Archive for May, 2008

May 30, 2008

Friday, May 30th, 2008

Naked Capitalism republishes a review of potential problems in the CDS market.

Changes were rumoured the LIBOR setting mechanism:

The group that sets the London interbank offered rate can restore its credibility by following the example of Australia and New Zealand, said Morgan Stanley. Or, the British Bankers’ Association could look to the U.S., according to UBS AG and Credit Suisse Group.

The loss of confidence in the benchmark rate for $350 trillion in derivatives and corporate bonds and 6 million U.S. mortgages spurred the world’s biggest banks to recommend fixes, though they reached no consensus. The BBA plans to announce after 5 p.m. today the first changes to Libor in 10 years after the Basel-based Bank for International Settlements suggested in March that some lenders were misstating borrowing costs to avoid speculation that they were in financial straits.

I imagine that being a world-scale benchmark is very useful for the participants; but the rumours were unfounded:

The group that oversees the London interbank offered rate will implement no changes to the way the measure is set, confounding critics who said it has become unreliable as a gauge of the cost of borrowing.

“The committee will be strengthening the oversight of BBA Libor,” the British Bankers’ Association said in an e-mailed statement today. “The details will be published in due course.” The composition of the bank panels that contribute rates were left unchanged, it said.

Berger and Nitsch have an interesting piece on VoxEU regarding the optimal size of Central Bank Governing Councils … there are concerns that too much democracy is enough!

A few weeks ago, the European Commission recommended that Slovakia should be allowed to join the eurozone as of January 1, 2009. When the member states follow this recommendation and accept Slovakia’s adoption of the euro, the country will become the sixteenth member of the European single currency zone. At the same time, the Governor of the National Bank of Slovakia, Ivan Sramko, will take a seat at the Governing Council of the European Central Bank (ECB), thereby increasing the membership size of the eurozone’s interest-setting body to 22 members.

Moreover, with the expected future enlargement of the eurozone, the Governing Council will expand further, perhaps soon comprising 30 or more members.

It sounds very political and reminiscent of Canadian federal cabinets … perhaps five actual decision-makers and twenty-five-odd regional makeweights. By all means, let the ECB have a regionally representative governing council – but devolve the actual decision making to a sub-committee. For instance, like the Fed:

The Federal Open Market Committee (FOMC) consists of twelve members–the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee’s assessment of the economy and policy options.

Willem Buiter posts an interesting essay (verging on polemic) regarding Lessons from the North Atlantic Financial Crisis:

I conclude that although the Fed did a reasonable job dealing with the immediate financial crisis, it did significantly worse than the other two central banks as regards macroeconomic stability and the prevention or mitigation of future financial crises.

I identify two main causes for this underperformance by the Fed. As regards macroeconomic stability, there are flaws in its model of the transmission mechanism of monetary policy and other macroeconomic shocks. Two prominent errors are the overestimation of the effect of changes in house prices on consumer demand and the unfortunate focus on the will-o’-the-wisp of core inflation rather than on medium-term headline inflation. The Fed also either ignores the need for a major increase in the US saving-investment balance or believes that this can be achieved without passing through an extended spell of below-capacity growth of demand.

Second, the Fed, unlike the Bank of England and the ECB, has regulatory and supervisory responsbility for part of the US banking system. This has the advantage of giving it institution-specific information of a kind not available to the Bank of England or the ECB. The disadvantage is that the Fed’s position invites regulatory capture.

The macroeconomic stability records of the Bank of England and of the ECB have been superior to those of the Fed. After climbing a quite steep liquidity learning curve in the early months of the crisis, the Bank of England is now performing its lender of last resort and market maker of last resort roles more effectively. It would be desirable to have the information in the public domain that is required to determine whether the ECB (through the Eurosystem) is pricing illiquid collateral appropriately. There is reason for concern that the ECB may be accepting collateral in repos and at its discount window at inflated valuations, thus joining the Fed in boosting future moral hazard through the present encouragement of adverse selection.

Future regulation will have to be base on size and leverage of institutions. It will have to be universal (applying to all leveraged institutions above a certain size), uniform, countercyclical and global.

Financial crises will always be with us.

The full version of the paper is published by NBER; it is an update of a previous paper that has been reviewed on PrefBlog. The current paper has also been given its own post.

Hard on the heels of Accrued Interest‘s speculations on the future of leveraged fixed income (linked on PrefBlog yesterday) comes news that Deutsche Bank is creating REMICs:

Deutsche Bank AG’s asset management business may join other firms in repackaging their home-loan bonds into new securities without creating collateralized debt obligations, which are being shunned by investors.

The unit of the Frankfurt-based bank has studied using the technique on bonds in the portfolios it oversees, Julian Evans, a director who helps manage insurer money at Deutsche Asset Management, said in an interview yesterday. Bankers including Goldman Sachs Group Inc. and JPMorgan Chase & Co. have created more than $5 billion of new home-loan securities called Re-REMICs out of existing ones this year, newsletter Inside MBS & ABS says.

The difference between a REMIC and a CDO is that a CDO can be actively managed, while a REMIC is brain-dead.

While finding that last link, by the way, I found Calculated Risk‘s Compleat Ubernerd page … links to some of the more … er … technical posts on that excellent blog.

The market was up slightly to end the month with the CPD Exchange Traded Fund up 0.28% on the day to make it up 1.42% on the month. It looks like Malachite Fund will be up somewhat less … only a few basis points behind, but rather annoying after spending most of the month up 25-50bp against CPD. But that’s what happens when the former price is based on trades in a thin market, while the other is based on bids!

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.30% 3.86% 50,008 0.08 1 +0.0394% 1,114.1
Fixed-Floater 4.84% 4.65% 64,087 16.08 7 -0.2431% 1,033.4
Floater 4.05% 4.10% 61,882 17.15 2 -0.5463% 932.6
Op. Retract 4.83% 2.21% 89,177 2.71 15 -0.0076% 1,056.2
Split-Share 5.27% 5.45% 68,974 4.14 13 -0.1040% 1,057.8
Interest Bearing 6.12% 6.12% 51,814 3.81 3 +0.0337% 1,112.5
Perpetual-Premium 5.89% 4.57% 127,867 4.66 9 +0.0444% 1,025.6
Perpetual-Discount 5.66% 5.71% 287,992 14.32 63 +0.0975% 926.5
Major Price Changes
Issue Index Change Notes
BAM.PR.K Floater -1.5996%  
BCE.PR.G FixFloat -1.2987%  
W.PR.H PerpetualDiscount -1.0666% Now with a pre-tax bid-YTW of 5.98% based on a bid of 23.19 and a limitMaturity.
SLF.PR.E PerpetualDiscount +1.0370% Now with a pre-tax bid-YTW of 5.50% based on a bid of 20.46 and a limitMaturity.
TD.PR.O PerpetualDiscount +1.0989% Now with a pre-tax bid-YTW of 5.45% based on a bid of 22.50 and a limitMaturity.
RY.PR.F PerpetualDiscount +1.1483% Now with a pre-tax bid-YTW of 5.53% based on a bid of 20.26 and a limitMaturity.
BCE.PR.A FixFloat +1.3214%  
SLF.PR.D PerpetualDiscount +1.7043% Now with a pre-tax bid-YTW of 5.49% based on a bid of 20.29 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
BNS.PR.M PerpetualDiscount 32,285 Now with a pre-tax bid-YTW of 5.46% based on a bid of 20.87 and a limitMaturity.
CM.PR.H PerpetualDiscount 25,930 Now with a pre-tax bid-YTW of 5.88% based on a bid of 20.68 and a limitMaturity.
BNS.PR.O PerpetualDiscount 25,800 Now with a pre-tax bid-YTW of 5.66% based on a bid of 25.02 and a limitMaturity.
RY.PR.B PerpetualDiscount 22,870 Now with a pre-tax bid-YTW of 5.59% based on a bid of 21.19 and a limitMaturity.
RY.PR.H PerpetualDiscount 21,265 Now with a pre-tax bid-YTW of 5.72% based on a bid of 24.98 and a limitMaturity.

There were seventeen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

IQW.PR.C June Conversion Ratio Announced

Friday, May 30th, 2008

Quebecor World has announced:

that it has determined the final conversion rate applicable to the 517,184 Series 5 Cumulative Redeemable First Preferred Shares (TSX: IQW.PR.C) (the “Series 5 Preferred Shares”) that will be converted into Subordinate Voting Shares effective as of June 1, 2008. Taking into account all accrued and unpaid dividends on the Series 5 Preferred Shares up to and including June 1, 2008, Quebecor World has determined that, in accordance with the provisions governing the Series 5 Preferred Shares, each Series 5 Preferred Share will be converted on June 1, 2008 into 13.146875 Subordinate Voting Shares. Registered holders of Series 5 Preferred Shares who submitted notices of conversion on or prior to March 27, 2008 will receive in the coming days from Quebecor World’s transfer agent and registrar, Computershare Investor Services Inc., certificates representing their Subordinate Voting Shares resulting from the conversion. Approximately 6.8 million new Subordinate Voting Shares will thus be issued by Quebecor World to holders of Series 5 Preferred Shares on June 1, 2008.

There are currently 3,024,337 IQW.PR.C outstanding, according to the TSX – thus, just over a sixth of the shares are being converted. The notice of conversion was reported on PrefBlog. The preferred shares are in default.

IQW currently has a negative net worth and is in creditor protection.

Willem Buiter's Revised Prescription

Friday, May 30th, 2008

Willem Buiter has authored a paper Lessons from the North Atlantic Financial Crisis, which updates his previously reviewed ‘Lessons…’.

He states:

Very rapid growth of the broad monetary and credit aggregates could (and should) have been a warning sign that a financial bubble might be brewing. It was not considered worrying, probably because on the other side of these transactions were not primarily non-financial corporations and households but rather other, non-deposit-taking financial institutions. Leverage increased steadily in the financial sector (especially outside the commercial banks) and in the household sector. This was interpreted as financial deepening and further productivity and efficiency-enhancing financial sector development, rather than as a financial sector/household sector Ponzi game in which the expectations of future capital gains drove current capital values and made true earnings a side show.

One cause of the current crisis was securitization:

  • The greater opportunities for risk trading created by securitisation not only make it possible to hedge risk better (that is, to cover open positions); they also permit investors to seek out and take on additional risk, to further ‘unhedge’ risk and to create open positions not achievable before. … we can only be sure that the risk will end up with those most willing to bear it. There can be no guarantee that risk will end up being borne by those most able to bear it.
  • The ‘originate to distribute’ model destroys information compared to the ‘originate to hold’ model.
  • Securitisation also puts information in the wrong place. Whatever information is collected by the loan originator about the collateral value of the underlying assets and the credit worthiness of the ultimate borrower, remains with the originator …
  • Finally, there appears to be genuine irrationality afoot in the markets during periods of euphoria. Even non-diversifiable risk that is traded away is treated as though it no longer exists.

and proposes the following solutions:

  • Simpler structures … Central banks could accept as collateral in repos or at the discount window only reasonably transparent classes of ABS.
  • Unpicking’ securitisation (doing original credit analysis of the underlying) … This ‘solution’ is the ultimate admission of defeat in the securitisation process.
  • Retention of equity tranche by originator. … It could be made a regulatory requirement for the originator of
    residential mortgages, car loans etc. to retain the equity tranche of the securitised loans.
    Alternatively, the ownership of the equity tranche could be required to be made public
    information, permitting the market to draw its own conclusions.
  • External ratings. … This ‘solution’ to the information problem, however, brought with it a whole slew of new problems.

And that slew of new problems is then analyzed and discussed – it is virtually identical to the prior paper, which was discussed at length there, so I’ll skip over that.

The next section deals with the procyclical effects of leverage and bank regulation:

This pattern of procyclical leverage is reinforced through the Basel capital adequacy requirements. Banks have to hold a certain minimal fraction of their risk-weighted assets as capital. Credit ratings are procyclical. Consequently, a given amount of capital can support a larger stock of assets when the economy is booming then when it is slumping. This further reinforces the procyclical behaviour of leverage.

While I will agree that credit ratings are procyclical – the upgrade/downgrade ratio varies with the health of the economy, rather than being constant through a cycle, which is the ideal – I don’t think this element of his argument is particularly well documented; the effect, while there, is (in normal times) fairly small. It is certainly true, though, that credit ratings of non-AAA sub-prime RMBS have precipituously declined in a manner well-correlated to their prices and the housing market!

However, Dr. Buiter does not propose a solution for this problem, only further study and a re-opening of the Basel II accord.

He further attacks excessive disintermediation in the financial system and is in favour of most off-balance sheet vehicles being brought back on the balance sheet of their financial sponsors, claiming that their role is of regulatory arbitrage and tax-avoidance, rather than a more legitimate business purpose.

Bonuses paid to employees also come under attack, particularly when these are based on short-term performance and unrealized capital gains. It is interesting to consider this problem in light of his recommendation that issuers retain the equity tranche of securitizations … realizing the capital gain on a highly profitable undertaking could become a matter of decades! It is disappointing that there is no evidence presented in support of the idea that bonus sizes were a direct contributing factor to the crunch.

The remainder of the paper deals with macro-economic analysis which, while interesting, will not be reviewed here.

May 29, 2008

Thursday, May 29th, 2008

Accrued Interest opines on the future of CDOs.

Naked Capitalism collects some opinions on credit conditions.

Bloomberg reports on LIBOR reporting problems.

Bloomberg reports on how OIS is overtaking LIBOR as a measure.

Lou Crandall comments (a long time ago) on how LIBOR overtook US T-Bills as a measure.

Jeffrey Frankel defends his thesis that low real interest rates cause commodities to rise.

Standard & Poor’s points out that sub-prime borrowers bought cheap houses, which have less volatile prices than expensive ones … the mortgage carry quickly becomes comparable to renting, no matter how far underwater you are.

Standard & Poor’s Ratings Services’ current ratings on the 2006 subprime U.S. residential mortgage-backed securities (RMBS) vintage reflect, in part, an assumed loss severity of 45%. That assumption includes our estimate that, based on our views on the current housing market environment, foreclosure costs and market value declines account for losses of 26.3% and 18.7%, respectively, in the loan balances of these mortgages. We project a 19% aggregate loss for subprime mortgages backing U.S. RMBS sold in 2006 based on assumptions for foreclosure and loss severity. The 19% assumption is the product of projected foreclosures of approximately 42% and the assumed loss severity of 45%.

Standard & Poor’s current house price decline assumption is 33.4%, which is a 72% increase over the maximum price decline of 19.4% observed to date (see table 1). We believe this assumption appropriately protects against forecasted price declines through the housing downturn.

Dates have been set for the redemption of FAL.PR.A & FAL.PR.H; the post has been updated.

Plans – well, rumours of plans, anyway – are moving forward for a CDS Clearinghouse. I have updated my most recent post on the issue.

For those fascinated with all aspects of the David Berry affair, I’ve had a look at the career of Cecilia Williams, Scotia’s compliance officer, and have updated the most recent relevant post.

In case you missed the announcements amidst the Bank Capitalization posts, note that RY.PR.K has been called for redemption and TD has a new Fixed Reset, 5+160 … and the argument about the structure’s merits rages on. It takes two to make a market!

Good volume on the day, with some nice sized blocks going through for some Operating Retractibles. Prices were down … surely, people can’t be selling straights to buy fixed-resets?

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.33% 4.34% 50,628 16.3 1 -0.0786% 1,113.7
Fixed-Floater 4.83% 4.64% 64,513 16.07 7 +0.4845% 1,035.9
Floater 4.03% 4.07% 62,575 17.20 2 +1.3074% 937.7
Op. Retract 4.83% 2.50% 89,958 2.71 15 -0.0374% 1,056.3
Split-Share 5.27% 5.40% 69,117 4.15 13 -0.0021% 1,058.9
Interest Bearing 6.13% 6.12% 52,229 3.81 3 -0.0997% 1,112.2
Perpetual-Premium 5.89% 5.12% 128,420 3.49 9 +0.1534% 1,025.1
Perpetual-Discount 5.67% 5.71% 291,078 14.31 63 -0.2370% 925.6
Major Price Changes
Issue Index Change Notes
SLF.PR.E PerpetualDiscount -1.4119% Now with a pre-tax bid-YTW of 5.56% based on a bid of 20.25 and a limitMaturity.
GWO.PR.H PerpetualDiscount -1.3158% Now with a pre-tax bid-YTW of 5.38% based on a bid of 22.50 and a limitMaturity.
RY.PR.G PerpetualDiscount -1.2309% Now with a pre-tax bid-YTW of 5.65% based on a bid of 20.06 and a limitMaturity.
SLF.PR.E PerpetualDiscount -1.0120% Now with a pre-tax bid-YTW of 5.48% based on a bid of 20.54 and a limitMaturity.
TD.PR.O PerpetualDiscount +1.0989% Now with a pre-tax bid-YTW of 5.45% based on a bid of 22.50 and a limitMaturity.
HSB.PR.C PerpetualDiscount +1.1156% Now with a pre-tax bid-YTW of 5.72% based on a bid of 22.66 and a limitMaturity.
CL.PR.B PerpetualPremium +1.4805% Now with a pre-tax bid-YTW of 1.97% based on a bid of 25.70 and a call 2008-6-28 at 25.75.
BAM.PR.K Floater +3.0985%  
Volume Highlights
Issue Index Volume Notes
GWO.PR.I PerpetualDiscount 265,200 Nesbitt crossed 40,000 at 21.00, then another 213,800 at the same price. Now with a pre-tax bid-YTW of 5.38% based on a bid of 20.92 and a limitMaturity.
TD.PR.N OpRet 150,000 Desjardins crossed two lots of 75,000 each, both at 26.10. Now with a pre-tax bid-YTW of 3.89% based on a bid of 26.01 and a softMaturity 2014-1-30 at 25.00.
CM.PR.A OpRet 106,494 TD crossed 44,300 at 26.10, then Desjardins crossed 50,000 at the same price. Now with a pre-tax bid-YTW of -3.94% based on a bid of 26.06 and a call 2008-6-28 at 25.75.
CM.PR.R OpRet 104,510 Nesbitt crossed 100,000 at 26.20. Now with a pre-tax bid-YTW of -6.44% based on a bid of 26.10 and a call 2008-6-28 at 25.75.
TD.PR.R PerpetualDiscount (for now!) 61,904 Scotia crossed 25,000 at 25.14. Now with a pre-tax bid-YTW of 5.69% based on a bid of 25.10 and a limitMaturity.

There were thirty-one other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Bank Capitalization Summary : 2Q08

Thursday, May 29th, 2008

The Big-Six banks have now all released their 2Q08 financials. The results may now be summarized, with the links pointing to the PrefBlog posts reporting on the quarterly reports:

Big-6 Capitalization Summary
2Q08
  Note RY BNS BMO TD CM NA
Equity Capital A 17,527 16,113 13,499 15,069 9,078 3,534
Preferreds Outstanding B 2,555 2,210 1,696 1,675 2,931 573
Issuance Capacity C 1,321 1,936 1,644 3,039 954 270
Equity / Risk Weighted Assets D 7.03% 7.36% 7.24% 8.43% 7.91% 6.81%
Tier 1 Ratio E 9.5% 9.6% 9.4% 9.1% 10.5% 9.2%
A is a measure of the size of the bank
B is … um … how many are outstanding
C is how many more (million CAD) they could issue if they so chose
D is a measure of the safety of the preferreds – the first loss buffer, expressed as a percentage of their Risk-Weighted Assets. Higher is better. It may be increased by issuing common (or making some money and keeping it); preferred issuance will not change it.
E is the number that OSFI and fixed-income investors will be watching. Higher is better, and it may be increased by issuing preferreds.

NA Capitalization : 2Q08

Thursday, May 29th, 2008

NA has released its Second Quarter 2008 Report and Supplementary Package, so it’s time to recalculate how much room they have to issue new preferred shares – assuming they want to!

Step One is to analyze their Tier 1 Capital, reproducing the prior format:

NA Capital Structure
October, 2007
& April, 2008
  4Q07 2Q08
Total Tier 1 Capital 4,442 5,089
Common Shareholders’ Equity 95.0% 87.3%
Preferred Shares 9.0% 11.3%
Innovative Tier 1 Capital Instruments 11.4% 15.0%
Non-Controlling Interests in Subsidiaries 0.4% 0.3%
Goodwill -15.8% -13.9%

Next, the issuance capacity (from Part 3 of the introductory series):

NA
Tier 1 Issuance Capacity
October 2007
& April 2008
  4Q07 2Q08
Equity Capital (A) 3,534 3,753
Non-Equity Tier 1 Limit (B=A/3), 4Q07
(B=0.428*A), 2Q08
1,178 1,606
Innovative Tier 1 Capital (C) 508 763
Preferred Limit (D=B-C) 670 843
Preferred Actual (E) 400 573
New Issuance Capacity (F=D-E) 270 270
Items A, C & E are taken from the table
“Risk Adjusted Capital Ratiosl”
of the supplementary information;
Note that Item A includes everything except preferred shares and innovative capital instruments


Item B is as per OSFI Guidelines; the limit was recently increased.
Items D & F are my calculations

and the all important Risk-Weighted Asset Ratios!

NA
Risk-Weighted Asset Ratios
October 2007
& April 2008
  Note 2007 2Q08
Equity Capital A 3,534 3,753
Risk-Weighted Assets B 49,336 55,143
Equity/RWA C=A/B 7.16% 6.81%
Tier 1 Ratio D 9.0% 9.2%
Capital Ratio E 12.4% 13.3%
Assets to Capital Multiple F 18.6x 16.7x
A is taken from the table “Issuance Capacity”, above
B, D & E are taken from RY’s Supplementary Report
C is my calculation
F is taken from the OSFI site for 4Q07. The 2Q08 figure is approximated by subtracting goodwill of 707 from total assets of 123,608 to obtain adjusted assets of 122,901 and dividing by 7,353 total capital.

National Bank does not disclose its Assets-to-Capital Multiple. Their Report to Shareholders simply states:

In addition to regulatory capital ratios, banks are expected to meet an assets-to-capital multiple test. The assets-to-capital multiple is calculated by dividing a bank’s total assets, including specified off-balance sheet items, by its total capital. Under this test, total assets should not be greater than 23 times the total capital. The Bank met the assets-to-capital multiple test in the second quarter of 2008.

RY Capitalization : 2Q08

Thursday, May 29th, 2008

RY has released its Second Quarter 2008 Report and Supplementary Package, so it’s time to recalculate how much room they have to issue new preferred shares – assuming they want to!

Step One is to analyze their Tier 1 Capital, reproducing the prior format:

RY Capital Structure
October, 2007
& April, 2008
  4Q07 2Q08
Total Tier 1 Capital 23,383 23,708
Common Shareholders’ Equity 95.2% 99.8%
Preferred Shares 10.0% 10.8%
Innovative Tier 1 Capital Instruments 14.9% 15.3%
Non-Controlling Interests in Subsidiaries 0.1% 0.1%
Goodwill -20.3% -26.0%

Next, the issuance capacity (from Part 3 of the introductory series):

RY
Tier 1 Issuance Capacity
October 2007
& April 2008
  4Q07 2Q08
Equity Capital (A) 17,545 17,527
Non-Equity Tier 1 Limit (B=A/3), 4Q07
(B=0.428*A), 2Q08
5,848 7,502
Innovative Tier 1 Capital (C) 3,494 3,626
Preferred Limit (D=B-C) 2,354 3,876
Preferred Actual (E) 2,344 2,555
New Issuance Capacity (F=D-E) 10 1,321
Items A, C & E are taken from the table
“Regulatory Capital”
of the supplementary information;
Note that Item A includes everything except preferred shares and innovative capital instruments


Item B is as per OSFI Guidelines; the limit was recently increased.
Items D & F are my calculations

and the all important Risk-Weighted Asset Ratios!

RY
Risk-Weighted Asset Ratios
October 2007
& April 2008
  Note 2007 2Q08
Equity Capital A 17,545 17,527
Risk-Weighted Assets B 247,635 249,242
Equity/RWA C=A/B 7.09% 7.03%
Tier 1 Ratio D 9.4% 9.5%
Capital Ratio E 11.5% 11.5%
Assets to Capital Multiple F 19.8x 20.1x
A is taken from the table “Issuance Capacity”, above
B, D, E & F are taken from RY’s Supplementary Report
C is my calculation.

I am pleased to see that RY has commenced disclosing their Assets-to-Capital multiple – the undisclosed-but-high figure for 1Q08 made me very curious! They note that “Effective Q2/08, the OSFI amended the treatment of the general allowance in the calculation of Basel II Asset-to-capital multiple. Comparative ratios have not been revised.”

This amendment is available in an Advisory dated April 2008 … which I will now have to puzzle over.

RY.PR.K to be Redeemed

Thursday, May 29th, 2008

Royal Bank has announced:

that on August 22, 2008, it will redeem all of its issued and outstanding Non-Cumulative First Preferred Shares Series N (the “Series N shares”) for cash at a redemption price of $25.00 per share.

There are 12,000,000 shares of Series N outstanding, representing $300 million of capital. The redemption of the Series N shares will be financed out of the general corporate funds of Royal Bank of Canada.

Separately from the redemption price, the final quarterly dividend of $0.29375 per share for the Series N shares will be paid in the usual manner on August 22, 2008 to shareholders of record on July 24, 2008.

RY.PR.K has been a member of the HIMIPref™ Operating Retractible Index continuously since it was issued 1998-4-27. It’s habit of trading with a low or negative Yield-to-Worst has been an annoyance for quite some time!

CM Capitalization : 2Q08

Thursday, May 29th, 2008

CIBC (Stock symbol CM … I can never quite decide how to present it!) has released its Second Quarter 2008 Report and Supplementary Package, so it’s time to recalculate how much room they have to issue new preferred shares – assuming they want to!

Step One is to analyze their Tier 1 Capital, reproducing the prior format:

CM Capital Structure
October, 2007
& April, 2008
  4Q07 2Q08
Total Tier 1 Capital 12,379 12,009
Common Shareholders’ Equity 90.1% 90.3%
Preferred Shares 23.7% 24.4%
Innovative Tier 1 Capital Instruments 0% 0%
Non-Controlling Interests in Subsidiaries 1.1% 1.2%
Goodwill -14.9% -16.0%

Next, the issuance capacity (from Part 3 of the introductory series):

CM
Tier 1 Issuance Capacity
October 2007
& April 2008
  4Q07 2Q08
Equity Capital (A) 9,448 9,078
Non-Equity Tier 1 Limit (B=A/3), 4Q07
(B=0.428*A), 2Q08
3,149 3,885
Innovative Tier 1 Capital (C) 0 0
Preferred Limit (D=B-C) 3,149 3,885
Preferred Actual (E) 2,931 2,931
New Issuance Capacity (F=D-E) 218 954
Items A, C & E are taken from the table
“Regulatory Capital”
of the supplementary information;
Note that Item A includes Goodwill, FX losses, non-controlling interest, Gains on sale of securitizations and 50/50 deductions


Item B is as per OSFI Guidelines; the limit was recently increased.
Items D & F are my calculations

and the all important Risk-Weighted Asset Ratios!

CM
Risk-Weighted Asset Ratios
October 2007
& April 2008
  Note 2007 2Q08
Equity Capital A 9,448 9,078
Risk-Weighted Assets B 127,424 114,767
Equity/RWA C=A/B 7.41% 7.91%
Tier 1 Ratio D 9.7% 10.5%
Capital Ratio E 13.9% 14.4%
Assets to Capital Multiple F 19.0x 19.3x
A is taken from the table “Issuance Capacity”, above
B, D & E are taken from CM’s Supplementary Report
C is my calculation.
F is from Page 26 of the quarterly report

Fixed-Resets : Critchley Likes, Ruggins Doesn't

Thursday, May 29th, 2008

Barry Critchley of the Financial Post has written another column, reiterating his earlier praise of the structure. In the current column, BNS Offers Investors Better Deal he states:

But in five years, investors know that the yield on the new fixed-rate pref will be set at the same spread over Canada bonds as was the original pref share. (Every five years, investors have the ability to move in and out of fixed or floating pref shares.)

In this way, the issuer won’t benefit from any improvement in credit spreads over the five-year period.

This is not correct. If credit spreads improve significantly, the issue will be called. One of the Big Black Marks against this structure is the 5-year call at par; the standard provisions for a normal fixed rate issues are a 5-year-call at a premium, declining to a 9-year call at par. Those extra four years are very important.

Of more interest are the reported comments of Len Ruggins … but I might just be saying that because I agree with him!

In response to an earlier column that focused on Scotia’s original deal, Ruggins called and gave his thoughts. In short, he didn’t like the earlier deal because the issuer is paying a yield that is lower than what it would have paid had it chosen to issue a perpetual pref share.

“The bank has issued a Tier 1 security that will most likely be redeemed in five years’ time [because] a regular bank perpetual [issued today] would require a dividend in excess of 5%.

“If market interest rates and dividend yields return to a more normal level in 2013 it is unlikely that the banks will reset the rate on these prefs. I would have bought this issue, if the bank had said that it would not be callable for, say, 20 years, thereby paying a very good dividend which is reset every five years. I’ll bet that during the last year of this issue, the pref will trade on the assumption that it is going to be called regardless of where the Canada bond is trading,” said Ruggins.

Hat tip to Assiduous Reader tobyone who brought the column to my attention.

Newly Assiduous Reader meander likes the structure, as he explains in his comment on the new issue TD+160. As for myself, I will stick to my previously published analysis: these issues, at these rates, are trading as pretend-five-year money. If they actually WERE five year money, I’d be scooping them up by the hatfull. If there was a 20-year no-call period and I could actually be assured of receiving these headline spreads for a lengthy period … back up the truck!

But since the credit risk is actually perpetual and my absolute best case scenario is that it’s five year money … I’ll wait until I’m actually paid to take on that credit risk.

Or, to put it another way … look at Table #1 in my previously published analysis: would you have bought this structure in February ’07 if the fixed rate had been 4.0% with a +60bp reset? If so, how would you feel?

Fixed-Resets – according to me – share the sales and investment philosophy of Principal Protected Notes:

  • Yes, in bad times there is a degree of risk mitigation
  • At all other times, you pay through the nose for it