-- 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 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.
-- We are lowering our long- and short-term issuer credit ratings on Caisse centrale Desjardins to ‘A+/A-1’ from ‘AA-/A-1+', following our revision of the stand-alone credit profile on the bank to ‘a’ from ‘aa-'. The outlook is stable.
-- The stable outlook reflects our expectation that Caisse centrale Desjardins’ credit fundamentals will remain consistent with current ratings over the next 24 months.
On Dec. 13, 2012, Standard & Poor’s Ratings Services downgraded its long- and short-term issuer credit ratings on Caisse centrale Desjardins to ‘A+/A-1’ from ‘AA-/A-1+’ and assigned a stable outlook. In addition, Standard & Poor’s lowered its issue ratings on Caisse centrale Desjardins’ senior unsecured debt to ‘A+’ and nondeferrable subordinated debt to ‘A-’ from ‘A+'. The group’s treasury and funding needs are met through Caisse centrale Desjardins and Capital Desjardins.
Both companies are wholly owned subsidiaries of the Federation des caisses Desjardins du Quebec (not rated). We view both companies as vital, integrated, and strategic units within the group and believe both are “core” entities.
We have therefore equalized the ratings on both companies with the implied rating on the group.
The rating action follows our review of banking sector industry and economic risks in Canada, taking into account the headwinds facing the Canadian economy, high debt levels of Canadian consumers, 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 operating in Canada are vulnerable 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 stand-alone credit profile (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 the Banking Industry Country Risk Assessment (BICRA) for Canada to group ‘2’ from ‘1’ and our revision of the 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.
Standard & Poor’s ratings on Caisse centrale Desjardins reflect an “adequate” (as our criteria define it) business position given its 45% market share in Quebec, “strong” capital and earnings based on a strong Standard & Poor’s projected risk-adjusted capital (RAC) ratio of 11.9%-12.4%, “adequate” (revised from strong) risk position reflecting the group’s heightened vulnerability to a weakening domestic real estate market given its large mortgage portfolio and potentially higher loan losses, and “average” funding and “adequate” liquidity scores.
The SACP is ‘a’. At the lower SACP, Desjardins Group benefits from one notch for extraordinary government support given its moderate systemic importance to the Canadian banking system to arrive at an issuer credit rating of ‘A+'.
The stable outlook reflects our expectation that Caisse centrale Desjardins will maintain its strong retail platform and loyal customer base, considerable franchise position in Quebec, stable core deposit base, acceptable asset quality, limited exposure to capital markets-related businesses, and strong capital levels.
The outlook or ratings could come under pressure if asset quality were to deteriorate significantly, resulting in a significant rise in loan losses or if the forecasted RAC ratio were to fall below 10%. Unless the group’s geographical reach gets closer to the large Canadian banks’ profiles, we do not anticipate any positive rating or outlook revisions.