News

FINANCIAL SERVICES REPORTER

Toronto-Dominion Bank's exposure to the troubled U.S. commercial real estate market is significantly higher than many of its investors believe, a new report suggests.

The sector's continuing deterioration is fuelling concerns about the banking industry and the recovery of the U.S. economy.

While this has been seen as a lesser problem for Canadian banks, TD's filings with U.S. regulators suggest it has about $19.5-billion (U.S.) in exposure, versus the roughly $12-billion that the bank disclosed in a recent presentation to shareholders, says Hamilton Capital, a new Toronto-based boutique asset manager specializing in financial services.

The difference appears to come from the way TD classifies the loans it makes on owner-occupied premises, such as a factory where the owner has a commercial mortgage against the building.

In its presentation to analysts, the bank appears to deem those loans to be business loans rather than commercial real estate, which is what they're classified as in the disclosure to U.S. regulators, the report suggests.

A spokesman for the bank said the U.S. filings are not an extension of TD's formal corporate disclosure record.

"Trying to bridge from them to the bank's official reporting is difficult and could lead to confusing and misleading interpretations of our exposures and results," he said.

The report does not make a recommendation that investors buy or sell shares of Toronto-Dominion Bank. Rather, it makes the case for why they should pay attention to the bank's U.S. commercial real estate exposure.

"This is not a one-quarter issue," said Rob Wessel, author of the report and managing partner at Hamilton Capital. "Commercial real estate credit deterioration is in the early stages of what could be a multi-year credit downturn, and TD has very significant exposure."

The report is the first from Hamilton Capital, which will be launching an investment fund early next year. Prior to starting this venture, Mr. Wessel was a managing director and former high-ranked bank analyst at National Bank Financial. The new asset manager's board includes former Bank of Nova Scotia vice-chairman Robert Brooks, former Sun Life chief financial officer Paul Derksen, and former co-head of Dundee Securities Corp. Lawrence Haber.

Commercial real estate is the second-biggest loan category in the U.S. banking system after residential mortgages, accounting for about $1.9-trillion of the total $7.6-trillion loans, the report notes. Total commercial real estate includes owner-occupied properties such as factories, income-producing properties such as office buildings, hotels and malls, apartment buildings and other multi-family properties, and construction.

Values of commercial real estate have fallen more than 40 per cent since their peak in October, 2007, and there's no sign of a recovery yet, the report says.

Given the severity of the recent economic downturn and crisis, it's quite possible that, at their peak, the banking sector's losses on commercial real estate in coming years could ultimately top the peak losses reached in 1992 during the savings and loan crisis, it adds.

Last week, the U.S. Federal Reserve's open market committee said the commercial real estate sector represents a downside risk to the central bank's economic forecasts, and a potential source of increased pressure on banks.

With many regional and small banks vulnerable to the deteriorating performance of commercial real estate loans, banks are continuing to tighten lending standards and bank loans have continued to contract, the Fed said in the committee's minutes. While home sales and construction have picked up in recent months, commercial real estate activity continued to fall markedly in most areas of the U.S. because of deteriorating fundamentals, including declining occupancy and rental rates, and very tight credit conditions.

The report on TD suggests much of the bank's exposure in this area stems from its acquisitions of TD Banknorth Inc. and New Jersey-based Commerce Bancorp Inc.

TD chief executive officer Ed Clark announced the latter $8.5-billion acquisition in the fall of 2007, as he embarked on a strategy to create the first truly North American bank. As a result of that deal, TD became the 14th-largest bank in the United States when ranked by deposits.

On the positive side, TD's exposure to construction loans - the riskiest segment of commercial real estate - is lower than many other U.S. banks, the report says.

But, it says, the quick pace of loan growth at Commerce prior to its takeover raises questions. In the four years prior to TD's acquisition of Commerce, the New Jersey-based bank's total loans increased 140 per cent, going from $7.5-billion in 2003 to $17.9-billion in 2007. Growth in its commercial real estate portfolio was also robust, going from $2.9-billion in 2003 to $6.6-billion in 2007, the report adds. "Such rapid loan growth is generally a red flag as it may suggest that the bank is loosening underwriting standards to build market share," the report said.