Moody’s lowers Big Banks a notch over debt worries

‘Deterioration in credit conditions,’ hot housing could put dent in assets

TORONTO For the second time in five years, Moody’s Investors Service has downgraded the debt ratings of a group of Canada’s largest banks over concerns about their exposure to increasingly indebted consumers and high housing prices.

There was no major news event behind the ratings agency’s onenotch downgrade late Wednesday to the Big Six banks, but the conditions Moody’s warned about with the last downgrade in January 2013 haven’t been put to the test. And things have only got bubblier.

In the fourth quarter of last year, household debt hit a record high of 167.3 per cent of disposable income, a figure that has drawn concern from global monitors including International Monetary Fund.

Despite Moody’s warning of a more challenging operating environment for Canada’s biggest banks that could lead to “deterioration in … asset quality and increase their sensitivity to external shocks,” the country’s banks remain among the highest rated by Moody’s, according to David Beattie, a senior vice-president at Moody’s and one of the authors of the report.

However, a bump in the economy could put a dent in the quality of the banks’ assets, particularly if unemployment levels or interest rates rise, the ratings agency warned.

“We believe the largest vulnerability is currently consumer credit losses that reduce profitability and possibly impact capital,” Moody’s analyst Jason Mercer said in an interview. “Unemployment is a big driver in credit quality for all consumer lending — people need a job to pay their bills.”

Moody’s lowered TorontoDominion’s rating to Aa2, and dropped the other five banks — Royal Bank of Canada, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce, and National Bank of Canada — to A1.

Officials at the banks declined to comment.

The downgrade will raise the cost of capital for the banks, as their debt is perceived as slightly more risky, analysts said. It can also be expected to squeeze net interest margins because those are determined by the difference between rates at which banks borrow and lend money.

But, perhaps more important, the downgrade illustrates there is more at stake for the Big Banks than simplying their mortgage portfolios as mounting household debt combines with — and is perhaps driven by — high house prices.

Canada is often seen as less vulnerable to the shocks that hit the U.S. housing market in 2007 and 2008.

Part of the reason is that about half the $1.6 trillion in total mortgage debt in Canada is supported by insurance from providers including the Canada Mortgage and Housing Corp.

But the lenders’ unsecured lending — including credit cards and auto loans — is viewed by some analysts as much more vulnerable because it has also been growing and does not have the safety net of government-backed insurance.

When soaring house prices in Vancouver showed early signs of slowing last year, analysts at National Bank Financial warned that a large-scale cooling of the real estate market could trigger a cascade of events beginning with less consumer spending. This, they suggested, could lead to higher unemployment, and eventually to rising household credit losses for the banks.

Beattie, the author of this week’s Moody’s report, said the ratings agency looked at Canada in a global context and “decided the deterioration in credit conditions warranted a change at this time … even given mitigating structural features of the Canadian mortgage market.”

A Moody’s analysis last year suggested Canada’s seven largest lenders, including the big banks, could suffer losses of close to $12 billion from a severe housing downturn. But Mercer, the author of that report, said mortgages would be at the end of the line in the “hierarchy of credit sacrifice” in such a scenario.

“Credit cards and autos would go first,” he said. “Our concerns are for all consumer lending, not just residential mortgages,” Mercer said.

Moody’s doesn’t rate Home Capital Group Inc., Canada’s largest alternative mortgage lender, which was swept up in a crisis of confidence in recent weeks after the Ontario Securities Commission accused the company of providing misleading disclosure to investors in 2014 and 2015. None of the allegations has been proven.