) mid-August announcement that it had added $300 million to its reserves to cover potential liability from a series of suits arising from the Enron collapse. Toronto-Dominion's move brings to seven the number of financial institutions that have announced that they're boosting legal reserves related to those suits.
The largest of such legal actions, the Newby suit, seeks relief, on behalf of securities holders, from several major banks and brokerages alleged to be complicit in the demise of the energy trading giant, which filed for Chapter 11 bankruptcy in December, 2001. Only five banks have actually settled that suit: Lehman Brothers Holdings (LEH
), Bank of America (BAC
), Citigroup (C
), J.P. Morgan Chase (JPM
), and Canadian Imperial Bank of Commerce (CIBC). Others have settled smaller related suits.
A handful of banks and brokers named in the Newby suit have yet to either settle or proceed to trial: Toronto-Dominion, Credit Suisse (CSR
), Merrill Lynch (MER
), Deutsche Bank (DB
), Barclays Bank (BCS
), Royal Bank of Canada (RY
), and Royal Bank of Scotland.
Banks and Their Enron Settlements
Announced Settlements (Mil. $)
Est. Announced Legal Reserves Left (Mil. $)
Bank of America
Royal Bank of Canada
Royal Bank of Scotland
Standard & Poor's Ratings Services hasn't altered the ratings on any of the banks that have settled the Newby suit. With the exception of CIBC, the charges represented less than a quarter of earnings and were deemed to be a one-time event that didn't alter the company's future prospects. The sum was a year's worth of earnings for CIBC, but the bank had substantial excess capital stockpiled for the event.
Thus, while S&P changed the outlook to negative to reflect the potential constraints on strategic initiatives and financial flexibility, it maintained CIBC's ratings. Future rating actions would take into consideration the total financial impact as well as any ways in which the bank's longer-term prospects would be affected.
NO CRYSTAL BALL. S&P has stated that on the whole, there should be no ratings consequences for financial institutions involved in the Enron suits as long as any settlement, penalty, or reserve addition remains at about one-fourth of annual earnings. That has so far proven to be the case for all but CIBC, whose outlook we changed to negative.
However, S&P says it cannot project that the same will hold true at institutions that haven't yet settled, for two principal reasons: It's impossible to know the size of any future settlement or penalty, and without knowing that, it's impossible to know how any given resolution -- representing a one-time charge to earnings -- will affect the balance sheet.
While each of the remaining banks in unresolved situations continues to contest the case, the fact is that each bank that has settled in the Newby suit has done so for a progressively larger amount. Moreover, plaintiffs' attorneys have stated that it's their intent to seek increasingly larger settlements. If this pattern holds, that would mean that the next banks to settle could do so in excess of the $2.4 billion that CIBC agreed in early August to pay. That seems to give those institutions whose cases are unresolved an incentive to settle.
RIPPLE EFFECT? S&P isn't predicting that this pattern will persist, although plaintiffs' attorneys would clearly like to win the most money for their clients. The last two announcements on the part of Toronto-Dominion and Credit Suisse involved reserve increases, rather than settlements, as they continue to vigorously defend their cases. Also complicating the matter is the nature of the suit. Any judgment, were the case to go to trial and be decided against the banks, would be "joint-and-several," meaning that all the remaining banks and brokers would be equally responsible for the total amount.
Given the stakes, will any of the banks that haven't yet settled want to take that chance, no matter how innocent they believe themselves to be? The Newby suit, after all, is seeking in excess of $30 billion in damages. Investors should pay careful attention to how these remaining institutions put the matter behind them -- because the possible liability for any one of them could be considerable.
McNatt is a features editor for Standard & Poor's Securities Services