Jim Flaherty right to toughen bank disclosure

You have to give federal Finance Minister Jim Flaherty credit. He’s been patient. But with many months under the bridge and no action by Canada’s market regulators (see prior post “Canadian gumshoes ignore fraud & billions in losses” February 3-08) to deal with the extremely poor subprime, SIV and related disclosure out of Canada’s chartered banks – Minister Flaherty has decided to fix it himself. Not that we need another excuse for a national regulator, as any major province could have easily opened a file on the topic, but this one will do for today.

Last summer, banks such as CIBC (CM:TSX) started their dance of the seven veils; we have US$330 million in subprime exposure, no, we have US$1.7 billion. Yikes, maybe $3 billion, no, $4 billion…. (see prior post “When US$330 million of subprime becomes US$1.7 billion at CIBC“, November 13-07). At least CIBC was taking a shot at it; BMO (BMO:TSX) waited months to explain what exactly they’d found under the carpet (see prior posts “Joe & Jill Retail deserve to know BMO’s SIV exposure
“, February 17-08, “BMO bares all part 2” February 19-08, “SIV values may mean more pain to come” January 16-08 and “Genuity research on BMO’s ‘rogue trader’” May 14-07). For whatever reason, Canada’s securities regulators haven’t shown a passing interest in the $7.5 billion that has been written off since mid 2007. Author Brian Costello might be a hot topic, but not $7.5 billion.

If you ever need a refresher on the differences between our nation’s Parliamentary system and that of our U.S. neighbour, it is worth noting that the number of domestic hearings regarding this fiasco amount to absolutely zip. The U.S. Congress has met on a whole host of topics in recent months, including executive pay as it related to disclosure to the timeliness of subprime losses, the impact of the subprime collapse on home foreclosures and so forth.

Wouldn’t that be an interesting hearing? Who knows what would come to the surface. The timing of Canadian bank losses had a huge impact on the share prices – obviously. But if the timing of the subprime, SIV and related losses was delayed at all, the valuation and actual payout of billion of dollars of delayed compensation might have been affected as a result.

The way it works is this: a huge whack of 2004-vintage performance-related pay of Canadian bankers and investment bankers was put into a medium term program (MTIP). The payout of those monies is determined, in part, based upon the performance of the bank’s own stock over the three year period. On a relative and absolute basis. The dates that are used to strike that performance – and determine if the MTIP will pay out at all – vary across the banks between October 31, 2007 and December 15, 2007, but you get the point.

On November 1, 2004, CIBC shares traded at about $72; the MTIP would have been struck around there. On October 31, 2007, CIBC shares traded around $100. On December 15, 2007, it was back to $71. The timing of the analysis and release of any of the bank’s unusual losses certainly had an impact on their stock. That much investors and legislators understand. But what impact – if any – did it have on the MTIP payouts at CIBC and elsewhere?

Had the valuations been done a bit more accurately, a bit sooner, or had the reserves increased back when the risks were the highest, it doesn’t take a rocket scientist to figure out what would have happened to bank shares last September, October and November. Citigroup (C:NYSE) and Merril Lynch (MER:NYSE) took some serious medicine back then, so the subprime and SIV mayhem wasn’t exactly a secret to the financial and accounting community.

Take an earlier whack at the necessary analysis and disclosure, see a swoon in Canadian bank share prices, and bilions of MTIP payouts might have vapourized.

MRM