Moody's Investors Service has downgraded Canada's six big banks in another worrying sign about growing consumer debt and housing prices.
The cut reflects an ongoing concern that expanding levels of private-sector debt could weaken asset quality in the future, Moody's senior vice-president David Beattie said.
"Continued growth in Canadian consumer debt and elevated housing prices leaves consumers, and Canadian banks, more vulnerable to downside risks facing the Canadian economy than in the past," Beattie said.
Shares of TD Bank (TSX:TD), Bank of Montreal (TSX:BMO), Scotiabank (TSX:BNS), CIBC (TSX:CM), National Bank (TSX:NA) and Royal Bank (TSX:RY) all fell Thursday in the wake of the downgrade, which may increase their cost of borrowing. Royal Bank closed down 58 cents at $92.75, while TD Bank dropped 47 cents to $63.42.
David Madani, senior Canada economist at Capital Economics, said the downgrade comes amid mounting concerns about the housing market and its effect on the economy.
"Even the banks themselves have admitted recently that housing is a problem," he said.
Despite moves by the federal government in recent years to cool the housing market, Moody's noted that house prices and consumer debt levels remain historically high and business credit has also grown rapidly.
"We do note that the Canadian banks maintain strong buffers in terms of capital and liquidity," the Moody's report said.
"However, the resilience of household balance sheets, and consequently bank portfolios, to a serious economic downturn has not been tested at these levels of private sector indebtedness."
But Madani said the Canadian banks have taken steps to protect themselves even if there is a major housing correction that leads to a broader economic slowdown.
"The thing to keep in mind though is when it comes to the major traditional larger banks, they've been very careful to insure a lot of their non-conventional mortgages," he said.
Madani said the Canadian banks would take a hit, but they have also expanded their operations outside of the country and diversify where they make their money in recent years.
Moody's said it expects the six big banks will face a more challenging operating environment for the remainder of this year and beyond.
The debt rating agency downgraded the baseline credit assessments, the long-term debt and deposit ratings and the counterparty risk assessments of the banks and their affiliates by one notch, with the exception of TD Bank's counter party risk assessment which was affirmed. It also maintained its negative outlook for the relevant ratings on the six banks.
The change cut TD Bank's long-term rating to Aa2, while the five other banks fell to A1.
The move comes amid heightened scrutiny of the Canadian housing and financial sector, particularly around alternative mortgage lender Home Capital, which was forced to seek an emergency $2-billion line of credit recently as customers rushed to withdraw their deposits from their high-interest savings accounts.
Madani downplayed the possibility of trouble at Home Capital causing broader problems in the sector.
"They aren't too big to fail, their balance sheet is very small and lately we've already seen some private lenders step up and purchase some of their presumably better quality mortgages," he said.