Moody's downgrades long-term ratings of 5 Canadian banks, one credit union

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The office towers of Canada's biggest banks are shrouded in fog and cloud as a sign board display's the final closing number of the year for the TSX of Friday December 30, 2011. Most of Canada's biggest banks have been downgraded by the Moody's rating agency, which believes they will be more vulnerable than in the past if there's a major shock to the economy. THE CANADIAN PRESS/Frank Gunn

TORONTO - Five big Canadian banks and a credit union were downgraded Monday by Moody's rating agency, which believes they will be more vulnerable than in the past if there's a major shock to the economy.

The downgrades, which Moody's had warned were likely to happen, reflect the agency's ongoing concern that Canadian household debt has risen to historical highs — putting pressure on the institutions' mortgage businesses.

"The Canadian consumer is leveraged almost to the extent that the U.S. consumer was ahead of the housing crash down there some years ago," said Moody's vice-president David Beattie.

As a result, Moody's thinks it's likely that consumers will slow down their borrowing, a major source of business for the banks.

There's also a remote possibility defaults could jump to a dangerous level for the banks if there's a major economic shock that causes a lot of unemployment and a dramatic drop in real estate prices, he said.

"If we thought it was a higher probability, we wouldn't rank the banks as high as we do," Beattie said.

He noted the five banks and the Quebec-based Desjardins credit union remain among the most highly rated of those tracked by Moody's.

Toronto-Dominion Bank (TSX:TD) is the highest rated of the six, at AA1 (down from AAA). Scotiabank and Desjardins drop to AA2 (from AA1), CIBC (TSX:CM), Bank of Montreal (TSX:BMO) and National Bank (TSX:NA) slip to AA3 (from AA2).

A downgrade by a credit rating agency usually means investors will demand a higher interest rate when a company goes to raise cash by issuing bonds or other debt.

The rating agency said National, BMO and Scotiabank face additional risk from the amount of their profit that comes from capital markets operations, which lend large amounts to corporations and advise businesses on debt and stock issues.

"What's concerning for us is the degree of reliance that some of the Canadian banks have to their capital markets businesses — because of their instability," Beattie said.

He noted that Moody's had already downgraded Royal Bank (TSX:RY) last year as part of a review of large global players in the capital markets industry.

Finance Minister Jim Flaherty issued a statement saying the Canadian financial sector is "sound and well regulated" by the federal government.

"Our government has taken aggressive and proactive actions since 2008 to protect the Canadian housing market and curb personal debt. We will continue to monitor the housing market to ensure its long-term stability," Flaherty said in statement.

New Democrat finance critic Peggy Nash disagreed, accusing the Conservatives of mismanaging the long-term health of Canada's economy.

"With sluggish business investment and a contracting government sector, Conservatives have relied on consumer debt to prop up Canada’s economy. This reckless policy has clearly hurt Canada’s banks," Nash said.

Moody's Investors Services warned in October it was placing the long-term ratings of the six Canadian financial institutions banks under review for a possible downgrade.

Royal Bank wasn't on the list because its long-term deposit rating had already been dropped to Aa3 from Aa1 in June as part of a move to cut the credit ratings of 15 of the world's largest banks, including Bank of America, JPMorgan Chase, Citigroup and Goldman Sachs.