PrefBlog

I don’t have much time to post at the moment, but I would like to get some facts out before the issue takes off … and this looks like an issue that will take off.

In a piece picked up by Naked Capitalism, the New York Times reported:

With little notice, regulators at four agencies that oversee the nation’s banks and savings associations on Monday and Tuesday proposed a significant change in accounting rules to bolster banks and encourage widespread industry consolidation by making them more attractive to prospective purchasers. The regulators and the Bush administration have decided to resort to further loosening of the accounting rules to try to get the industry through problems that some experts have attributed in large part to years of deregulation.
…
The action by the four banking agencies provides more favorable accounting treatment of so-called good will, an intangible asset that reflects the difference between the market value and selling price of a bank.
…
“It’s a desperate thing,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics, a consulting company.

“If we’ve learned anything,” she added, “it’s that capital at risk is the way to protect the financial system. Giving any institution a capital incentive to double down the federal backstop would be dangerous.”

Sounds scary, right? Goodwill? Counted as part of Tier 1 Capital? A patent absurdity! Credit Slips has a lot to say, but does not appear to have looked at the source documents.

The Assiduous Readers around here, though, LOVE to look at source documents! Let’s look at the Fed’s press release:

The Federal Reserve Board on Monday requested public comment on an interagency notice of proposed rulemaking (NPR) that would permit a banking organization to reduce the amount of its goodwill deduction from tier 1 capital by any associated deferred tax liability.

Under the proposed rule, the regulatory capital deduction for goodwill would be equal to the maximum capital reduction that could occur as a result of a complete write-off of the goodwill, which is equal to the amount of goodwill reported on the balance sheet under generally accepted accounting principles (GAAP) less any associated deferred tax liability. The proposal is consistent with the treatment of other similar assets.

… and the draft Federal Register Notice:

Under the Agencies’ existing regulatory capital rules, a banking organization1 must deduct certain assets from tier 1 capital.2 A banking organization is permitted to net any associated deferred tax liability against some of those assets prior to deduction from tier 1 capital. Included among those assets are certain intangible assets arising from a nontaxable business combination. Such netting generally is not permitted for goodwill and other intangible assets arising from a taxable business combination. In these cases, the full or gross carrying amount of the asset is deducted.

Statement of Financial Accounting Standards No. 141, Business Combinations (FAS 141), requires that all business combinations be accounted for using the purchase method of accounting for financial reporting purposes under generally accepted accounting principles (GAAP).3 FAS 141 also requires that the acquiring entity assign the cost of the acquired entity to each identifiable asset acquired and liability assumed. The amounts assigned are based generally upon the fair values of such assets and liabilities at the acquisition date. If the cost of the acquired entity exceeds the net of the amounts so assigned, the acquiring entity must recognize the excess amount as goodwill.

Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (FAS 142), prohibits the amortization of goodwill for financial reporting purposes under GAAP and requires periodic testing of the carrying amount of goodwill for impairment.

However, a banking organization generally amortizes goodwill for tax purposes. This difference in treatment generally results in the recognition of a deferred tax liability under GAAP. The deferred tax liability increases over time and is reflected in corresponding reductions in earnings for financial reporting purposes until the goodwill has been fully amortized for tax purposes.

The deferred tax liability generally is not reduced or reversed for financial reporting purposes unless the associated goodwill is written down upon a finding of impairment, or is otherwise derecognized.

The Agencies have received requests from several banking organizations to permit the amount of goodwill arising from a taxable business combination that must be deducted from tier 1 capital to be reduced by any associated deferred tax liability. The Agencies believe that this treatment would appropriately reflect a banking organization’s maximum exposure to loss if the goodwill becomes impaired or is derecognized under GAAP.

Accordingly, the Agencies are proposing to amend their respective capital rules to permit a banking organization to reduce the amount of goodwill it must deduct from tier 1 capital by the amount of any deferred tax liability associated with that goodwill. However, a banking organization that reduces the amount of goodwill deducted from tier 1 capital by the amount of the associated deferred tax liability would not be permitted to net this deferred tax liability against deferred tax assets when determining regulatory capital limitations on deferred tax assets.

The proposed change would permit a banking organization to effectively reduce its regulatory capital deduction for goodwill to an amount equal to the maximum regulatory capital reduction that could occur as a result of the goodwill becoming completely impaired or derecognized. This would increase a banking organization’s tier 1 capital, which is used to determine the banking organization’s leverage ratio and risk-based capital ratios.

Quite frankly, this seems eminently reasonable. I look forward to seeing some contrary opinions in the comments on the draft proposal; but at first blush it looks to me simply like a clearing up of a bureaucratic ‘you can’t get there from here’ rule maze.

At the very least, the New York Times is to be castigated for trying to make this into a Dumb Regulator story. We want INFORMATION, guys! I’ll form my own opinions, thank you!

I haven’t checked yet what the rules are in Canada. I’ll look into it … soon.

Update, 2008-9-30: The official FDIC package on this matter has been posted on their website.

This updates a review of Canadian bank constraints for 2Q08.

In determining the limiting factor, it has been assumed that 23x is the actual limit for the Assets to Capital multiple; OSFI has stated that 23x is OK as long as they meet certain conditions and otherwise apply for permission. Given that OSFI maintains a veil of secrecy over the issue, it has been assumed that the 20x multiple is simply stated for decorative purposes.

It should also be noted that the calculation of the ACM has been recently revised by OSFI, with what I must say is rather weak justification.

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:

NA has released its Third 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:

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

and the all important Risk-Weighted Asset Ratios!

National Bank does not disclose its Assets-to-Capital Multiple. Their Report to Shareholders simply states (Note 4):

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.

Well … at least they’re delevering! It is also interesting to note that they have – basically – maxed out on their expanded allowance of non-equity Tier 1 Capital.

TD has released its Third 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:

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

and the all important Risk-Weighted Asset Ratios!

The reported Assets-to-capital multiple reflects that goodwill is deducted from total capital (the denominator) AND FROM TOTAL ASSETS (the numerator); given TD’s huge goodwill, this makes rather a difference! It is noteworthy that they have delevered so much in the past year.

The average credit risk-weight of the assets has increased to 26.6% in 3Q08 from 24.6% in 1Q08, largely due to Corporate lending, which during this period has increased to 26.0% from 24.8% of total exposure and to 46.2% from 40.6% of risk-weighted exposure.

RY has released its Third 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:

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

and the all important Risk-Weighted Asset Ratios!

It’s good to see that RY has reduced its Assets-to-Capital multiple to within normal bounds (this has not always been the case) – even if we follow international practice and retain the EL/ALLL deductions, the ratio is 19.8x.

We see from the supplementary data that the average credit risk weight of their assets has increased from 23% in 2Q08 to 25% in 3Q08, which ties in with the minimal change in their capital ratios. This, in turn, is due to a decline in their “Trading-Related” exposure, in which “Repo-Style Transactions”, with a risk-weight of 2%, has declined to total exposure of $151-billion from $168-billion.

CIBC (Stock symbol CM … I can never quite decide how to present it!) has released its Third 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:

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

and the all important Risk-Weighted Asset Ratios!

Again, the 4Q07 figures are not directly comparable with the 3Q08 figures due to the change from Basel I to Basel II.

On a Basel I basis, the Tier I and Total Capital ratios got a big boost in the first quarter with the capital raise, but have since declined; the Tier 1 ratio is now the lowest it has been in the last two years, but the total capital ratio has improved since the second quarter. The improvement in the total capital ratio over the quarter may be attributed to issues of sub-debt.

Further, on a Basel I basis, Total Risk Weighted Assets have increased somewhat since 4Q07, basically due to an increase of $5-billion in the risk-weight of “Other Loans”. It is not entirely clear what these other loans are; the balance sheet amounts for Personal Loans and Credit Card Loans are up $2.2-billion and $1.4-billion, respectively, but that doesn’t account for the increase. It may possibly be the risk weighting that has changed rather than the unadjusted balance sheet value.

BNS has released its Third 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:

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

and the all important Risk-Weighted Asset Ratios!

The calculations for the Assets-to-Capital multiple are not comparable; the OSFI figure will include an allowance for off-balance-sheet exposure. It should be noted that, according to the Supplementary Report, The “Tangible Common Equity” ratio, calculated according to Basel I, has declined to 6.5% in 3Q08 from 7.2% in 4Q07.

The Basel I “Tier 1” and “Total Capital” ratios also show a declining trend for the year to date. As has been noted before, Scotia does not adequately disclose its “Expected Losses” under Basel II, as distinct from its “General Allowances”.

It is apparent from the Quarterly Trend in the Basel I data that Scotia has been bulking up on its Risk Weighted Assets big-time, largely through “Loans and Acceptances” (which includes Securities Purchased under Resale Agreements”. This has been financed largely through deposits. To some extent, this reflects Scotia’s acquisition of Banco del Desarrollo in 2Q08:

The Bank completed the acquisition of Chile’s Banco del Desarrollo on November 26, 2007, through the acquisition of 99.5 per cent of the outstanding shares for $1.0 billion Canadian dollar equivalent (CDE). Total assets at acquisition were approximately CDE $5.6 billion, mainly comprised of loans. The Bank will combine the operations of Banco del Desarrollo with its existing Scotiabank Sud Americano banking operations. Based on acquisition date fair values, approximately CDE $797 million has been allocated to the estimated value of goodwill acquired. The purchase price allocation may be refined as the Bank completes its valuation of the assets acquired and liabilities assumed.

According to the 3Q08 Report:

The Bank’s total assets at July 31, 2008, were $462 billion, up $50 billion or 12% from October 31, 2007, including a $16 billion positive impact from foreign currency translation and the acquisition of Banco del Desarrollo. Growth was widespread across most asset categories, including retail, commercial and corporate lending. Compared to the prior quarter, assets grew by $9 billion.

The Bank’s loan portfolio grew $45 billion or 20% from October 31, 2007, including $7 billion from foreign currency translation. On the retail lending side, domestic residential mortgage growth was $15 billion, before securitization of $3 billion. The International acquisition of Banco del Desarrollo in Chile contributed $1 billion to the increase in mortgages. Personal loans were up $7 billion, with all regions experiencing positive growth.

Business and government loans increased $26 billion from October 31, 2007, or $21 billion excluding the impact of foreign currency translation. Loans in Scotia Capital were up $11 billion on the corporate lending side as well as to support trading operations. In International Banking,
business and government loans increased $13 billion. The acquisition of Banco del Desarrollo contributed $3 billion, and loans in Asia and the Caribbean grew $5 billion and $2 billion, respectively.

Update: Right on cue, Scotia announced a new issue of Tier 1-eligible preferreds after releasing the results; this will help their Tier 1 and Total Capital ratios.

BMO has released its Third 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, 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 7.44%; it is not immediately clear to me how this figure is calculated.

Of interest is the improvement in their capital ratios, including the Assets-to-Capital multiple. It appears that their earnings are being used to displace borrowings, rather than being levered up.

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.