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:
| TD Capital Structure October, 2008 and January, 2009 |
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| 4Q08 | 1Q09 | |
| Total Tier 1 Capital | 20,679 | 21,320 |
| Common Shareholders’ Equity | 144.2% | 164.2% |
| Preferred Shares | 11.7% | 15.6% |
| Innovative Tier 1 Capital Instruments | 13.4% | 17.9% |
| Non-Controlling Interests in Subsidiaries | 0.1% | 0.1% |
| Goodwill | -73.3% | -78.3% |
| Miscellaneous | +3.9% | -19.4% |
| ‘Common Shareholders Equity’ includes ‘Common Shares’, ‘Contributed Surplus’, ‘Retained Earnings’, ‘FX net of Hedging’ and ‘Unrealized loss on AFS’ ‘Miscellaneous’ includes ‘Securitization Allowance’, ‘ALLL/EL shortfall’, ‘Substantial Investments’ and ‘Other’. ‘Reporting Lag’ is a wash |
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Next, the issuance capacity (from Part 3 of the introductory series):
| TD Tier 1 Issuance Capacity October 2008 & January 2009 |
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| 4Q08 | 1Q09 | ||
| Equity Capital | (A) | 15,489 | 14,179 |
| Non-Equity Tier 1 Limit | (B=0.666*A) | 10,326 | 9,443 |
| Innovative Tier 1 Capital | (C) | 2,765 | 3,821 |
| Preferred Limit | (D=B-C) | 7,561 | 5,622 |
| Preferred Actual | (E) | 2,425 | 3,320 |
| New Issuance Capacity | (F=D-E) | 5,136 | 2,302 |
| Items A, C & E are taken from the table “Regulatory Capital” of the supplementary information; Note that to calculate Item A I have included everything except preferred shares and innovative instruments Item B is as per OSFI Guidelines; the limit was recently increased. Note, however, that my calculations are based on ‘Adjusted net Tier 1 capital’, while the limit is based on ‘Net Tier 1 Capital’. The difference between the two is substantial and comprises essentially all of the ‘Misc.’ items in the ‘Capital Structure’ Table. Items D & F are my calculations |
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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!
| TD Risk-Weighted Asset Ratios October 2008 & January 2009 |
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| Note | 4Q08 | 1Q09 | |
| Equity Capital | A | 15,489 | 14,179 |
| Risk-Weighted Assets | B | 211,750 | 211,715 |
| Equity/RWA | C=A/B | 7.31% | 6.70% |
| Tier 1 Ratio | D | 9.8% | 10.1% |
| Capital Ratio | E | 12.0% | 13.6% |
| Assets to Capital Multiple | F | 19.3x | 16.9x |
| A is taken from the table “Issuance Capacity”, above B, D & E are taken from TD’s Supplementary Report C is my calculation. F is from Note 9 of the Earnings Release. |
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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 …