PrefBlog

BNS has released its 1Q09 Report to Shareholders 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:

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

It is noteworthy that the increases in Goodwill (about $550-million) and Other Capital Deductions (about $1,500-million) have been met largely through the issuance of Preferred Shares. Scotia’s note on Other Capital Deductions states:

Comprised of net after-tax gains on sale of securitized assets, and 50% of all investments in certain specified corporations, and other items.

TD was also affected by the rule change, which requires a 50/50 deduction from Tier 1 and Tier 2 instead of the old 0/100 split. Additionally, Scotia’s purchase of CI Investments closed and this will have affected Goodwill as well.

and the all important Risk-Weighted Asset Ratios!

Scotia reports a “Tangible Common Equity” Ratio of 7.8%; I suspect that this is the same as my “Equity / RWA” ratio without accounting for the Miscellaneous Deductions. As I stated when reviewing TD, I am comfortable with my figure; in times of stress the bank might find it difficult to remove or realize capital from non-consolidated subsidiaries.

The bank does not disclose its 1Q09 Assets-to-Capital multiple, stating only:

OSFI has also prescribed an asset-tocapital leverage multiple; the Bank was in compliance with this threshold as at January 31, 2009.

Scotia as $43,526-million exposure to derivatives on the balance sheet; but notes on page 30 of the supplementary report that the effect of Master Netting Agreements and Collateral is to reduce this to $16,757-million – an entirely manageable amount.

BMO has released its First Quarter 2009 Report and Supplementary Package. Their earnings were at least able to cover their dividend!

There has been a lot of punditry recently exhorting BMO to cut its common dividend. While this may make all kinds of business sense it’s a risky thing to do – there is an army of pseudo-quants out there applying stock screens with the purpose of investing only in companies with a steadily rising (or at least constant) dividend. The investment industry being what it is, these guys are also being pandered to by index preparers and the ETF industry with things like “Dividend Aristocrats” indices and such.

What this means is that if the common dividend were to be cut, then not only will there be an immediate rush to the exists in a classic “crowded trade”, but the common will be left off all these lists for the next ten years. There is a very powerful market disincentive to cut the common dividend.

Anyway it’s time to recalculate how much room they have to issue new preferred shares – assuming they want to, in this environment!

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

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

and the all important Risk-Weighted Asset Ratios!

BMO’s supplementary data discloses a “Tangible common equity-to-risk-weighted-assets” figure that sounds like it should be equal to my “Equity/RWA” in the table. Their figure is 7.77%; it is not immediately clear to me how this figure is calculated, but it’s pretty close!

Capital ratios improved

I note as well that there is no adjustment to capital for “Expected loss in excess of allowance”, indicating that their ALLL is again equal to the EL which is indicative of conservative approach to assessing credit write-offs.

In the 4Q08 review, I noted:

Update, 2008-11-28 The following query …

I note that there has been a significant gross-up in your balance sheet with respect to derivatives.

Do you have a table available showing the degree to which your derivative-based assets are collateralized or backed up by the credit strength of your counterparties? Or other information that would allow an assessment of the quality of these assets?

… has been met with the following response:

Thank you for your question.

Unfortunately we do not disclose information regarding the strength of our counterparties.

However, in Q4 the increase in derivatives is due mainly to the impact of the stronger U.S. Dollar. Page 29 of the Q4 supplemental package shows the exposure by risk weight and comparing quarter over quarter the actual risk weighting has not largely changed.

Our supplemental package is available at:

http://www2.bmo.com/ir/qtrinfo/1/2008-q4/Suppq408.pdfhttp://www2.bmo.com
/ir/qtrinfo/1/2008-q4/Suppq408.pdf.

Their earnings release discloses that they have now taken a charge of $214-million ($146-million after tax) on counterparty credit exposures on derivative contracts, largely as a result of corporate counterparties’ credit spreads widening relative to BMO.

But there’s still not enough disclosure on these agreements. BMO has assets of $82.0-billion in derivatives (more than half of this is in Interest Rate Swaps, by the way) compared to, for instance, $50.1-billion in residential mortgages, and better disclosure is needed.

CIBC has announced:

that CIBC Capital Trust (the “Trust”), a trust wholly-owned by CIBC, and CIBC had entered into an agreement with a group of underwriters led by CIBC World Markets Inc. for an issue of $1.3 billion of CIBC Tier 1 Notes – Series A due June 30, 2108 (the “Tier 1 – Series A Notes”) and $300 million of CIBC Tier 1 Notes – Series B due June 30, 2108 (the “Tier 1 – Series B Notes”) (collectively, the “Tier 1 Notes”). The Trust intends to file a final prospectus with Canadian securities regulators today. The Tier 1 Notes are expected to qualify as Tier 1 capital of CIBC for regulatory purposes.

CIBC reported a Tier 1 capital ratio at January 31, 2009 of 9.8%. Giving effect to the $325 million Series 35 preferred share issue that closed on February 4, 2009, the $200 million Series 37 preferred share issue scheduled to close on March 6, 2009, and the $1.6 billion Tier 1 Notes issue announced today, CIBC’s pro-forma Tier 1 capital ratio at January 31, 2009, would be approximately 11.5%.

From the date of issue to, but excluding June 30, 2019, interest on the Tier 1 – Series A Notes is payable semi-annually at a rate of 9.976% per annum. Starting on June 30, 2019, and on every fifth anniversary thereafter until June 30, 2104, interest on the Tier 1 – Series A Notes will reset as described in the prospectus.

From the date of issue to, but excluding June 30, 2039, interest on the Tier 1 – Series B Notes is payable semi-annually at a rate of 10.25% per annum. Starting on June 30, 2039, and on every fifth anniversary thereafter until June 30, 2104, interest on the Tier 1 – Series B Notes will reset as described in the prospectus.

On or after June 30, 2014, the Trust may, at its option and subject to certain conditions, redeem the Tier 1 – Series A Notes or the Tier 1 – Series B Notes, in each case, in whole or in part.

In certain circumstances, the Tier 1 Notes may be automatically exchanged for, or interest thereon may be paid by, the issuance of non-cumulative Class A Preferred Shares of CIBC.

The expected closing date is March 13, 2009. The net proceeds of this offering will be used for general purposes of CIBC.

The prospectus is not yet available on SEDAR.

Cumulative Tier 1 Capital with a maturity date … sigh … this is being issued under OSFI’s ill-advised rule relaxation of December 2008.

Assiduous Readers will remember that Innovative Tier 1 Capital pays interest and may be loosely regarded as RSP-Friendly Preferred Shares for investment classification purposes.

It is noteworthy that this is – as far as I know – CIBC’s first foray into this kind of financing. Certainly they had none outstanding at 1Q09.

Update, 2009-3-11: DBRS rates A(high), trend negative.

NA has released its First Quarter 2009 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:

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

and the all important Risk-Weighted Asset Ratios!

Prior Reports to Shareholders have included statements such as:

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 third quarter of 2008.

… but they can no longer be bothered to note that they can’t be bothered to disclose this critical figure.

Earnings in the quarter were affected by a charge due to ABCP:

National Bank reported net income of $69 million for the first quarter of fiscal 2009, compared to net income of $255 million in the first quarter of 2008. Diluted earnings per share stood at $0.36, as against diluted earnings per share of $1.58 for the corresponding quarter of 2008. The results for the quarter included charges attributable to the impact of asset backed commercial paper (ABCP). These charges comprise the after-tax cost of holding ABCP of $98 million, which consisted of a net loss on available for sale securities related to ABCP of $129 million, financing costs, professional fees and the cost of economic hedge transactions totalling $10 million and interest income on ABCP further to the restructuring of $41 million. In addition, an after-tax loss related to commitments to extend credit to clients holding ABCP of $86 million was recorded in the first quarter of 2009. In the first quarter of 2008, the Bank had recorded after-tax charges related
to holding ABCP of $14 million, as well as a gain of $32 million on the sale of its subsidiary in Nassau.

Readers will remember that National Bank had an ownership interest in ABCP packagers, and their branded Money Market Fund was a major investor in these assets.

RY has released its Fourth Quarter 2008 Earnings 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:

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

and the all important Risk-Weighted Asset Ratios!

Derivatives exposure, which was an issue last quarter as their long-term FX contracts grossed up the balance sheet, declined in notional terms but the risk-weighting increased to leave the risk-weighted exposure flat on the quarter. The notional decline was due to a reduction in short-term exposures; values for terms extending beyond one year were flat. It is possible – though not discussed! – that Royal is using its counterparty strength to go after the more profitable long-term business. Additionally, there appears (page 37 of the supplementary PDF) to be a shift from Foreign Exchange to Interest Rate derivatives.

It was a good solid quarter with nothing particularly exciting happening … just the way we like it! Very nice to see the delevering indicated by the Assets to Capital Multiple and improved Preferred Share subordination shown by the the Equity/RWA ratio.

CIBC (Stock symbol CM … I can never quite decide how to present it!) has released its 1Q09 Earnings Report and 1Q09 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:

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

and the all important Risk-Weighted Asset Ratios!

The Shareholders’ Report comments:

The Tier 1 ratio was down by 0.7% from the year end mainly due to structured credit charges in the quarter and higher credit risk weighted assets in the trading book resulting primarily from financial guarantor downgrades. The Tier 1 ratio was also adversely impacted by the expiry of OSFI’s transition rules related to the grandfathering of substantial investments pre-December 31, 2006, which were deducted entirely from Tier 2 capital at year end. The Tier 1 ratio benefited from lower risk weighted assets on residential mortgages resulting from higher insured mortgages.
The total capital ratio was down 0.6% from year end mainly due to structured credit charges in the quarter and higher credit risk weighted assets in the trading book, resulting primarily from financial guarantor downgrades. The ratio benefited from lower risk weighted assets on residential mortgages resulting from higher insured mortgages.

The big news in the reports was:

$708 million ($483 million after-tax, or $1.27 per share) loss on structured credit run-off activities

… which meant they didn’t make much money this quarter – only $147-million. They warn:

As at January 31, 2009, the fair value, net of valuation adjustments, of purchased protection from financial guarantor counterparties was $2.4 billion (US$1.9 billion). Market and economic conditions relating to these financial guarantors may change in the future, which could result in significant future losses.

In addition, it should be noted (page 9 of the report) that they still have $38.8-billion of actual ($10.2-billion) and notional ($28.6-billion) exposure in their “run-off portfolio”, offset by notional protection of $36.1-billion. It is the creditworthiness of the notional protection that is an issue.

Roughly half the notional exposure is derivatives written on Corporate Debt, while another quarter is writes on Collaterallized Loan Obligates; protection has been bought within these two sub-classes to basically offset. On Page 13 of the report, they do a very good job of breaking down these exposures by counterparty credit rating. About $8.7-billion of the notional exposure is to counterparties rated below investment grade; they do not disclose collateralization agreements that would give some comfort if they existed.

TD has released its First Quarter 2009 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:

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

I am going to have to ponder this table. The very substantial difference between “Net Tier 1 Capital” and “Adjusted net Tier 1 capital” is due mostly to the 50/50 deduction on “Substantial Investments”, which used to be deducted solely from Tier 2 Capital. The relevant note in TD’s Supplementary statement states:

Based on OSFI advisory letter dated February 20, 2007, 100% of substantial investments and investments in insurance subsidiaries held prior to January 1, 2007 (excluding goodwill / intangibles) is deducted from Tier 2 capital. The 50% from Tier 1 capital and 50% from Tier 2 capital deduction has been deferred until 2009 and 2012 for substantial investments and insurance, respectively. Increases in the investment value of insurance subsidiaries and / or substantial investments on or after January 1, 2007 are subject to the 50% from Tier 1 capital and 50% from Tier 2 capital deduction.

and the all important Risk-Weighted Asset Ratios!

The OSFI Capital Guidelines state:

Net tier 1 capital is defined as gross tier 1 capital less the above two deductions [Goodwill & Excess Intangibles].
• 50% of investments in unconsolidated entities in which the institution has a substantial investment [Footnote]
• 50% of investments in subsidiaries deconsolidated for regulatory capital purposes, net of goodwill and identified intangibles that were deducted from tier 1 capital
• 50% of other facilities that are treated as capital by unconsolidated subsidiaries and by unconsolidated entities in which the institution has a substantial investment
• Back-to-back placements of new tier 1 capital, arranged either directly or indirectly, between financial institutions
• 50% of payments made under non-DvP trades plus replacement costs where contractual payment or delivery is late by five days or more (see Annex 3)
• Deductions from tier 2 capital in excess of total tier 2 capital available (see section 2.5.2)

[Footnote] The term “substantial investment” as used in this guideline means an investment that falls within either or both of the following categories:
• investments that are defined to be a substantial investment under section 10 of the Bank Act or the Trust and Loan Companies Act
• investments in common equity and other tier 1 qualifying instruments of a financial institution that, taken together, represent ownership of greater than 25 percent of that financial institution’s total outstanding tier 1 qualifying instruments
Goodwill related to substantial investments in unconsolidated entities that is not otherwise deducted for regulatory purposes represents a diminution in the quality of tier 1 capital and will be subject to supervisory scrutiny in the assessment of the strength of capital ratios against industry wide target ratios. Institutions will not be required to report goodwill related to substantial investments on a regular basis, but must be able to produce this information if requested by OSFI.

In other words, the “Net Adjusted Tier 1 Capital” used for calculating the Tier 1 Capital Ratio removes half of the investment in unconsolidated subsidiaries; in TD’s case, at any rate, this appears to be the Insurance subsidiary.

I have made a preliminary determination that it is justifiable to make these deductions from equity when calculating the degree of subordination of the preferred shares; if TD gets into trouble, they will – at the very least – have to jump through some hoops in order to get their capital out of these subsidiaries, which may well be having problems of their own at such a time.

It is fascinating to note that their Assets to Capital multiple has shrunk so dramatically while their Risk-Weighted-Assets are unchanged. The Earnings Release states:

OSFI’s target Tier 1 and Total capital ratios for Canadian banks are 7% and 10%, respectively. As at October 31, 2008, the Bank’s Tier 1 capital ratio was 9.8%. Effective November 1, 2008, substantial investments held prior to January 1, 2007, which were previously deducted from Tier 2 capital, are deducted 50% from Tier 1 capital and 50% from Tier 2 capital. Insurance subsidiaries continue to be deconsolidated and reported as a deduction from Tier 2 capital. The Tier 1 capital ratio, as of November 1, 2008, taking into effect this change was 8.3%. As of January 31, 2009, the Bank’s Tier 1 capital ratio was 10.1%. The increase was largely due to various capital issuances, including common shares, preferred shares and innovative Tier 1 capital securities. The Total capital ratio was 13.6% as at January 31, 2009 compared to 12.0% at year-end. The increase was largely due to the capital issuances.

The decline in the Equity/RWA ratio, supremely important to preferred share investors, is a bookkeeping change; the ratio has actually improved over the quarter due to retained earnings and the equity raise, but this has been swamped by the new 50/50 deduction. We shall soon see how the other banks have been affected …

Manulife has issued its 4Q08 Press Release, which includes the entertaining line:

During the quarter, the Company successfully raised $4,275 million of new capital, consisting of $2,275 million of common shares and $2,000 million of term loans.

Inablility to discern a difference between term loans and capital might go a long way towards explaining their problems!

Of the $2,920 million equity related loss, $2,407 million is due to the post tax increase in segregated fund guarantee liabilities, comprised of $1,805 million for the reduction in the market value of the funds being guaranteed and $602 million because the sharp drop in swap interest rates reduced the discount rates used in the measurement of the obligation. The remaining $513 million of the equity related loss is on equity investments supporting non-experience adjusted policy liabilities ($196 million), reduced capitalized future fee income on equity-linked and variable universal life products ($100 million), impairments on equity positions in the Corporate and Other segment ($158 million) and lower fee income ($59 million).
…
Regulatory capital adequacy is primarily managed at the insurance operating company level (MLI and JHLICO). MLI’s Minimum Continuing Capital and Surplus Requirements (“MCCSR”) ratio of 233 as at December 31, 2008 has increased by 40 points from 193 per cent as at September 30, 2008. The increase in MLI’s new capital, funded largely by MFC’s common equity issuance and $2 billion term loan, plus the changes OSFI made to the capital requirements were in excess of the fourth quarter loss, dividends to its parent MFC and capital increases in segregated fund guarantees as a result of the equity market declines. JHLICO’s Risk-Based Capital (“RBC”) ratio is calculated annually and is estimated to be 400 per cent at December 31, 2008 compared to a regulatory target of 200 per cent.

Page 9 of their presentation slides is comprised of the following table:

Page 36 shows that they have a net unrealized loss of $5.2-billion on a fixed income portfolio of $112.6-billion, a decline of 8%.

What I am trying to obtain is a view as to how well their default assumptions reflect credit spreads. Given that an unrealized loss of $5,200-million translated into impairment charges of $128-million (a transmission rate of just under 2.5%), it appears to me that they are (probably!) relying totally on credit ratings as an estimator of default risk. For an unleveraged and diversified investor, this is not entirely unreasonable (subject to sanity checks!); for a leveraged investor – such as MFC and any other insurer – it is … somewhat suspect.

Great-West Lifeco has released its 4Q08 Results. They consider their results to be so shameful that they have put anti-copying protection on the PDF on their site; thus, I have had to copy-paste from the MarketLink version:

Lifeco’s Canadian operating subsidiary, Great-West Life, reported a Minimum Continuing Capital and Surplus (MCCSR) ratio of 210% at December 31, 2008, which did not include any benefit from the $1,230 million of common and preferred share capital that was raised by Lifeco in the fourth quarter.
…
Gross unrealized bond losses were $6.1 billion at December 31, 2008. These unrealized losses reflect the mark-to-market values at December 31st, the magnitude of which is significantly impacted by the duration of the bonds. These bonds are typically held in support of long-term policyholder liabilities.
…
In the fourth quarter, the Company recorded a non-cash impairment charge in connection with Putnam goodwill and intangible assets of $(1,353) million after-tax. In addition, the Company recorded a valuation allowance against a Putnam deferred tax asset of $(34) million after-tax, and a Putnam restructuring charge of $(45) million after-tax. The impairment charge primarily reflects the significant deterioration in financial markets since the acquisition by Lifeco in August 2007. This charge did not impact the regulatory capital ratios of Lifeco’s operating subsidiaries, and it is not expected to impact the credit ratings of the Company.
…
A replay of the call will be available from February 12 to February 19, 2009, and can be accessed by calling 1-800-408-3053 or 416-695-5800 in Toronto (passcode: 3280920 followed by the number sign).

Their Management Discussion and Analysis (similarly copy-protected) states that:

The held for trading bonds are held primarily in support of actuarial liabilities with changes in the fair value of these assets, excluding changes on other-than-temporarily impaired assets, offset by a corresponding change in the value of the actuarial liabilities

This appears to imply that they have held their default estimates constant and ascribed every single bp of spread widening to liquidity. Page 20 of the copy-protected PDF contains the delicious line:

Actuarial liabilities in Canada decreased $1.4 billion due mainly to changes in the fair value of assets backing actuarial liabilities since January 1, 2008

That’s certainly a convenient way to keep the balance sheet pristine!

Assiduous Readers will remember that OSFI made a late Christmas Eve announcement of major changes to the MCCSR guidelines, which included:

Revised methodologies for calculating available capital. The key change recognizes that unrealized gains and losses on available for sale (AFS) debt securities held by life insurance companies do not reflect the capital value of these assets to a life insurer as, in most cases, these assets will be held for the long term (e.g. to maturity). As such, OSFI is updating its life insurance company capital rules so that, when fully implemented, they will correspond to the capital treatment for banks holding similar securities (i.e. unrealized gains and losses on AFS debt securities do not change capital adequacy).

As noted yesterday, this issue has come to the fore in the UK, with companies being sternly warned to ensure that when determining the profit and loss on their annuity business, increased spreads lead to at least a certain amount of increase in the implied default risk of the assets.

In fact, OSFI’s new Capital Guidelines state:

OSFI will begin phasing out the capital adjustments for accumulated unrealized gains and losses on available-for-sale debt securities reported in Other Comprehensive Income (OCI) on December 31, 20086. At year-end 2008, companies must elect whether to phase out these adjustments over three years, or to phase them out immediately.

All this is of interest due to the following information in SunLife’s 4Q08 Earnings Release:

Net income of $129 million for the fourth quarter of 2008 was driven by an after-tax gain of $825 million from the Company’s sale of its interest in CI Financial. This was offset by a significant decline in equity markets, asset impairments, credit-related write-downs and spread widening, changes to asset default assumptions in anticipation of higher future credit-related losses, charges taken in the Company’s life retrocession reinsurance business related to the strengthening of actuarial reserves to reflect more comprehensive information on potential future premiums and claims as well as the weakening of the Canadian dollar relative to foreign currencies from losses in business segments in which the U.S. dollar is the primary currency. The Company’s hedging program helped offset some of the losses related to volatility in capital markets during the quarter.

Credit market losses include the following amounts:

With an MCCSR ratio of 232% Sun Life Assurance was well above minimum regulatory capital levels as at December 31, 2008, compared to 213% as at December 31, 2007. The increase in the MCCSR ratio is primarily due to revisions by OSFI to the MCCSR rules in the fourth quarter of 2008, as well as the impact of the portion of the proceeds of the CI Financial transaction attributable to Sun Life Assurance. This was partially offset by market impacts experienced during 2008 and write-downs on assets in Sun Life Assurance’s investment portfolio. Other subsidiaries are subject to local capital requirements in the jurisdictions in which they operate.

The current market environment highlighted the need to revise the treatment of certain components of capital to better reflect both the nature of the risks and the quality of capital supporting these risks. In response to the issues surfaced, OSFI issued several revisions to the current MCCSR rules effective December 2008. First, the minimum capital rules for segregated fund guarantees were updated to differentiate between near-term and long-term obligations. Second, companies were given the option to exclude from available capital the net after-tax unrealized gains and losses on available-for-sale bonds reflected in other comprehensive income to better reflect the long-term nature of these bonds. Finally, the requirement to hold capital for future pricing decisions was eliminated to avoid potential redundancy with risk charges and actuarial reserves.
…
The Company’s principal operating subsidiary, Sun Life Assurance, is subject to the MCCSR capital rules for a life insurance company in Canada. The MCCSR calculation involves using qualifying models or applying quantitative factors to specific assets and liabilities based on a number of risk components to arrive at required capital and comparing this requirement to available capital to assess capital adequacy. Certain of these risk components, along with available capital, are sensitive to changes in equity markets. The estimated impact on the MCCSR of Sun Life Assurance from an immediate 10% increase across all equity markets as at December 31, 2008 would be an approximate 2% – 4% increase in MCCSR. Conversely, the estimated impact on the MCCSR of Sun Life Assurance from an immediate 10% drop across all equity markets would be an approximate 3% – 5% decrease in MCCSR.

The MCCSR is a very nice number, insofar as it can be trusted. Unfortunately, there is not enough detail in their Supplementary Information (available here) to make a determination of how well their credit impairment assumptions correspond to their liability net present value assumptions.