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Moody’s Investors Service has announced that it:

has placed the long-term ratings of six Canadian banks (including the bank financial strength ratings, all senior debt, junior subordinated debt, and preferred stock ratings) on review for downgrade.
…
Following the review, the senior debt and deposit ratings for the six banks are expected to generally be no more than one notch lower than today.

During this review Moody’s will also consider the removal of systemic support from the ratings of all seven Canadian banks’ subordinated debt instruments that benefit from support. It is our view that the global trend towards imposing losses on junior creditors in the context of future bank resolutions may reduce the predictability of such support being provided to the sub-debt holders of the large Canadian banks. We currently incorporate two notches of systemic support into the subordinated debt ratings of the six banks outlined above as well as in Royal Bank of Canada (RBC; Aa3 Stable (m); C+/a2 Stable). All RBC ratings were affirmed (as they were addressed by our rating actions on Firms with Global Capital Markets Operations in June 2012) except for its supported subordinated debt ratings that have been placed on review for downgrade.
…
High levels of consumer indebtedness and elevated housing prices leave Canadian banks more vulnerable to downside risks to the Canadian economy than in the past. By the second quarter of 2012, Canadian household debt to personal disposable income reached a record 163%, up from 137% in the second quarter of 2007, reflecting growth in debt that significantly outpaced personal incomes. Growth in consumer debt has been driven by rising house prices, which have increased by 21% since August 2007 (Source: Teranet-National Bank House Price Index).

Moody’s central scenario for Canada’s gross domestic product (GDP) is to grow between 2% and 3% in 2013, but downside risks have increased. The open, commodity-oriented economy is exposed to external risks, primarily (i) the weak US economic recovery (ii) the ongoing sovereign and banking crisis in the euro area; and (iii) a slowdown in emerging markets which weighs on commodity prices. Should these risks materialize, they would have significant ramifications for the Canadian economy that would be transmitted into the banking system.

Additionally, the large Canadian banks’ noteworthy reliance on confidence-sensitive wholesale funding, which is obscured by limited public disclosure, increases their vulnerability to financial markets turmoil.

In addition to the macro-economic factors cited above, National Bank of Canada, Bank of Montreal, Bank of Nova Scotia and Canadian Imperial Bank of Commerce have sizable exposure to volatile capital markets businesses. Moody’s believes that trading and investment banking activities expose financial firms to the risk of outsized losses and risk management and controls challenges, and leave them highly dependent on the confidence of investors, customers and counterparties.

Toronto Dominion and Caisse Centrale Desjardins have other idiosyncratic factors that are additive to the macro-economic risks. Toronto Dominion’s exceptionally robust creditworthiness may be weakened by the increasing contribution of its less-strong US subsidiary…

There has been lots of handwringing and crocodile tears from Lapdog Carney regarding Canadian consumer debt recently:

Mr. Carney also said the risk posed by household debt might be dissipating as the Bank of Canada’s repeated warnings sink in.

… and – after the water has been tested – from his boss:

Finance Minister Jim Flaherty has also made this a crusade as the ratio of household debt to disposable income holds at record levels, and is expected to rise further.

… but the most obvious way to address the problem is though the other group of highly politicized financial lackeys. Unfortunately, however, there has been nothing – absolutely nothing – from OSFI on the subject.

The problem is that reducing interest rates has not had as great an effect on business spending as might have been hoped, but there has been a large effect on consumer spending; that is, low rates have not been used to buy capital goods so much as they have been to finance consumption (and I believe that while there is an element of “capital goods” in houses, there is also a large component of “consumption”, an effect that can be captured through such concepts as “owner equivalent rents” or, perhaps the price to rent ratio)

Monetary policy is a very blunt instrument and Spend-every-penny has been gleefully exploiting this weakness to indulge in micro-management of the mortgage market and – at last, this part is actually good, if long overdue – throttling back on the money he’s been using to inflate a housing bubble.

This possible downgrade serves as a great argument in favour of countercyclical capital buffers. This is much more general than the micro-management indulged in so far, because, if properly designed, it is irrelevant whether consumers are over-borrowing for houses or tulip bulbs. Trouble is, this might require OSFI to spend some time actually thinking about what it’s doing, so I don’t think we’ll see it any time soon.

Issues affect by the possible downgrade are (deep breath):
BMO.PR.H, BMO.PR.J, BMO.PR.K, BMO.PR.L, BMO.PR.M, BMO.PR.N, BMO.PR.O, BMO.PR.P, BMO.PR.Q
BNS.PR.J, BNS.PR.K, BNS.PR.L, BNS.PR.M, BNS.PR.N, BNS.PR.O, BNS.PR.P, BNS.PR.Q, BNS.PR.R, BNS.PR.T, BNS.PR.X, BNS.PR.Y, BNS.PR.Z
CM.PR.D, CM.PR.E, CM.PR.G, CM.PR.K, CM.PR.L, CM.PR.M, CM.PR.P
NA.PR.K, NA.PR.L, NA.PR.M, NA.PR.N, NA.PR.O, NA.PR.P
TD.PR.A, TD.PR.C, TD.PR.E, TD.PR.G, TD.PR.I, TD.PR.K, TD.PR.O, TD.PR.P, TD.PR.Q, TD.PR.R, TD.PR.S, TD.PR.Y

This entry was posted on Saturday, October 27th, 2012 at 1:36 pm and is filed under Issue Comments. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.