-- 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-term issuer credit rating on Home Capital Group to ‘BBB-’ from ‘BBB’ and on its subsidiary Home Trust Co. to ‘BBB’ from ‘BBB+', and assigning a stable outlook, following our revision of the stand-alone credit profile on the company to ‘bbb’ from ‘bbb+'. In conjunction with these actions, we are also lowering our issue rating on Home Capital’s senior unsecured debt to ‘BBB-’ from ‘BBB’.
-- The stable outlook reflects our expectation that Home Capital will maintain its current credit profile across a range of future scenarios.
On Dec. 13, 2012, Standard & Poor’s Ratings Services lowered its long-term issuer credit rating on Home Capital Group (HCG) to ‘BBB-’ from ‘BBB’ and on its subsidiary Home Trust Co. to ‘BBB’ from ‘BBB+'. The outlook is stable. Standard & Poor’s also lowered its issue rating on Home Capital’s senior unsecured debt to ‘BBB-’ from ‘BBB’. In addition, Standard & Poor’s revised its stand-alone credit profile (SACP) on HCG 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.
The ratings on Home Capital reflect its revised anchor of ‘a-’ along with company-specific rating factors. We view Home Capital’s business position as “weak”, given its effectively monoline business focus, and concentrated exposure to conditions in the Canadian housing sector, while recognizing the company has an incumbent position providing mortgage funding to the nonprime portion of the Canadian mortgage market.
We view Home Capital’s capital and earnings as “strong” due to capital ratios above the regulatory threshold and ratios of most peer institutions, a projected risk-adjusted capital ratio above 11%, along with high quality of capital and a consistent and sizable earnings buffer.
We assess Home Capital’s risk position as “moderate” due to the high growth orientation of the company and its concentrated exposure to the Canadian mortgage sector, including a focus that has shifted in favor of uninsured mortgages over the past year. We view the funding of Home Capital as “average” and its liquidity as “adequate”, but anticipate ongoing evolution of funding arrangements given changing dynamics in Canada’s retail deposit market, as well as structural changes relating to options for funding secured by residential mortgages.
The stable outlook reflects Standard & Poor’s view that Home Capital’s niche market position provides a degree of insulation from competition for mortgage origination, and that the company will effectively manage risks associated with elevated consumer debt levels and housing prices. We also expect that Home Capital has sufficient flexibility to adapt to funding market pressures.
An upgrade would depend primarily on the company achieving substantial further diversification of its asset portfolio while maintaining consistent performance in top-line growth and profitability.
We could lower the rating on HCG if there is sustained evidence of difficulties managing its growing loan portfolio while maintaining consistent credit standards, or if a severe and sustained downturn in the Canadian mortgage market undermines HCG’s strong capital and earnings performance. A projected RAC ratio falling below 10% would trigger a reassessment of the rating.