A last-minute bank rescue
By Michael Salter and Rod McQueen
The six senior bankers who talked late into the night on Sunday, March 24, in the Bank of Canada’s Ottawa headquarters rarely assemble in one room except in extraordinary circumstances. Deliberating anxiously over pizza and coffee were the Bank of Montreal’s outspoken chairman, William Mulholland, Cedric Ritchie, his cool-headed counterpart from the Bank of Nova Scotia, and their peers from the Royal Bank of Canada, the Canadian Imperial Bank of Commerce, the Toronto Dominion Bank and the National Bank of Canada. The six were meeting to find a way to avert the looming collapse of Canada’s 10th-largest bank, the Edmonton-based Canadian Commercial Bank (CCB).
Across the street on Parliament Hill, Finance Minister Michael Wilson and Barbara McDougall, the minister of state for finance, conferred repeatedly with the bankers by telephone and anxiously waited for their decision. The ministers finally imposed a 7 a.m. deadline on the bankers—to coincide with the start of the banking day in the Maritimes. The pressure worked. After 12 hours of discussion and just five hours before the deadline, the bankers finally reached a deal. Said McDougall: “We were all exhausted by the end of it, but extremely gratified that we had an agreement.”
The major banks agreed to contribute $60 million to a $255-million bailout plan to rescue the CCB. The bankers’ accord was the final stage in a tense week of secret negotiations in which the federal and Alberta governments, as well as the Canada Deposit Insurance Corp. (CDIC), the federally run insurance agency for financial institutions, agreed to join forces to avert Canada’s first bank collapse in 62 years. Said McDougall: “It cost millions to save the bank. But the price of letting it fail could have been much higher.”
The decisive action staved off the worst fear of all the participants: investor panic that could have produced a run on deposits at the CCB, then spread to other banks and caused a crisis of confidence in the entire financial system. But the reason for the CCB’s brush with disaster—the continued stagnation of the Alberta economy which has also hurt
many other financial institutions in the West—remained a troubling problem for the country’s financial regulators. The near-collapse of the CCB was the latest—and most spectacular—in a string of failures and near-failures suffered by Western Canadian banks, trust companies and credit unions.
Alberta has not yet fully recovered from the 1982 recession or the flight of energy activity precipitated by the 1980 National Energy Program. The economic malaise has led to a collapse in Alberta real estate prices which, in turn, has devastated the mortgage portfolios of lending institutions. According to William Hancock, a Calgary-based vicepresident of Royal LePage Commercial Real Estate Services, an upward spiral
of real estate prices in the West reversed dramatically when the recession hit Alberta in early 1982. By late 1983, he said, real estate prices had fallen, on average, by a disastrous 50 per cent, “back to their 1978 levels.”
At the same time, the province’s unemployment rate jumped to 11.2 per cent in 1984 from 3.8 per cent in 1981. Many homeowners found themselves unable to meet their mortgage payments and simply walked away from their properties. Last year there were a record 8,023 foreclosures in Alberta, compared with 626 in 1981. As the economy shrank in 1982 and 1983, hundreds of commercial properties remained vacant or partially rented, and undeveloped
land depreciated drastically in value. Many developers declared bankruptcy or, like the homeowners, gave up their properties. As a result, financial institutions were left with thousands of mortgage loans secured by real estate that had plummeted in value.
The CCB was one of many institutions caught in the lending squeeze. Formed in 1976 as a commercial bank—lending mainly to small businesses—the CCB by 1983 had made about 43 per cent of its loans in Alberta and British Columbia, and many of those were in real estate. As property prices fell the bank’s loan losses rose, to $25.2 million in 1984 from $14.5 million the previous year. With $194 million in nonperforming loans—those on which interest has not
been paid for more than 90 days—and interest revenue falling, the bank staggered under the load. For the fiscal year ended Oct. 31, 1984, the CCB lost $6.9 million.
But the final blow came early in March when the bank, already overextended in real estate, learned that $100 million in loans to U.S.-based oil and gas drilling companies was in jeopardy. As the price of oil fell last year, making costly offshore exploration unprofitable, many energy companies stopped drilling and their cash flow dried up—as did interest payments on the CCB’s loans. As Gerald McLaughlan, the CCB’s president, admitted last week, “It was quite obvious we had a serious problem.” In
fact, McLaughlan estimated that after the bank sells off the collateral on the $100 million—mainly oil drilling equipment—which backed the loans, the CCB will lose $89 million.
For two weeks in March, McLaughlan and his executive team searched fruitlessly for solutions. Then, on March 14, McLaughlan approached the federal inspector general of banks, William Kennett, and asked for a bailout. On Friday, March 22, after negotiations with the federal and Alberta governments, Bank of Canada Gov. Gerald Bouey called in the six chartered banks, which together had $150 million on deposit at the CCB.
But the rescue plan nearly faltered because the six banks wanted several large trust companies, including National Victoria and Grey Trust Co., Canada Trust Co. and Montreal Trust Co., to forgo principal and interest payments for 10 to 15 years on $39 million in CCB debentures —a form of bond— held by the trust companies. At the all-night bargaining session in Ottawa on March 24, the banks threatened to liquidate the CCB if the trust companies did not meet their demands. Finally, Ottawa and the governments of Alberta and British Columbia decided to purchase the $39 million of debt from the trust companies—adding it to the $10 million in CCB debentures already held by the two provincial governments.
Under the bailout 0 agreement Ottawa, Alberta and the banks will 1 contribute $60 million I each in interest-free § loans to the CCB, while
the CDIC will provide another $75 million in loans. The money will be used to write off the CCB’s nonperforming loans. In return, the CCB agreed to give its rescuers 50 per cent of its future pre-tax earnings until the loans are fully repaid, in 10 to 15 years’ time.
Although the banks and governments succeeded in arranging a rescue package, the CCB’s shareholders are paying a heavy price. When trading of the CCB’s shares resumed on March 27 after a twoday halt, the share price plummeted to $5.25 per share from $19.62. During the repayment period, dividends on common shares will be suspended. In addition, the bailout partners may wind up effectively controlling the bank because they have received share purchase war-
rants allowing them to buy as much as 75 per cent of the CCB’s outstanding common shares at the rock-bottom price of 25 cents per share.
The rescue of the CCB immediately provoked a storm of criticism. Two CCB shareholders, whose combined $450,000 worth of preferred shares fell in value to $94,500 in the wake of the deal, announced that they plan to file lawsuits against the bank if they conclude that the institution did not reveal the true state of its affairs, as required by law, when the shares were issued in January, 1984.
At the same time, a political controversy erupted in Ottawa, where New Democratic Party Leader Ed Broadbent said that taxpayers’ money should not be used to prop up any Canadian bank. For his part, Liberal finance critic Donald Johnston said that the office of the inspector general of banks, a federal regulatory agency charged with overseeing the banks, should have intervened when it first heard of the CCB’s troubles last September. In reply, McDougall, whose department supervises the laws regulating financial institutions, said that the government was not aware of exactly how serious the CCB’s problems were until it alerted federal officials on March 14. Added McDougall: “We did not move to save a bank. We moved to save the borrowers and depositors of a bank.”
For the western provinces, the CCB dilemma was only the latest in a series of financial crises in recent months caused by the real estate collapse. In Alberta on March 20, just five days before the CCB bailout was revealed, the province’s Credit Union Stabilization Corp. was forced to prop up 44 of the province’s 131 credit unions. Corporation officials announced that the provincially controlled agency will set up a new, as yet unnamed real estate subsidiary to take 1,500 foreclosed properties worth $325 million from the credit unions. The troubled credit unions had already taken a $100-million loss on the 1,500 properties, accounting for the bulk of the $106 million in losses they suffered in 1984.
Alberta’s credit union rescue came only weeks after the provincial government stepped in to stabilize a trust company that had also been devastated by souring mortgage loans in the West. Last January the Alberta Treasury Branches, a provincially run banking institution, provided loan guarantees backing two new issues of preferred shares, worth $85 million, to help prop up money-losing North West Trust, an Edmonton-based firm with major real estate investments. The 28-year-old firm, with branches in Alberta, British Columbia and Saskatchewan, suffered a $1-million loss in the first nine months
of 1984 and by the end of the year faced bankruptcy.
By contrast, in Saskatchewan, where financial institutions are facing similar problems, the government recently decided against bailing out Pioneer Trust Co., a Regina-based firm with heavy real estate investments which suffered a $1.7-million loss in the first nine months of 1984. On Feb. 7, Pioneer Trust locked its doors. Most of
the firm’s 36,000 customers, who held $243 million in deposits, were protected by the CDIC, which insures bank and trust deposits by as much as $60,000 per account. But 1,800 depositors with a total of $24 million in accounts containing more than $60,000 were not insured.
As some western financial institutions were buckling under the weight of bad real estate loans, others were manoeuvring adroitly to survive. One of those firms is Calgary-based Northland Bank, a commercial bank with more
than $1 billion in assets that in 1983 was on the verge of collapse. Formed in 1976, the bank held about two-thirds of its loan business in Alberta by 1982—and most of that was in real estate. As with other institutions, Northland’s loan losses and nonperforming loans soared as the real estate market collapsed.
The bank lost $2 million in 1982 and, by 1983, $110 million—17.5 per cent of its total loan portfolio, which then stood at $622 million—was classified as nonperforming. With shareholders’ equity of only $31 million, president William Neapole told Maclean’s that the bank was “on the brink of disaster.”
Then, in mid-1983, in a move the financial community considered unorthodox but extremely astute, Northland formed a real estate subsidiary called Epicon Properties Inc., owned 55 per cent by the bank and 45 per cent by Edmonton-based Ellesmere Developments Ltd. The bank then sold about $70 million worth of foreclosed properties to Epicon in return for the subsidiary’s newly created preferred shares, the collateral for which was the foreclosed properties. In effect, admits Neapole, the bank financed the entire transaction.
But by selling the real estate to Epicon, Northland avoided having to dispose of the properties at bargain-basement prices and take additional, crippling losses. Said Neapole: “Typically, bankers know very little about real estate. When a property is seized, potential buyers know the bank is anxious to sell and they offer perhaps 40 or 50 cents on the dollar.” Added Neapole: “And with the market this poor, the pressure to sell creates a fire sale mentality.” By selling $70 million in seized property to Epicon and another $53.9 million in property to a second real estate company, Northland will soon have reduced its nonperforming loans to three per cent of the total loans outstanding from a crippling high of 18 per cent in early 1984.
Unlike the Northland bank, the CCB did not move quickly to solve its loan problems, which steadily increased until last week’s rescue became the only alternative to collapse. Indeed, according to Rowland Frazee, chairman of the Royal Bank, the CCB rescue was too large for any single bank. Said Frazee: “The problems were so severe that no one bank wanted or was capable of taking it on. It was too far gone for that.”
In fact, the joint public and private sector bailout of the CCB marked a dramatic departure from the banking system’s traditional practice of rescuing failing members by merging them with larger, more stable sisters—a practice that began after the last failure of a Canadian bank. In 1923 the Home Bank of Canada collapsed, taking with it $15 million, as much as Canadians had lost
in all bank failures since Confederation. In the wake of the Home Bank debacle, the inspector general’s office was formed to guard against further failures. After that, when problems came to the inspector general’s attention, the banks loaned money to faltering institutions to support them or worked out merger agreements. Both the Toronto Dominion Bank, founded in 1955 from the Bank of Toronto and Dominion Bank, and the Canadian Imperial Bank of Commerce, created in 1961 from the Imperial Bank of Canada and the Canadian Bank of Commerce, were the products of such mergers.
But the 1982 recession and a recent change in government policy have altered the face of banking. The Bank Act,
which sets legislative guidelines for the banks, was amended in 1980 to permit foreign competition. There are now 14 chartered domestic banks and 56 foreign banks operating in Canada. But while competition among the banks has increased, many corporate customers are still getting their balance sheets in order following the 1982 recession. More banks are now battling for fewer loans, and profit margins have become razorthin. That trend, in addition to the fact that Canada’s chartered banks are saddled with $9 billion in nonperforming loans, has forced them to change their attitude toward rescue mergers. Said Steven Kressler, an analyst with Toronto-based Merrill Lynch Canada Inc.: “The banks have stiffened against taking on somebody else’s problems.”
The CCB’s troubles and those of other banking institutions are also a blow to
western communities and governments. Both have encouraged the growth of regional financial firms in hopes that the institutions would be more sensitive to the needs of westerners than the Big Five national banks, all based in Toronto or Montreal. But Roy Palmer, a banking analyst for Alfred Bunting & Co., a Toronto-based investment house, said that the current upheaval reveals the vulnerability of small, narrowly focused financial institutions to economic downturns. Said Palmer: “The big chartered banks have their share of bad western loans, but they are big enough and diversified enough to support them.”
Indeed, seeking to ensure their own financial health, some western institutions are now racing to establish
branches in Eastern Canada in order to cushion themselves against the boombust fluctuations of the resource-based western provincial economies. Said the Northland’s Neapole: “We are working hard to establish ourselves in Ontario—and to reduce our exposure to real estate loans.”
Despite criticism of the bailout, Frazee told Maclean’s that the major banks had little choice but to resort to private and public sector co-operation to deal with the CCB crisis because of the system’s problems with loan losses. Added Frazee: “The financial services industry right now is quite fragile. If this bank had failed, what would have been the public’s reaction?” The bankers who gathered over pizza in Ottawa clearly knew the answer.
With Steve Mertle in Calgary.