Canadian banks face pressure to raise more money in wake of increase to capital requirements

Canada’s largest banks are under pressure to raise money after the country’s banking regulator raised capital requirements, with analysts predicting that Canadian Imperial Bank of Commerce CM-T will be the next of the Big Six banks to bolster its reserves.

In early December, the Office of the Superintendent of Financial Institutions (OSFI) boosted the reserves that banks must hold, which prompted Bank of Montreal BMO-T to sell new shares for the second time this year. BMO raised a total of $3.35-billion in a share offering early this month, as it works toward closing one of the largest takeover deals on record by a Canadian bank.

With CIBC facing a potential US$1-billion charge in a lawsuit with a New York hedge fund, analysts expect it will be the next bank to turn to public markets to raise funds.

OSFI’s announcement “has put a spotlight on bank capital levels across the group,” Scotiabank analyst Meny Grauman said in a note to clients. “The market was most concerned about BMO, but now that it has come to market, investor attention shifts to CIBC. The complicating variable for that bank is a legal charge it has announced it will take in Q1.”

OSFI raised the domestic stability buffer (DSB) to 3 per cent from its previous level of 2.5 per cent on Dec. 8, requiring banks to store more capital during good times to help cushion the blow in the case of an economic downturn. It also increased the maximum level of the DSB which, as of Feb. 1, could range as high as 4 per cent of a bank’s risk-weighted assets.

That change, in turn, raised the common equity tier (CET1) ratio – a measure of a bank’s ability to sustain sour loans – to 11 per cent from 10.5 per cent, and the extended range of the DSB means the regulator could increase the CET1 ratio to as high as 12 per cent. This would require the banks to hold onto billions of dollars in additional capital.

CIBC’s CET1 ratio was 11.7 per cent at the end of the fourth quarter of the banks’ 2022 fiscal year (Oct. 31), one of the lowest levels of reserves among the Big Six. While this is higher than OSFI’s new level, the bank faces impending hurdles that could weigh on its capital buffer and several analysts have said that CIBC is the most likely bank to need extra money.

Looming large is the US$1-billion in damages that the bank could owe after a New York State court found it liable for losses incurred by Cerberus Capital Management LP over two debt deals related to the 2008 U.S. housing crisis. The bank is appealing the decision.

To further complicate matters, CIBC’s loan growth – which is largely driven by its commercial unit – has driven its risk-weighted assets higher over the past four quarters, according to Keefe, Bruyette & Woods analyst Mike Rizvanovic. As a bank’s risk-weighted assets increase, it has to hold onto more capital to provide shelter from potentially sour loans.

Both these factors could drive CIBC’s CET1 ratio down to 11 per cent, “precariously” in line with the new level. When speculation builds that a bank may need to raise funds, “the share price tends to underperform and then you potentially have to issue at a lower price point,” Mr. Rizvanovic said in an interview. “It’s not a good scenario when your investor base is saying that you need to build capital. You want to get ahead of it.”

BMO was an early mover. Less than a week after OSFI’s announcement, the bank raised $3.15-billion in a major share issue, citing the need to meet the regulator’s raised capital requirements. It’s the lender’s second share sale this year as it works on closing its pending $17.1-billion acquisition of California-based Bank of the West from BNP Paribas. Upon closing the deal, BMO could have been at risk of falling below OSFI’s new capital requirements.

The bank offered an overallotment option that was fully subscribed, hiking the total it raised to $3.35-billion. The equity issuance will raise BMO’s CET1 ratio to about 11.7 per cent after the deal closes, putting it comfortably above the minimum, according to CIBC analyst Paul Holden.

Bank of Nova Scotia BNS-T, with the lowest ratio at 11.5 per cent, could also feel pressure to raise its reserves in anticipation of potential further hikes of the DSB to the highest end of the range.

While Toronto-Dominion Bank TD-T and Royal Bank of Canada RY-T carry some of the highest levels of capital – even with their respective deals to acquire U.S.-based First Horizon Corp. and HSBC Bank Canada – OSFI’s decision to increase the level range could make the Big Six feel compelled to raise their reserves to the higher end.

“The big question for all banks is capital management in light of an upper bound for the DSB at 4 per cent,” Mr. Holden said in a note.