TEXT-S&P Takes Various Rating Actions On Canadian Banks

Thu Dec 13, 2012 7:55pm EST

-- We believe that the Canadian banking sector is encountering incremental pressure from headwinds facing the Canadian economy, which is heightening economic risk in the banking system. We also believe that industry risk for the Canadian banking sector is increasing. We expect that intensifying competition for loans and deposits will lead to pressure on profitability growth, especially in banks' retail businesses.

-- We are therefore lowering our issuer credit ratings by one notch on The Bank of Nova Scotia, Central 1 Credit Union, Caisse centrale Desjardins, Home Capital Group Inc., Laurentian Bank of Canada, and National Bank of Canada. The outlook is stable.

-- We are affirming our issuer credit ratings and stable outlooks on Bank of Montreal (and BMO Financial), Canadian Imperial Bank of Commerce, and Manulife Bank of Canada. We have lowered the related stand-alone credit profiles (SACPs) for these institutions by one notch, however.

-- We are also affirming our issuer credit ratings on Royal Bank of Canada and The Toronto-Dominion Bank, and revising the respective outlooks to stable from negative.

-- We are also affirming our issuer credit rating with a negative outlook on HSBC Bank Canada, which reflect those on its parent.

TORONTO (Standard & Poor's) Dec. 13, 2012--Standard & Poor's Ratings Services said today it lowered by one notch its long- and short-term issuer credit ratings on six Canadian financial institutions: The Bank of Nova Scotia (BNS), Central 1 Credit Union, Caisse centrale Desjardins, Home Capital Group Inc., Laurentian Bank of Canada, and National Bank of Canada. The outlooks are stable.

Standard & Poor's affirmed its long- and short-term issuer credit ratings and stable outlooks on Bank of Montreal (and its core subsidiary BMO Financial), Canadian Imperial Bank of Commerce (CIBC), and Manulife Bank of Canada.

The stand-alone credit profiles (SACPs) on these institutions have been reduced by one notch, along with SACP-linked issue ratings. At the same time, Standard & Poor's affirmed its long- and short-term issuer credit ratings on Royal Bank of Canada (RBC) and on Toronto-Dominion Bank (TD Bank) and revised the respective outlooks to stable from negative.

The SACP of RBC was unaffected as the company's capitalization, as measured by Standard & Poor's risk-adjusted capital (RAC) ratio has strengthened at a faster pace than we had previously expected, largely driven by RBC's initiatives to de-risk a number of its capital markets businesses, which led to a revision of the capital and earnings score to "adequate" from "moderate".

Similarly, the SACP for TD Bank incorporates our view that the company's strong asset quality performance, continued favorable loss experience, and diversity of risk exposures supported a revision to its risk position score to "strong" from "adequate", offsetting the impact of the lowered anchor. In addition, we affirmed our ratings on HSBC Bank Canada with a negative outlook, which reflects those on its parent. We have also affirmed our ratings on Manulife Bank and stable outlook, which reflects those on its parent.

Finally, for the downgraded Canadian financial institutions, we also lowered the ratings on their senior unsecured debt. Similarly, for those Canadian financial institutions for which we lowered the SACP, Standard & Poor's also lowered the respective ratings on nondeferrable subordinated debt, preferred shares, and hybrids.

We have lowered our assessment of industry risk to reflect our expectations for ongoing intensification of competitive dynamics of the Canadian banking sector, though overall our view is that Canada still remains positioned favorably vis-a-vis most of its global peers. After several consecutive quarters of robust growth, loan demand is approaching a cyclical peak and we expect it to moderate.

A slowing economy risks exacerbating the already-intense competition between banks for loan and deposit share and puts further pressure on the margin and profitability of Canadian financial institutions' retail and commercial lending businesses, the cornerstone of Canadian banking and the largest contributor to revenues.

We also believe that Canadian financial institutions' risk tolerances may increase to compensate for lower profitability by reaching for yield through investments, more aggressive lending in higher yielding loans such as personal loans and credit cards, or potentially a pickup in merger and acquisitions activity.

Even though we haven't changed our overall assessment of economic risk, we view the overall trend as negative. In our opinion, economic risks to the Canadian banking sector remain relatively low by global comparison but the banks face incremental pressure from the headwinds facing the Canadian economy. The acceleration of household debt to record levels has, in our view, increased Canadian households' vulnerability to sudden shocks in incomes, employment, or a spike in interest rates.

Exposure to the consumer sector accounts for nearly three-fifths of total bank loans, and losses on banks' uninsured loan portfolios--although recent performance levels have generally been strong--may be driven higher in the event of a substantial shock to household creditworthiness. We expect effective regulatory supervision to remain a positive influence on Canadian bank credit quality.

Canadian banks are well positioned to meet the initial requirements for new capital regulations coming into effect in 2013. Based on Standard & Poor's projected risk-adjusted capital (RAC) ratio, the large Canadian banks are typically above 8%, which is within the 7%-10% range considered "adequate" under our criteria. Organic capital generation has been strong and a key driver in the strengthening RAC ratios of the Canadian banks. We expect Canadian banks' RAC ratios to remain within our adequate range.

Deterioration of capital ratios could result, however, if asset risk weightings rise while earnings growth falters. We also expect that continuing industry conditions will test Canadian banks' operational capabilities. Relative performance in areas such as service standards, cost control, operational effectiveness, underwriting discipline, and ability to integrate acquisitions will likely contribute to changes in market position and financial performance, and will have an impact on relative credit standing among industry participants.

Our concerns over heightened industry and economic risks in Canada affect the 12 Canadian financial institutions we rate through a lowering of the anchor SACP, or starting point for our ratings, but the ratings and outlook outcomes vary for a number of reasons.

The downgrade on Bank of Nova Scotia, Central 1, Caisse centrale Desjardins, Home Capital, Laurentian Bank, and National Bank is a result of a downward revision in their SACPs following a lowering of the anchor as well as, in some cases, reassessments of bank-specific factors.

We affirmed our issuer credit ratings on CIBC and Bank of Montreal (and BMO Financial) despite the downward revision of their respective SACPs, given the notching uplift applied at different SACP levels in connection with our assessment of the potential for receiving extraordinary government support in a crisis.

We affirmed our issuer credit rating on RBC despite the downward revision of the bank's anchor SACP. This is because we revised RBC's capital and earnings score to "adequate" from "moderate" based on a stronger projected RAC ratio in the range of 8.4%-8.8% by fiscal year-end 2014. (Standard & Poor's views a RAC ratio in the 7% to 10% range as adequate.) The projected capital improvement reflects a significant decline in market risk-weighted assets in 2012 resulting from RBC's initiatives to de-risk a number of its capital markets businesses, in light of stricter regulatory capital requirements, combined with strong internal capital generation.

We also affirmed our issuer credit rating on TD Bank despite the downward revision of the bank's anchor SACP, as TD Bank's strong asset quality performance, continued favorable loss experience, and diversity of risk exposures led to a reassessment of its risk position to "strong" from "adequate" resulting in no change to the SACP.

Under our group methodology, the issuer credit ratings and outlooks on Manulife Bank of Canada and HSBC Bank Canada are linked to those on their respective parents, as a result of our application of "core" subsidiary status to these entities. Our stable outlooks on BNS, Central 1, Caisse centrale Desjardins, Home Capital, Laurentian Bank, and National Bank reflect our view that these institutions' credit profiles will remain consistent with current ratings in the face of the incrementally higher stress incorporated in our expectations for Canada's industry risks and economic risks.

The stable outlooks on BMO (BMO Financial), CIBC, and Manulife Bank reflect our expectation for these financial institutions to maintain their current credit profiles and that heightened economic and industry risk is reflected in the lowered SACPs.

The outlook revisions to stable from negative on RBC and TD Bank follow our affirmation of their respective SACPs and ratings. There are also company-specific key drivers of ratings and outlooks. For further details, please see the research updates on all the banks, including a list of our ratings on affiliated entities and debt issues, to be published following this press release.

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