Citigroup Global Markets, 20 March 2008
• Potential Capital Issuances — Based on our analysis and likely obligations to extend various forms of lending facilities, we think BMO, BNS, and RY likely to issue some form of capital to shore up balance sheet and regulatory capital ratios.
• On Average, Risk Weighted Assets Declined 5% — Implementation of Basel II reduced RWA by utilizing risk profile and activity. The reduction contributed to the average 40bp and 15bp gain in Tier 1 and Tier 2 Capital, respectively. TD benefited the most, RWA declined 11%; however, NA RWA increased 5%.
• Changes to the Components of Capital Reduced Capital an Average 4% — Using the new guidelines securitization gains are deducted and a smaller portion of the general allowance may be applied toward capital. Also, the banks have to deduct expected credit losses. To remain compliant 4 banks issued assorted capital.
• New Category, Operational Risk Contributed C$19B to RWA — Basel I did not incorporate operational risk. This new category significantly increased RWA. RY was the most impacted, +C$30B in RWA. However, the increase was offset by a 23% reduction in credit risk related RWA. Market risk related RWA increased 5% under Basel II.
• Bank Liquidity Ratios Depend on Value of Securities — If we assume the securities maintain the values on the balance sheet, as of Q108 the Canadian banks average a 41% liquidity ratio. The ratio declines to 31% if we assume valuations decline 35%. On average, the repo market contributes 25% to bank liquidity. Based on our analysis, NA is the most dependent on repo market.
Overview of Basel II and Liquidity Parameters
Basel II
The new framework for capital management and reporting, Basel II replaced Basel I which had been utilized for 20 years. The primary differences between Basel II and Basel I are:
• Introduction of Operational Risk
• Capital Requirements are based on Risk Profile vs. Volume by type
Liquidity / Funding
The state of the market since the 2H07 has created a liquidity crisis for certain financial institutions. Contributing to the effect are the credit concerns and significant valuation reductions to various securities. Market participants are unwilling to accept many of the structured instruments on bank balance sheets. The combined effect has led to a build up of cash on bank balance sheets as collateral for lending and as a component of regulatory capital.
Measures of Liquidity:
• Liquidity ratio – cash resources + securities as a percent of total assets. Provides a quick view on how easy assets can be converted into cash/cash substitutes to meet commitments
• Percentage of Securities borrowed/purchased under resale agreements – this component has had problems recently but typically can be used for commitments
• Core deposits – customer savings and deposits, fixed date deposits less than C$100k.
• Core deposits + Capital/Total Loans (excl reverse repos) ratio – Core funding reduces dependence on wholesale funding
• Assets to Capital Multiple – Gross adjusted assets divided by Total Capital. The OSFI regulated max is 20x, the regulator will allow up to 23x with special approvals.
As of Q108, the Canadian banks appear to be well capitalized. Many of them issued various forms of capital, most notably the nearly C$3B equity raise by CIBC. One of the primary risks to liquidity is reduced valuations of securities. Additional risks are: draw downs on credit facilities, liquidity facilities, and purchases of collateral for pledging.
Also of note are the debt maturities for the banks.
Asset to Capital Multiple
The regulatory guidelines for the asset to capital multiple are the multiple should not exceed 20x. With prior approval from the Office of the Superintendent of Financial Institutions, the multiple can be as high as 23x. In our view, this multiple will be challenged as the banks begin to build up their assets due to various liquidity or lending facilities. Royal has the highest of the banks and may need to issue capital to remain compliant.
Debt Securities on Balance Sheet
Based on size alone, Royal is the most exposed to foreign debt instruments, C$78B. However, given the massive size of Royal’s balance sheet, these asset comprise less than 15% of total assets. We are highlighting the amounts of “other” debt instruments on the balance sheet to shed some light on the magnitude of exposure for write downs. These securities are not issued or guaranteed by the Canadian government, province or municipality.
Comparison of Basel II to Basel I
Implementation of Basel II was widely expected to make regulatory capital ratios some what easier to achieve. However, the guidelines what is acceptable Tier 1 capital are more stringent and there are credit risk related deduction to capital. Combined, these impacts make it a tad more difficult to attain the regulatory ratios.
BMO
• Operational risk added C$16B to risk weighted assets
• The bank’s excess capital is C$2.2B, down from C$3.1B at YE07
• Assuming the same components, BMO can add a maximum of C$20B to RWA and maintain regulatory capital of Tier 1 8.5% and Total 10%.
CIBC
• The bank’s nearly C$3B capital issuance significantly shored up the regulatory ratios and excess capital for CM
• At C$6.1B, the bank has the second highest excess capital of the six bank reviewed.
• Assuming the same capital components, CM could add C$50B to risk weighted assets and remain compliant with Tier 1 of 8% and Total of 10.7%
National Bank
• National did not benefit to the same degree as the larger banks. National’s RWA increased 5%, due in part to the bank using the standardized approach for much of their metrics. The advanced internal risk rating method contributed to the reduction in RWA.
• The bank could add just under C$8B to the RWA and remain compliant
• Innovative trust securities were issued during Q108 to contribute to the regulatory capital
RBC
• Royal could add approximately C$25 in RWA and remain regulatory compliant assuming same capital components
• Royal did not provide Basel I results detail for Q108
Scotiabank
• Assuming the same components, BNS can add a maximum of C$3B to RWA and maintain regulatory capital of Tier 1 8.9% and Total 10%.
• Implementation of Basel II and q/q changes reduced excess capital to C$383 million from C$1.15B at year end. We would anticipate the bank would issue some form of capital to build its base.
• The bank benefited from a 21% reduction in credit RWA
TD Bank
• The most notable difference for TD is the placement of substantial investments as a component of Tier 1
• TD has solid capital ratios with excess capital over C$7B
• The bank has the capacity to add nearlyC$60B to its RWA and remain compliant. The stress for TD’s capital will come when the bank consolidates its most recent acquisition.
Liquidity
Overall liquidity levels at the banks appear sufficient. The key concern is the value of the securities on the balance sheet and any margin/collateral calls.
As Figure 10 details, Bank of Nova Scotia has the lowest liquidity ratio. The chart also shows the spike in liquidity maintained by National Bank of Canada during last summer’s Canadian ABCP crisis. As expected, National bank relies the most heavily on wholesale funding.
• Potential Capital Issuances — Based on our analysis and likely obligations to extend various forms of lending facilities, we think BMO, BNS, and RY likely to issue some form of capital to shore up balance sheet and regulatory capital ratios.
• On Average, Risk Weighted Assets Declined 5% — Implementation of Basel II reduced RWA by utilizing risk profile and activity. The reduction contributed to the average 40bp and 15bp gain in Tier 1 and Tier 2 Capital, respectively. TD benefited the most, RWA declined 11%; however, NA RWA increased 5%.
• Changes to the Components of Capital Reduced Capital an Average 4% — Using the new guidelines securitization gains are deducted and a smaller portion of the general allowance may be applied toward capital. Also, the banks have to deduct expected credit losses. To remain compliant 4 banks issued assorted capital.
• New Category, Operational Risk Contributed C$19B to RWA — Basel I did not incorporate operational risk. This new category significantly increased RWA. RY was the most impacted, +C$30B in RWA. However, the increase was offset by a 23% reduction in credit risk related RWA. Market risk related RWA increased 5% under Basel II.
• Bank Liquidity Ratios Depend on Value of Securities — If we assume the securities maintain the values on the balance sheet, as of Q108 the Canadian banks average a 41% liquidity ratio. The ratio declines to 31% if we assume valuations decline 35%. On average, the repo market contributes 25% to bank liquidity. Based on our analysis, NA is the most dependent on repo market.
Overview of Basel II and Liquidity Parameters
Basel II
The new framework for capital management and reporting, Basel II replaced Basel I which had been utilized for 20 years. The primary differences between Basel II and Basel I are:
• Introduction of Operational Risk
• Capital Requirements are based on Risk Profile vs. Volume by type
Liquidity / Funding
The state of the market since the 2H07 has created a liquidity crisis for certain financial institutions. Contributing to the effect are the credit concerns and significant valuation reductions to various securities. Market participants are unwilling to accept many of the structured instruments on bank balance sheets. The combined effect has led to a build up of cash on bank balance sheets as collateral for lending and as a component of regulatory capital.
Measures of Liquidity:
• Liquidity ratio – cash resources + securities as a percent of total assets. Provides a quick view on how easy assets can be converted into cash/cash substitutes to meet commitments
• Percentage of Securities borrowed/purchased under resale agreements – this component has had problems recently but typically can be used for commitments
• Core deposits – customer savings and deposits, fixed date deposits less than C$100k.
• Core deposits + Capital/Total Loans (excl reverse repos) ratio – Core funding reduces dependence on wholesale funding
• Assets to Capital Multiple – Gross adjusted assets divided by Total Capital. The OSFI regulated max is 20x, the regulator will allow up to 23x with special approvals.
As of Q108, the Canadian banks appear to be well capitalized. Many of them issued various forms of capital, most notably the nearly C$3B equity raise by CIBC. One of the primary risks to liquidity is reduced valuations of securities. Additional risks are: draw downs on credit facilities, liquidity facilities, and purchases of collateral for pledging.
Also of note are the debt maturities for the banks.
Asset to Capital Multiple
The regulatory guidelines for the asset to capital multiple are the multiple should not exceed 20x. With prior approval from the Office of the Superintendent of Financial Institutions, the multiple can be as high as 23x. In our view, this multiple will be challenged as the banks begin to build up their assets due to various liquidity or lending facilities. Royal has the highest of the banks and may need to issue capital to remain compliant.
Debt Securities on Balance Sheet
Based on size alone, Royal is the most exposed to foreign debt instruments, C$78B. However, given the massive size of Royal’s balance sheet, these asset comprise less than 15% of total assets. We are highlighting the amounts of “other” debt instruments on the balance sheet to shed some light on the magnitude of exposure for write downs. These securities are not issued or guaranteed by the Canadian government, province or municipality.
Comparison of Basel II to Basel I
Implementation of Basel II was widely expected to make regulatory capital ratios some what easier to achieve. However, the guidelines what is acceptable Tier 1 capital are more stringent and there are credit risk related deduction to capital. Combined, these impacts make it a tad more difficult to attain the regulatory ratios.
BMO
• Operational risk added C$16B to risk weighted assets
• The bank’s excess capital is C$2.2B, down from C$3.1B at YE07
• Assuming the same components, BMO can add a maximum of C$20B to RWA and maintain regulatory capital of Tier 1 8.5% and Total 10%.
CIBC
• The bank’s nearly C$3B capital issuance significantly shored up the regulatory ratios and excess capital for CM
• At C$6.1B, the bank has the second highest excess capital of the six bank reviewed.
• Assuming the same capital components, CM could add C$50B to risk weighted assets and remain compliant with Tier 1 of 8% and Total of 10.7%
National Bank
• National did not benefit to the same degree as the larger banks. National’s RWA increased 5%, due in part to the bank using the standardized approach for much of their metrics. The advanced internal risk rating method contributed to the reduction in RWA.
• The bank could add just under C$8B to the RWA and remain compliant
• Innovative trust securities were issued during Q108 to contribute to the regulatory capital
RBC
• Royal could add approximately C$25 in RWA and remain regulatory compliant assuming same capital components
• Royal did not provide Basel I results detail for Q108
Scotiabank
• Assuming the same components, BNS can add a maximum of C$3B to RWA and maintain regulatory capital of Tier 1 8.9% and Total 10%.
• Implementation of Basel II and q/q changes reduced excess capital to C$383 million from C$1.15B at year end. We would anticipate the bank would issue some form of capital to build its base.
• The bank benefited from a 21% reduction in credit RWA
TD Bank
• The most notable difference for TD is the placement of substantial investments as a component of Tier 1
• TD has solid capital ratios with excess capital over C$7B
• The bank has the capacity to add nearlyC$60B to its RWA and remain compliant. The stress for TD’s capital will come when the bank consolidates its most recent acquisition.
Liquidity
Overall liquidity levels at the banks appear sufficient. The key concern is the value of the securities on the balance sheet and any margin/collateral calls.
As Figure 10 details, Bank of Nova Scotia has the lowest liquidity ratio. The chart also shows the spike in liquidity maintained by National Bank of Canada during last summer’s Canadian ABCP crisis. As expected, National bank relies the most heavily on wholesale funding.
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Financial Post, Duncan Mavin, 20 March 2008
Blackmont Capital analyst Brad Smith put out a note about two of Canada’s banks that have been heading in opposite directions lately, and for once the most positive news came from Bank of Montreal – at least on the surface.
BMO earns some plaudits for restructuring two asset-backed commercial paper trusts known as Apex and Sitka, whose troubles had threatened to cost the bank $1.5-billion. But the nature of the restructured notes, BMO is now exposed to $1.35-billion or more of risk related to collateralized debt obligations (CDOs) linked to the trusts, Mr. Smith said.
At Toronto-Dominion Bank, which has been a top pick in the sector for many analysts as it has avoided the worst of the credit crunch, the news this week revolves around its acquisition of New Jersey-based Commerce Bancorp. The deal is set to close in the next couple of weeks and TD has announced that its newly acquired operations, merged with its existing TD Banknorth franchise, will be renamed TD Commerce bank — that seems like a smart idea given that Commerce has a strong brand presence in the U.S. and a reputation for high levels of customer service. It also makes sense because Banknorth has struggled to provide the sort of returns TD hoped for when it bought the Portland, Maine-based bank back in 2005.
But Mr. Smith notes that once the Banknorth brand is gone, there will be a good case for TD to scrap roughly $6-billion in related goodwill that is currently sitting on the bank’s balance sheet. As discussed in a Financial Post story in February, TD has more goodwill on its balance sheet than any of its Canadian competitors.
With Banknorth out, can a goodwill writedown be far behind, asks Mr. Smith.
Blackmont has “hold” ratings on both TD and BMO. Mr. Smith has a 12-month target price for TD of $63.00 and for BMO of $54.00
;
Blackmont Capital analyst Brad Smith put out a note about two of Canada’s banks that have been heading in opposite directions lately, and for once the most positive news came from Bank of Montreal – at least on the surface.
BMO earns some plaudits for restructuring two asset-backed commercial paper trusts known as Apex and Sitka, whose troubles had threatened to cost the bank $1.5-billion. But the nature of the restructured notes, BMO is now exposed to $1.35-billion or more of risk related to collateralized debt obligations (CDOs) linked to the trusts, Mr. Smith said.
At Toronto-Dominion Bank, which has been a top pick in the sector for many analysts as it has avoided the worst of the credit crunch, the news this week revolves around its acquisition of New Jersey-based Commerce Bancorp. The deal is set to close in the next couple of weeks and TD has announced that its newly acquired operations, merged with its existing TD Banknorth franchise, will be renamed TD Commerce bank — that seems like a smart idea given that Commerce has a strong brand presence in the U.S. and a reputation for high levels of customer service. It also makes sense because Banknorth has struggled to provide the sort of returns TD hoped for when it bought the Portland, Maine-based bank back in 2005.
But Mr. Smith notes that once the Banknorth brand is gone, there will be a good case for TD to scrap roughly $6-billion in related goodwill that is currently sitting on the bank’s balance sheet. As discussed in a Financial Post story in February, TD has more goodwill on its balance sheet than any of its Canadian competitors.
With Banknorth out, can a goodwill writedown be far behind, asks Mr. Smith.
Blackmont has “hold” ratings on both TD and BMO. Mr. Smith has a 12-month target price for TD of $63.00 and for BMO of $54.00
