PrefBlog

Last February, Moody’s slashed bank preferred ratings by three notches, reflecting a reappraisal of the likelihood of government support, at least as far as preferreds were concerned:

Prior to the global financial crisis, Moody’s had incorporated into its ratings an assumption that support provided by national governments and central banks to shore up a troubled bank would, to some extent, benefit the holders of bank subordinated capital as well as the senior creditors. The systemic support for these instruments has not been forthcoming in many cases. The revised methodology largely removes previous assumptions of systemic support, resulting in today’s rating action. In addition, the revised methodology generally widens the notching on a bank hybrid’s rating that is based on the instrument’s features.

In that action, RY prefs were downgraded three notches, taking them from Aa2 to A2. The three notch downgrade was in line with almost every other bank. Almost.

A little while earlier, Moody’s had taken BMO prefs down four notches, due to concerns over the volatility of its capital market business.

In the RY Annual Report for 2010, they stated their strategic goals:

• In Canada, our goal is to be the undisputed leader in financial services.
• Globally, our goal is to be a leading provider of capital markets and wealth management solutions
• Intargeted markets, our goal is to be a leading provider of select financial services complementary to our core strengths.

Moody’s takes exception to the goal of growing the capital markets business:

Moody’s Investors Service has downgraded the ratings of Royal Bank of Canada, driven principally by the bank’s commitment to its sizeable and growing capital markets business, which potentially exposes bondholders to increased earnings volatility and poses significant risk management challenges .
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As part of its universal banking strategy, RBC management is selectively expanding upon its strong domestic investment banking and trading capabilities to build a global investment banking platform. Tactically, RBC has been able to exploit the continuing disarray at many of its investment banking competitors to upgrade and build out its banking, sales and trading capabilities outside Canada.

“Shareholders and bank managers are attracted to the growth potential of capital markets businesses, but these businesses can expose bank bondholders to hidden tail risks,” said Peter Nerby, a Moody’s Senior Vice-President.

Although Moody’s expects RBC’s other businesses will provide a substantial buffer against these risks, the rating agency believes the opacity and the potential volatility associated RBC’s enlarged and expanding capital markets operations are not consistent with its former B+ unsupported bank financial strength rating.

RBC already has a substantial commitment to the capital markets business. At year end 2010, the capital markets segment represented roughly 45% of the bank’s consolidated balance sheet, and management is attributing roughly 25% of the firm’s $33 billion in common equity to the capital markets segment. Over the long run, management has signaled that the contribution from capital markets businesses could be as much as 30% of overall revenue and earnings through the cycle.
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..Issuer: Royal Bank of Canada
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….Preferred Stock Preferred Stock, Downgraded to A3 from A2

Royal Bank has a host of preferreds outstanding: RY.PR.A, RY.PR.B, RY.PR.C, RY.PR.D, RY.PR.E, RY.PR.F, RY.PR.G, RY.PR.H, RY.PR.I, RY.PR.L, RY.PR.N, RY.PR.P, RY.PR.R, RY.PR.T, RY.PR.W, RY.PR.X and RY.PR.Y.

This entry was posted on Monday, December 13th, 2010 at 12:09 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.