PrefBlog

Assiduous Reader Louis writes in and says:

Thank you very much for the very interesting link to Bronte.

On a totally other note, I first thought that the following news concerning NA was a good sign:

“(Marketwire – Feb. 16, 2009) – National Bank of Canada
(TSX:NA) announced today its intention to redeem, for the purpose of
cancellation, all of its 5.70% debentures due April 16, 2014, on Thursday,
April 16, 2009, for 100% of the principal amount of the debentures.
The regular interest due in respect of the debentures on April 16, 2009 will
be paid in the normal course, leaving no accrued and unpaid interest on the
debentures at the time of their redemption.”

But could not then refrain being (again) cynical about it linking this news with the only 15 days earlier news of the closing of NA’s last fixed reset issuance:

“Jan 30, 2009: The Series 26 Preferred Shares will yield 6.60% annually, payable quarterly, for the initial period ending February 15, 2014…Therafter, the dividend rate will reset every five years at a level of 479 basis points over the then 5-year Government of Canada bond yield.”

I fear you are gonna think that I am just not bright enough to understand but, here I am again:

I understand that the above “moves” by the NA may make “capitalisation” sense and that people will say that I am mixing apples with oranges. However, money is money whether you call capital or a debenture and it “moneywise” does not make sense to me issuing prefs paying a non-tax deductible 6.6% dividend while using an equivalent amount of money (for the sake of the discussion here) to buy back debentures now which only cost a tax deductible 5.7% interest which does not mature until 2014.

Bearing in mind that NA was more than meeting its regulatory capital requirements anyway beore its last issuance of resetables, wouldn’t it have been wiser not to issue the costly resetable at this particular time (when they are so expensive to issue due to the prevailing market conditions) and wait a bit longer before redeeming the debentures?

I suspect you are going to say that capital is key since it allows the bank to lend “10″ times that figure while borrowed money by way of the debenture doesn’t have that effect. However, does the NA have so much quality borrowers cuing up at their counters to borrow highly profitable (for the bank) loans? Not that I know.

I also take it that it looks good to redeem debentures at the first opportunity and I recall the DB having been highly criticised for not having done so but its shareholders now appear to accept that it is what had to be done. I submit that the market is weel beyond the “if it looks good, it must be good” stage? We are going through extremely difficult times such that I don’t understand why should our bankers even feel guilty of having to get closer to the minimum required tier 1 capital ratio if adding a cushion doesn’t impress anyone anyway (unless, obviously, more write-offs are to come). We are in a confidence crisis and the only way to fix this is, in my opinion, by stopping playing games.

One should increase his capital cushion when things go well, not in times of troubles when you most need it. Doing the opposite makes longer, costier and more painful the recovery. You cannot fixing the under-capitalisation now, it is when time will get better that I hope we will remember.

Buying back all these resetable in five years or letting them reset is going to come up quite expensive (I doubt very much the 5years Canadas will be anywhere near what it is now). Inflation will be back making high returns expectations even higher.

So, what is wrong with my thinking here?

I don’t think anything is wrong with your thinking here.

You know about the Deutsche Bank situation. It’s possible you’re not drawing a fine enough distinction between Tier 1 Capital (the prefs), which counts towards NA’s Tier 1 Capital Ratio, and between Tier 2 Capital (the sub-debt) which counts towards its Total Capital Ratio, but I’m basically fine with your reasoning.

One thing you did not take explicit account of was the penalty rate that sub-debt usually has, set at issuance to convince the market that they will be called five years before maturity … but according to page 132 of the Annual Report PDF:

Bearing interest at a rate of 5.70% until April 16, 2009, and thereafter at an annual rate equal (1) to the 90-day bankers’ acceptance rate plus 1%

Not much of a penalty in this environment!

All I can suggest to you is that it’s a game of chicken. It makes all kinds of financial sense to let the issue extend past the pretend-maturity (although five years prior to actual maturity, the Tier 2 effect starts amortizing on a straight line basis; after April 19 they would only be able to claim 80% of the face value as Tier 2), but … the market might freak out on them.

NBC unable to redeem debentures! the headlines scream, and all of a sudden their stock price is halved and nobody wants to buy their debt. Banking – as this crisis amply demonstrates – is all about confidence.

The market should not freak out. The market should accept that they will do whatever makes financial sense for them. But there are no guarantees that the market will behave in a rational manner and I can’t find it in my heart much to blame them for not wanting to find out.

Maybe TD or Royal could get away with it…

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