Call Report Provides Further Details on Capital Injection at City National Bank

Plus: a decision in a master account case

In late September Royal Bank of Canada issued a press release about “recent intercompany transactions.”

The press release disclosed that RBC’s U.S. national bank subsidiary, City National Bank, had engaged in a transaction involving the sale of certain debt securities, resulting in realized losses at the City National Bank level (eliminated at the RBC level on consolidation).

In addition, RBC stated that:

an intercompany capital injection has been made into the City National subsidiary, further strengthening the capital and liquidity position of the subsidiary balance sheet, while also being used to pay down higher cost borrowing.

Specific details as to the amount of the realized losses at City National or the amount of the capital injection were not included in the press release.

City National Bank has now filed a call report for Q3 2023 that quantifies the transactions described in RBC’s late September press release.¹ This post looks at the details.

Standard disclaimer: the choice to discuss City National in this post is only because I think the developments are interesting as an example of the choices facing many U.S. banks as they think about what to do with their securities portfolios, not because I think anything about the City National situation is scandalous, alarming, etc.

The Realized Losses

According to its Q3 call report, the City National sale of debt securities first reported by RBC in its press release last month resulted in a realized loss for City National of $2.735 billion.²

Overall for the quarter, City National reported a net loss of $1.8 billion.

The Capital Injection

As of the end of the second calendar quarter of 2023, City National had already this year received capital contributions totaling $950 million, which it described in its Q2 call report as “capital contribution from parent to bank.”

City National Bank reporting the receipt of meaningful parent company capital contributions³ in its call report is not unusual in recent years:

• Full year 2022: $450 million in total contributions, again described in the call report as a capital contribution from parent to bank

• Full year 2021: $700 million in total contributions, described in the call report as an equity injection from parent holding company

• Full year 2020: $600 million in total contributions, described in the call report as an asset contribution from parent company

The magnitude here, though, is a little different.⁴

The call report City National Bank filed late yesterday states that as of the end of Q3 2023, City National has received total capital contributions this year in the amount of $2.947 billion. As noted above, before this quarter City National had already this year received capital contributions of $950 million, so this means that in Q3 City National received additional capital contributions in the amount of just under $2 billion. The call report again describes these as “capital contributions from parent to bank.”

The Reinvestment

In its press release last month, RBC stated that City National had reinvested “most of the proceeds” of the intercompany transaction into new securities. Information reported in City National’s latest call report adds further context.

For Q2 2023, City National reported approximately $4.7 billion in HTM securities and approximately $16 billion in AFS securities. For Q3 2023, City National reported approximately $8.96 billion in HTM securities and approximately $8 billion in AFS securities.

I am yet again embarrassed by my shaky Excel and formatting skills, but nonetheless I think the table below is a decent illustration of how City National’s HTM and AFS securities portfolio has been rebalanced.

****

District Court Rules in Favor of Federal Reserve Board and FRBNY in Master Account Dispute

Last week a judge in the Southern District of New York denied a motion for preliminary injunction sought by Banco San Juan Internacional (BSJI).

Briefly, the underlying dispute centers around a decision by the Federal Reserve Bank of New York, with no objection from the Federal Reserve Board,⁵ to close BSJI’s master account and terminate its access to FRBNY financial services. The FRBNY based its decision on a conclusion that BSJI’s continued account access would “pose[] undue risk to the overall economy by facility [sic] activities such as money laundering, economic or trade sanctions violations, or other illicit activities.”

The headline takeaway from the ruling is the court’s conclusion that BSJI is not entitled to a preliminary injunction because, among other things,⁶ BSJI is not likely to succeed on the merits. In particular, the court determined that there is no statutory right for banks to have master accounts.

Beyond that headline takeaway, the opinion includes three more esoteric things I thought were interesting.

Court Finds NDAA Supports Fed’s Position

We have discussed before on this blog the argument that the FY 2023 National Defense Authorization Act, which included a provision requiring the Board to maintain a public database of pending, approved, rejected, and withdrawn master account access requests, supports the notion that Reserve Banks have discretion to reject master account requests.

The author of this section of the NDAA, former Senator Toomey, has said that in making this argument “[t]he Fed totally mischaracterized” the purpose of the provision, and in June of this year a federal judge in Wyoming concluded that this provision of the NDAA “does not, expressly or impliedly, carry the statutory construction load the Board of Governors asserts it does.”

Undeterred, the Board and/or Reserve Banks have continued to make this argument in other district courts,⁷ and in the BSJI case the judge found it compelling:

Moreover, Congress recently amended the FRA to add a new provision concerning master accounts. On December 23, 2022, the President signed into law the National Defense Authorization Act (“NDAA”). Section 5708 of Title LVII of the NDAA amends the FRA by inserting § 11C, entitled “Master Account and Services Database.” This amendment confirms that Federal reserve banks may “reject” applications from depository institutions, by requiring the Board to “create and maintain a public, online, and searchable database” that includes “a list of every entity that submits an access request for a reserve bank master account and services . . . including whether . . . a request was approved, rejected, pending, or withdrawn[.]

Are Reserve Banks Agencies for Purposes of the APA?

In support of its argument that the FRBNY’s decision to close BSJI’s master account should be subject to judicial review, BSJI argued that the FRBNY is an agency of the U.S. government for purposes of the Administrative Procedure Act.

This is a question that has not yet produced a definitive opinion at the appellate level. In last week’s opinion, the court observed that the Second Circuit “has not yet ruled on this narrow question” and in a footnote said that the “parties agreed at the argument on the current motion that no United States Court of Appeals has determined whether Federal reserve banks should be treated as ‘agencies,’ under the APA.”

Here, the court seems to pretty definitively say that in its view, no, Reserve Banks are not agencies for APA purposes.

Although Courts of Appeals in other circuits have referred to Federal reserve banks as “instrumentalities” of the federal government in other contexts, Federal reserve banks are not part of any executive department or agency. Nor do they have the authority to promulgate regulations with the force and effect of law. Instead, they are “corporations that operate under the supervision and control of a board of directors, which shall perform the duties usually appertaining to the office of directors of banking associations.”

But then the court goes on to say that, in this case at least, it doesn’t matter anyways:

In any event, treating the FRBNY as an agency does not subject the FRBNY’s decision in this case to judicial review. […] The FRA provides the FRBNY with discretion to open or terminate Master Accounts. See 12 U.S.C. § 342. The statute therefore forecloses judicial review under the APA.

Moreover, judicial review under the APA would be “highly deferential and presume[] the agency’s action to be valid.” […]

No Standing to Sue the Federal Reserve Board

Finally, the court agreed with the Federal Reserve Board’s argument that BSJI lacks standing to seek a preliminary injunction against the Board “because the Board cannot reopen BSJI’s account.”

The Board exercises supervision over reserve banks, but does not have the statutory authority to receive deposits, open or close Master Accounts, or perform other banking services. […] Because the Board lacks enforcement power to open or terminate a Master Account, BSJI does not have standing to obtain a preliminary injunction against the Board.”

BSJI says it plans to appeal the district court’s decision.

1. The call report for City National is based on calendar year quarters, so the numbers from the most recent report discussed here are for the three months ended September 30, 2023. RBC is on an October 31 fiscal year, so the fourth quarter results that it will announce in late November, including results for City National over that period, will be different from the numbers discussed in this post.

2. This is from Schedule RI, Item 6. See also the optional narrative statement on the very last page of the call report: “During the period, CNB sold debt securities to an affiliate and realized a pre-tax loss of $2.7 billion. As this was a sale to a subsidiary of our parent company, Royal Bank of Canada (RBC), this pre-tax loss is eliminated on consolidation at the RBC group level.”

3. Important context: City National’s immediate parent company is not RBC, its ultimate parent. Instead, City National, as required by U.S. regulations, is held by RBC under an intermediate U.S. holding company that also holds other significant RBC U.S. non-branch subsidiaries (e.g., RBC’s U.S. broker-dealer subsidiary). So, when the previous iterations of City National’s call report listed here talked about receiving contributions from its parent company, this was not necessarily money being downstreamed all the way from Canada.

4. As is, perhaps, where the contribution is coming from. See footnote 3.

5. See page 10 of the opinion:

On April 12, 2023, having reviewed the FRBNY’s pre-decisional analyses of BSJI’s existing access, the Board advised the FRBNY: “We have no concerns with the Reserve Bank’s application of the Guidelines to BSJI’s [access] and with it moving forward with its intended action to terminate BSJI’s access based on this analysis.”

Query how this should be interpreted in light of the court’s decision on BSJI’s lack of standing to sue the Board, discussed later in this post.

6. The court was also unconvinced by BSJI’s argument that it would suffer irreparable harm in the absence of a preliminary injunction - see the discussion on pp. 14-16.

7. See for example the briefing in the ongoing PayServices master account dispute.