Turns out, the biggest short in the banking industry anywhere in the world isn’t in Switzerland or Silicon Valley, but rather, in the relatively tame financial centre of Canada.

In recent weeks, short sellers have upped their bearish bets against Toronto-Dominion Bank, and now have roughly US$3.7 billion on the line vis-à-vis Canada’s second-largest lender, according to an analysis by S3 Partners. That’s the most among financial institutions globally and puts TD ahead of the likes of France’s BNP Paribas SA and Bank of America Corp.

Part of it has to do with the general skittishness toward the banking sector after three U.S. regional banks failed and Credit Suisse was forced into a shotgun wedding with UBS Group AG. And there are few signs Canadian lenders have any of the liquidity issues that investors have zeroed-in on recently. But analysts also point to worries about TD’s exposure to the country’s housing slowdown, as well as its ties to the U.S. market through its stake in Charles Schwab Corp. and a planned regional bank acquisition.

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“Short sellers have been actively shorting into a declining banking sector,” said Ihor Dusaniwsky, S3’s managing director of predictive analytics

TD didn’t immediately respond to requests for comment from Bloomberg. 

Granted, short interest as a percentage of TD’s shares available for trading, or float, remains relatively low at 3.3 per cent and up from 2.8 per cent a year ago. By that measure, TD is third among the top 20 U.S. and Canadian financial firms.

TD’s position atop the list of biggest bank shorts comes as it seeks to close a $13.4 billion deal for First Horizon Corp., which would expand its foothold in the U.S.. TD is widely expected to renegotiate the deal after the recent bout of turmoil among US regional banks drove share prices lower in March.

As a result, traders are “playing with short interest for TD more than normally” because the bank has become a merger arbitration play, according to Daneshvar Rohinton, a portfolio manager at Industrial Alliance.

HOUSING BUBBLE

Rohinton says some short sellers also have zeroed-in on TD because of its roughly 10 per cent stake in Charles Schwab — which recently lost $47 billion in market value as it came under scrutiny over its unrealized bond losses — as well as TD’s position in Canada’s housing market, where variable-rate mortgages are common and consumer insolvencies are on the rise.

“TD sits uniquely in the middle of two broad headwinds,” Rohinton said. “The fears around Canadian housing will be projected onto TD.”

So far, the TD short has been a winner. In March, shares of TD tumbled 11 per cent, which was the biggest decline in the S&P/TSX Banks Index. The decline wiped out C$18.1 billion from the bank’s market value. Nevertheless, S3’s Dusaniwsky cautions that short-seller profits can evaporate just as fast, particularly when they are the result of a broad-based rally.

“Outsized short-selling like we saw in the banking sector are usually knee-jerk reactions to market turmoil and can reverse as quickly as they occur,” he said.

With assistance from Alexandra Semenova.