Of Canada's five biggest banks, Toronto-Dominion Bank and Canadian Imperial Bank of Commerce expect to exercise so-called regulatory event redemption rights under guidelines pertaining to the phasing out of nonqualifying Basel III capital.
A regulatory event is defined as when innovative noncommon capital instruments no longer qualify as regulatory capital under the new Basel III rules that banks worldwide must adopt by 2019.
Toronto-Dominion said Monday that it "currently expects" to exercise a regulatory event redemption right "only in 2022" for any TD Capital Trust IV notes, Series 2, outstanding at that time. CIBC said it also expects to exercise a regulatory event "only in 2022" and only on its CIBC Capital Trust-issued Series B Innovative Tier 1 notes.
On Friday, Canada's regulator, the Office of the Superintendent of Financial Institutions, issued guidelines to clarify the phaseout of more than $70.8 billion of capital from 2013 to 2023 that under Basel III will no longer qualify as a buffer against a financial crisis.
The agency also urged the banks to redeem capital instruments at par on their regular par redemption data rather than buying them back because of a so-called regulatory event. The regulator also wanted the banks to disclose publicly if they are expected to exercise a capital redemption because of a regulatory event and to publish a schedule of when those redemptions might occur.
"We do not believe this will have a major impact on the earnings to common shareholders, as the instruments with regulatory event clauses do not appear to be a major part of the banks' capital structure," said Mario Mendonca, a Canaccord Genuity analyst, in a research note.
Beginning Jan. 1, 2013, capital instruments that no longer qualify as noncommon Tier 1 or Tier 2 under Basel III will be phased out. The initial phaseout for nonqualifying Tier 1 and Tier 2 instruments will be capped at 90% separately at Jan. 1, 2013, with the cap reducing at a rate of 10% annually.
The new Basel rules will force banks worldwide to hold thicker capital cushions and deeper pools of liquidity.
The near-term impact on the valuations of Canada's big banks is expected to be "quite limited" in part because of the decade-long transition phase, Peter Routledge, an analyst at National Bank Financial, said in a note. The incremental cost of improving the capital quality of Tier 2 instruments, the vast majority of which are subordinated debt, "will be quite manageable," he said.
In Canada, Tier 1 capital consists of common and preferred equity. Noncommon equity Tier 1 capital includes noncumulative preferred shares and innovative Tier 1 capital instrument liabilities, according to Canaccord Genuity. Tier 2 capital is mostly subordinated debt.
Royal Bank of Canada, Bank of Nova Scotia and Bank of Montreal all said Monday that based on their current analysis, they expect to manage the transition to Basel III without invoking the regulatory event redemption clause. As well, they will not be disclosing a regulatory event redemption schedule.
They all reserved the right to redeem, call or buy back any capital instruments within the terms of each offering.
"We have no economic incentive to use the regulatory event clause," said Gillian McArdle, an RBC spokeswoman.
BMO said its regulatory capital instruments include the bank's preferred shares and subordinated debt, innovative Tier 1 capital instruments issued by BMO Capital Trust and BMO Capital Trust II and innovative Tier 2 capital issued by the BMO subordinated note trust.
Dominion Bond Rating Service of Toronto said Monday there are no credit rating implications arising from the superintendent office's advisories.
