15 Jul OSFI issues a capital ruling on Limited Recourse Capital Notes (LRCNs) Form Use and Background
July 15, 2020 – OSFI routinely assesses the quantity and quality of financial instruments FRFIs issue as regulatory capital / total loss absorbing capacity (TLAC) to ensure firms maintain adequate capital as well as loss absorbing capacity as per governing statutes.
OSFI concluded that banks have full discretion to trigger the delivery of preferred shares to LRCN holders in lieu of making interest payments on LRCNs and would then cancel LCRNs. Results of the review determined that foregone interest payments would be canceled, are non-cumulative, and do not result in events of default or other restrictions. LRCN noteholders’ recourse is limited to perpetual tier 1-qualifying instruments in all circumstances, including at maturity of notes in year 60 (preferred/common shares).
OSFI concluded that the LRCN structure is perpetually based on its economic substance and consideration of the structure holistically rather than its component instruments. Determined LRCNs do not constitute an incentive to redeem, contrary to the CAR guideline. Delivery of preferred shares in exchange for LRCNs under certain events not dilutive to the bank’s shareholders’ equity. Considered when assessing incentives to redeem for instruments with mandatory/holder-initiated common share conversions. Limitations are small investor base as LRCNs can only be issued to institutional investors.
LRCNs – preferred shares must have minimum par/stated value of $1000, be traded on institutional desks (not exchange-listed) with an initial term to maturity that must be 60 years. Unless an instrument replaced with higher capital quality, the issuer can only redeem notes/shares, carrying cost exceeds the cost of replacement capital of equivalent quality. Can be replaced with CET1-qualifying common shares, retained earnings.
LRCN issuances subject to a cap of 0.75% of RWA; 50% of AT1 bucket on the issue date. To calculate – compare aggregate of outstanding, proposed issuances of LRCNs on date of issuance to 0.75% of RWA limit; consider issuer’s capital at last reporting date. Adjust for subsequent transactions, issuances, redemptions, buybacks, and acquisitions.
Disclosure required in marketing to investors, as it must disclose how risks are equivalent to investing indirectly issued tier 1-qualifying non-viability contingent capital (NVCC) preferred shares.
For more information, visit www.osfi-bsif.gc.ca