Banks

Since the start of the credit crisis, there have been repeated pronouncements that Canada’s banks are sounder, better regulated than their global rivals and bound to pull through the recession relatively unscathed.

To shore up their capital reserves, most of the Big Five have turned to preferred share offerings, and have had little trouble finding buyers in a time when common equity is viewed with skepticism.

On April 21, Royal Bank of Canada (RBC) announced it would issue another $300 million in preferred shares, having issued $875 million since the start of the year. Record low interest rates are allowing the banks to issue preferreds with fairly low yields. The latest offering from RBC, for example, yields 6.1%, down from the previous offering, which paid 6.25%.

Today, April 23, the Canadian Imperial Bank of Commerce announced plans to redeem $750 million in debentures, on which it was only paying 4.25%. The bank said it was funding the buyback — five years early — with “general corporate funds.”

Not to be outdone, RBC also announced it was redeeming all outstanding subordinated debentures, due June 1, 2014, to the tune of $1 billion. These debentures were costing the banks between 4.18% and 4.25%.

These debentures are issued at a fixed rate for a defined period, after which they convert to a floating interest rate. This earns them the moniker of “fixed-floaters” in the debt market. Bond traders treat these instruments as fixed rate debt, which matures on the earliest possible redemption date.

“The market expectation of people who buy these things is that the banks will redeem them on the first date and refinance them with other issues,” says James Cole, senior vice-president and portfolio manager with AIC Ltd. “The banks aren’t required to do that, but that’s the market expectation.”

He explains that in December, global financial giant Deutsche Bank did not redeem a series of fixed-floaters as expected, allowing them to switch to a floating rate. This panicked the market, which took the move as a sign that the bank was unable to repay the debt holders.

“That decision by Deutsche Bank blew out credit spreads among the Canadian banks,” says Cole. “What the Canadian banks have been doing in the four and a half months since Deutsche Bank made that decision is to be at pains to show that they are acting in the normal course and are meeting market expectations.”

“Canadian banks took the lesson from Deutsche Bank: ‘We have to call fixed-floaters at the first opportunity, or else,'” he says. “They’re at pains to show that this is business as usual.”

(04/23/09)