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Moody's Investors Service – the credit rating arm of Moody's Corp. (MCO - Analyst Report) – has downgraded the long-term ratings of six major Canadian banks, concluding the review initiated in Oct 2012. However, the outlook for these banks has been maintained at ‘Stable’.

Banks witnessing a one-notch downgrade include Bank of Montreal (BMO - Snapshot Report), The Bank Of Nova Scotia (BNS - Snapshot Report), Canadian Imperial Bank of Commerce (CM - Snapshot Report), National Bank of Canada (NTIOF) and The Toronto-Dominion Bank (TD - Snapshot Report). The rating of Canada’s largest association of credit unions – Caisse Centrale Desjardins – also went down by one notch. The ratings of these six institutions now range between Aa1 and Aa3.

Downgrade Rationale

As per Moody’s, Canadian banks face a bunch of risks owing to the substantial increases in the nation’s consumer debt over the last few years. The household debt-to-income ratio came in at 165% at the end of Sep 30, 2012, up from 137% in the second quarter of 2007. This reflects the rising disparity between the growth in debt and hike in personal incomes.

Another contributor to the escalating consumer debt is the substantial rise in housing prices. There has been a 20% hike in housing prices since Nov 2007. According to the rating agency, although Canadian Gross Domestic Product will likely grow in the range of 2%–3% in 2013, the potential downside risks to the economy have increased manifold.

Further, unsettling macro economic factors will weigh down on the commodity markets with severe ramifications on the overall Canadian economy, which will consequently engulf the nation’s entire banking system.

In addition to the abovementioned macro economic factors, there are certain other bank-specific factors taken into consideration by Moody’s to assess the ratings of these banking biggies. Such factors include the considerable exposure to volatile capital markets and significant dependence on wholesale funding.

Rating Action by Standard & Poor's

In Dec 2012, Standard & Poor's Ratings Services downgraded the ratings of six Canadian financial institutions namely Scotiabank, National Bank of Canada, The Laurentian Bank of Canada, Central 1 Credit Union, Caisse Centrale Desjardins and Home Capital Group by a notch. The downgrades came on the back of a sluggish economy, low interest rate environment and problems faced by the Canadian economy.

Our Viewpoint

The removal of government’s support from the ratings of the subordinate debt of some institutions will force the debt holders to bear the brunt in case of losses, thereby keeping safe the taxpayers’ money.

However, it must be mentioned that these aforementioned Canadian banks have been performing better than their global peers for the last couple of years. The strong fundamentals and franchise structures of these banks are expected to absorb the ill effects of the rating downgrades.

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