-- 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.
-- We also believe 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.
-- We are lowering our long- and short-term issuer credit ratings on Laurentian Bank to ‘BBB/A-2’ from ‘BBB+/A-2’, and assigning a stable outlook, following our revision of Laurentian Bank’s stand-alone credit profile to ‘bbb’ from ‘bbb+'. In conjunction with these actions, we are also lowering our issue ratings on Laurentian Bank’s senior unsecured debt to ‘BBB’ from ‘BBB+’ and its nondeferrable subordinated debt to ‘BBB-’ from ‘BBB’, and its preferred shares and hybrids to ‘BB+’ from ‘BBB-'.
-- The stable outlook reflects our expectation that Laurentian will maintain its current credit profile across a range of future scenarios.
On Dec. 13, 2012, Standard & Poor’s Ratings Services lowered its long- and short-term issuer credit ratings on Laurentian Bank of Canada to ‘BBB/A-2’ from ‘BBB+/A-2’. The outlook is stable. We also lowered our issue ratings on Laurentian’s senior unsecured debt to ‘BBB’ from ‘BBB+', its nondeferrable subordinated debt to ‘BBB-’ from ‘BBB’, and its preferred shares and hybrids to ‘BB+’ from ‘BBB-'.
In addition, we have lowered our stand-alone credit profile (SACP) on the bank to ‘bbb’ from ‘bbb+'.
The rating action follows our review of banking sector industry and economic risks in Canada, taking into account the headwinds facing the Canadian economy, Canadian consumers’ high debt levels, expectations of decelerating loan demand and continued pressure on margins, particularly in the Canadian retail sector, and areas of continuing weakness in the global economy and financial system.
We believe banks and credit unions operating in Canada are subject to an expanding set of potential stresses arising from competitive pressure on growth and margins, while asset quality is potentially vulnerable--in light of high consumer indebtedness--to developments that may trigger general economic deterioration in Canada.
Consequently, we lowered our anchor SACP, which is the starting point for our ratings on financial institutions operating primarily in Canada, to ‘a-’ from ‘a’. This is reflected in our revision of Banking Industry Country Risk Assessment (BICRA) for Canada to group ‘2’ from ‘1’ and revised our industry risk score, a component of the BICRA, to ‘2’ from ‘1’ (see “Various Rating Actions Taken On Canadian Financial Institutions Due To Rising Industry and Economic Risks,” published Dec. 13, 2012, on RatingsDirect on the Global Credit Portal).
We believe that the banks and credit unions are under incremental pressure from the headwinds facing the Canadian economy. The acceleration of household debt to record levels has increased Canadian households’ vulnerability to sudden shocks in incomes, employment, or a spike in interest rates.
Exposure to the consumer sector accounts for nearly three-fifths of total bank loans, and losses on banks’ uninsured loan portfolios--although recent performance levels have generally been strong--may be driven higher in the event of a substantial shock to household creditworthiness, though we expect effective regulatory supervision to remain a positive influence on Canadian bank credit quality.
Although we expect ongoing intensification of competitive dynamics in the Canadian banking sector, we note that overall Canada still remains positioned favorably vis-a-vis most of its global peers. However, 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 the Canadian financial institutions’ retail and commercial lending businesses, the cornerstone of Canadian banking and largest contributor to revenues.
We also believe that Canadian financial institutions’ risk tolerances 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 pick-up in mergers and acquisitions activity.
Furthermore, we expect that continuing industry conditions will test 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 the relative credit standing among industry participants. Our “weak” business position assessment of Laurentian recognizes the bank’s limited diversity of business lines and somewhat concentrated regional focus.
Recent acquisitions to expand Laurentian’s B2B franchise may over time contribute to the resilience of Laurentian’s business position, although integration costs and risks offset the potential benefits in the near term. Laurentian’s capital position benefited from recent capital issues, offsetting acquisition-related growth in risk-weighted assets. Standard & Poor’s expects Laurentian’s risk-adjusted capital (RAC) ratio to be in the 7.5%-8.0% range over the next two years, which is toward the lower end of the adequate range.
We also expect that earnings growth and capital generation will be limited by the impact of integration costs in 2013. Our view of Laurentian’s risk position as “adequate” recognizes the bank’s highly favorable asset quality performance over the last few years, offset by considerations of concentrated exposures and managing growth.
We view Laurentian Bank’s funding as “above average” and liquidity as “adequate”, given the bank’s relatively low reliance on more expensive and less reliable wholesale funds; competition for retail deposits will likely continue to impose margin pressure on Laurentian, however.
The stable outlook reflects Standard & Poor’s expectation that Laurentian Bank of Canada will continue to generate sustainable and consistent earnings, supported by its solid asset quality, adequate RAC ratio, and predominantly retail deposit funding base.
The outlook or ratings could come under pressure if deteriorating economic conditions lead to expectations of substantial increases in loss rates for retail loan exposures. A positive outlook or rating action could be the result of material strengthening of Laurentian’s capital and earnings, or of the achievement of a more diverse earnings base, possibly related to successful expansion of Laurentian’s B2B franchise.