Standard & Poor’s Ratings Services has downgraded six Canadian financial institutions, including two of the big six banks, on concerns about elevated risks to the banks amid growing economic pressure.
The rating agency reduced its ratings by one notch on 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 outlooks are stable.
At the same time, S&P affirmed its ratings and stable outlooks on Bank of Montreal, CIBC, and Manulife Bank of Canada. And, it affirmed its ratings, but revised the outlooks to stable from negative, for Royal Bank and TD Bank.
“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,” it said. “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.”
S&P says that after several consecutive quarters of robust growth, loan demand is approaching a cyclical peak and it expects that 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,” it says.
And, it cautions that the risk appetite of the Canadian banks 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.”
S&P notes that it hasn’t changed its overall assessment of economic risk, but that it views 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,” it says.
“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,” it says, noting that exposure to the consumer sector accounts for nearly three-fifths of total bank loans, ” and losses on banks’ uninsured loan portfolios may be driven higher in the event of a substantial shock to household creditworthiness.”
The banks’ capital positions are generally strong, S&P says, although it warns that a deterioration of capital ratios could result 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,” it adds.