Issue Comments

XTM eXchange Split Corp. Offering in Trouble?

XTM eXchange Split Corp. has announced:

that the deadline for investors to deposit securities of TSX Group Inc. in connection with the purchase of Units, consisting of Priority Equity Shares and Class A Shares, of the Company pursuant to the Exchange Option, as outlined in the preliminary prospectus of the Company dated April 30, 2008, has been extended to 5:00 p.m. (Toronto time) on June 11, 2008. The applicable exchange ratio will now be based on the volume-weighted average trading price of the common Shares of TSX Group Inc. on the TSX during the three consecutive trading days ending on June 11, 2008.

Prospective purchasers pursuant to the exchange option may acquire (i) Units (one Class A Share and one Priority Equity Share) or (ii) Class A Shares of XTM eXchange Split Corp. Prospective purchasers may also continue to acquire Class A Shares and/or Priority Equity Shares and pay the purchase price in cash.

I noted this potential new issue in a post written on May 5. I haven’t heard anything concrete … and I don’t know what the original closing date was supposed to be … but an extension of the closing date is not usually considered to be a Good Sign.

Regulation

Exchange Traded CDSs & Accrued Interest

Accrued Interest has come out in favour of Exchange Traded Credit Default Swaps in a new post:Bailouts, Wall Street, and the Bad Motivator, although he does not go so far as some in claiming that over-the-counter trading should be (effectively) banned.

I addressed a similar exhortation in my post Leverage, Bear Stearns & Econbrowser.

I’m not a proponent of Exchange Trading for CDSs – I can see a useful purpose being served by a clearinghouse, but exchanges are set up so that non-institutional players get to play. I will defer to any those with better information, but I don’t sense any clamour from retail to trade in Credit Swaps … several attempts to set up an exchange have died on the vine (see Update #4 to the ‘Econbrowser’ post) although I don’t know to what extent retail was invited to the party. By me, exchange trading will involve enormous listing fees and a huge bureaucracy to list a plethora of CDSs that will trade by appointment only at 100bp spreads. What’s the point?

While I have great respect for Accrued Interest, I think there are a number of misconceptions embedded in his post:

Had Bear Stearns been allowed to fail, banks world wide would have lost their counter-party on various derivative transactions.

Well, no. As I pointed out on the ‘Econbrowser’ post:

as far as the counterparties were concerned, their counterparty was not BSC per se, but wholly-owned, independently capitalized, highly rated subsidiaries of BSC. Just how adequate the capital, accurate the ratings, and ring-fenced the assets actually were is something I am not qualified to judge – seeing as how I haven’t even seen any of the guarantees and financial statements in question. But neither, it would appear, has Prof. Hamilton.

I should note that I brought this up in the comments to the Accrued Interest post:

JH: I don’t believe that this is correct. See my post Leverage, Bear Stearns & Econbrowser
…
James: I read your piece at the time. My reaction is that we don’t really know what would have happened if BSC actually declared bankruptcy.

Accrued Interest goes on to postulate:

Let’s say you allow Bear Stearns to fail and that caused XYZ bank to fail. Is that capitalism? Forcing XYZ to suffer for the sins of Bear Stearns?

I say … yes, that is capitalism, but no, it’s not forcing XYZ to suffer for the sins of BSC. It is forcing XYZ to suffer for their own sins in not demanding adequate collateralization from BSC when their position started winning (if XYZ’s trade was losing, BSC’s bankruptcy would not affect them). If XYZ failed, it would be due not only to insufficient collateralization, not only due to their extending far too great a credit line to BSC, but also a failure of regulation in not having previously assigned a capital charge to XYZ that reflected their risk.

When a position – of any kind – gets marked-to-market, P&L changes. If the position is winning and profit increases, then shareholders’ equity increases. So far, so good. But the credit exposure to the counterparty has also increased … it’s a loan to the counterparty and gets charged as such. In any reasonable regime, collateralization will reduce the risk measured from the gross exposure. It may, upon sober review of the evidence, be deemed necessary to fiddle with these various calculations of Risk Weighted Assets, but I fail to see a need for anything more.

Next! Accrued Interest then claims:

The first step is obvious. Credit-default swaps need to be exchanged-traded.

I don’t see that at all. If we accept for a moment that counter-party risk is out of hand (I don’t accept it, but let’s continue the discussion) then exchange trading is only one option. The option that minimizes change would be a clearing-house, whereby the clearing house acts as the counterparty for all trades and the clearing-house itself is guaranteed by each of its members. An exchange would incorporate this function, but the functionality does not require an exchange.

Accrued Interest continues:

There would be some relatively simple ways to bring such a thing about. What if banks were required to recognize the credit risk of their counter-parties directly?

They are. Assiduous Readers will remember that I looked at Scotiabank’s capitalization today. According to page 23 of their supplementary information, their Basel-I Risk-Weighted-Assets of 252.8-billion includes 240.5-billion of credit risk, which includes 34.0-billion of “Off-Balance Sheet Assets – Indirect Credit Instruments”. If we go to the OSFI website and look at Scotia’s 1Q08 “BCAR Derivative Components”, we find that they have Credit Derivative Contracts [OTC] of $108.9-billion outstanding (and those are REAL dollars, none of that sub-par American muck) giving rise to a replacement cost of $3.1-billion and a credit equivalent amount of $8.1-billion which (when combined with other derivatives) gives rise to a Risk-Weight-Equivalent of $10.7-billion … just over 4.2% of their total risk-weighted assets.

One may wish to twiddle with the numbers – converting the notional amounts and unrealized P&L in different ways to get different Risk-Weighted-Assets. But it is not correct to imply that the credit risk is not currently recognized.

Accrued Interest continues:

I think back to banks needing to reserve for losses dealt to them by XLCA/FGIC/Ambac/MBIA’s potential failure to perform on CDS contracts.

Now, this is a legitimate concern. According to OSFI Guidelines (Section 3.1.5, page 31) claims on Deposit Taking Banks of an AAA to AA- sovereign carry a risk-weight of 20%, which is the same as similarly graded corporates (section 3.1.7). Single A comes at 50%, BBB+ to BB- is 100% and let’s not go further.

If we look at the quarterly report for CM, we find:

During the quarter, we recorded a charge of US$2.30 billion ($2.28 billion) on the hedging contracts provided by ACA (including US$30 million ($30 million) against contracts unrelated to USRMM unwound during the quarter) as a result of its downgrade to non-investment grade. As at January 31, 2008, the fair value of derivative contracts with ACA net of the valuation adjustment amounted to US$70 million ($70 million). Further charges could result depending on the performance of both the underlying assets and ACA.

The problem here is: they (effectively) made a loan of USD 2.37-billion to ACA and have now written down 2.30-billion of it. Why were they making (effective) loans of this size to a single (effective) borrower?

It is my understanding that many of the monolines were refusing to write protection unless they were exempted from collaterallization, on the grounds that they were AAA rated. It is my further understanding that this was just fine by some of the banks and brokerages. Well, it’s a business decision. As long as it’s adequately charged, it can remain a business decision.

I will certainly agree that loans of this size to a single party (equivalent to about one-sixth of their October 2007 capital) should have attracted a concentration charge, on top of the regular charge for corporate debt. But this – the existence or lack thereof of concentration charges in capital requirements – is what we need to talk about, without jumping into mandatory exchange trading of CDSs!

Accrued Interest concludes:

Why not just make them reserve a larger amount for this possibility up front? Efforts to start an exchange would begin the next day.

Well … maybe. To the extent that the exchange’s clearing-house’s credit would be better than the sum of its sponsoring parts, it is entirely reasonable to suppose that $1-billion exposure to a clearing-house would be charged at less than 10x$100-million to its individual members. It may also be assumed that netting and novation will be facilitated with a clearing house, which will further reduce exposure.

Whether or not the improvement in credit quality and consequent (we hope) reduction in capital requirements balances the guaranteed extra costs and reduced flexibility implied by a clearing-house is something that can be discussed … and the decision regarding institutional participation in such a scheme becomes just another business decision. But let’s see some numbers first.

Update, 2008-5-28: Naked Capitalism reprints a Financial Times rumour of an announcement tomorrow. This will, as far as I can tell, make formal a proposal aired in April that has been well reported:

“There is not one element that is going to solve all the problems, but it is one piece of the puzzle that will help us create a more robust framework. The timing is right – whether it will be successful or not, only time will show,” says Athanassios Diplas, chief risk officer and deputy chief operating officer, global credit trading, at Deutsche Bank, speaking at Isda’s twenty-third annual general meeting in Vienna on April 17.

The initial focus of those involved in the discussions has been on index products. Over time, efforts will extend to single-name CDSs. According to Diplas, this will remove risk from the system and the worry that the failure of one dealer could cause a hazardous shock in the market.

No details were given on a time frame for when a central clearing house would be established, but Diplas says the admission criteria for participants would be strict. “The criteria will take into account how well capitalised the firm is, how the risk is dealt with, how the variation margins are going to be posted and what the expected gap risk is going to be. All these issues have to be dealt with carefully – we are not going to jump into something unless we are very confident it will work.”

Update, 2008-6-19: See the market update of June 9 for news of how the proposal is moving along. Accrued Interest has posted another good piece about CDS clearing and exposures.

Regulatory Capital

BNS Capitalization : 2Q08

BNS has released its Second 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:

BNS Capital Structure
October, 2007
& April, 2008
  4Q07 2Q08
Total Tier 1 Capital 20,225 21,073
Common Shareholders’ Equity 81.5% 83.9%
Preferred Shares 8.1% 10.5%
Innovative Tier 1 Capital Instruments 13.6% 13.0%
Non-Controlling Interests in Subsidiaries 2.5% 2.8%
Goodwill -5.6% -10.3%

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

BNS
Tier 1 Issuance Capacity
October 2007
& April 2008
  4Q07 2Q08
Equity Capital (A) 15,840 16,113
Non-Equity Tier 1 Limit (B=A/3), 4Q07
(B=0.428*A), 2Q08		 5,280 6,896
Innovative Tier 1 Capital (C) 2,750 2,750
Preferred Limit (D=B-C) 2,530 4,146
Preferred Actual (E) 1,635 2,210
New Issuance Capacity (F=D-E) 895 1,936
Items A, C & E are taken from the table
“Regulatory Capital”
of the supplementary information;
Note that Item A includes Goodwill, FX losses, “Other Capital Deductions” and non-controlling interest

Item B is as per OSFI Guidelines; the limit was recently increased.
Items D & F are my calculations

and the all important Risk-Weighted Asset Ratios!

BNS
Risk-Weighted Asset Ratios
October 2007
& April 2008
  Note 2007 2Q08
Equity Capital A 15,840 16,113
Risk-Weighted Assets B 218,300 218,900
Equity/RWA C=A/B 7.26% 7.36%
Tier 1 Ratio D 9.3% 9.6%
Capital Ratio E 10.5% 11.7%
Assets to Capital Multiple F 18.22x 17.68x
A is taken from the table “Issuance Capacity”, above
B, D & E are taken from BNS’s Supplementary Report
C is my calculation.
F is from OSFI (4Q07) and BNS’s Supplementary Report (2Q08) of total assets ($452.6-billion) divided by total capital ($25.588-billion)
New Issues

New Issue: BNS Perp Fixed-Reset-Floater (+170bp)

BNS has announced another issue, similar in structure to their March issuance.

Issue Name: Non-cumulative 5-Year Rate Reset Preferred Shares Series 20

Amount: 12-million shares @ $25 = $300-million

Greenshoe: 2-million shares (= $50-million) up to 48 hours before closing

Initial Rate: 5.00%, quarterly, until 2013-10-25 pay-date.

Reset: Resets every five years to 5-Year Canadas + 170bp, determined 30 days prior to the first day of a reset period.

Exchange: Exchangeable on every reset date to Series 21 (the Floaters), which pays 90-day bills + 170bp

Redemption: Redeemable every Exchange Date at $25.00. Floaters are redeemable every Exchange Date at 25.00 and at $25.50 at all other times.

Priority: Parri Passu with all other preferreds, senior to common, junior to everything else.

Ratings: S&P: P-1(low); DBRS: Pfd-1; Moody’s: Aa3

None for me thanks! I’ve commented on this structure previously and don’t like the fact that I’m expected to take perpetual credit risk for 5-year rates. It’s just another attempt to finance long with pretend-short-term paper … which was a major contributing factor to the Credit Crunch. However … some people like ’em!

Update: Oops! Forgot the closing! As noted on Scotia’s Press Release:

The Bank has agreed to sell the Preferred Shares Series 20 to a syndicate of underwriters led by Scotia Capital Inc. on a bought deal basis. The Bank has granted to the underwriters an option to purchase up to an additional $50 million of the Preferred Shares Series 20 at any time up to 48 hours before closing.
Closing is expected to occur on or after June 10, 2008. This domestic public offering is part of Scotiabank’s ongoing and proactive management of its Tier 1 capital structure.

Regulatory Capital

BMO Capitalization : 2Q08

BMO has released its Second 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:

BMO Capital Structure
October, 2007
& April, 2008
  4Q07 2Q08
Total Tier 1 Capital 16,994 17,633
Common Shareholders’ Equity 83.8% 84.3%
Preferred Shares 8.5% 9.6%
Innovative Tier 1 Capital Instruments 14.3% 13.8%
Non-Controlling Interests in Subsidiaries 0.2% 0.2%
Goodwill -6.7% -7.9%

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

BMO
Tier 1 Issuance Capacity
October 2007
& April 2008
  4Q07 2Q08
Equity Capital (A) 13,126 13,499
Non-Equity Tier 1 Limit (B=A/3), 4Q07
(B=0.428*A), 2Q08		 4,375 5,778
Innovative Tier 1 Capital (C) 2,422 2,438
Preferred Limit (D=B-C) 1,953 3,340
Preferred Actual (E) 1,446 1,696
New Issuance Capacity (F=D-E) 507 1,644
Items A, C & E are taken from the table
“Capital and Risk Weighted Assets”
of the supplementary information;
Note that Item A includes Goodwill and non-controlling interest

Item B is as per OSFI Guidelines; the limit was recently increased.
Items D & F are my calculations

and the all important Risk-Weighted Asset Ratios!

BMO
Risk-Weighted Asset Ratios
October 2007
& April 2008
  Note 2007 2Q08
Equity Capital A 13,126 13,499
Risk-Weighted Assets B 178,687 186,252
Equity/RWA C=A/B 7.35% 7.24%
Tier 1 Ratio D 9.51% 9.42%
Capital Ratio E 11.74% 11.64%
Assets to Capital Multiple F 17.17x 16.22x
A is taken from the table “Issuance Capacity”, above
B, D & E are taken from BMO’s Supplementary Report
C is my calculation.
F is from OSFI (4Q07) and BMO’s Supplementary Report (2Q08)
Miscellaneous News

Toronto Life Article on David Berry

As mentioned briefly yesterday, Toronto Life has a cover story on the David Berry Affair [Link updated 2013-1-16], which has been the topic of many posts on PrefBlog, the most recent dedicated post being David Berry Wins a Round.

There are many details of his personal life, but some information that is new to me.

For instance, it would appear that Cecilia Williams, head of Scotia Capital’s compliance department is somewhat unfamiliar with institutional trading.

She wanted to know why he’d sold the stock to the client at a price that was about a dollar more than the closing price the day before.

The article does not indicate Berry’s reply. However, all Assiduous Readers of PrefBlog will know that the correct answer is: “Because I could.” Berry was not a retail stockbroker, buying 100 shares for Granny Oakum with a fiduciary obligation to get the client the best price. Berry was an institutional trader, trading with institutions as principal, with the objective of sweeping every available penny off the table and into his own P&L.

There’s more about Ms. Williams – apparently she purported to be upset about Berry’s referring to himself in the third person when explaining why his price was so awful, and was surprised to learn that this is standard industry practice.

Now, this is interesting, but not really too surprising. Regulation has nothing to do with protecting anybody; the purpose of regulation is to ensure that everybody is guilty of something.

Of more interest is that one of the former bosses is willing to testify on Berry’s behalf:

One is Andrew Cumming, who, until 2002, was Berry’s direct supervisor under Jim Mountain in his role as managing director and head of equity-related products at Scotia, and today is a consultant to a money management firm. Last summer, Cumming swore an affidavit in support of Berry’s lawsuit, claiming that he saw nothing wrong with how Berry was ticketing new issue shares.

Cumming is willing to testify that senior executives at Scotia had divulged the bank’s desire to catch Berry in “something like a securities violation so Scotia could use it against him”, to either severely reduce his compensation package or fire him.

Update, 2008-5-29: According to her Scotia Capital biography:

Cecilia holds an LL.B. from Osgoode Hall Law School and has spent most of her career in various aspects of compliance and regulation in the financial services industry. She joined Scotia Capital from CIBC where she was Vice-President of Business Controls for the Imperial Service and Private Wealth Management businesses. Prior to that, Cecilia was Executive Director, Head of Legal and Compliance for UBS Bank/UBS Trust (Canada). Cecilia also previously held the positions of Director of Regulatory and Market Policy for The Toronto Stock Exchange and Senior Counsel, Derivatives with the Ontario Securities Commission.

Dates are a little hard to come by, but on 1999-2-26, she was Director of Regulatory and Market Policy at the TSX. On March 1, 2002, the Regulatory and Market Policy division was transferred holus-bolus to Regulation Services.

By 2005-4-22 she was with Scotia.

She currently sits on the RS Rules Advisory Committee.

I will emphasize that, in the incestuous world of finance (and I assume that the world of finance regulation is even more incestuous: David Berry’s lawyer, Linda Fuerst (who has also acted for me), got her start with the OSC) mere previous employment with an organization does not imply any conflict of interest or special influence afterwards; and mere conflict of interest or special influence does not imply any material conflict of interest or special influence. But this sort of thing doesn’t look good – particularly if Ms. Williams is in a position to influence hiring and compensation decisions. Revolving Door Regulation!

Update, 2008-6-5: An Assiduous Reader sends me a link to the on-line story.

Press Clippings

PrefBlog, inter alia, mentioned in Financial Post

Hugh Anderson has a column in today’s Financial Post, Clear Thinking for Smart Investing :

Above all, you need to understand clearly who has the upper hand in the never-ending tussle between issuer and buyer. The answer revolves around the ability of the issuer to terminate the investment at its option. Naturally, this almost always occurs at the best time for the issuer. That’s why James Hymas terms the yield to call the “yield to worst.”

Hymas owns Hymas Investment Management … one of the few easily available sources of comment and key data on the Canadian preferred market. He writes a monthly subscription newsletter, makes available detailed data on a selection of preferred issues at www.prefinfo.com and writes a blog (www.prefblog.com) about what’s going on in the preferred market.

Hymas’s writing is refreshingly candid, Buffett-style. He describes as “monumental bad timing” and “the greatest mistake of my professional life” his brief employment at Portus Alternative Asset Management three months before “the roof fell in.” Portus collapsed because of regulatory problems “over which he had no control”.

The website reported for Hymas Investment Management in the article is incorrect and I’ve removed it with ellipsis in the quotation. The correct website is www.himivest.com.

I should clarify that Yield-to-Worst is a technical, not a pejoritive, term. There is more than one yield to call … a perpetual has an infinite number of potential calls, although the difference between a call at $25 on November 27, 2185, and a call at $25 on November 28, 2185, might be considered negligible!

The Yield-to-Worst is the lowest yield that can result from the issuer exercising its privileges while honouring its responsibilities, and one of the choices is the possibility that the issue is not called at all. It is a much better predictor of performance than current yield, as further explained in my article A Call, too, Harms.

It’s nice to see my writing described as “refreshingly candid, Buffet-style” … but geez, there’s good old Portus being mentioned again. That, unfortunately, will be a millstone around my neck for the rest of my life – even though I have never even been accused of wrong-doing.

Market Action

May 26, 2008

Memorial Day in the US … very little interesting news!

The chatter regarding the SocGen / Kerviel fiasco continues:

“It validates what Jerome has said,” Guillaume Selnet, Kerviel’s defense lawyer, said yesterday in a telephone interview. “The only possible explanation is negligence, individual and systemic negligence.”

The full SocGen report is available via the SocGen Press Releases page. The report itself is illuminating. Essentially, their bookkeeping procedures did not produce exception reporting, or have adequate drill-down capability. Gross incompetence – an accident waiting to happen.

The report, while publicly available, has been encrypted to make extracts hard – I can only imagine they don’t want their various howlers discussed too readily! However, I’ll retype:

Furthermore, the Futures Back Office did not identify the significant frequency of cash complements paid in order to meet deposit requirements as such supervision is not within its mandate. Between January 1 and 18, 2008, in the absence of a sufficient quantity of bonds to cover an IMR requirement undergoing strong growth due to JK’s activities, the Futures Back Office paid a cash complement of over EUR 500 million on five occasions in order to meet deposit requirements, as opposed to one such payment made during 2007 (on March 13, 2007 for a total of EUR 699 million). In the absence of any supervision and of any alert threshold for cash amounts paid as deposits in the procedures in place at that time, Back Office failed to detect the substantial increase in cash payments made under IMR from January 2008 onward. Back Office in fact makes a global cash payment, including by currency and by clearer, other than the deposit paid in cash, margin calls, commissions and interest payments. The controls concern solely any discrepencies between the amounts claimed by the clearer and those calculated by the SG accounting system (GMI/clearer reconciliation). But it is not Back Office’s role to carry out checks on the consistency of the amounts concerned.

Finally, the detailed breakdown of the collateral re-invoicing by GOP, which should have allowed the abnormally high amounts to be identified, was not sent to JK’s direct heirarchal superiors. GOP 2A represented 10% on average of the re-invoicing of the securities deposit financing paid by GEDS to FIMAT Frankfurt since April 2007 (see Table no. 1). This re-invoicing is carried out on a monthly basis by the Securities treasury Middle Office on a pro rata basis in the form of an Excell spreadsheet to the GEDS/TRD manager only (who became GEDS manager on December 18, 2007), i.e. to JK’s L+5, a level which is too high for such data to be analyzed in detail. The DLP and DELTA ONE desk managers (JK’s L+1 and L+2 respectively), who could have identified this significant level of GOP 2A deposit expenditure, directly visible on such re-invoicing statement, were not recipients of this spreadsheet.

In other words, no accountability, no risk management, no brains at all. I’d say the onus is on senior management at this point to show that they should retain their jobs.

Michael J. Orlando, formerly of the Kansas City Fed, has written a piece for VoxEU: Let Form Follow Function: In Defense of Central Bank Independence. Somewhat cursory, but the basic assertion is sound:

Finally, recent events have demonstrated that the Fed may find it necessary to employ new and innovative approaches to target liquidity injections in times of crisis. For example, on December 12 the Fed established a new program to allow discount window borrowers to bid for additional liquidity extended for a fixed period of time. On March 11, the Fed established a program to lend U.S. Treasury securities against a pledge of other, presumably lower quality assets. And on March 16, the Fed initiated another new program to lend directly to primary dealers of government securities. Along with the Fed-arranged marriage between Bear Stearns and JPMorgan Chase, these programs merit continued debate and analysis. However, it is not obvious that the Fed’s ability to respond to this crisis in a timely and effective manner would be enhanced by more immediate legislative or executive oversight.

Willem Buiter disappoints me today with a rather breathtaking “therefore”:

Fundamentally, the key asymmetry is that the authorities are unable or unwilling, whether for good or bad reasons does not matter here, to let large leveraged financial institutions collapse. There is no matching inclination to expropriate or otherwise financially punish or restrain highly profitable financial institutions. This asymmetry has to be corrected. Therefore, any large leveraged financial institution, commercial bank, investment bank, hedge fund, private equity fund, SIV, Conduit or whatever it calls itself, whatever it does and whatever its legal form, will have to be regulated according to the same principles.

Dr. Buiter’s policy aim with this recommendation is, I’m afraid, not particularly clear to me. Additionally, I don’t see a lot of support for his premise that authorities are “unable or unwilling … to let large leveraged financial institutions collapse”. One may quibble over definitions, but I don’t think shareholders of Bear Stears are in 100% agreement with this assertion; neither are the beneficiaries of Carlyle’s leveraged mortgage fund or Amaranth – to name but two.

Protect the core, by all means! But to make all financial institutions as safe as the banks would be contrary to the ultimate public good.

Today’s BCE news (hat tip: Financial Webring Forum) is that the Supreme Court will move quickly on the BCE file:

Canada’s Supreme Court has agreed to speed up the process of deciding whether to hear BCE Inc.’s appeal of a lower court decision that threw the company’s $35-billion planned sale to a group of private-equity funds into doubt.

BCE had requested an expedited process to enable the company to try to stick to a plan to close the deal by June 30.

If leave to appeal is granted, the court said it will hear the case starting on June 17, with each side getting one hour for oral arguments.

Such excitement! There’s not just BCE news, but there’s Barry Critchley has asked a rather important question about the David Berry issue (emphasis added):

The current edition of Toronto Life has a major article on Berry that focuses on his time at Scotia — where he was the firm’s highest-paid employee — his $100-million lawsuit against his former employer and regulatory issues he is facing. Berry, his former associate Mark McQuillen and Scotia all faced allegations brought by Market Regulation Services: the latter two settled while Berry opted for a contested hearing.
…
Berry said the settlement materials are relevant and necessary because RS’s Discipline Notices “explicitly states that proceedings in respect of Scotia’s supervision of Berry and McQuillen were not taken by RS.

There is no information, however, that addresses why Scotia was not held responsible for failing to supervise Berry under [UMIR].”

Berry added that “the agreed facts in the settlement agreement entered into between RS and Scotia do not refer to Scotia’s supervisory obligations, and the agreed sanctions represent a simple disgorgement of financial benefits obtained by Scotia through Berry’s trading.”
…
When RS and Scotia settled, RS’s Maureen Jensen said, “We are pleased that Scotia Capital recognized in this settlement that, even though supervision was not an issue, it would not be appropriate to retain profits generated by the wrongdoing of its employees.” Which raises the question: Did Scotia get a special deal from RS?

It should be noted that it’s not too long ago that the Globe was oohing and ahhing over the fat paycheques handed out to dealers’ compliance staff … and RS was very proud of its role as a training ground. Why is revolving-door regulation permitted?

My last major post on the Berry issue was with respect to the OSC decision. There was some more detail given on May 23. Kerviel … Berry … motivations, methods and results were very different. But the basic issue is the same: does management have any responsibility at all to design a risk management system, use it and take responsibility for it? Or is it just there as an after-the-fact ass-covering and blame-casting device?

The market drifted slightly upwards today on light-ish volume.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.45% 4.47% 54,802 16.4 1 0.0000% 1,109.9
Fixed-Floater 4.85% 4.73% 65,899 15.97 7 -0.1163% 1,030.8
Floater 4.13% 4.18% 63,977 17.00 2 +0.2767% 914.1
Op. Retract 4.83% 2.70% 89,398 2.68 15 +0.0832% 1,056.1
Split-Share 5.25% 5.39% 69,692 4.15 13 -0.1095% 1,058.9
Interest Bearing 6.07% 6.06% 53,190 3.81 3 +0.4025% 1,116.4
Perpetual-Premium 5.87% 5.65% 133,951 3.35 9 +0.0837% 1,024.5
Perpetual-Discount 5.65% 5.70% 295,097 14.20 63 +0.0378% 928.0
Major Price Changes
Issue Index Change Notes
BAM.PR.M PerpetualDiscount -1.8329% Now with a pre-tax bid-YTW of 6.65% based on a bid of 18.21 and a limitMaturity.
BCE.PR.Z FixFloat -1.7316%  
Volume Highlights
Issue Index Volume Notes
GWO.PR.H PerpetualDiscount 54,700 Now with a pre-tax bid-YTW of 5.42% based on a bid of 22.71 and a limitMaturity.
PWF.PR.L PerpetualDiscount 52,355 Nesbitt crossed 50,000 at 23.10. Now with a pre-tax bid-YTW of 5.58% based on a bid of 23.07 and a limitMaturity.
PWF.PR.H PerpetualPremium 31,350 Nesbitt was on the buy side of the day’s last seven orders, totalling 30,400 and including a cross of 25,000 at 25.25. Now with a pre-tax bid-YTW of 5.65% based on a bid of 25.22 and a call 2012-1-8 at 25.00.
RY.PR.B PerpetualDiscount 30,600 Desjardins crossed 25,000 in two tranches at 21.20. Now with a pre-tax bid-YTW of 5.59% based on a bid of 21.16 and a limitMaturity.
CM.PR.P PerpetualDiscount 29,300 Scotia crossed 25,000 at 23.45. Now with a pre-tax bid-YTW of 5.91% based on a bid of 23.40 and a limitMaturity.

There were thirteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Regulatory Capital

RY : Assets-to-Capital Multiple of 22.05 for 1Q08

Assiduous Readers will recall the post on the Assets to Capital Multiple and my correspondence with Royal Bank’s Investor Relations department:

Well! This is interesting! According to these very, very rough calculations, RBC has an Assets-to-Capital multiple of 23.3:1, which is both over the limit and well above its competitors. This may be a transient thing … there was a jump in assets in the first quarter:

RBC: Change in Assets
From 4Q07 to 1Q08
Item Change ($-billion)
Securities +6
Repos +12
Loans +8
Derivatives +7
Total +33

I have sent the following message to RBC via their Investor Relations Page:

I would appreciate learning your Assets-to-Capital multiple (as defined by OSFI) as of the end of the first quarter, 2008, and any detail you can provide regarding its calculation.

I have derived a very rough estimate of 23.3:1, based on total assets of 632,761 and total regulatory capital of 27,113

Update, 2008-04-17: RBC has responded:

Thank you for your question about our assets to capital multiple (ACM). In keeping with prior quarter-end practice, we did not disclose our ACM in Q1/08 but were well within the OSFI minimum requirement. Our ACM is disclosed on a quarterly basis (with a 6-7 week lag) on OSFI’s website. We understand this should be available over the next few days. Below is an excerpt from the OSFI guidelines outlining the calculation of the ACM. We hope this helps.

The supplied excerpt from the guidelines was:

From OSFI Capital Adequacy Requirements (No. A-1)

1.2. The assets to capital multiple

Institutions are expected to meet an assets to capital multiple test. The assets to capital multiple is calculated by dividing the institution’s total assets, including specified off-balance sheet items, by the sum of its adjusted net tier 1 capital and adjusted tier 2 capital as defined in section 2.5 of this guideline. All items that are deducted from capital are excluded from total assets. Tier 3 capital is excluded from the test.

Off-balance sheet items for this test are direct credit substitutes1, including letters of credit and guarantees, transaction-related contingencies, trade-related contingencies and sale and repurchase agreements, as described in chapter 3. These are included at their notional principal amount. In the case of derivative contracts, where institutions have legally binding netting agreements (meeting the criteria established in chapter 3, Netting of Forwards, Swaps, Purchased Options and Other Similar Derivatives) the resulting on-balance sheet amounts can be netted for the purpose of calculating the assets to capital multiple.

Under this test, total assets should be no greater than 20 times capital, although this multiple can be exceeded with the Superintendent’s prior approval to an amount no greater than 23 times. Alternatively, the Superintendent may prescribe a lower multiple. In setting the assets to capital multiple for individual institutions, the Superintendent will consider such factors as operating and management experience, strength of parent, earnings, diversification of assets, type of assets and appetite for risk.

1. When an institution, acting as an agent in a securities lending transaction, provides a guarantee to its client, the guarantee does not have to be included as a direct credit substitute for the assets to capital multiple if the agent complies with the collateral requirements of Guideline B-4, Securities Lending.

I’ve been checking the OSFI disclosures page fairly regularly and today was rewarded with the actual data. As of 1Q08, Royal Bank had:

RY Capital Adequacy, 1Q08
Tier 1 Ratio 9.77%
Total Ratio 11.24%
Assets to Capital Multiple 22.05

Well! Here’s a howdy-do! I’ve been puzzling for some time as to how my approximate calculation could be so different from the sub-20 multiple that I assumed was actually reported! I’m glad to see that backs of envelopes still serve some purpose.

I have sent the following query to Royal’s Investor Relations department:

Sirs,

I am most interested to learn that your ACM was 22.05 as of 1Q08.

When did you seek approval from OSFI to exceed 20.0, and what was the rationale for exceeding the normal guideline?

Sincerely,

Incidentally … PrefBlog’s Scary Number Department recommends a glance at the “BCAR Derivative Components” figure. RY has nearly 3.4-trillion in interest-rate swaps outstanding and nearly 414-billion in credit swaps. The total notional for all derivatives is about 5.3-trillion.

Given that RY’s Total Capital Ratio (based on Risk Weighted Assets) is close to that of the other banks, the implication is that RY has greater total exposure with a small average risk weight. I’ll try to have a look at this shortly.

Update: I have also sent an inquiry to OSFI:

I was most interested to learn that Royal Bank had an Assets-to-Capital ratio of 22.05 as of the 1Q08 filing.

It is my understanding that the general maximum allowed by OSFI for this ratio is 20.0, which may be increased to 23.0 upon prior application to the Superintendant.

Is this correct? If so, then:

(a) When did Royal Bank apply to have the maximum increased?

(b) On what grounds did the Superintendant allow the increase?

(c) Were any terms, conditions, or time limits attached to the approval?

Sincerely,

Update, 2008-6-5: I have not received a response from RY Investor Relations. I have received a reply from OSFI:

Thank you for your e-mail of May 26, 2008, concerning the assets to capital ratio for banks.

You are correct that under the assets to capital test, total assets should be no greater than 20 times capital, although this multiple can be exceeded with the Superintendent’s prior approval to an amount no greater than 23 times. Further information on this ratio can be found in Section 1.2 of the Capital Adequacy Guideline (http://www.osfi-bsif.gc.ca/app/DocRepository/1/eng/guidelines/
capital/guidelines/CAR_A_e.pdf).

In response to the second part of your enquiry, you may wish to note that pursuant to section 22 of the Office of the Superintendent of Financial Institutions Act, any information that is obtained by the Superintendent regarding the business or affairs of a federally regulated financial institution (FRFI), or regarding persons dealing with the FRFI, or any person acting under the direction of the Superintendent, is to be treated as confidential and may not be disclosed to a third party.

Thank you for taking the time to write to this Office with your questions.

Issue Comments

FAL.PR.B : Correction to PrefInfo

It has been brought to my attention that the redemption provisions for FAL.PR.B as listed on PrefInfo are incorrect. The following description is provided in the Falconbridge Annual Report for 2004, available on SEDAR, filing date March 23, 2005:

Holders of Preferred Share Series 3 are entitled to fixed cumulative preferential cash dividends, as and when declared by the Board of Directors, which accrue from March 1, 2004. The dividends are payable quarterly on the first day of March, June, September, and December in the amount of Cdn$0.2863 per share or Cdn$1.1452 per share per annum until March 1, 2009. The Preferred Share Series 3 are not redeemable prior to March 1, 2009. The Preferred Share Series 3 will be redeemable on March 1, 2009 and on March 1 every fifth year thereafter, in whole but not in part, at the Corporation’s option, at Cdn$25.00 per share, together with accrued and unpaid dividends up to but excluding the date of redemption. Holders of Preferred Share Series 3, upon giving notice, will have the right to convert on March 1, 2009, and on March 1 in every fifth year thereafter, their shares into an equal number of Preferred Share Series 2, subject to the automatic conversion provisions.

PrefInfo will be corrected shortly.

Update: PrefInfo has been corrected. Note that it is listed as having a potential redemption at par 2009-3-1, and a redemption forever afterwards at 25.50. This is not strictly correct, but it is the best representation I can think of for analytical purposes: the assumption is made that on reset date, the five-year fixed rate is so awful, conversion into the floater is effectively forced – this is reflected in the presumed post-reset dividend rate. The floater (FAL.PR.A) is always redeemable at 25.50.

As has been previously noted, FAL.PR.A and FAL.PR.H will soon be redeemed. FAL.PR.B will remain outstanding, but redemption of FAL.PR.A implies that Xstrata intends to redeem it next March 1. Intends. Implies. My interpretation carries no guarantees.

Update: See also previous post regarding FAL.PR.B