Moody’s announced that they were reviewing the BoM’s credit rating in anticipation of downgrading it this week. They are concerned over the health of BoM’s US-based Harris banking unit but otherwise do not appear to be concerned over the BoM’s asset quality.
That is not a view shared by the DBRS rating agency whose most recent credit ratingreport indicates that they are very concerned over the BoM’s continuing exposure to $6 B in loans to prop-up off-balance sheet Structured Investment Vehicles.
In fact the DBRS report bluntly states that they rate the BOM’s debt as high as AA(low) only because they believe that the Canadian government will offer “systematic and timely external support” to BoM.
Other analysts are also concerned over the continuing SIV exposure. This is due to the fact that:
- the market value of these derivatives is significantly less than the bailout loans provided by BoM and
- the BoM continues to publicly deny that they have a problem here.
So how much of a problem does the BoM have with SIVs? It’s on the same scale as the Israeli problem with Iran’s nuclear program.
According to the BOM’s published Q3 Supplementary Financial Information, the total Regulatory Capital of the bank is $24 B. That’s the amount of real investor capital put into the BoM. As previously described in earlier posts, banks inflate this asset by also counting the loans that they have made as “assets” since those loans generate interest revenue.
The total BoM’s “asset” base of $334 B includes $65 B of derivatives of which $49 B are securitized assets. According to the Q3 Supplementary Report, 90% of the $49 B is impaired and a full $37 B is rated as having a high risk of default ( Risk weight >7%).
Prudently the BoM has reserved $735 M of capital against this risk, however, that provision will be about as effective as a fart in a thunderstorm should these derivatives prove worthless.
Given the recent signs of economic recovery, it is likely that not all of the $37 B will tank. A risk weight of >7% means that roughly 1/2 of these loans will likely default in 5 years (1.07^6 = 1.50). Many analysts believe that the $6 B in SIV loans made to support Link SIV and Parkland SIV are at greatest risk however.
To put the danger posed by $6 B in bad loans in perspective, the BoM’s entire quarterly revenue in Q3 was $3 B and its net income is currently approximately $1 B / quarter.
Hence, a $6 B default can cause a life-threatening liquidity crisis that would require a government bailout to prevent outright bank failure.