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RBC writedowns no cause for worry

awillis@globeandmail.com

To bring a perspective to Royal Bank of Canada's $855-million of writedowns yesterday, a good question to ask might be: "Does the bank seem to know what it's doing?"

To answer that, contrast what's happening at RBC to the behaviour at the two problem children of Canadian banking during this credit crisis, CIBC and Bank of Montreal.

At both CIBC and BMO, senior management seemed gob smacked by their problems. CIBC had far more exposure to credit derivatives than it realized, and with the benefit of hindsight, far too much riding on the health of just a few monoline insurers. At BMO, there was an initial round of surprises on natural gas trading losses, then another round of guessing games over exposure to structured products.

In both cases, the stock got whacked in part because managers seemed to be reacting, rather than controlling their fate. Now, let's look at RBC's problems, with a focus on $715-million of capital markets writedowns.

Canada's largest bank took a $200-million writedown on hedges it has struck with monoline insurer MBIA. Contrast that to the $2.9-billion hit that CIBC took in the first quarter of 2008 to reflect its monoline exposure.

RBC took a $185-million writedown on the value of a U.S. auction rate security portfolio that mainly consists of student loans, which are insured by the U.S. government. Right now, there are no buyers for this type of debt, and the tyranny of mark-to-market accounting means their value must be slashed.

As Desjardins Securities analyst Michael Goldberg noted in a report yesterday, RBC "management believes a significant portion of the writedowns reflect liquidity pressures on assets that it continues to hold, rather than the underlying credit quality related to those assets."

These are modest hits for a bank that's active in U.S. markets during a credit crunch. There's nothing here that suggests RBC executives were in over their heads, that they took unacceptable or unexpected risks.

BCE repricing unlikely

It's highly unlikely the BCE takeover gets repriced the way the Clear Channel Communications buyout was reworked Tuesday.

But if there's one thing the drama around these private equity deals has taught us, it's that anything is possible. In that spirit, Desjardins Securities telecom analyst Joseph MacKay took his best shot yesterday at figuring out what price tag would be attached if the BCE takeover was recut by the Ontario Teachers' Pension Plan and its partners.

Clear Channel agreed to a deal that will see the company sold for 8.16 per cent less than what was agreed to last June. Three of the four banks lending on the BCE takeover are also funding Clear Channel's buyers, which is part of the reason the U.S. deal is seen influencing what might happen at the Canadian phone company.

Straight math shows that if the BCE acquisition were redone on the same terms, the company would be bought for $39.25 a share, rather than the $42.75 agreed to last June. That's in line with the current price.

However, Mr. MacKay says: "Post the privatization, BCE will have a stronger credit profile than Clear Channel." So he estimates the buyers would come back with a bid that's 5 per cent to 8.16 per cent below the current offer, which means an upper end of $40.60 and a floor of $39.25.

Again, this is all completely hypothetical, and unlikely.

Teachers has repeatedly stated it intends to close the deal as planned, in June. A read of the BCE takeover documents shows the buyers have very little wiggle room. One major lender, Toronto-Dominion Bank, has said it will make the loans, and has already taken its mark-to-market lumps.

But this buyout doesn't make sense in face of current market realities, so it will have its doubters until the day it closes.

ipo day on tsx

Today is a big day for IPOs on the TSX, and we're not talking about the public market debut of PC Gold.

Sprott Asset Management starts trading in what qualifies as the biggest initial public offering seen to date in 2008. The hedge fund raised $200-million by selling stock at $10 a share, in a heavily over-subscribed offering. The deal, led by Cormark Securities and TD Securities, values the company at $1.5-billion.

The dynamic underlying Sprott's stock price, a tension that also exists at some of the large U.S. money managers, is that the company will start trading at a healthy multiple to its performance-based fee income. Companies such as Blackstone and Fortress went public last summer on the back of record performance, and have since seen their stock prices slump as the credit crunch bit into results, and into future fee income.

Sprott must continue to deliver top-notch returns on its $6.9-billion of client assets to justify its lofty valuation - the stock will open at a price that's 30 times trailing earnings.

Oh, and best of luck to junior mining play PC Gold, which steps on to the TSX after an $11-million, Canaccord Capital-led IPO.

See Andrew Willis's Streetwise Blog at ReportonBusiness.com

© The Globe and Mail

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