale Banking, and corporate.

The bank is known for its customer-centric approach and innovative financial products and services. It has won numerous awards for its customer service, including being named the JD Power award winner for customer satisfaction in Canadian Retail Banking for the 15th consecutive year in 2020.

Committed to social responsibility and environmental sustainability, the bank has set ambitious environmental goals, including sourcing 100% renewable electricity by 2030.

Click here to learn about the 5 worst bank collapses in the US.

Short-Sellers are Onto TD Bank

Today, TD is the most-shorted banking stock globally. Short sellers have bet around $3.7 billion against Toronto-Dominion Bank (TD), making it the most shorted financial institution globally, even ahead of BNP Paribas and Bank of America.

Data show that hedge funds have also taken short positions against TD, with the value of these positions reaching $4.2 billion on Wednesday.

Short-selling is a trading strategy in which an investor bets against a stock or other security by borrowing shares and selling them with the expectation that the price will fall. And if the price does fall, the investor can buy back the shares at a lower price, return them to the lender, and pocket the difference as profit.

Traders and investors often use this strategy to profit from a decline in a stock's price or hedge against potential losses. It is also used by institutional investors to express negative views on a company's prospects or to take advantage of market inefficiencies.

In some cases, short-selling can be a self-fulfilling prophecy, as increased short interest can put downward pressure on a stock's price and create a negative feedback loop. This can be particularly problematic for companies that are targeted by short-sellers for reasons that are not necessarily related to their fundamental performance.

Why are Traders Short-Selling TD?

Investors have shorted TD primarily because of the bank's planned takeover of US regional bank First Horizon, its exposure to Canada's weakening housing market, and its ties to troubled US lender Charles Schwab.

TD's exposure to Canada's housing slowdown is a concern because the lender operates in an environment where variable-rate mortgages are popular, and consumer insolvencies are growing.

The Canadian government reported that the total number of insolvencies rose by 13.5% in January, which could pose problems for TD if it has a significant number of consumer loans on the line. This has led investors to project the fears around Canadian housing onto TD.

Additionally, TD's minority stake in Charles Schwab, which recently experienced a stock plunge after it revealed $28 billion in unrealized losses on its bond holdings as of Dec. 31, may have prompted short-sellers interest. TD's material 10% stake in Charles Schwab is down 40% year-to-date (YTD).

A big reason for investor concerns is the bank's exposure to US regional lenders, which is higher than other Canadian banks. While TD's acquisition of First Horizon would make it the sixth-largest commercial bank in the US, it could also be seen as a risky bet due to the ongoing crisis in the US regional banking sector.

This has prompted some small shareholders to call for TD Bank to abandon or renegotiate its $13.4 billion acquisition of First Horizon Corp.

What's up With the First Horizon Deal?

TD's buyout of First Horizon (NYSE: FHN) was first announced in February 2022. However, the closing date for this deal was pushed back to May 27, three months later than the originally projected deadline. TD Bank has not provided a new expected closing date for the deal.

Then late last month, TD Bank's CEO Bharat Masrani said that the bank is “fully committed” to the takeover of First Horizon Corp, a regional bank based in Memphis, Tennessee.

However, investors are turning cautious about the Canadian bank's US acquisition strategy due to First Horizon's shares trading almost 30% below TD's offer price of $25 each.

Although shareholders are not required to vote on the deal, TD is still obligated to proceed with the transaction. In the event that regulators do not approve the deal, TD would be liable to pay a fee of $25 million to First Horizon. However, if TD were to back out of the deal, First Horizon would have the option to sue for damages, and legal experts estimate that the cost of such damages could easily be hundreds of millions of dollars.

Some shareholders who support TD going ahead with the deal say it should not pay the original price proposed, while others believe TD should renegotiate the deal at a lower price.

First Horizon share prices are in the green today but still down 28% YTD. Between late February and the first half of March, it dropped almost 40%. The bank's shares are trading at $17.63 as of writing this, a level last seen in late 2021. First Horizon's share prices peak was last seen at the end of 2003 at around $45.

The shares of US regional lenders have been under intense pressure. The KBW Regional Banking Index has dropped 20% in just two weeks to its lowest level since December 2020.

The deal has been looking shaky for some time now, with First Horizon disclosing last month that regulators are unlikely to approve the deal by the end of May with US regulators busy with more pressing banking issues. Toronto-Dominion has been in discussions with First Horizon about extending the closing deadline.

Moreover, Canadian Imperial Bank of Commerce analyst Paul Holden states that First Horizon “is seeing deposit pressure and at a worse rate than the industry average.” The bank saw average deposits decline 5% in the fourth quarter to about US$65 billion.

However, compared to SVB, First Horizon is more diversified and less susceptible to uninsured deposits, reducing its vulnerability to a bank run. It is also part of the Mid-Size Bank Coalition of America, which has requested that US regulators extend FDIC insurance to all deposits for two years to promote stability in the banking sector and minimize the risk of additional bank failures.

A Mixed State of Affairs

Before TD Bank became the most shorted bank, Brand Finance PLC counted the Toronto-Dominion Bank as the country's top brand, surpassing Royal Bank of Canada (TSX: RY) in its annual report on the most valuable and strongest Canadian brands.

This came as TD Bank experienced a boost in its retail banking operations in Canada and the US in the last quarter, thanks to rising interest rates, which made lending to consumers more profitable.

The bank's US business saw its net interest margin expand to 3.29% in the quarter that ended Jan. 31, while its Canadian retail operation also got a similar boost, leading to overall profit topping analysts' estimates. Total net interest income rose to C$7.73 billion ($5.68 billion), a 23% YoY increase.

However, the bank's decision to set aside more capital (C$690 million) than analysts expected (C$597.4 million) to absorb loan losses held back its profit.

Amidst all this, TD Bank agreed to pay over $1.2 billion to settle a lawsuit by investors claiming that the bank aided a $7 billion Ponzi scheme over a decade ago.

And now, the bank is being aggressively shorted. The First Horizon acquisition is actually a part of TD Bank's US expansion strategy. In contrast to this deal, TD recently announced the successful completion of its $1.3 billion acquisition of Cowen Inc, a New York-based investment bank. Despite Cowen reporting a significant drop in Q4 net income, the deal was finalized in March.

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