BRENDA DALGLISH November 16 1992



BRENDA DALGLISH November 16 1992




Ronald McKinlay, a veteran accountant who is chairman of the Canada Deposit Insurance Corp. (CDIC), is proud of his latest accomplishment. The portly receivership expert helped to steer Central Guaranty Trust Co., once the fourth largest trust company in Canada, through the dangerous shoals of bankruptcy and liquidation into the friendly harbor of a merger with the Toronto-Dominion Bank. The deal for Central Guaranty, which has $11 billion in deposit assets, represents both the largest financial institution failure and the biggest such acquisition ever in Canada. The Toronto-Dominion Bank—breaking its own rule of building rather than buying assets—agreed to pay $125 million to acquire most of the assets and liabilities of the nearly bankrupt trust company. For McKinlay, who at 68 will retire at the end of this year, it is the successful culmination of an accounting career spent trying to “fix problems, not bury them.”

The deal, however, is far from perfect. It is certain to mean that CDIC, the federal agency that guarantees that depositors in failed member financial institutions are reimbursed for their losses up to a maximum of $60,000, will have to increase its $ 1.9-billion debt to the federal government, and that it will continue to be exposed to risk from Central Guaranty, particularly if the economy continues to deteriorate. In addition, the CDlC’s member institutions—143 banks and trust companies that are directly responsible for bearing the cost of the failure—can likely expect that their deposit insurance premiums will increase significantly next year. When the buck finally stops, it will be the consumer who pays most of the bill.

Despite those problems, McKinlay told Maclean’s last week in an interview in his Toronto office that the deal is better than the CDlC’s other option: liquidating the trust company. McKinlay said that the task of winding up

Central Guaranty, the major asset of Halifaxbased Central Guaranty Trasteo, would have been horrendously complex. In addition to causing an upheaval among the trust company’s depositors, borrowers and employees, liquidation would have required such massive borrowing by the federal government that financial markets could have been harmed. Even the administrative costs would been exorbitant. Said McKinlay: “We calculated that the cost of postage stamps alone would have amounted to almost a million dollars.” Instead, CDIC chose to provide financial support to help the TD Bank acquire Central Guar-

anty. Under terms of the agreement in principle that the TD Bank announced on Oct. 13, the bank will acquire $9 billion of Central Guaranty’s $11 billion in assets. (In bank accounting terms, assets are primarily loans and liabilities are primarily deposits). The CDIC will retain the remaining portfolio of $2 billion in so-called “soft loans”—those which the TD Bank has identified as being less desirable, including a significant number of non-performing commercial real estate loans. In addition, the insurance corporation will provide almost complete insurance coverage on $2.5 billion of the $9-billion worth of loans that the TD Bank is acquiring.

Toronto-Dominion will pay $125 million and acquire Central Guaranty’s 154 branches across Canada, its mutual funds and its Visa credit card business. The bank will also gain Central’s $5-billion personal and pension trust business. CDlC’s total risk exposure amounts to about $4.5 billion. McKinlay said that he would not estimate what the corporation’s total cost could be, but added: “Remember, being exposed is not the same as having to pay.” McKinlay acknowledges that the deal con-

tains more risks for CDIC than two of its other big bank and trust company failures. In those earlier deals, the corporation transferred $2.6 billion in Bank of British Columbia assets to the Hongkong Bank of Canada in 1986, and in 1991 wound up Toronto-based Standard Trust Co., in an operation that transferred most of its $1.3 billion in assets to the Montreal-based Laurentian Bank of Canada. But those two failed institutions were much smaller than Central Guaranty. Given the problem of Central’s size, McKinlay said that the TD Bank acquisition will certainly be less disruptive to the stability of the country’s financial system and it will probably be less costly than a liquidation—a cost difficult to accurately de-

termine until after asset sales are concluded.

Still, the CDIC is carrying more of the risk than ever before. “They [the TD Bank] are probably assuming no risk at all, at least very, very little risk,” said McKinlay. “Comments have been made that this is a sweetheart deal, but everybody had an opportunity (to bid). The TD Bank provided the proposal that our board and Central Guaranty and Central Guaranty Trustco (the parent company) thought was the best proposal.” Gordon Capital Corp., a Toronto securities dealer, conducted a tendering process in which more than 40 financial institutions were provided information and invited to make a proposal to acquire Central Guaranty’s business.

TD Bank president Robert Korthals, however, disagrees with McKinlay’s assessment of how the risk is shared. The bank president said that although the potential benefits of the deal outweigh the potential risks, it is not risk-free. “There are always risks any time you try to merge two organizations,” said Korthals. “Central Guaranty has $6 billion to $7 billion in residential mortgages and we have another $17 billion. What if the economy gets worse? What happens if people start walking away from their mortgages and giving us the keys to their houses?” In fact, the deal has not been finalized yet and Central Guaranty shareholders still have to vote on it.

Although the CDIC is assuming most of the risk for Central Guaranty’s bad loans, it is only a middleman. It relies on two sources for its funds: the federal government provides loans, which are to be paid back eventually by premiums collected from member institutions. The CDIC currently owes the government, which provides the immediate financing at an interest rate slightly higher than the government’s cost of funds, $1.9 billion. The ultimate source of money, however, is the member institutions. They currently pay annual premiums equal to 10 cents for every $100 in deposits, or a total of $291 million in 1991.

That is a bargain compared with the cost of deposit insurance in the United States, where financial institutions paid 23 cents for each $100 in deposits this year. The Federal Deposit Insurance Corporation (FDIC) is in debt to the U.S. government for $12.5 billion for bank failures alone, not including the costs of the U.S. savings and loan debacle. The huge problems of the U.S. banks are also reflected in another comparison. The FDIC has 14,000 employees, the CDIC 100.

Despite that favorable comparison, the CDlC’s biggest contributors, the big banks, still complain about Canada’s deposit insurance scheme. Because of their large deposit bases, the big banks pay more than 70 per cent of CDlC’s premiums, even though they are also the group that has so far had the lowest failure rate. The Canadian Bankers’ Association is lobbying for the deposit insurance system to be revised. Shawn Cooper, vice-president of financial institutions at the association, says that either depositors should share more of the losses in the event of a bank or trust company failure, or that riskier institutions should pay

higher premiums commensurate with the greater probability of their failure. Cooper added that the deposit insurance system should be modified to “build incentives into the system so that institutions are encouraged to manage their risks more conservatively.” The current system, he said, “over-provides a safety net that undermines market discipline.”

However, changes such as Cooper has proposed would also serve as an incentive for depositors to move their money to those institutions that they perceived to be the safest, the biggest banks and trust companies. As a result, there would be even less competition in an industry that consumer groups already criticize for being less competitive than desirable. The federal government is currently reviewing the entire deposit insurance system, including the question of who should pay for it. Hearings on the issue are scheduled to open before a House of Commons finance subcommittee on Nov. 16.

Whatever the outcome of that debate, however, consumers are still likely to carry the biggest share of the cost of failed institutions. In the case of the cost of the Central Guaranty failure, said John Evans, president of the Trust Companies Association of Canada in Ottawa: “Let’s not kid ourselves, ultimately it’s going to come from the consumer.” He added that a reasonable, rough estimate of the final cost to CDIC of the Central Trust failure is between $500 million and $1 billion. To pay for that, the association president said, financial institutions will tend to increase the interest rates they charge borrowers and reduce the rates they pay savers by something like one-quarter of

one-tenth of one per cent. “It is not a hell of a lot,” said Evans. “It is not something that consumers will even see.”

That attitude infuriates consumers. Said David Simpson, executive director of the Consumers’ Association of Canada in Ottawa: “It should be the ones who make the decisions who pay. It should be the institutions, not their customers, who pay. Heads should roll, towers should crumble.” As for the argument that deposit insurance losses are modest in Canada compared with those in the United States, he said, “Sure, we have gotten away with fewer

financial disasters, but we have also had less competition.”

The happiest solution, clearly, would be for even fewer institutions to fail. After a decade of such failures, McKinlay says that the CDIC, working closely with the Office of the Superintendent of Financial Institutions, the watchdog body that monitors the accounts of the financial institutions for CDIC, has developed a new system that he says that he hopes will greatly reduce the number of failures. Working on McKinlay’s premise that “no well run financial institution has ever failed,” CDIC has prepared detailed business standards which member institutions will have to follow. The standards will govern everything from the way real estate appraisals are performed and recorded to credit granting policies. “It is always better to keep a financial institution out of trouble rather than having to pull it back from the brink,” said McKinlay. “We think that this is regulatory pioneering. And I am confident it will go a long way towards preventing these failures from ever happening again.” It is an elegant solution. But with institutions that make use of other people’s money, even extraordinary remedies may not be enough.



Conventional wisdom used to hold that the affluent urban population clustered around Toronto made southern Ontario the best market in the country for buying or selling just about anything. But the recession showed, yet again, just how wrong conventional wisdom can be. Few companies have felt that change of view more sharply than the Toronto-Dominion Bank, with interests heavily concentrated in Ontario. Now, in its proposed purchase of Halifax-based Central Guaranty Trust Co., the bank has not only abandoned a long-standing policy of avoiding acquisitions, but it is also broadening its geographical base by investing heavily in the Atlantic provinces, one of the poorest regions in the country. But, according to Roy Palmer, a banking analyst with Bunting Warburg Inc. in Montreal, Atlantic Canada presents reliable, if not spectacular, opportunities for the slow-growth economy that is predicted for the 1990s. Says Palmer: “The loan-loss rates there tend to be lower than the national average; the clientele is very conservative. The banks do not lose

much money in the Atlantic provinces.”

If the TD Bank succeeds with its plans for Central Guaranty, it will be the second time that a virtually bankrupt institution has turned into a money spinner. In 1986 the Hongkong Bank of Canada paid $63.5 million to buy the failed Bank of British Columbia, an institution with $2.6 billion in assets and a loyal local franchise. Since then, and in part because of the acquisition, the Hongkong Bank has soared from obscurity to become the largest foreignowned bank in the country with assets of more than $11 billion and profits of $40.5 million in the first nine months of this year.

The Central Guaranty acquisition would increase the bank's assets by 11 per cent to $80 billion, its mortgage holdings by 28 per cent and its personal deposit base by g 31 per cent. But for the 3 TD Bank, increasing its I size is only one benefit, s The bank, Canada’s fifth I largest in terms of assets, 1 could also get an existing “ estate and trust business, giving it a head start on its rival banks who are scrambling to develop the ability to offer such fiduciary services to their customers.

The administrative demands of completing the deal are enormous. TD Bank president Robert Korthals says that the bank is struggling to retain depositors and employees, while trying to rebuild morale at Central Guaranty. The bank has as many as 400 people working at least part time on the deal. Some of them, says Korthals, “are risking their careers on it.” And that is the kind of risk that focuses the mind.