- Big six can fill gap by refinancing old debt, RBC estimates
- Cost of doing business set to rise across Canada as a result
Canadian banks are starting to get their share of the bill for global regulations designed to prevent a repeat of the taxpayer funded bailouts of the 2008 financial crisis.
Over the next five years the nation’s six-largest banks will need to convert C$152 billion ($114 billion) of capital into securities that can be used as a shock absorber during a crisis, according to estimates from Royal Bank of Canada. That pales in comparison with the $1.2 trillion tab the world’s biggest lenders face, but the Canadians are unusual in that they never needed rescuing in the first place.
While RBC predicts much of the capital, which is designed to shift risk to investors from taxpayers, can be met simply by replacing maturing debt with the new types of securities, the market is signaling banks will have to pay up to do it, raising the cost of doing business -- possibly across the entirety of the Canadian economy.
"The Canadian banks are like any other bank, they will now have to figure out how to reprice every service they provide," said James Dutkiewicz, who oversees C$1.8 billion in fixed-income assets as chief investment strategist of Sentry Investments Inc. in Toronto. "It will make credit more expensive, make it more difficult to get, or there’ll be less of it around."
The Bank of Montreal’s cost to raise capital compliant with the new rules doubled when it went to sell C$600 million of preferred shares last month, compared to what it paid to issue similar securities in May, according to National Bank of Canada research. As word got out what BMO paid the impact was felt at other banks too, and in securities even higher up the capital structure. The market-implied cost of similarly compliant bonds, which have a higher claim on a bank’s assets than preferred shares, spiked up for every other bank.
A Bank of Montreal spokeswoman didn’t respond to requests seeking comment about the lender’s cost of capital or what the new rules will mean for the price of banking services.
Now, investors demand 0.81 percentage point, or 81 basis points, more yield to hold a Royal Bank of Canada bond that’s compliant with the new rules than one that isn’t, according to data compiled by Bloomberg. That’s about the biggest premium for the so called bail-in debt since the security hit the market in July last year, the data show.
"Investors demand a higher return to buy these debt instruments because they are convertible" into equity during a crisis, Maura Drew-Lytle, a spokeswoman for the Canadian Bankers Association, said in an e-mailed statement. "In terms of whether or not this would increase the cost of credit in the marketplace, that would really be up to each bank to determine how they would build the increased cost of funding into the cost of credit."
Though Canada never had to provide the kind of multi-billion dollar bailouts that other governments did during the financial crisis, the country’s banks are still subject to the new rules. The bailouts were criticized for rescuing the investors who’d lent money to the banks as much as the depositors themselves, because laws ranked both groups’ claims equally.
The new global rules require that by 2022 liabilities equal to 18 percent of a bank’s risk-weighted assets must be convertible to equity if it faces insolvency. Though Canada’s six largest banks are not viewed as possible risks to the global financial system, and therefore not subject to the rules, the country will probably move in step with its peers, RBC analysts led by Robert Poole wrote in a note last week.
Of the C$332.8 billion in compliant capital they’ll need, the Canadian banks currently have C$180.8 billion, leaving a C$152 billion gap they’ll have to fill, according to RBC.
The Canadian government will probably release the details of its own bail-in regime at the beginning of next year with the banks expected to be fully compliant by 2020, according to Poole.
“The federal government has announced an intention to adopt a similar regime for Canada’s domestic systemically-important banks that would protect taxpayers from losses in the unlikely event of a failure,” David Barnabe, a spokesman for the Department of Finance, said in an e-mailed statement. “The timing of implementation has not been announced.”
Until last month, Canadian banks’ attempts to drum up the new kind of capital had come at cheaper rates than the rest of the world, according to a note from National Bank analyst Peter Routledge.
That all changed on Oct. 8, when BMO privately sold preferred shares, which can also be converted into common equity in a crisis. BMO was forced to pay about 500 basis points above benchmarks to get the deal done, double the 271 basis point spread of its last deal and the 238 basis point average spread it had paid until then, Routledge wrote in a note earlier this month.
The market for preferred shares had already tumbled since 2013 as about two-thirds is made up of securities whose coupons adjust with interest rates. With the Bank of Canada unexpectedly cutting interests rates this year and market rates sliding, the Standard & Poor’s/TSX Preferred Share Index fell about 27 percent from January until mid-October.
Since then, market yields have risen amid expectations for higher interest rates in the U.S. and reset preferred shares have climbed in tandem. Meanwhile, the yields on junior debt Canada’s banks have sold to comply with the new rules spiked to their highest since the securities were first issued, though they too have recouped some losses, according to data compiled by Bloomberg.
"So BMO blinked and then paid them the coupon they needed, which repriced the entire" market, Sentry’s Dutkiewicz said by phone from Toronto. "At the end of the day banks are going to be more expensive to run."