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The Office of the Superintendent of Financial Institutions has released a Draft Advisory envisaging a new type of Tier 1 Capital that may be considered to be slightly senior to preferred shares.

Key provisions under this advisory are:

• innovative instruments issued to the public can now include securities which mature in 99 years. These, however, will be subject to straight-line amortization for regulatory capital purposes beginning 10 years prior to maturity.
• An innovative instrument is now permitted to be “share cumulative” where deferred cash coupons on the inter-company instrument issued by the FRE to the SPV become payable in directly issued perpetual preferred shares of the FRE, subject to the following requirements:
  • Coupons on the innovative instrument can be deferred at any time, at the FRE management’s complete discretion, with no limit on the duration of the deferral, apart
    from the maturity of the instrument.

  • The preferred shares issued by the FRE to the SPV under the inter-company instrument may only be distributed by the SPV to the holders of the innovative instrument to pay for deferred coupons once the cash payments on the inter-company instrument are resumed.
  • The number of preferred shares to be distributed by the FRE to the SPV to effect payment of deferred coupons must be calculated by dividing the deferred cash coupon amount by the face amount of the preferred shares.
  • The credit spread imbedded in the dividend rate of the preferred shares must be determined based on market rates prevailing at the outset – i.e. upon original issuance of the innovative instrument.

Tier 1 Capital with a cumulative coupon? That’s innovative indeed!

The following eMail has been sent to OSFI:

I read the captioned notice with great interest.

i) Are any background papers available which would shed some light on the somewhat startling intention to allow cumulative payments on these new instruments?

ii) Innovative Tier 1 Capital has historically been marketted to the public as having an effective maturity equal to the step-up date. This creates a certain amount of reputational risk for the issuing bank which could lead to riskier decisions being made regarding refinancing at step-up; or, at the very least, to a presumed penalty rate being paid on capital following the step-up date at a time when it may be assumed the bank is experiencing difficulties. Why does the draft advisory not prohibit step-ups for these instruments? Why is there no allowance for partial amortization for regulatory capital purposes prior to any step-up?

iii) Will comment letters and OSFI discussion be published?

This entry was posted on Monday, June 9th, 2008 at 12:23 pm and is filed under Regulatory Capital. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.