A unique sale of shares by Royal Bank of Canada has turned into an unexpected success, offering financial institutions some much needed comfort as they navigate a new regulatory landscape.
The new financing, worth $500-million, is for securities that look almost identical to traditional preferred shares, but carry a unique distinction: They can be converted to common equity in the event of a financial emergency.
That feature offers some important advantages. To beef up bank soundness, the Basel Committee on Banking Supervision, which oversees global financial institutions, recently ruled that only shares resembling common equity can be counted in calculations of a bank's capital.
The ruling put Canada's banks in a bit of a pickle. In the early days of the financial crisis, many of them beefed up their capital levels by selling billions of dollars' worth of ordinary preferred shares. Under the new guidelines, the capital benefits from these issues will ultimately wear out. (The extent to which these securities count toward capital calculations diminishes by 10 per cent a year, until they receive a zero-per-cent weighting in 2023.)
Canada's banks are being forced to decide what they want to do with the outstanding issues. All of the preferred shares issued in the immediate aftermath of the crisis are hitting their five-year anniversaries – dates at which the banks can buy them back from investors, or roll them over for another five years.
For the past year, no one knew if the banks would try to replace the old issues with new "capital compliant" offerings. But RBC tested the water Tuesday, selling the first preferred share issue of this kind in Canada, and investors made it clear that they weren't fazed by the new clause that allows for a conversion to common equity. RBC set out to sell $200-million of the securities, and quickly upsized the deal to $500-million.
There is no word yet on whether other banks will follow suit, but it's reasonable to assume that some will try. Even if the old preferred-share issues aren't bought back from investors, the new issues will help to beef up capital levels, and from the looks of it, they won't be a hard sell.
Rating agency Moody's Investors Service noted that it expects Canadian financial institutions to sell more than $20-billion worth of these securities.