I have been fascinated with the IMF Global Financial Stability Report that was recently reviewed on PrefBlog … particularly Figure 1.17:
The IMF comments:
Some banks have rapidly expanded their balance sheets in recent years, largely by increasing their holdings of highly rated securities that carry low risk weightings for regulatory capital purposes (see Box 1.3 on page 31). Part of the increase in assets reflects banks’ trading and investment activities. Investments grew as a share of total assets, and wholesale markets, including securitizations used to finance such assets, grew as a share of total funding (Figure 1.16). Banks that adopted this strategy aggressively became more vulnerable to illiquidity in the wholesale money markets, earnings volatility from marked-to-market assets, and illiquidity in structured finance markets. Equity markets appear to be penalizing those banks that adopted this strategy most aggressively (Figure 1.17).
The variation in multiple for the banks listed is ENORMOUS. The new derisive nickname for UBS is Union Bank of Singapore … but what are the implications for Canadian banks?
First, let’s gather up the ratios for these banks:
Assets to Risk-Weighted-Assets Ratios for Canadian Banks | |||||
RBC | BNS | TD | BMO | CIBC | |
Risk-Weighted Assets | 241,206 | 234,900 | 163,230 | 179,487 | 128,267 |
Total Assets | 632,761 | 449,422 | 435,200 | 376,825 | 347,734 |
Assets:RWA | 2.6 | 1.9 | 2.7 | 2.1 | 2.7 |
All the numbers are within the range for most banks – as reported by the IMF – but there are some fascinating differences that I might write about at another time.
Clearly, however, these differences can be significant and there is a clear indication that UBS was “gaming the system” by loading up with AAA assets that had no risk weight but – regardless of their investment merit – had, shall we say, considerable mark-to-market risk.
OSFI attempts to control such gaming by the imposition of an Assets-to-Capital multiple:
Institutions are expected to meet an assets to capital multiple test on a continuous basis. The assets to capital multiple is calculated by dividing the institution’s total assets, including specified off-balance sheet items, by the sum of its adjusted net tier 1 capital and adjusted tier 2 capital as defined in section 2.5 of this guideline. All items that are deducted from capital are excluded from total assets. Tier 3 capital is excluded from the test.
Off-balance sheet items for this test are direct credit substitutes1, including letters of credit and guarantees, transaction-related contingencies, trade-related contingencies and sale and repurchase agreements, as described in chapter 3. These are included at their notional principal amount. In the case of derivative contracts, where institutions have legally binding netting agreements (meeting the criteria established in chapter 3, Netting of Forwards, Swaps, Purchased Options and Other Similar Derivatives) the resulting on-balance sheet amounts can be netted for the purpose of calculating the assets to capital multiple.
Under this test, total assets should be no greater than 20 times capital, although this multiple can be exceeded with the Superintendent’s prior approval to an amount no greater than 23 times. Alternatively, the Superintendent may prescribe a lower multiple. In setting the assets to capital multiple for individual institutions, the Superintendent will consider such factors as operating and management experience, strength of parent, earnings, diversification of assets, type of assets and appetite for risk.
BMO is to be commended for disclosing its Asset-to-Capital multiple of 18.39, but I don’t see this number disclosed for any of the others. So … it will have to be done roughly, using the total assets from the table above, over the total regulatory capital:
Assets to Risk-Weighted-Assets Ratios for Canadian Banks | |||||
RBC | BNS | TD | BMO | CIBC | |
Total Assets | 632,761 | 449,422 | 435,200 | 376,825 | 347,734 |
Total Regulatory Capital Tier 1 + Tier 2 |
27,113 | 23,874 | 23,117 | 20,203 | 18,713 |
Very Rough Assets-to-Capital Multiple (internal check) |
23.3 (23.3) |
18.8 (18.6) |
18.8 (19.0) |
18.7 (18.6) |
18.6 (18.5) |
Reported Total Capital Ratio |
11.2% | 10.2% | 14.2% | 11.3% | 14.6% |
The internal check on the Assets-to-Capital multiple is the Assets-to-RWA multiple divided by the Total Capital Ratio. Variance will be due to rounding. |
Well! This is interesting! According to these very, very rough calculations, RBC has an Assets-to-Capital multiple of 23.3:1, which is both over the limit and well above its competitors. This may be a transient thing … there was a jump in assets in the first quarter:
RBC: Change in Assets From 4Q07 to 1Q08 |
|
Item | Change ($-billion) |
Securities | +6 |
Repos | +12 |
Loans | +8 |
Derivatives | +7 |
Total | +33 |
I have sent the following message to RBC via their Investor Relations Page:
I would appreciate learning your Assets-to-Capital multiple (as defined by OSFI) as of the end of the first quarter, 2008, and any detail you can provide regarding its calculation.
I have derived a very rough estimate of 23.3:1, based on total assets of 632,761 and total regulatory capital of 27,113
Update, 2008-04-17: RBC has responded:
Thank you for your question about our assets to capital multiple (ACM). In keeping with prior quarter-end practice, we did not disclose our ACM in Q1/08 but were well within the OSFI minimum requirement. Our ACM is disclosed on a quarterly basis (with a 6-7 week lag) on OSFI’s website. We understand this should be available over the next few days. Below is an excerpt from the OSFI guidelines outlining the calculation of the ACM. We hope this helps.
Update, 2008-6-4: From the FDIC publication, Estimating the Capital Impact of Basel II in the United States:
Crosses
Wednesday, March 5th, 2008The following has been copied from the comments to March 4, 2008. The rule of thumb is: if one person asks, twenty want to know! The question was:
A dealer “crosses” a trade when he acts for both the buyer and the seller. In institutional trading, it is very common for large trades not to be posted publicly – showing too much size might scare away counterparties, and lead to other traders playing traders’ games.
There are other, better reasons: say, for instance that you are the investment manager for 100 clients holding varying numbers of shares. If you were to put it up publicly and only get a partial fill – say, 57,600 shares – you’ve got headaches splitting it up fairly and headaches having all those clients with tiny, virtually untradeable positions.
The best reason for doing this is if the order is contingent: maybe you want to sell PWF.PR.K to buy POW.PR.D and take out $0.45 on the switch. In that case, the dealer’s got two orders to fill. Maybe he can sell the PWF.PR.K, but can’t find any POW.PR.D for you (or he finds some, but he can’t put the deal together in such a way that you take out your $0.45). In that case, nothing will happen – and the next day, maybe you’ll call another dealer.
Whatever your reason, if you want to sell 100,000 shares of PWF.PR.K, you will not get your dealer to put this on the board for you. What you will do is ask him to find a buyer. He then checks his rolodex for people who have shown interest in PWF.PR.K in the past – or managers he’s talked to recently who have expressed a longing to purchase a high quality perpetual discount issue of any nature – and start dealing. Once he’s found a buyer who is willing to pay what you’re willing to sell for, he’s happy.
The exchange requires that this trade be recorded on their books. As long as the price is equal to or higher than the posted bid, and equal to or lower than the posted offer, then everything is OK and the trade gets filled as a cross.
A more specialized type of cross is when the dealer is acting for both the buyer and the seller – and so is the investment manager! This is an internal cross. The investment manager might have two funds: Acme Dividend Fund and Acme Preferred Share Fund. These two funds have differing cash flows, such that Dividend Fund needs to raise $2.5-million, and Preferred Fund needs to invest the same amount. In many cases – not all cases, but many cases – it makes sense according to the mandates of both funds that one sells to other. The investment manager gets the dealer to do it for him, the dealer ensures the price is fair, marks the trade as an “internal cross”, and Bob’s your uncle.
There are other specialized cross types as well.
Posted in Primers, Reader Initiated Comments | 1 Comment »