Fitch Ratings has affirmed its ratings on the six largest Canadian banks, with stable outlooks, citing the banks’ sound capital levels, high asset quality, continued earnings stability, and strong funding and liquidity positions.
The rating agency said that the banks’ strengths are counterbalanced by continued risk from the residential housing market, increasing consumer debt levels, global economic headwinds, slowing loan growth, margin compression and heightened competition.
The main domestic threat to the stability of the Canadian banks remains the record level of consumer indebtedness and the risk of overvaluation in the housing market, Fitch says, noting that “the increased vulnerability of Canadian households to an adverse shock could pressure Canadian banks’ ratings should borrowers’ ability to pay weaken due to worsening domestic or global economic conditions.”
However, Fitch also believes the immediate impact of deterioration in the household sector would be partly mitigated by a number of structural factors, including the high proportion of mortgages that the banks have insured with Canada Mortgage and Housing Corporation and low initial loan to value ratios on uninsured mortgages.
Canadian banks also benefit from sound capital levels, “leaving the banks well positioned to withstand a moderate housing stress.”
Fitch says it does not believe there is upside rating potential for the big six banks in the foreseeable future, given their current high ratings and ongoing uncertainty with respect to the Canadian residential mortgage market and broader international markets. But that ratings could be adversely affected by a sharp reversal in Canadian housing prices that weakens consumers’ ability to pay while driving rapid and disorderly consumer deleveraging.
“Banks with lower levels of insured mortgage exposure (such as RBC) would likely be more exposed to the first order effects of a housing downturn than those that have higher levels of mortgage insurance (such as CIBC and TD). In the case of NBC, given its geographic concentration in Quebec, its ratings would be more sensitive to a housing downturn that was concentrated within this province,” it notes.
Fitch adds that other potential negative rating drivers include contagion risk from U.S., European or Asian markets, weakened capital or liquidity positions, or material acquisitions outside of Canada. It suggests that it may have a negative rating bias towards large acquisitions that are outside of Canada and/or that increase leverage or introduce undue integration costs.
“In the case of U.S. contagion, those banks with meaningful U.S. operations (such as BMO and TD) could be more exposed to the effects of a U.S. downturn. Banks with larger trading activities as a percent of total revenues (such as RBC and BNS) could be exposed to negative rating pressure in the event of outsized losses and or performance volatility with respect to this business line, particularly if it grows to represent a larger portion of overall revenues,” it notes.