How capital ratios can steer a bank’s financing options

It may not be as popular an assignment now as it was in the past, but compare and contrast is still a useful way to analyze a situation.

Here the situation is the different approach taken recently by Canadian Western Bank (CWB) and National Bank of Canada (NA) to improve their various capital ratios.

This week CWB announced a $125 million common equity financing, which was later upped to about $150 million. In the revised deal the underwriters bought 6.125 million shares at $24.50 a share.

The immediate effect of the financing was a rise in the bank’s common equity Tier I ratio (CET1) to about 8.9 per cent. Prior to this the ratio — which measures the bank’s core equity capital compared with its total risk-weighted assets — stood at about 8.2 per cent. (That ratio will fall about 15 basis points when the bank’s previously announced purchase of GE’s Franchise Finance portfolio closes this quarter.)

At the current 8.2 per cent, the bank’s CET1 ratio was viewed as a tad low when compared with the seven per cent minimum allowed by the regulators and the same ratio at the other banks. But the regulators demand a cushion above that minimum and a one percent spread is the lowest they’ll tolerate.

In those circumstances and with the immediate priority to improve its CET1 ratio, the bank opted to sell common shares. Earlier this year, when the same bank had a different set of priorities, it chose to sell rate-reset preferred shares: 5.6 million at $25 a share for which it will pay 6.25 per cent.

But rate-reset pref shares don’t have the ability to change a bank’s CET1 ratio. Instead they change two other capital ratios: the Tier 1 ratio and the Total Capital Ratio. (After its recent common equity financing, those two ratios for CWB will rise to 10.80 per cent — up 70 basis points — and 12.90 — again up 70 basis points — respectively.)

For CWB, the longer-term effect of the common equity financing is that it will add to its capital base and aid in its growth plans.

On the other hand, the National Bank decided to raise permanent capital by way of two issues of rate-reset preferred shares. In January it raised $400 million — at a yield of 5.60 per cent — and followed up with another $400 million at 5.40 per cent this month.

In both cases, the financings were not done to improve any capital ratios. Instead, as the release said at the time, the offerings’ net proceeds will be used “for general corporate purposes” and added to the bank’s “capital base.” As one analyst noted Friday, the financing was done at a time when other banks were raising capital in the same form. “They took advantage of the market opportunity,” he said, noting that while rate-resets are permanent capital, the issuer has the option to redeem them every five years.

Last October, National Bank deviated from the script when it raised $300 million of common equity — a move that upped its CET1 ratio. While the proceeds were earmarked for general corporate purposes, the bank noted overall restructuring changes ($85 million) and a potential substantial loss on its investment in Maple Financial Group added to the desire to raise permanent capital.

Financial Post

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