John Greenwood | Financial Post Jan 7, 2013
Toronto-Dominion Bank has just come off one of its most profitable years ever. Its shares have nearly regained the ground they lost in the financial crisis and the country’s second-biggest bank is riding high on the Canadian consumer’s apparently insatiable appetite for debt. But how much longer can it go on? TD chief executive Ed Clark recently sat down with Financial Post reporter John Greenwood to talk about the shaky state of household finances, the frothy housing market and what it all means for the banking sector. Here is an edited version of the interview.
Q What do you think is the biggest challenge facing TD in the medium term?
A No question for all banks, for insurance companies, for pension funds, it is the prospect of low interest rates for an extended period of time. I think people have this idea that, “Well, gosh, low interest rates must be good for banks.” [The truth is that] low interest rates are terrible for banks. I’ll put it in simple terms: The charges that we [have] for a bank account do not pay the costs of giving people a bank account. So as interest rates come down, the spread you earn on those [deposits] dramatically changes and that means that you have to figure out a way to deliver that chequing account for less money.
Q Canada’s housing boom has so far been good for the banks. It’s helped drive near record profits and enabled lenders to recover from the financial crisis. But now some critics worry that it could turn into a bust if the economy weakens. What do you think?
A I think the banks have been divided on this issue. We are not going to have a housing meltdown like they had in the United States. We haven’t been doing subprime lending like the United States, so we don’t have a whole population that bought houses in which it’s obvious that they will never pay back the mortgage. But I guess the way I look at it is, you can only leverage society up so far. It’s not very different from an ordinary person: “I’m sure I can borrow more money than I borrowed today, but could I keep on borrowing more money than I borrowed every year? Eventually I reach a point where I can’t keep borrowing more and in fact I have to start paying it back.”
Well, societies are exactly the same, and when you look around the world [you see that] every country that allowed this leveraging to go on too long had a really bad ending, a disastrous ending. And so the way we run the bank is to say, “If we see a trend where you know it’s going to end in a bad story, you know, always leave the party first, don’t leave the party last.” And I think Canada was right to say, “Let’s leave this party early.”
Q Did we leave the party? Household debt in Canada just went up.
A Exactly. What I think we’ve done is to start. [We’ve tapped] the brakes, and I think it’s working. We haven’t really seen the effects, because some of the rule changes that [the banking regulator] put through didn’t start until Oct. 1…. It’s going to take a number of months, but I think the market has already slowed down.
Q Is the housing boom an unintended consequence of the measures taken by Bank of Canada after the financial crisis?
A Yes. They obviously thought it would stimulate housing but I think the fact that we got into this is an unintended consequence. [Bank of Canada Governor] Mark Carney gave a speech several years ago outlying this exact risk. The problem is that if you set key interest rates low, you have a tendency to have asset bubbles. So what do you do about that? [One option is to] try to use administrative means to lean against these bubbles and that’s what Canada’s trying, and I think that’s the right thing to do.
Q You said you don’t think Canada is headed for a U.S.-style housing bust, but there have been plenty of housing busts around the world, in fact many countries in Europe have had one.
A Yes, but I think [most were victims of] a combination of both low interest rates and poor lending policies. We had the advantage in Canada that the bulk of mortgage lending is done by regulated banks and those banks hold those mortgages on our balance sheet.
Q Yes, but about $600-billion of those mortgages are insured by CMHC, so banks like TD don’t have to pay the consequences if something goes wrong.
A There’s two categories of CMHC insurance, one is the social program where this is in a sense a government program and there is no question, that’s a higher risk program. The government is saying, we would like people to be able to borrow more than 80% loan to value, we think that’s a social good. When you do stress tests on that — which we’re able to do — it’s clear that in the case of a downturn, you’re going to suffer more losses [on those loans].
You then have a second portfolio, a big part of the $600-billion where the banks have gone to the CMHC and said, we would you like to insure our portfolio [of loans where the borrower has put down more than the minimum 20%]. CMHC makes money, huge money on that portfolio.
In one sense, the portfolio part subsidizes the social part, and it’s the part that people look at and say, jeez, the banks are getting a free lunch. No, they’re not. They’re paying for insurance that is highly, highly profitable for the government of Canada.
Q In the mid-2000s, before the financial crisis, a lot of banks, including yours, were predicting that we were not going to have the financial crisis and yet it happened. And now people are saying don’t worry, interest rates are going to stay low and we’re not going to have a U.S. style housing bust. Can you help me understand that?
A I agree with [the] view that it’s very hard to run an economy with very low interest rates and not have asset bubbles. So if you’re not going to have asset bubbles, you’re going to do exactly what the government then did. And that’s start to lean against it and tighten up the rules and say, we’re going to just keep touching that brake to try to offset the fact that we’re running on an unusually low interest rate environment. So I completely agree with that… I think that [the government] so far got it about right. And there are people in my own organization that say they’ve gone too far and they’re going to risk pushing this over into stopping it too quickly. I haven’t seen evidence of that yet, so I think they’ve done exactly the right thing. But a year from now we could be having this discussion again if it turns out that having slowed it down, it then starts to speed back up again.
Q Jim Flaherty, the finance minister, has talked about privatizing the CMHC. Do you think that’s a good idea?
A I don’t think it’s a good idea. I think the U.S. experience with that is a disaster. If you look at why the Canadian banks do as well [in the crisis] and why the Canadian economy did as well as it did, certainly the Americans would say, well you had CMHC which was 100% government owned. [They would say] we foolishly went with this idea that you could have an agency that played a public policy role but was also privately owned, and with disastrous consequences. I’m perfectly sympathetic with the government’s view. To me, if you’re going to have a public policy agency playing a public policy role, don’t confuse it with having private ownership because then you run the very real risk that the private investors are riding on the benefit of being a quasi government agency. That’s what happened in the United States.