Regulation

IFRS Seg Fund Treatment to Strain Insurer Capital?

In a prior post I discussed IFRS and the Assets-to-Capital Multiple with respect to banks and their mortgage securitization habits, but I’ve just realized there’s another nuance lying in ambush behind the thickets of regulation.

The OSFI Draft Advisory on Conversion to International Financial Reporting Standards (IFRSs) by Federally Regulated Entities (FREs) states:

With respect to life insurance entities, current CGAAP specifically requires that segregated funds should be accounted for separately (off balance sheet). However, IFRSs do not specifically address accounting for segregated funds. As a result, most segregated funds are expected to require consolidation treatment because of the “control” tests in IAS 27 and SIC 12. Most life insurers are, therefore, expected to report their segregated fund assets and liabilities on balance sheet through a one-line reporting format rather than commingled with other asset and liability categories.
…
OSFI is not issuing any additional accounting guidance or clarification in this area at this time.

OSFI will consider the accounting treatment of segregated funds if it becomes apparent that life insurers intend to commingle assets and liabilities, rather than use the expected one-line reporting format.
…
With respect to segregated funds, risk based capital requirements already exist and OSFI requires that the current treatment continue. Therefore, although segregated funds will appear on the balance sheet, they would not attract asset specific capital charges outside of the existing Segregated Fund Risk charge.

This is interesting in light of recent OSFI speeches by Julia Dickson:

As OSFI regulates non-operating insurers acting as holding companies, we are considering updating our current regulatory guidance for these entities to promote a more integrated and consistent approach to determining regulatory capital requirements. For example, OSFI’s MCCSR tests could be used to evaluate the group’s consolidated risk-based capital – and a test similar to the asset-to-capital multiple (ACM) test could be used to evaluate leverage.

… and her speech-tester, Mark White:

For example, OSFI’s Minimum Continuing Capital and Surplus Requirements (MCCSR) tests could be used to evaluate a financial group’s consolidated risk based capital – and an ACM like-test could be used to evaluate leverage.

These speeches were reported on PrefBlog in the posts OSFI Looking Closely at Lifeco Consolidated Capital and OSFI to Address Double-Leverage?, respectively.

If we look at, for instance, the Manulife 4Q09 Report we see that total capital is $33.2-billion, and total funds under management are $440-billion, which includes the general fund of $187-billion and seg-funds (on balance sheet, but not included in “Total Assets”) of about $192-billion.

After consolidation – particularly if mutual funds, etc., are consolidated – we could see reported total assets change dramatically:

MFC 4Q09
CAD Billions
Total Assets as Currently Reported 205
Seg Funds 192
Other Funds under Management 64
Potential Total Assets 461

Capital of 33.2 implies an ACM of about 14x; not only have we not been particularly thorough in digging up off-balance sheet committments, but it should also be remembered that a big chunk of these AUM are equities and should logically be constrained by a lower ACM than the banks’ loan-based accounts.

Life could well get interesting in the next few years!

Reader Initiated Comments

IFRS and the Assets-to-Capital Multiple

An Assiduous Reader writes in and says:

I know how much you love to play the guess the ACM game. But here’s a new twist: what do you think the ACM of your favourite DTI’s are after OSFI requires all the billions of dollars of CMHC NHA MBS to be consolidated back on balance sheet? [link])

But here are some more interesting questions:

  • -why has no OSFI regulated publicly traded company commented on how this proposed change will affect their ACM? (home capital got through their entire earnings call without any mention of the ACM) they’ve obviously done the work (IFRS has been planned for years) but have chosen not to share their findings with investors.
  • -why has OFSI or the government (although perhaps this is too technical to score political points) not provided any timely clarity on this issue given the importance to the entire mortgage and residential real estate market? (The draft advisory was dated october 2009)
  • -will the government/cmhc allow the mortgage business to simply move into lightly capitalized unregulated vehicles to avoid the new OFSI rules? (i.e. is it OK to setup a shell company with $2MM in it that issues $10B in MBS pools?, do we really want the majority of mortgage origination occurring in the unregulated space as a public policy matter?)

A glossary will be helpful here:
OSFI : Office of the Superintendent of Financial Institutions
DTI: Deposit Taking Institution
FRE: Federally Regulated Entity
MBS: Mortgage Backed Securities
CMHC: Canada Mortgage & Housing Corporation
ACM: Assets to Capital Multiple
CGAAP: Canadian Generally Agreed Accounting Principles

The advisory states:

OSFI notes that off balance sheet assets under CGAAP have, during the recent financial turmoil, resulted in DTIs increasing their balance sheet assets during times of stress in respect of assets that no longer qualified to be derecognized and securitization conduits which were no longer exempted from consolidation. Lessons learned in the recent financial turmoil are that certain securitization structures did not transfer the risk out of the FREs as expected. OSFI is of the view that securitization assets which are not derecognized or which are not exempted from consolidation should be included in the calculation of the ACM.

Given that the implementation of IFRSs is expected to increase FREs’ on balance sheet assets and therefore to increase the ACM of DTIs and the borrowing multiple of cooperative credit associations, OSFI is of the view that, in some cases, an immediate application of those rules may be difficult for FREs to meet.

Insured mortgages securitized through the Canada Mortgage and Housing Corporation’s (CMHC’s) National Housing Act (NHA) Mortgage Backed Securities and Canada Mortgage Bond Programs (MBS/CMB Programs) are unlikely to achieve derecognition and will therefore be brought on balance sheet under IFRSs. To facilitate compliance with the ACM under IFRSs and permit an orderly transition, OSFI will permit mortgages sold through the MBS/CMB Programs up to and including December 31, 2009 to be excluded from the ACM calculation when IFRSs are adopted, regardless of whether they are brought onto the balance sheet under IFRSs. If so, FREs will be required to exclude pre December 31, 2009 MBS/CMB programs from the assets in the ACM calculation. However, to create an ACM which is more consistent and which reflects the lessons from the recent financial turmoil, MBS/CMB exposures occurring after December 31, 2009 will be included in the calculation of the ACM under the current ACM definition and limits; that is, they will be included in the asset definition of the ACM upon implementation of IFRS if (but only if) they are accounted for as on balance sheet exposures under IFRSs. No changes will be made to the non capital regulatory returns and FREs will be required to report in accordance with IFRSs; FRFIs will be required to adjust their assets included in their ACM calculation to give effect to the transition provisions.

Footnote: Irrespective of the IFRS determination of what is on balance sheet, the ACM should reflect the MBS/CMB originator’s risk profile. Where the risk profile of the MBS/CMB originator is not materially improved by participation in such a securitization, continued inclusion in the ACM may be appropriate.

Overall, this is not an enormous problem. OSFI reports that the Assets to Capital Multiple for all domestic banks was 15.58x as of 3Q09, with total capital at about $161-billion. The special NHA MBS buying programme is $25-billion and the CMHC had about $200-billion assets on the 2008 books … so consolidating the securitizations will add another multiple of 1 to the total ACM for the system.

As the Assiduous Reader points out, though, there could be trouble at the margins, particularly with specialty lenders; additionally, OSFI has shown in the past that it is incapable of running stress tests that include attention to the ACM.

This one bears watching …

PrefLetter

February Edition of PrefLetter Released!

The February, 2010, edition of PrefLetter has been released and is now available for purchase as the “Previous edition”. Those who subscribe for a full year receive the “Previous edition” as a bonus.

The February edition contains an appendix examining the concept of Strong Pairs of FixedFloater / Ratchet Rate preferreds, the implications of their pairing, and the market inefficiency in pricing these instruments.

As previously announced, PrefLetter is now available to residents of Alberta, British Columbia and Manitoba, as well as Ontario and to entities registered with the Quebec Securities Commission.

Until further notice, the “Previous Edition” will refer to the February 2010, issue, while the “Next Edition” will be the March, 2010, issue, scheduled to be prepared as of the close March 12 and eMailed to subscribers prior to market-opening on March 15.

PrefLetter is intended for long term investors seeking issues to buy-and-hold. At least one recommendation from each of the major preferred share sectors is included and discussed.

Note: A recent enhancement to the PrefLetter website is the Subscriber Download Feature. If you have not received your copy, try it!

Note: PrefLetter, being delivered to clients as a large attachment by eMail, sometimes runs afoul of spam filters. If you have not received your copy within fifteen minutes of a release notice such as this one, please double check your (company’s) spam filtering policy and your spam repository. If it’s not there, contact me and I’ll get you your copy … somehow!

Note: There have been scattered complaints regarding inability to open PrefLetter in Acrobat Reader, despite my practice of including myself on the subscription list and immediately checking the copy received. I have had the occasional difficulty reading US Government documents, which I was able to resolve by downloading and installing the latest version of Adobe Reader. Also, note that so far, all complaints have been from users of Yahoo Mail. Try saving it to disk first, before attempting to open it.

PrefLetter

February PrefLetter Now in Preparation!

The markets have closed and the February edition of PrefLetter is now being prepared.

PrefLetter is the monthly newsletter recommending individual issues of preferred shares to subscribers. There is at least one recommendation from every major type of preferred share with investment-grade constituents. The recommendations are taylored for “buy-and-hold” investors.

The February edition will contain an appendix discussing the concept of Strong Pairs, their strange and unjustifiable treatment by the marketplace and how investors may exploit the pricing inefficiencies that thereby occur.

Those taking an annual subscription to PrefLetter receive a discount on viewing of my seminars.

PrefLetter is available to residents of Ontario, Alberta, British Columbia and Manitoba as well as Quebec residents registered with their securities commission.

The February issue will be eMailed to clients and available for single-issue purchase with immediate delivery prior to the opening bell on Tuesday. Note that Monday is a holiday. I will write another post when the new issue has been uploaded to the server … so watch this space carefully if you intend to order “Next Issue” or “Previous Issue”! Until then, the “Next Issue” is the February issue.

Market Action

February 12, 2010

Looks like Toyota learned lessons from the securities industry:

Former regulators hired by Toyota Motor Corp. helped end at least four U.S. investigations of unintended acceleration by company vehicles in the last decade, warding off possible recalls, court and government records show.

Comrade Peace-Prize’s regulatory reforms are bogging down:

Senator Bob Corker, the lead Republican negotiator on legislation to overhaul financial regulation, said he is considering removing the Federal Reserve’s power to oversee banks.
…
Corker made clear that his agreement to work with Senator Christopher Dodd, the Connecticut Democrat who leads the Senate Banking Committee, would require President Barack Obama to make significant concessions to get his long-stalled financial reform proposal through the Senate.

Beyond reducing the Fed’s bank supervisory role, Corker said he could not support a standalone Consumer Financial Protection Agency, a top priority for Obama. In addition, Corker appeared unwilling to back the president’s call for mandatory limits on banks’ size and trading activities. And he suggested he was nearing agreement with Dodd on using bankruptcy laws to wind down large, failing companies, rather than the out-of-court resolution process Obama prefers.

There’s moral hazard in Greece:

BlackRock Inc., the world’s biggest asset manager, increased its Greek bond holdings, betting the European Union won’t allow the nation to default as Prime Minister George Papandreou cuts the bloc’s biggest deficit.
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“They won’t allow a Lehman-type crisis,” said [Blackrock co-head of European fixed-income Michael] Krautzberger, who helps oversee BlackRock’s $3.35 trillion of assets. “The market has worried too much about an imminent government default in Europe that will not happen because of the solidarity.”

I wonder if countries will be required to produce “living wills”, hold liquid assets, have their management removed, vilified and investigated for fraud, or any of the other fun games we’ve had recently?

Light volume today, as traders were too busy watching money be thrown away to be bothered trying to make any. PerpetualDiscounts were off 6bp, but FixedResets were up 11bp, with yields on the latter issues again beginning to flirt with the 3.50% level.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices
Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)		 Median
YTW		 Median
Average
Trading
Value		 Median
Mod Dur
(YTW)		 Issues Day’s Perf. Index Value
Ratchet 3.01 % 3.64 % 28,817 20.24 1 0.3200 % 1,836.1
FixedFloater 5.69 % 3.77 % 36,589 19.26 1 0.2625 % 2,776.8
Floater 2.02 % 1.75 % 42,050 23.16 4 0.5795 % 2,279.6
OpRet 4.84 % -2.36 % 103,655 0.09 13 0.0324 % 2,325.0
SplitShare 6.31 % 3.63 % 134,610 0.08 2 0.0871 % 2,130.6
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0324 % 2,126.0
Perpetual-Premium 5.75 % 5.26 % 87,366 2.00 7 -0.1072 % 1,901.3
Perpetual-Discount 5.83 % 5.86 % 166,945 14.08 69 -0.0601 % 1,810.2
FixedReset 5.41 % 3.52 % 313,411 3.78 42 0.1109 % 2,186.1
Performance Highlights
Issue Index Change Notes
PWF.PR.K Perpetual-Discount -1.32 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-12
Maturity Price : 20.86
Evaluated at bid price : 20.86
Bid-YTW : 5.99 %
BAM.PR.K Floater 1.10 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-12
Maturity Price : 16.55
Evaluated at bid price : 16.55
Bid-YTW : 2.39 %
Volume Highlights
Issue Index Shares
Traded		 Notes
TRI.PR.B Floater 226,700 Nesbitt crossed three blocks, one of 125,000 and two of 50,000, all at 22.35.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-12
Maturity Price : 22.01
Evaluated at bid price : 22.25
Bid-YTW : 1.75 %
RY.PR.A Perpetual-Discount 128,619 Nesbitt crossed 100,000 at 20.00.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-12
Maturity Price : 19.96
Evaluated at bid price : 19.96
Bid-YTW : 5.60 %
BNS.PR.P FixedReset 78,256 RBC crossed 20,000 at 26.45, then Desjardins crossed 49,600 at 26.42.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-05-25
Maturity Price : 25.00
Evaluated at bid price : 26.42
Bid-YTW : 3.21 %
SLF.PR.C Perpetual-Discount 49,985 Nesbitt crossed 40,000 at 19.25.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-12
Maturity Price : 19.25
Evaluated at bid price : 19.25
Bid-YTW : 5.87 %
TD.PR.E FixedReset 32,625 National crossed 25,000 at 27.95.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-30
Maturity Price : 25.00
Evaluated at bid price : 27.95
Bid-YTW : 3.38 %
TD.PR.N OpRet 31,720 RBC crossed 30,000 at 26.20.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-03-14
Maturity Price : 26.00
Evaluated at bid price : 26.18
Bid-YTW : -2.36 %
There were 19 other index-included issues trading in excess of 10,000 shares.
Issue Comments

XMF.PR.A Announces Reorg Details

M-Split Corp. has announced:

In connection with the reorganization, the Company’s investment manager, Quadravest Capital Management Inc. (“Quadravest”), will be lowering its annual management fee from 0.55% to 0.45% per annum of the net asset value of the Company. In addition, the discount to net asset value applicable to monthly redemptions of Class I Preferred Shares, Class II Preferred Shares and Capital Shares will be decreased from 4% to 3% and this discount will be paid to Quadravest and not retained by the Company. These measures are intended to lower ongoing expenses of the Company and improve trading prices of the Class I Preferred Shares, Class II Preferred Shares and Capital Shares relative to net asset value for the Company.

Shareholders are being given a special retraction right as a result of the approval of this capital reorganization, which is in addition to the regular monthly retraction at the end of February and the dissent rights which Shareholders had in respect of the special meeting under the Business Corporations Act (Ontario).

Shareholders who do not wish to remain invested in the Company under its reorganized share structure will have until 5:00 p.m. (Toronto time) on February 26, 2010 to provide the Company with notice through their CDS participant that they wish to have their Priority Equity Shares or Class A Shares redeemed pursuant to this special retraction right. On such a special retraction, each holder of a Priority Equity Share will receive the lesser of (i) 96% of the net asset value per Unit of the Company at the retraction date, and (ii) $7.63 per Priority Equity Share (representing the volume weighted average trading price (“VWAP”) of the Priority Equity Shares on the Toronto Stock Exchange (“TSX”) for the 20 trading days ending on February 2, 2010); while holders of Class A Shares will receive the lesser of (i) 4% of the net asset value per Unit of the Company at the retraction date, and (ii) $0.46 per Class A Share (representing the VWAP of the Class A Shares on the TSX for the 20 trading days ending on February 2, 2010). Shareholders interested in exercising such retraction right should contact the CDS Participant through which they hold the Shares for further information and instructions as to how to exercise this right. Shareholders should note that the requirements of any particular CDS Participant may vary, and that Shareholders may need to inform their CDS Participant of any intention to exercise this retraction right in advance of the February 26 deadline.

If more Class A Shares are tendered for retraction under the special retraction right than Priority Equity Shares, the outstanding Priority Equity Shares will be consolidated so that following the retraction pursuant to this special retraction right there would be an equal number of Priority Equity Shares and Class A Shares outstanding. Similarly, if more Priority Equity Shares are tendered for retraction than Class A Shares, the outstanding Class A Shares will be consolidated so that again there would be an equal number of Priority Equity Shares and Class A Shares outstanding following implementation of the special retraction. The Company may implement this consolidation by adjusting the number of Class I Preferred Shares, Class II Preferred Shares, 2011 Warrants and 2012 Warrants to be issued to holders of Priority Equity Shares (in the event a consolidation of Priority Equity Shares is required) or by adjusting the number of Capital Shares to be issued to holders of Class A Shares (in the event a consolidation of Capital Shares is required).

The Company has the discretion not to proceed with this capital reorganization, notwithstanding it has been approved by Shareholders. The Company expects that it will exercise its discretion in this regard only if the number of Priority Equity Shares or Class A Shares being retracted pursuant to the special retraction right is such that the number of Shareholders remaining, or the number of Class I Preferred Shares, Class II Preferred Shares and Capital Shares to be issued and outstanding following implementation of the capital reorganization, is insufficient to meet the listing requirements of the TSX in respect of the Class I Preferred Shares, Class II Preferred Shares and Capital Shares.

The NAVPU as of January 29 is 8.50 net of accrued dividends for the preferred shareholders according to the company, so the ability to retract at 7.63 is no great shakes. It is a total disgrace that the capital unitholders are being allowed to retract at over thirty cents; this displays the spinelessness of preferred shareholders who voted for this plan.

XMF.PR.A was last mentioned on PrefBlog when the reorganization was approved. XMF.PR.A is not tracked by HIMIPref™.

Issue Comments

XCM.PR.A Announces Reorg Details

Commerce Split Corp. has announced:

In order to elect one of the two investment options, Shareholders must ensure that they make their election through their CDS Participant, in accordance with such participant’s election process and timing, so that the election is received by Computershare Investor Services Inc. no later than 5:00 p.m. (Toronto Time) on February 26, 2010 (the “Notice Deadline”).

Shareholder should note that the requirements of any particular CDS Participant may vary, and that Shareholders may need to inform their CDS Participant of any intention to elect in advance of the February 26 deadline.

If an Election Notice is not received from a Shareholder by the Notice Deadline, the Shareholder will be deemed to have elected to transfer to into the New Commerce Split Fund. Shareholders are advised to contact their financial advisers if they need assistance in making an investment decision in respect of this election.

Assiduous Readers will remember I recommended against the Reorg but that it passed anyway. Bloodied but unbowed, I now recommend that holders of XCM.PR.A elect to receive units in the “Original Commerce Split Fund”, since I don’t really see any financial advantage on a portfolio perspective that would justify the recapitalization of the company with preferred share-holder money without the extant capital unitholders being wiped out.

XCM.PR.A is not tracked by HIMIPref™.

Issue Comments

ALB.PR.A: Partial Call for Redemption

Allbanc Split Corp. II has announced:

that it has called 441,030 Preferred Shares for cash redemption on February 26, 2010 (in accordance with the Company’s Articles) representing approximately 11.683% of the outstanding Preferred Shares as a result of the special annual retraction of 882,060 Capital Shares by the holders thereof. The Preferred Shares shall be redeemed on a pro rata basis, so that each holder of Preferred Shares of record on February 25, 2010 will have approximately 11.683% of their Preferred Shares redeemed. The redemption price for the Preferred Shares will be $25.00 per share.

In addition, holders of a further 911,822 Capital Shares and 455,911 Preferred Shares have deposited such shares concurrently for retraction on February 26, 2010. As a result, a total of 1,793,882 Capital Shares and 896,941 Preferred Shares, or approximately 21.201% of both classes of shares currently outstanding, will be redeemed.

Holders of Preferred Shares that are on record for dividends but have been called for redemption will be entitled to receive dividends thereon which have been declared but remain unpaid up to but not including February 26, 2010.

Payment of the amount due to holders of Preferred Shares will be made by the Company on February 26, 2010. From and after February 26, 2010 the holders of Preferred Shares that have been called for redemption will not be entitled to dividends or to exercise any right in respect of such shares except to receive the amount due on redemption.

ALB.PR.A was last mentioned on PrefBlog when it was upgraded to Pfd-3(high) by DBRS. ALB.PR.A is tracked by HIMIPref™, but is relegated to the Scraps subindex on credit concerns.