National Post (National Edition)
Bank downgrade has no ill effects on stock markets.
Downgrades show no effect on stocks, borrowing
One of the world’s leading debt rating agencies downgraded five of Canada’s big banks Monday because of exposure to over-leveraged consumers, but stock markets seemed not to notice as bank shares continued on a winning streak that’s been going on for more than six months.
The action “reflects our ongoing concerns that the Canadian banks’ exposure to the increasingly indebted Canadian consumer and elevated housing prices leaves them more vulnerable to unpredictable downside risks facing the Canadian economy than in the past,” said David Beattie, a senior credit analyst at Moody’s Investors Service Inc.
Bank stocks have moved up more than 5% since June, suggesting investors are confident real estate “is not going to crash,” said Ian Nakamoto, director of research at MacDougall, MacDougall & MacTier Inc., a Toronto-based asset manager.
Even debt markets appear to be brushing off the move.
Theoretically, ratings downgrades make it more expensive for firms to borrow. But in today’s zero interest rate environment, yields on Canadian bank debt are close to the lowest in living memory and it’s hard to see how — especially at a time when demand for highly rated bonds is so strong — that’s going to change any time soon.
Lenders affected by the single-notch downgrade were Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce, National Bank of Canada and Caisse centrale Desjardins.
Royal Bank of Canada, the largest lender, is not included in the group.
For the last several years Bank of Canada governor Mark Carney has been warning about the dangers of ballooning consumer debt and the vulnerability it creates for the economy.
Household borrowing has been rising steadily for more than a decade as more Canadians jumped into the housing market, driving up prices and the value of mortgages they had to take on.
The ratio of household debt to income is sitting at nearly 165%, the highest on record, according to the latest numbers from Statistics Canada.
Moody’s is predicting economic growth of between 2% and 3% for the current year “but downside risks have increased,” it warned, pointing out that Canada’s open, commodity-oriented economy is exposed to global trends.
Banks are largely protected from the direct impact of losses in their mortgage portfolios that might result from a housing correction through the use of default insurance provided by the Canada Mortgage and Housing Corp. But the concern is that a sharp drop in home values might spark negative changes in the broader economy such as a decline in consumer spending and borrowing, potentially even a drop in
A sharp drop in home values might spark negative changes
home construction, a major driver in cities such as Toronto and Vancouver. That sort of fallout would weigh heavily on bank results.
Monday’s ratings action comes about seven months after Moody’s downgraded 15 global banks, including Royal Bank of Canada, because of exposure to increasingly volatile international capital markets.
Housing prices have been on a tear since the financial crisis but over the past few months most markets have started to cool with sales down 17% nationally, following moves by Finance Minister Jim Flaherty and the banking regulator to tighten mortgage lending rules.
For now most analysts are calling for a soft landing. Moody’s Mr. Beattie said in an interview he does not anticipate further ratings changes in the near future.
But even a gentle correction in household borrowing could be bad news for the banks, which over the past 10 years have increasingly relied on consumer borrowing as a key earnings driver. Lenders say retail lending has decelerated in the past few months and they expect the trend to continue.
The question is, how will they replace those revenues? The entire sector is aggressively pursuing opportunities in wealth management and business lending but analysts are skeptical it will fill in the hole left by retreating consumers.