I was interested enough in the banks’ capital structures to extend the table:
|Tier One Capital of the Canadian Big 5 Banks
(From October 31, 2006 Financial Statements)
|Total Tier 1 Capital (millions)||21,478||20,109||17,079||16,641||11,935|
|Common Shareholders’ Equity||98.1%||84.3%||112.0%||86.9%||83.2%|
|Innovative Tier 1 Capital Instruments||15.0%||14.9%||7.3%||13.2%||0.0%|
|Non-controlling interests in subsidiaries||0.1%||2.2%||14.0%||0.2%||0.0%|
So there’s a wide variation in reliance upon preferred shares, to say the least! To continue this investigation, we should look at the ranking of preferred shares relative to Innovative Tier 1 Capital … are they junior, senior, or parri passu?
For the sake of an example, I looked at the prospectus for the RY.PR.E new issue:
Rights on Liquidation
In the event of our liquidation, dissolution or winding-up, the holders of the Series AE Preferred Shares will be entitled to receive $25.00 per share, together with all dividends declared and unpaid to the date of payment, before any amount may be paid or any or our assets distributed to the registered holders of any shares ranking junior to the Series AE Preferred Shares. The holders of the Series AE Preferred Shares will not be entitled to share in any further distribution of our assets.
Restrictions on Dividends and Retirement of Shares
So long as any of the Series AE Preferred Shares are outstanding, we will not, without the approval of the holders of the Series AE Preferred Shares:
- pay any dividends on any second preferred shares, any common shares or any other shares ranking junior to the Series AE Preferred Shares (other than stock dividends in any shares ranking junior to the Series AE Preferred Shares); or
- redeem, purchase or otherwise retire any second preferred shares, any common shares or any other shares ranking junior to the Series AE Preferred Shares (except out of the net cash proceeds of a substantially concurrent issue of shares ranking junior to the Series AE Preferred Shares); or
- redeem, purchase or otherwise retire less than all the Series AE Preferred Shares; or
- except pursuant to any purchase obligation, sinking fund, retraction privilege or mandatory redemption provision attaching to any series of preferred shares, redeem, purchase, or otherwise retire any other shares ranking on a parity with the Series AE Preferred Shares;
unless all dividends up to and including the dividend payment date for the last completed period for which dividends are payable have been declared and paid, or set apart for payment, in respect of each series of cumulative first preferred shares then issued and outstanding and all other cumulative shares ranking on a parity with the first preferred shares and we have paid, or set apart for payment, all declared dividends in respect of each series of non-cumulative first preferred shares (including the Series AE Preferred Shares) then issued and outstanding, and on all other non-cumulative shares ranking on a parity with the first preferred shares. See “Bank Act Restrictions” in the prospectus.
Now lets look at a recent issue of Innovative Tier 1 Capital : RBC TruCS – Series 2015. These are sold as, and trade as, bonds with a maturity in 2015, with a spread to regular bonds due to the fact that non-repayment in 2015 is an unpleasant event for the bank, but is not actually a default:
On each Regular Distribution Date following December 31, 2015, the Indicated Distribution per RBC TruCS — Series 2015 will be determined by multiplying $1,000 by one half of the sum of the Bankers’ Acceptance Rate (as herein defined) for the Distribution Period (as herein defined) immediately preceding such Distribution Date plus 150 basis points.
Pursuant to the terms of a Bank Share Exchange Trust Agreement between the Bank, the Exchange Trustee (as defined herein) and the Trust (the ‘‘Bank Share Exchange Agreement’’), the Bank has covenanted for the benefit of holders of RBC TruCS — Series 2015 (the ‘‘Dividend Stopper Undertakings’’) that if, on any Regular Distribution Date, the Trust fails to pay the Indicated Distribution in full on the RBC TruCS — Series 2015, the Bank will not declare dividends of any kind on any preferred shares or common shares of the Bank (the ‘‘Bank Common Shares’’ and collectively with preferred shares, the ‘‘Dividend Restricted Shares’’) until the month commencing immediately after the third Dividend Declaration Month (as defined herein) following the Trust’s failure to pay the Indicated Distribution unless the Trust first pays such Indicated Distribution (or the unpaid portion thereof) to holders of RBC TruCS — Series 2015. It is in the interest of the Bank to ensure, to the extent within its control, that the Trust pay the Indicated Distribution on the RBC TruCS — Series 2015 on each Regular Distribution Date so as to avoid triggering the Dividend Stopper Undertakings.
Each RBC TruCS — Series 2015 will be exchanged automatically (the ‘‘Automatic Exchange’’), without the consent of the holder, for 40 newly issued non-cumulative, perpetual First Preferred Shares, Series Z of the Bank (‘‘Bank Preferred Shares Series Z’’) if: (i) an application for a winding-up order in respect of the Bank pursuant to the Winding-Up and Restructuring Act (Canada) is filed by the Attorney General of Canada or a winding-up order in respect of the Bank pursuant to that Act is granted by a court; (ii) the Superintendent of Financial Institutions (Canada) (the ‘‘Superintendent’’) advises the Bank in writing that the Superintendent has taken control of the Bank or its assets pursuant to the Bank Act (Canada) (the ‘‘Bank Act’’); (iii) the Superintendent advises the Bank in writing that the Superintendent is of the opinion that the Bank has a riskbased Tier 1 Capital ratio of less than 5.0% or a risk-based Total Capital Ratio of less than 8.0%; (iv) the Board of Directors advises the Superintendent in writing that the Bank has a risk-based Tier 1 Capital ratio of less than 5.0% or a risk-based Total Capital Ratio of less than 8.0%; or (v) the Superintendent directs the Bank pursuant to the Bank Act to increase its capital or provide additional liquidity and the Bank elects to cause the Automatic Exchange as a consequence of the issuance of such direction or the Bank does not comply with such direction to the satisfaction of the Superintendent within the time specified therein (each, a ‘‘Loss Absorption Event’’).
The Bank Preferred Shares Series Z will pay semi-annual, non-cumulative per share cash dividends, as and when declared by the Board of Directors on the last day of June and December in each year (subject to adjustment on the first such payment date if the Bank Preferred Shares Series Z have been issued and outstanding for less than six months), equal to $0.60625.
The RBC TruCS — Series 2010, the RBC TruCS — Series 2011 and the RBC TruCS — Series 2015 rank pari passu on the distribution of the property of the Trust in the event of a termination of the Trust (together with the Bank as sole holder of the Special Trust Securities) and rank pari passu in respect of the Indicated Distributions payable on each series of RBC TruCS.
So the Series Z preferreds carry an indicative dividend of 4.85% of par, paid semi-annually (not quarterly!). That’s a reasonable rate, considering the date of issue. Certainly nothing extraordinary.
Now here’s something that will sound very familiar!
The Bank Preferred Shares Series Z will not be redeemable prior to December 31, 2010. On and after December 31, 2010, but subject to the provisions of the Bank Act and the prior approval of the Superintendent and the provisions described below under ‘‘Description of the Bank Preferred Shares Series Z — Restrictions on Dividends and Retirement of Shares’’, the Bank may redeem at any time all, or from time to time any part, of the outstanding Bank Preferred Shares Series Z, at the Bank’s option without the consent of the holder, by the payment of an amount in cash for each such share so redeemed equal to (i) $26.00 per share if redeemed on or prior to December 31, 2011; (ii) $25.75 per share if redeemed after December 31, 2011 and on or prior to December 31, 2012; (iii) $25.50 per share if redeemed after December 31, 2012 and on or prior to December 31, 2013; (iv) $25.25 per share if redeemed after December 31, 2013 and on or prior to December 31, 2014; or (v) $25.00 per share if redeemed after December 31, 2014, plus, in each case, all declared and unpaid dividends up to but excluding the date fixed for redemption.
And in addition there is language describing the Series Z that is substantially identical to the “Restrictions on Dividends and Retirement of Shares” for the Series E Preferreds, above.
Now let’s look at the redemption provisions for the TruCS:
Upon the occurrence of a Tax Event or a Capital Disqualification Event, in each case prior to December 31, 2010, the RBC TruCS — Series 2015 will be redeemable by the Trust at its option in whole (but not in part) without the consent of the holders thereof, upon at least 30 and not more than 90 days’ prior written notice by the Trustee and with Superintendent Approval for a cash amount per RBC TruCS — Series 2015 equal to the Early Redemption Price, being the greater of: (i) the Redemption Price; and (ii) a price per RBC TruCS — Series 2015 calculated to provide an annual yield thereon to December 31, 2015 equal to the Government of Canada Yield plus 0.195% determined on the Business Day immediately preceding the date on which the Trust has given notice of the redemption of the RBC TruCS — Series 2015 as a consequence of the exercise of the Trust Special Event Redemption Right plus the Unpaid Indicated Distribution (the ‘‘RBC TruCS — Series 2015 Canada Yield Price’’).
On December 31, 2010 and on any Distribution Date thereafter, the Trust may, at its option, redeem the RBC TruCS — Series 2015 in whole (but not in part) without the consent of the holders thereof, upon at least 30 and not more than 60 days’ prior written notice and with Superintendent Approval, for a cash amount per RBC TruCS — Series 2015 equal to: (i) the Early Redemption Price if the redemption occurs prior to December 31, 2015; or (ii) the Redemption Price if the redemption occurs on or after December 31, 2015.
The “Redemption Price” is par value. These are good provisions – or, at least, relatively good provisions, if a buyer has to give up some call rights! Very often there are provisions in Eurobonds and related instruments that a change in tax law can lead to redemption at par. This is contrary to the interests of the holder, since it might mean he gives up capital gain if interest rates have fallen. However, this prospectus specifies that the worst redemption price will be at a spread to Canadas – and a profitable spread compared to issue price at that. I’m OK with that provision.
What does all this boil down to? After all, you must suspect that after all this quotation I’m going to get to the point eventually, right?
- The bank has some incentive to redeem the TruCS on the intended date of December 31, 2015. After this date, the interest payable on the TruCS changes to BAs + 150bp. Given current conditions, this is far more than the rate at which the bank could otherwise raise money, but this will not necessarily always be the case:
- The credit quality of the bank may have deteriorated to the point at which BAs + 150 bp is a pretty good deal. After all, prime is now 6.00% at RBC … BAs + 170 bp.
- The curve could get steeper. These bonds are perpetual. A 0-30 term spread of 150bp is by no means unheard of.
- I note that an RBC Floating Rate Note maturing in 2083 is quoted at 97bp over BAs.
- Income is better protected in the TruCS than in the Preferreds – if they stop paying interest on the TruCS, dividends on the prefs can’t be paid for about a year.
- Default on Principal has the same protection on TruCS as on preferreds. This assumes that default on principal will be preceeded by an automatic conversion of the TruCS to Series Z 1st preferreds, which are pari passu with regular preferreds.
And what does all this mean in terms of investment policy? Ah, for that you’ll have to wait for Part 3!