Laurentian Bank: the impact of the announcement of a cut in dividends.

At the height of the 2008-09 financial crisis that revealed the fragility of global financial systems, particularly in the USA, a key topic

of conversation in Canada among investors and analysts was whether the chartered banks, faced with dire earnings forecasts would

cut their dividends. Regulators were concerned too and together their concern was one of loss of systemic confidence. As John Heinzl reported in

the Global and Mail on December 5t 2008,

“A divfdend cut at a time when investors’ nerves are already frayed would send a terrible signal, possibly rattling the faith of

depositors and touch off a crisis”

Investors today can thus point to history that apart from the National Bank, which cut its dividend in 1992, Canadian banks

have not cut their dividends, even when faced with past economic recessions eg. in the early 1980’s. Rather they have

rebuilt their balance sheets and focused on their core banking business as they did during the Great Recession that followed

the 2009-09 financial crisis.

Fast forward to 2020 by which time the Canadian financial sector had largely recovered from the near death experience of that crisis,

but was now facing a global pandemic with lock downs and significant economic disruption. All the banks were reporting significant

declines in earnings and having to make substantial provisions for credit losses.

But it was Laurentian Bank (TSX: LB), Canada’s 7*h

whose profits had fallen by 79%, higher than the forecasts of many analysts forecasts, that announced a cut in its dividend by 40% which took it back

to the level it was in 2011. A move that was not followed by the other banks.

So what went wrong at Laurentian that caused it to make such a significant decision when its competitors were facing the same pandemic

but chose not cut? The answer lies with its own issues. Prior to the dividend cut there had been persistent earnings erosion and a 35%

stock price decline that lead to a 8.6% dividend yield. By comparison, National Bank, also based in Montreal saw its stock price increase by 30%

over the same period. Even with the cut in May, Laurentian’s dividend yield, with a stock price of $31 was still over 5%, and at the time of writing this case,

with an increased stock price and a P/E ratio of 15.20, its yield was 3.97%. Above some of its rivals.

Laurentian, ahead of its 175’ h anniversary in 2022 had embarked on a $250m 7 year strategic plan with a push into digital banking through LBC Digital a direct to customer channel. It closed up to half of its branches and converted the others to ‘financial clinics”. Its personal loan and residential mortgage growth stalled and Barry Schwartz of Baskin Wealth Management commented in June that

“ Laurentian Bank needs to figure out what type of bank it is and what’s the

strategy going forward.”

The bank in justifying its dividend decision described it as a prudent move that would ‘provide greater financial strength and//ex/b/lily” at a time of a “ highly uncertain economic environment.” Such a decision had a clear rationale as analysts reported that to maintain the dividend would have absorbed 98.6% of 1st quarter 2020 earnings.

Apart the immediate fall in stock price following the dividend cut, the bank announced on June 15th that the CEO, Francois Desjardins would be retiring at the end of month and that Stephane Therrien, an executive VP was appointed as acting CEO. On October 30th Ms Rania Llewellyn, whose career with Scotiabank spanned over 20 years was appointed CEO. The bank’s first quarter 2021 results showed a 4% increase in total revenue.

Discuss the case.

Hints:

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3
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1. You could follow the literature here of establishing a dividend policy for a firm. While this case is set in the context of a bank where dividends have become sacrosanct for those investors seeking regular income — the widows and orphans argument as well as institutional investors such as pension funds, the same arguments would apply to other stocks who are known for their regular dividends. (have a look online at John Heinzl’s model dividend growth portfolio).

2. Laurentian Bank (LB) argued that the cut was a prudent decision to conserve cash. However, the ‘market’ clearly did not see it that way.

3. Given LB’s earnings had been eroding for some time and stock price too so you need to ask the question why would the ‘market’ not expect a cut?

4. If you had more time to spend on this you could use an Event methodology to examine the pre- and post- market reaction ( both volume and price data) to the cut. Likewise you could use the same methodology for the announcement of the exit of the CEO in June and Rania Llewellyn’s appointment in October.

Magna International Inc. – the elimination of the dual class structure.

“ We believe the proposed transaction if approved by shareholders, has the

potential

for

to unlock significant value for Magna shareholders and establish a strong foundation

the company’s long-term success.”(Don Walker and Siegfried Wolf, Co-Chief Executive

Officers)

“ I created the company [in 1957] from scratch and worked like crazy for 50 years

….[and] I’m still working

and making a contribution.”( Frank Stronach, Founder and Chairman of Magna)

Magna International Inc. announced at its AGM on May 6th 2010 that an agreement had been reached with the Stronach Family Trust (ST)

that subject to shareholder and court approval, it would eliminate its dual share structure. It dated back to 1978 and did

not contain a ’sunset’ clause or “coattail protection for the minority shareholders of Class A shares in the event of a change of control

transaction” (Osler 2010). Magna’s share price rose to $73.26 on the news.

A notice of a special meeting of shareholders was mailed out on June 2’ d.

and the Board of Magna established a special committee of independent directors to review the proposal.

The Class A subordinated voting shares (one vote per share) were widely held and traded on both the NYSE and TSX . But the

Superior Class B shares gave 300 voting rights per share and majority control, with less than 1% of the total equity of Magna.

They were wholly owned by the Stronach Family Trust (ST) and did not trade.

The details of the proposed ‘plan of arrangement‘ were that ST would:

1. relinquish 726,829 Class B shares and in exchange receive $300US in cash and 9 million new Class A shares

which at the current stock price were valued at $563m. This would lead to a dilution of Class A shares of close to 11.4%. ST would still be the largest single shareholder.

1. That ST and Magna would form a new joint venture aimed at building hybrid and electric

vehicles with an injection of $20m from Magna and $80m from ST with the latter having three of the five members of the Management Committee.

1. Frank Stronach would remain with Magna on a 5-year non-renewal consulting agreement which in 2011 would give him 2.75% of Magna’ s pre-tax profit, but would decline over the remaining 4 years. If the contract was cancelled, there was a guaranteed payment of $120m.

Dual class shares are not uncommon in Canada and this type of share structure often came about in many family businesses eg Empire in Nova Scotia, Ford in the USA and Volkswagen in Europe. The founders did not want to dilute control, particularly if they needed to raise additional equity capital. With the increased focus on corporate governance issues by regulators and the media, many boards in North America and Europe have eliminated dual voting structures without the degree of largesse found in this case. However, they have seen a resurgence in the USA with Google, Facebook, Fitbit, and Alibaba to name a few, all adopting various restrictive share structures. While the empirical evidence is mixed as to the performance of one type of voting structure to another, what is clear is that it can magnify success ( Couche-Tard which removed its structure when the sunset clause kicked in) or failure ( Bombardier). The OSC now require that companies with subordinated stock identify that such shares have subordinated voting rights

While Mr Stronach was admired for his entrepreneurship and vision in building Magna to be a major multinational, he was not without controversy. Whether it was his compensation, lifestyle or his investments in what were seen as non-core assets such as the Santa Anita race track in California, Magna was often in the news. In addition, Magna was involved in an abortive bid with a Russian partner to buy Opel, the European GM subsidiary (as of 2017 now owned by Groupe PSA).

The arrangement drew criticism from many quarters, but praise in others. On the latter it was expected that it would lead to longer-term share appreciation. The reasoning for this was not just from the more ‘democratic’ structure and the potential for board reform with all shareholders voting on board membership thus replacing the potential for cronyism, but a more effective market monitoring and influence thus reducing agency costs. If the company performed poorly, there was the potential for shareholder activism including a take-over bid In both instances top management could be replaced, another a corporate control check.

Additionally it was argued that Magna’s the stock would be more liquid and marketable.

For the opposing view on the deal, there were several contentious issues voiced in particular by some of the major institutional investors, including the Ontario Teachers’ Pension Plan Board and the Canadian Pension Plan Board over:

2. the size of the premium to the ST

2. the due process of the deal itself.

Indeed the OSC raised concerns over the disclosures to shareholders ruling that the approval process of the Board was

“defective from the start” and “issued a notice of a hearing alleging that the proposal was contrary to the public interest and issued a temporary cease-trade order” Osler, 2010

Legal challenges were launched in the Ontario Supreme Court to determine if the proposal was fair and reasonable and if the Board had fulfilled its fiduciary responsibility. The Court found that “the elimination of Magna’s dual class structure would benefit from both corporate governance and financial perspectives.” The OSC then permitted the arrangement to proceed to a vote but criticized the lack of a “fairness opinion from the special committee and the board and stipulated additional disclosures in the proxy documentation” (Osler, 2010).

In the event more than 75% of the Class A shareholder approved the plan at the July 23rd meeting. On an appeal by dissenting shareholders to the Ontario Divisional Court of Justice, this was dismissed and the arrangement was approved on August 30′. Although with the Court’s endorsement of the deal, the matter would appear to have ended. However, in April

2011, two major proxy advisory firms recommended against the re-election of the Magna International’s Board of Directors. To be specific, ISS Proxy Advisory Services is quoted as saying:

‘it was unacceptable that the special committee (of the Board) did not offer any recommendation to shareholders on whether to approve the offer and did not provide an independent fairness opinion on the deal’

Frank Stronach stepped down as a director of Magna in 2012, but remained as a consultant until 2014.

Question

What does the Magna case inform us as to how the ‘market’ values a firm with restrictive voting rights and how does it exercise its monitoring role.