UPDATE 3-Moody's warns may downgrade five big Canadian banks
* Cites concerns on housing sector, economy, consumer debt
* Concerned with four banks' capital markets exposure
* RBC, which was downgraded in June, excluded
By Luciana Lopez and Cameron French
NEW YORK/TORONTO, Oct 26 (Reuters) - Moody's Investors Service warned on Friday it could cut its ratings on five top Canadian banks on concerns about a softening economy and volatile capital markets, a blow to a banking system named the soundest in the world four years in a row.
But the outlook for the sector is no longer as rosy, Moody's said, because of the risks presented by the macroeconomic environment and a business mix that leans heavily on domestic mortgages and other consumer lending.
Canadian consumer debt has risen to record highs in recent months, a situation reminiscent of the United States before its 2008 housing crisis. The household debt-to-income ratio jumped to 163.4 percent in the second quarter from 161.8 percent in the first quarter, Statistics Canada said a week ago.
Meanwhile, Canada's housing market appears to be cooling after several years of red-hot gains.
"Domestically, we're concerned about the high and increasing levels of consumer indebtedness and elevated housing prices, and we feel that they may tend to leave the Canadian banks more vulnerable to downside risks to the economy than they have been in the past," David Beattie, Moody's vice president and senior credit officer, told Reuters.
The warning applies to long-term debt ratings for Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada. It also applies to Caisse Centrale Desjardins, Canada's largest association of credit unions.
The ratings agency said any cuts would likely be only one notch. The sector's ratings are still among the highest in the world.
"We continue to believe that the Canadian banks rank among the strongest in the world, and this review is based on concerns about system-wide and bank-specific risks that aren't fully captured in their current ratings," said Beattie.
The only bank not put on credit watch on Friday was Royal Bank of Canada, the country's largest. That's because Moody's lowered RBC's ratings by two notches in June as part of a review of 17 global banks.
Moody's did place RBC's supported subordinated debt ratings on review for downgrade, while affirming its other ratings.
CAPITAL MARKETS EXPOSURE
Moody's also cited the sizable capital markets exposure of Scotiabank, BMO, CIBC and National Bank as reasons for the warning. Exposure to capital markets was the main reason behind RBC's ratings cut earlier this year.
For TD, the highest-rated Canadian bank, Moody's cited concern with its "less-strong" U.S. subsidiary. TD has about 1,300 branches in the United States, outnumbering its branch count in Canada.
TD's long-term credit rating is currently Aaa, which is the highest rating. Scotiabank and Desjardins are rated Aa1, the next level down, while BMO, CIBC, and National Bank are rated Aa2.
Desjardins was cited because of its more "concentrated" franchise than its Canadian peers, which Moody's said leaves it less flexibility to respond to profit pressures.
Desjardins has a dominant retail bank presence in the province of Quebec, but lacks the geographic diversity and business mix of the big banks.
Canada's banks, which had held up much better than their peers during the global economic crisis, were named soundest in the world for four straight years by the World Economic Forum.
The second major debt rating agency, Standard & Poor's, made a similar move in July, putting RBC, TD, Scotiabank and National Bank on "negative outlook" citing rising consumer debt and elevated housing prices.
Shares of the Canadian banks did not appear to be affected by the Moody's report, which was released about an hour before markets closed on Friday.
Of the banks placed on review, only TD declined, slipping 0.1 percent to C$81.17 on the Toronto Stock Exchange.
CIBC would not comment on the review, while a TD spokesman said the bank "continues to be well capitalized and remains one of the safest and strongest banks in the world."
The other lenders did not immediately respond to a request for comment.