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Hedge funds shorting Canada "dead wrong:" TD CFO

Tags: TD Bank

Amid concerns that Canada's housing market is headed for a soft landing and the more than decade-long surge in commodity prices is over, a number of investors have come out with calls to 'short Canada,' particularly the largest banks.

But Colleen Johnston, the chief financial officer at TD Bank  – Canada's second largest by market capitalization – tells BNN why that call is off the mark.

"I think the hedge funds are dead wrong," she says. "The strength in the Canadian housing market has been sustained – yes we're seeing slower growth, that's what we've said that all along, that we will see rates of growth slow down."

Johnson says the credit quality of mortgages in Canada is "excellent" and that TD (TD-T) currently posts loan losses of just $20 million on the $220 billion in lending it currently has in Canada.

"It's very good and every metric on that [real estate lending] business is excellent," she says. "And a largest part of the business is insured – most of it by the Canadian government."

On Thursday, TD reported a 2-percent increase in second-quarter earnings, but admitted that it is facing a "slow growth environment" in Canada.

Income from TD's flagship Canadian retail operations – which still account for a majority of its profit although it currently has more branches in the U.S. – rose 5 percent to $847 million. While in the U.S., the bank's retail network generated $392 million US in net income for the quarter – a 9-percent increase compared to the same time last year.

Overall, the bank earned $1.72 billion, or 1.78 a share, in the second quarter, compared to $1.69 billion, or $1.78 a share, a year earlier.

More importantly, TD's quarterly earnings provided investors with a first look at how the country's banks are faring with a slowdown in the housing market, which unlike many other developed economies, saw surging sales, soaring prices and booming construction in the wake of the financial crisis.

One fallback from a booming housing market has been an increase in debt, with the average debt-to-income ratio of Canadian households currently sitting at a record 165 percent.

Canada's housing market has shown signs of weakness in recent months.

The number of new housing starts in Canada slipped to an annualized rate of 174,858 units in April from the 181,146 figure in March, according to the Canada Mortgage and Housing Corporation (CMHC). The number of new housing starts peaked in the second quarter of 2012, hitting an annualized pace of 228,942, and have now fallen to 175,191 in the first quarter of this year – marking a decline of more than 23 percent.

That combination of high home prices and indebted consumers – and the potential for a further decline in housing activity -- has attracted the attention of U.S.-based short sellers in recent months.

Short-seller Vijai Mohan, the founder and portfolio manager at the San Francisco-based Hyphen Fund Management, recently laid bare his wager against Canada, admitting that nearly his entire portfolio is set up to profit on a downturn in both the housing market and a pullback in commodity prices.

Mohan also said that the mortgage default insurance bought by many banks – and mentioned by Johnson in her interview with BNN – may not hold once regulators take a close look at underwriting practices. Mohan called this a "put-back," something that became common in the U.S. in the wake of the housing boom after many financial institutions were alleged to have pursued unethical or fraudulent lending practices.

Meanwhile Ben Rabidoux, Hanson Advisor analyst says the Canadian housing market – as it currently stands – is simply not sustainable. And when the housing market slows down it will have serious implications for the overall economy, he recently told BNN.

"If you look at how levered our economy and our labour market is to this current housing boom, my position has been that it will be very difficult for policymakers to unwind this boom without significant collateral damage," he said. "If we look at housing-related industries as a percentage of GDP, we're well above where the U.S. peaked."

But Johnson remains unfazed by such speculation.

"I think the Canadian banks continue to be the envy of the world in terms of the strength of our capital and the strength of our balance sheet," she says.

Johnson also highlighted the bank's strong capital position. TD said in its quarterly earnings that TD's Tier 1 ratio – a core metric used to measure the health of a bank and how well it can absorb losses -- was 8.8 percent, well above the minimum of 7 percent required by the Basel Committee on Banking Supervision.

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