Handling Problem Financial Institutions

1. Handling Problem Financial Institutions J.P SabourinPresident and Chief Executive Officer Canada Deposit Insurance Corporation December 9, 2003

2. CDIC Objects CDIC Mandate • Provide insurance against loss of deposits (maximum $60,000) • Promote standards of sound business and financial practices • Minimize exposure to loss for the Corporation

3. CDIC Objects The Corporation pursues objects throughout the life cycle of members • Oversees member application process • Undertakes ongoing risk assessment, monitoring, intervention • Deals with financial institution failures

4. Deposit Insurance Application Process Institutions must obtain approval from: • Minister of Finance • Office of the Superintendent of Financial Institutions (OSFI)

5. Deposit Insurance Application Process Board of Directors • Licensed under Bank Act or federal or provincial legislation • CDIC ensures sound financial and governance footing of institutions CDIC Act

6. Deposit Insurance Risk Assessment, Monitoring and Intervention Process Insurer (CDIC) Supervisor (OSFI) • Provision of insurance • Assessment and management of risk • Traditional supervisory role Assessment of safety and soundness of institutions

7. Deposit Insurance Risk Assessment, Monitoring and Intervention Process Risks to CDIC are both internal and external to member institutions. They include: • Soundness and prudence of risk management activities • Financial performance • Economic and competitive environment • Compliance with statutory requirements

8. Deposit Insurance Risk Assessment, Monitoring and Intervention Process CDIC’s Standards of Sound Business and Financial Practices • Applied to “directing minds” of an institution • Sanctions can, and are, imposed when there is a breach of the Standards • Termination of insurance policy • Legal action against management and directors

9. Deposit Insurance Risk Assessment, Monitoring and Intervention Process Differential Premium System • Able to charge institutions a higher premium • Disincentive to higher risk-taking • Provides and early warning to developing problems • Information gathering allows for timely and appropriate action against institutions

10. Intervention Process CDIC may apply measures / sanctions to minimize exposure to loss Premium Surcharge • Short-term behaviour modification • Can be applied to healthy institutions that are following a riskier path 1

11. Intervention Process CDIC may apply measures / sanctions to minimize exposure to loss Special examination • Detailed review of assets and liabilities • Assessment will dictate options for intervention and resolution 2

12. Intervention Process CDIC may apply measures / sanctions to minimize exposure to loss Termination of policy • Can be imposed immediately if and institution is in breach of Standards, by-laws or conditions of the policy 3

13. Intervention Process CDIC may apply measures / sanctions to minimize exposure to loss Termination of policy • Deposits in these institutions are insured for two years for demand deposits or to maturity for longer-term deposits • Steps are generally taken to liquidate the bank or find a going concern solution 3

14. Dealing with Failures Options for intervention • Formal liquidation and payout • Sale of the institution • Options are assessed accounting for: • Stability of the overall financial system • Minimizing exposure to loss for CDIC

15. Dealing with Failures 1. Deposit payout • CDIC releases payments to a maximum of $60,000 • Depositor preference does not apply • Insured, uninsured and general creditors receive a proportionate return • “Modified payout” – funds are transferred to another member institution in a lump-sum payment

16. Dealing with Failures 2. Purchase and assumption • Actual purchase of the shares or purchase of some or all of the assets and the assumption of all liabilities 1 • “Clean institution” purchase and assumption • Purchase only the highest quality assets and assumes all liabilities • May purchase only specific pools of assets

17. Dealing with Failures 2. Purchase and assumption • Actual purchase of the shares or purchase of some or all of the assets and the assumption of all liabilities 2 • “Whole institution” transaction • All assets are purchased • Occurs before insolvency • Seen as re-capitalization of institution

18. Dealing with Failures 2. Purchase and assumption • Bids reflect the expected value of assets, liabilities and perceived franchise value • CDIC provides financial assistance for the difference between the market value estimate and the liabilities assumed • Assistance varies: • Fixed dollar amount; • Secured loan; or • A combined solution.

19. Dealing with Failures Distinctions for purchase and assumption transactions • All depositors (uninsured or insured) receive full payment • Non-deposit creditors may receive partial or full payment • Full or substantial losses are imposed on subordinate debt holders and shareholders

20. Failure Resolution of Central Guaranty Trust Company Central Capital Corporation Central Guaranty Trustco Central GuarantyTrust (CGT) (Late 1980s) 4th largest trust company in Canada

21. Failure Resolution of Central Guarantee Trust Company Early 1990s Trustco showing deficits CGT paying high dividends to Trustco

22. Failure Resolution of Central Guaranty Trust Company December 1991 • CGT Q3 = $116 million loss • CDIC constructed financial models to compare formal liquidation versus a going concern transaction

23. Failure Resolution of Central Guaranty Trust Company • Expression of interest solicited from 45 organizations • Toronto-Dominion Bank (TD) agreed to acquire $9 billion of assets and all liabilities • Also acquired personal and pension trust business

24. Failure Resolution of Central Guaranty Trust Company • CDIC provided a $1.35 billion loan for the transaction • The loan was converted to an asset management company (Adelaide Capital Corporation) • Adelaide managed, collected and optimized recoveries with assets to retire the CDIC loan • Transaction closed January 1, 1993

25. Criteria for Assisting a Transaction • Cost of purchase and assumption must resemble cost of liquidation • CDIC must have assurance of future viability of the institution • Must provide sufficient capitalization and meet capital requirements • CDIC must receive sufficient specified repayment of assistance

26. Criteria for Assisting a Transaction • Assistance must benefit troubled member, depositors and CDIC • Transaction must involve substantial investment or a guarantee (or combination) from acquirer • Acquirer must share risk with CDIC • Proposal must provide for adequate management resources

27. Criteria for Assisting a Transaction • Acquirer must service all assets • Professionally managed bidding process must be in place • Acquirer must establish quantitative limits on all financial items in a proposal • Shareholders, subdebtholders and other creditors must be prepared to make some concessions

28. Conclusion • Need for open communications and a transparent process • Open communication must extend to the public • Need to revisit trigger mechanisms to initiate an intervention situation • Determination of ongoing viability results in prompt action before insolvency

29. Handling Problem Financial Institutions J.P SabourinPresident and Chief Executive Officer Canada Deposit Insurance Corporation December 9, 2003