06 November 2006

Speculation on Possible Taxation of Tier 1 Eligible Trust Preferreds

BMO Capital Markets, 6 November 2006

There is some concern among treasurers of banks and insurers that the new income trust tax policy will result in their “trust preferreds” being taxable. In a worst-case scenario, these companies would lose access to a very cost-effective form of capital. y way of background, trust preferreds make up about 10% of Tier 1 of banks and insurers. These structures, which are used by financial institutions all around the world, are low cost and involve the issuer setting up a trust vehicle that holds mortgages or debentures. We are confident that it was not the government’s intent to tax these entities, but this could be an unintended consequence. The scale of the impact is small. Were these structures to be taxed, we estimate that it could cost banks and insurers about 1% of earnings. Note that the impact would not be felt until 2011 and there are several alternative funding options which could further reduce the impact. All institutions would be affected marginally, except for CIBC, which, by luck, has never issued any of these securities. We do not believe this is a material issue that should concern equity investors.
BMO Capital Markets, 6 November 2006

Speculation continues regarding the possible taxation of Tier 1 eligible trust preferred shares, and in a worst-case (and in our estimation low probability) scenario, there exists the potential that these instruments would lose their tax efficiency and be called as a result. We highlight that these securities are used by financial institutions globally as a tax-efficient source of Tier 1 capital, and that the tax changes announced last week certainly were not crafted with the intent of limiting bank and insurance company access to this form of capital. Additionally, any impact would not come into effect until 2011; therefore the timing of any potential impact remains unclear. We believe that any consequences would most likely be limited to so-called “loan-based” structures, and while only slightly material to financial institutions from an equity perspective, holders of affected debt could be the beneficiaries of an early call should capital trust securities be unintentionally caught up in last week’s surprise announcement.