As a result of changes to the qualifying criteria for capital under the guidelines published by the Basel Committee on Banking Supervision (BCBS) on December 16, 2010 and January 13, 2011 and subsequent OSFI guidance regarding the treatment of non-qualifying capital instruments published on February 4, 2011, certain capital instruments may no longer qualify as capital beginning January 1, 2013. RBC’s non-common capital instruments will be considered non-qualifying capital instruments under Basel III and will therefore be subject to a 10 per cent phase-out per year beginning in 2013. These non-common capital instruments include preferred shares, trust capital securities and subordinated debentures.
The regulatory event redemption clause applies to RBC’s innovative tier 1 capital instruments (RBC trust capital securities). Based on current analysis, RBC does not intend to invoke the clause to effect early redemption of these instruments.
RBC maintains the right to redeem capital instruments based on other existing terms and conditions not linked to regulatory event clauses. RBC also retains the right to invoke any applicable regulatory event redemption clause in accordance with its terms should circumstances change.
Based on the rules as set out in OSFI’s February 4th Advisory regarding the Treatment of Non-Qualifying Capital Instruments, CIBC currently expects to exercise a regulatory event redemption only in 2022 and only in respect of the Series B Innovative Tier 1 Notes issued by CIBC Capital Trust.
Future circumstances within or outside CIBC’s control, including generally applicable legal changes that have the effect of causing non-qualifying regulatory capital to become compliant, may cause CIBC to change its expectation regarding the exercise of regulatory event redemptions and require CIBC to disclose an updated regulatory event redemption schedule.
As stated in the advisory, OSFI intends to adopt the Basel III changes in its domestic capital guidance. Under the Basel III rules text, any non-qualifying capital instruments outstanding as of 2022, the final year of the phase-out period, will not be recognized as regulatory capital. Based on the rules set out in OSFI’s advisory, TD currently expects to exercise a regulatory event redemption right only in 2022 in respect of the TD Capital Trust IVTM Notes – Series 2 outstanding at that time.
TD’s expectations are based on a number of factors and assumptions, including, but not limited to TD’s current and expected future capital position taking into account the expected redemptions of TD’s capital instruments, the assumption that other redemption rights, as applicable, are not exercised or other capital management actions are not taken, and current market conditions. These expectations are not intended to apply to capital instruments issued by TD’s U.S. subsidiaries. Given the uncertainty related to the financial, economic, legislative and regulatory environments, these factors – some of which are beyond TD’s control and the effects of which can be difficult to predict – could change materially over time and result in a change in the expectations expressed in this press release.
While the Bank has no present intention of invoking any regulatory event redemption features in its outstanding capital instruments, the Bank reserves the right to redeem, call or repurchase any capital instruments within the terms of each offering, in accordance with OSFI’s advisory.
BMO Financial Group today confirmed that it does not anticipate redeeming any of its outstanding regulatory capital instruments through the use of a regulatory capital event and that the Bank will not be disclosing a regulatory redemption event schedule. Regulatory capital instruments include the Bank’s outstanding preferred shares and subordinated debt, innovative tier 1 capital instruments issued by BMO Capital Trust and BMO Capital Trust II, and innovative tier 2 capital issued by BMO Subordinated Note Trust.
National Bank has not issued a press release at time of writing.
So those purchasing Innovative Tier 1 Capital securities at issue time, with the legitimate expectation that extant IT1C issues would be grandfathered in the event of rule changes (as was done with retractible preferred shares), and were willing to pay up for a long “no call” period … have had their expectations dashed.
And those who took the view that instruments would not be grandfathered, and took investment action on the basis of a legitimated expectation that the regulatory event clause would be applied in a manner consistent with the economic best interests of the issuer … have had their expectations dashed.
Those issuers with the foresight (and luck!) to issue Straight Preferred shares at the top of the market in the first quarter of 2007 and have been congratulating themselves ever since that they have financed with cheap money … have had their legitimate expectations dashed.
The OSFI advisory on extant issues was discussed in OSFI Does Not Grandfather Extant Tier 1 Capital. The probable new rules for Tier 1 are discussed at OSFI Releases Contingent Capital Draft Advisory. Rumours of potential bond index manipulation are discussed at OSFI Seeking to Manipulate Bond Indices and Retail Investors?.
So, if I understand this correctly, deposit-taking institutions (DTI = banks) will be redeeming pref shares at par no later than 2022 (or cooking up some method other than redemption before then).
I’m sure I’m not the only one with questions, but here are some of mine:
1. This only applies to banks (DTI). Any reason why insurers (SLF, MFC, IAG, ELF) would need to do this? Yet? I notice their deep discount prefs gained nicely today (as did that other well known DTI called Weston Group).
2. Must they redeem at par at the first opportunity, or can they wait until they “need to” based on eliminating 10% of non-common per year? Would they have the flexibility to redeem higher dividend perpetuals before lower dividend perpetuals?
3. Is it not feasible to amend the perpetual pref terms to make it convert to common a la OSFI requirements (without redemption)? After all, most pref shares are worthless when the common is worthless so converting into common at near-insolvency does not seem a big deal. Are you aware of any restructuring where prefs got something in bankruptcy that common did not? If the bank offered a somewhat higher dividend to compensate, could they not convert non-conforming perpetuals into conforming ones, saving themselves redemption and re-issue costs?
4. Assuming par redemption sometime in the next 11 years, then all bank prefs become more like fixed maturity prefs. Isn’t a definite maturity date a property that should result in lower than perpetual yields due to less risk? This could be 50-75 bp (or 150 bp if Fixed Resets are the benchmark). In that case, depending on par redemption data, should not premium perpetuals AND discount perpetuals both move up in price to reflect the lower yield expectation? Today we mostly saw deeper discount prefs rallying.
5. It sounds like the bank press releases issued today deal only with bond investors worried about regulatory event calls. They want to stay in the market, so are “doing the right thing” by investors — calling as late as possible rather than now (which is in their economic best interest). Do you think that economic self interest will govern pref share redemptions — roll over fixed resets (lower cost) and redeem perpetuals IF their yields remain higher?
6. Is the bank perpetual pref dead? Lifeco? Other firms?
This is quite the earthquake for investors hoping to retire on the strength of a pref share portfolio. Do short term gains mask long term adverse changes?
There is opportunity and risk in turmoil — we’re counting on your insight to lead us through!
Holy smokes, prefhound, when you post you don’t fool around.
A lot of these questions are rather detailed and we still have to see OSFI’s position on the insurers, particularly with respect to regulation at the consolidated level. I’m sure you will appreciate that, much as I enjoy writing this blog and seek to help out casual retail investors, most of the hard-core stuff is reserved for paying customers.
But here goes!
1: OSFI is attempting to harmonize regulation for banks and insurers as much as is possible. For instance, rules regarding what counts as Capital have been virtually identical. Hence, many players are reasoning that essentially the same Advisory will be made for insurers in the near future … but this is not guaranteed, particularly since the Big 3 Insurers issue prefs at the holdco level, not the opco.
2: The banks can redeem in whatever order they like. OSFI is only regulating the total amount of capital benefit they can get from their non-qualifying holdings. Conceivably, they might not redeem at all, if market yields became so much higher than the coupon that it was worthwihile to keep the stuff on the books.
3: They could, but would need shareholder approval to change the terms. It’s very difficult to imagine what would be better for holders of a 4.5% coupon pref than redemption at par, and would also make business sense for the bank.
4: Your views are in accord with mine.
5: I suspect economic self interest will govern the timing of pref redemptions. but OSFI has made it clear that redemptions requiring the regulatory event clause (only applicable to some of the IT1C) must come last.
6: I think straights will always be the Little Black Dress of the preferred share market. FixedResets are fashionable now, but I am hesitant to speculate how much longer that will be the case.
On 6. The new rules will not prevent or favor any particular type of prefs?
On 6. The new rules will not prevent or favor any particular type of prefs?
No. The new rules merely require that any pref issue included in Tier 1 Capital have a clause allowing OSFI to convert it to common at a defined rate prior to government injection of cash. Everything else is still wide open.
It’s very difficult to imagine what would be better for holders of a 4.5% coupon pref than redemption at par, and would also make business sense for the bank.
A rather cynical acquaintance has told me that preferred share votes are controlled by preferred shareholders, preferred shareholders are retail and controlled by their brokers, their brokers are controlled by their firms and their firms are controlled by the banks (who may be controlled by the Illuminati, but he didn’t go that far).
His view is that at some point a bank will issue a straight with the NVCC clause, sell the hell out of it ensure that the price is good, use that as a benchmark and hold shareholder vote to add the NVCC clause to extant issues, offering extant holders maybe a nickel a share per year more, and offering their brokers a dime per vote.
Such cynical acquaintances I have! It makes me blush!
Ahh, see — the future is still quite uncertain. A nickel extra for a dime vote will work if the market price is “low” at the time, but could be somewhat more expensive if the market price anticipates something else.
Of course, with 11 years to go and the banks in control of the timing, anything could happen.
I still love those par prefs.
AND, as a paying customer, I am looking forward to my PrefLetter — I just wanted to tee up a few questions in advance 😉
Cynicism is very healthy.
Would it not be more profitable for the banks to get their brokers to buy up the extant stocks now while they are below par. Then redeem the stocks from their brokers at $25 or higher. Any profits the brokers make will flow though into the Group’s P&L so money is shifting from one pocket to the other pocket.
At the moment, I believe the majority of the banks have excess Tier 1 capital so they would not have to issue new prefs today. As BNS has shown they can issue new prefs at well below the 4.5% coupon rate of the extants!
If rates are expected to go up from here the time period for the banks to redeem the extants may be much shorter then the 11 years you foresee.
The banks will be fighting both a rising rate environment and a reduction in Tier 1 equity value at 10% per annum straight line.
As Prefhound stated
AND, as a paying customer, I am looking forward to my PrefLetter — I just wanted to tee up a few questions in advance